IGCSE Economics Revision

1 Property of Kirit Narain

Economics Revision Notes Unit 1

Scarcity – Unlimited wants exceed finite resources

Unit 2 FOP are economic resources of – Land,Labour,Capital,Enterprise

Land: Any natural resource used in production

Supply of land doesn’t change much with time however natural resources may be limited in supply

Renewable and non renewable resources

Renewable can turn into non renewable if they are over exploited

Land is geographically immobile but occupationally mobile

Capital: Any man made good used to produce other goods and services

Capital goods are not wanted for themselves but because of what they can produce

Capital tends to increase with time

Gross investment: Total value of capital

Depreciation: Value of capital that has worn out

Net investment: Gross investment - Depreciation

Unit 3 Opportunity cost: The cost of a decision in terms of the next best alternative forgone.

Producers choose the option that will give them the maximum profit

Consumers choose the option that gives them the most satisfaction

Workers choose an occupation depending on Wage and Non-wage factors

If government raises taxes in order to fund more things, the opportunity cost falls on consumers

Economic Good Free good

Takes resources to produce No resources involved

Has an opportunity cost No opportunity cost

Limited in supply May be Unlimited in supply

Production possibility curve

Unit 4 Three main Economic questions –

o What to produce

o How to produce it

o Who is to receive the products produced

An economic system covers the institutions, organizations and mechanisms in a country that influence economic

behavior.


Planned economy Market economy Mixed economy

Government makes decisions as to what to produce (Directives)

Consumers make decisions as to what to produce via the Price Mechanism

Both price mechanisms and directives play a part in determining what is produced

Government owns resources Private firms own resources Both governments and firms own resources

Government decides who will receive products using wages and controlling prices

Products are distributed according to people’s ability to earn high incomes

Product distribution is influenced by both people’s income and government intervention

Most people would have access to basic necessities

High efficiency as firms who respond the best to changes in demand and provide products at a price acceptable to consumers receive high profits. Those who earn the highest incomes exert maximum influence.

Efficiency due to incentive as well as government benefits

Advantages of a market economy:

o Consumers are the sovereign

o Choice

o Efficiency due to incentive and threat

o Better quality products

Disadvantages of a market economy:

o Failure to take into account all costs and benefits

o There may be a monopoly which can freely raise its prices/produce poor quality products

o Immobility of resources may restrict efficiency

o Wont produce public goods since people can act as free-riders

o Insufficient / asymmetric information

o Advertising can distort consumer choice

o Very unequal distribution of income

o Short termism

Advantages of a Mixed economy:

o Government would take into account all costs and benefits

o Government subsidies can encourage consumption of merit goods

o Governments can discourage consumption of demerit goods

o Governments can finance public goods through taxation

o Governments can prevent private firms from exploiting consumers

o Governments would provide jobs

o Governments may plan ahead and devote resources to capital goods

o More even distribution of income by taxing the rich

However Government intervention may make the situation worse

Unit 5 Demand: The willingness and ability to purchase a product

Demand and price are inversely related

Market demand = ∑Individual demand

Changes in demand due to price is referred to as an extension, increase in quantity demanded, expansion

/contraction in demand, decrease in quantity demanded


Supply: The willingness and ability to sell a product

Supply is directly related to price

A rise in price causes an extension in supply/ increase in quantity supplied while a fall in price results in a contraction

in supply/ fall in quantity supplied

Equilibrium price: Price at which demand and supply are equal, there are no shortages or surpluses

Unit 6 A change in demand results in a change in quantity demanded at every given price.

Causes of changes in demand –

o Changes in disposable income – If the disposable income hence purchasing power of consumers

increases the demand for normal goods would increase. Inferior goods are goods whose demand

decreases as a result of a rise in disposable income since consumers switch to better quality

products.

o Changes in the price of related products – If the price of a complementary good falls or the price of a

substitute good rises, demand for the product will increase.

o Advertising – A successful advertising campaign will bring the product to the notice of new

customers and increase existing customers to purchase more thus increasing demand

o Changes in population – An increase in the population would raise demand for most products while

a change in age composition may increase/decrease the demand depending on the product.

o Changes in taste and fashion – Affects mainly clothing, food and entertainment.

o Other factors – Changes in future price expectations and weather

Unit 7 A change in supply occurs when the conditions facing suppliers change and at each price a different amount is

supplied.

Causes of changes in supply –

o Changes in the cost of production – If costs of production rise, supply will fall. This intern is cause by:

Change in the price of factors of production

Change in the productivity of factors of production – changes unit costs

The price of transporting goods is very volatile since the cost of petrol changes frequently

o Improvements in technology – Increases the productivity of capital goods

o Taxes – An introduction of a tax or a rise in the rate of a tax will make it more expensive for firms to

supply products thus reducing the supply.

o Subsidies – A subsidy would reduce the firms cost of production hence increasing supply

o Weather conditions – Affects agriculture

o Prices of other products – If the prices of other products that the firm sells rises , they would devote

more resources to producing that product hence decreasing the product in questions supply. An

exception to this would be if the products are jointly supplied in which case in the rise in the price of

one product would increase the supply of the other.

o Disasters and wars – These would reduce the supply of the product

o Discoveries – If more sources are discovered, the supply of the finished product would rise


Unit 8 Price Elasticity of Demand is a measure of the extent to which demand changes as a result of a unit change in price

Price Elasticity of Demand is a measure of a measure of the responsiveness of demand to a unit change in price

PED =

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐷𝑒𝑚𝑎𝑛𝑑

𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒

𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑟𝑖𝑐𝑒

Elastic demand : A change in price results in a greater change in quantity demanded (PED is greater than 1 but less

than infinity).

Inelastic demand: A change in price causes a smaller change in quantity demanded(PED is less than 1 but greater

than 0).

To raise revenue reduce the price in the case of elastic demand or raise the price if there is inelastic demand.

PED is dependent on –

o Availability of substitutes – If there are close substitutes available then PED would be elastic since

consumers can easily switch to the cheaper alternative.

o Proportion of Income spent on the product – If the product takes up a small proportion of peoples

incomes, demand would be inelastic since even the price change would be too small for most to

even notice. In contrast if the price of a product that takes up a large proportion of peoples income

rises, it would be significant hence demand would be elastic

o Luxury or necessities – Necessities have inelastic demands while demand for luxury products is

elastic.

o Addictive or not – Addictive products tend to have inelastic demand

o Time period under consideration – Longer the purchase of the product can be delayed, more elastic

the demand since consumers can alter their purchases backed by adequate information.

As people become richer products that were previously luxuries become necessary hence their demand becomes

inelastic.

Perfectly elastic demand: A change in price causes a complete change on the quantity demanded

Unit elasticity of demand: A change in price causes an equal change on the quantity demanded

Perfectly inelastic demand: A change in price has no effect on the quantity demanded.

An increase in price makes demand more elastic

An increase in demand makes PED more inelastic

Unit 9 Price Elasticity of supply is a measure of the extent to which quantity supplied changes as a result of a change in

price.

PES =

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑢𝑝𝑝𝑙𝑦

𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑠𝑢𝑝𝑝𝑙𝑦

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑟𝑖𝑐𝑒

Inelastic supply: Quantity Supplied changes by a smaller extent than price

Elastic supply: Quantity supplied changes by a larger extent than price

Factors affecting PES –

o Time taken to produce the product – Longer the time taken, more inelastic the supply since there is

a lag before changes in supply can be implemented.


o The cost of altering the Supply – The more costly it is to alter supply, the more inelastic the supply.

o The feasibility of Storing the product – If the product can be stored, supply would be elastic since

suppliers may choose not to supply a larger quantity if the price falls while can draw on stores to

increase supply if the price rises

If the product is mobile, the supply would be more elastic

Perfectly inelastic supply: Quantity supplied does not change with price

Perfectly elastic supply: A change in price causes a complete change in quantity supplied

Unit elasticity: A change in price causes an equal change in quantity supplied

As the time period under consideration increases, supply becomes more elastic

Advances in technology by reducing the production period and decreasing costs of production make the supply more

elastic

Producers want their supply to be as elastic as possible since then they can raise a significant amount of revenue by

cutting prices.

Unit 10 In a market system resources are constantly being reallocated away from products whose demand is declining

towards products that have increased demands.

The market responds to changes in costs of production and raises prices, thus clearing the market when supply

decreases as a result of for instance natural disasters.

There is lots of competition hence choice in terms of which products to consume for consumers.

Producers are efficient since they are competing for consumers and subsequently will try to lower their costs of

production in order to lower prices.

There is actual competition – Number of competing firms and potential competition – Easy for firms to enter and

leave the market in response to changes in profit.

Incentive in the form of profit to be efficient and threat in the form of bankruptcy

The most productive workers whose skills are in demand and are geographically and occupationally mobile receive

high wages while unproductive workers who are unable to adapt to market conditions receive low/no wages.

Allocative efficiency: Resources are allocated in a way that maximizes consumer satisfaction. Firms produce the

products that consumers demand in the right quantities.

Productively efficient: Firms produce at the lowest possible cost per unit. If all producers are productively efficient

the country would be producing on its production possibility curve.

Productive inefficiency – Workers lying idle, capital equipment not fully exploited, offices spaces empty

Dynamic efficiency: Resources are used efficiently over a long period of time – Technological advancements. Firms

spend money on research and development to innovate.

Advantages of a Market system –

o Consumers are sovereign – They determine what is produced

o Choices

o Low prices

o High quality products

o Efficiency – Manufacture products that consumers want, in the right quantity and at the lowest

possible cost per unit.


o Promote improvements in methods of production

Unit 11 Market failure occurs when markets are inefficient – High prices, shortages, surpluses, poor quality and lack of

innovation.

Nature of Market Failure-

o Failure to take into account all costs and benefits- Social costs include external costs as well as private costs.

Decisions taken on the basis of only private costs would lead to overproduction if the social cost is higher

(external costs present). Social benefit includes external benefits and private benefits. Decisions taken on

the basis of only private benefits will lead to underproduction if social benefits are higher (existence of

external benefits)

o Information Failure – Consumers may lack information about the nature of products on offer, the benefits

they can receive from them and their prices. Workers may lack knowledge about the Jobs on offer, the

remunerations paid, the qualifications required and their location while keeping in mind where their skills

are best suited. Firms need to know about the lowest cost method of production, where good quality raw

materials for a low price can be sourced, what products are in demand etc. If this occur they may make

decisions not in their best interests and consumers may purchase products that are overpriced and are of

poor quality, workers may end up in the wrong jobs and producers costs may be high and revenue low.

There may be a lack of information/ inaccurate information or asymmetric information (consumers and

suppliers do not have equal access to information).

Merit Goods are more beneficial to consumers than they realize and have external benefits hence they would be

under consumed and consequently under produced. In order to increase consumption, governments may

provide information about the merit good, subsidize it, or if it has significant benefits then provide it free of cost

or making its consumption compulsory.

Demerit goods are more harmful to consumers than they realize and pose external costs. They would be

overconsumed and hence overproduced if left to market forces. In order to discourage production governments

may provide information about their harmful effects, impose a tax on them or completely ban the demerit good.

Public goods are both non-excludable – It is not possible to stop people from consuming them without paying

(free-riders) and non-rival – Consumption by a person does not affect other people’s ability to consume them.

Therefore private sector firms would not produce them and instead they would have to be financed through

taxation. Government can then produce them or pay private sector firms to produce them.

If there is only one firm dominating the market then that firm may abuse its market power by charging high

prices or producing poor quality products since it has the assurance that consumers have no other alternative. It

will not be forced to be productively, allocatively or dynamically efficient. Even if there are multiple firms in the

market, they may engage in uncompetitive practices such as price fixing (all agreeing to charge the same high

price). In order to deal with this, Governments can remove barriers to entry and exit and prevent uncompetitive

practices. It may also stop firms from merging if it is thought that they will act against consumer interests.

In order to achieve allocative efficiency and produce as per consumer demands, it is necessary that resources be

occupationally and geographically mobile which in practice may not be the case. To improve occupational

mobility of labor governments can improve education and provide training in the new skills needed while to

improve geographical mobility governments may construct housing in areas that have a high demand for labour

or provide workers with some kind of financial help. Governments may also provide firms with grants, thus

making it easier for them to switch capital and land.

In a market economy sufficient resources may not be devoted to producing capital equipment since firms may

be interested in making a quick profit thus resulting in a lack of investment and restricting production in the

future. As a result the government may have to cut taxes on firms and undertake some investment itself.


Since there is likely to be high income inequality, private sector firms may only produce products demanded by

the rich and hence the products needed by the poor would not be manufactured. Therefore governments would

want to ensure that basic necessities are provided to the poor at subsidized rates or free of cost which would be

financed by taxation. Taxation could also be used to reduce income inequality since it is socially divisive and due

to worse health and education, the poorer also tend to be less productive.

However if governments lack adequate information, and for instance find it difficult to calculate the correct

amount of public goods to supply, or overestimate the benefits of merit goods then government intervention

may worsen the situation. Government decisions may be influenced by political factors and by taxing the rich too

high, it may have an adverse effect on the efficiency of the market.

Unit 12 Renewable resources may be turned into non-renewable if they are over exploited

Exploiting resources raises employment, income, living standards and improves the countries trade position.

If non renewable resources are being exploited then it is necessary that an alternative industry is developed for

sustainability.

Choice of whether to exploit resources-

o Current living standards

o Countries need for income

o Where the countries comparative advantage lies

o Current world demand

o Future world demand

Private costs/benefits: Costs/benefits born/received by those that are directly involved in the consumption or

production of a product

External costs/benefits: costs/benefits born/received by those that are not directly involved in the consumption or

production of a product(Third parties)

Social costs/benefits: The total costs/benefits to the society of an economic activity

Social costs/benefits = Private costs/benefits + External costs/benefits

Socially optimum output: When social costs == social benefits

Unit 13 Public expenditure: Expenditure undertaken by the public sector (Central government, Regional bodies/ SOE’s)

o Exhaustive spending – Directly buying goods and services (Gov determines use of resources)

o Transfer payments – Transfer of money to other people (Gov doesn’t determine use of resources)

Uses of public expenditure-

o Public goods

o Merit goods

o Supporting vulnerable groups

o Helping private sector industries

o Covering losses incurred by SOE’s

o Managing the economy (Promoting employment)

Public expenditure can be financed by-

o Taxation

o Income of the country – Higher income, more revenue even with a low rate


o Willingness of citizens to pay taxes – May not vote for a gov that wants to raise tax

o Reaction of workers and firms to changes in taxation – Increased tax would increase informal sector

o Tax rates in other countries

Flat taxes have only one uniform rate

o Borrowing

o Credit worthiness at home and abroad

o State of the economy

o Level of economic development

o Acceptable rate of interest

The more SOE’s, higher potential for revenue however if they are making losses then it may drain the

Gov

o Privatization

Can raise revenue in the short term but if the SOE’s were profitable then it reduces their revenue

Government influence on private sector expenditure –

o Taxing income and expenditure

o Providing subsidies

o Giving grants

o Influencing the level of economic activity (Interest rates)

Private vs Public sector firms-

o Private sector would be more efficient due to competition (High quality, low costs, less time)

o If private sector firm is a monopoly it may charge high prices, produce poor quality output

o SOEs may not be forced to keep its costs down

o SOEs may lack technical expertise

o Government may take a long time due to delays in decision making

o SOEs will take into account all costs and benefits (CBA – Cost benefit Analysis)

o Government expenditure has an opportunity cost (eg education/healthcare)

Unit 14 Specialization: To concentrate on a particular product or task

What countries are good at producing is influenced by the quantity and quality of resources

If countries specialize in products they have a comparative advantage in, output, employment and living standards

will be better. They can export the product they produce and earn revenue which would be used to purchase

imports that their country needs. However if demand falls suddenly or costs rise the country can run into difficulty.

Diversification spreads risks

Specialization of firms is influenced by the nature of resources. Firms can get to know their markets well, build up a

reputation and it is easier to control firms producing a narrow range of products. If firms diversify, a fall in demand

for one of its products may be accompanied by a rise in demand for atleast one other product. Firms usually start

out by specializing.

Division of workers leads to lower unit costs since by practicing the same task they can become perfect at it and they

can be trained more quickly since they do not need to have knowledge about handling all tasks. Time can be saved

since workers don’t have to switch tasks, the production process can be broken down and mechanized. However

workers may get bored thus reducing productivity and raising unit costs, also it will be difficult to replace or cover up

for them. Workers can pursue their interests and become very skilled. If demand for their services falls, they may

find it difficult to find another job.


Specialization should reduce prices but consumers may loose out in terms of variety.

Extent of specialization –

o Size of market – More workers would be employed hence greater chance for specialization

o Transport links – Good transport links increase size of market

o Internal and external trade – Trade/Money facilitates specialization

Functions of money –

o Medium of exchange – Products are sold for money which is used to buy other products

o Act as a store of value – Money can be saved and does not deteriorate with time hence will be acceptable in

the future

o Unit of account – Money can be used to place a value on an item.

o Standard for deferred payments – Money allows people to borrow and lend, people can strike an agreement

about the amount of money to be repaid in the future.

Types of money – Coins, Notes, Bank accounts

Bank accounts account for the largest proportion of payments via – Direct debits and cheques

Legal tender: Forms of payment which by law have to be accepted in the settlement of a debt (Bank accounts are

not legal tender)

Characteristics of money –

1. Generally acceptable

2. Limited in supply

3. Durable – Will last some time

4. Portable – Can be carried around easily

5. Homogeneous – Every unit of the same value should be exactly the same

6. Divisible – Can be divided into units of different values

7. Recognizable – People can easily see that the item is money

Unit 15 Banks enable more efficient use of resources and encourages the growth of output of economies.

Commercial Banks –

o Commercial – Business organization which seeks to make a profit

o Joint Stock – Limited liability and are in the private sector

o Retail – Selling the public banking services

o High street – found in most of the towns and cities

Functions of Commercial Banks –

1. To accept deposits – Customers can keep their money in a safe place.

Current account/Demand account – Immediate access to money but no interest paid. Used for receiving and

making payments.

Deposit/time account – Interest is paid however a period of notice has to be given before money can be

withdrawn. Used for saving.

2. To lend – Banks make profits by charging a higher rate of interest on borrowed money than that on money

held in the bank.

Overdraft: Enables customers to spend more money than they currently have upto an agreed limit. High rate

of interest charged. Used to cover short term gap between expenditure and revenue.


Loan: For a particular purpose and period of time. Rate of interest is lower than that on an overdraft.

Customer may be made to provide some form of security (collateral). If the loan is not repaid, the collateral

can be sold and the money recovered.

Banks act as financial intermediaries.

3. To enable customers to make payment – Via cheques, standing orders, direct debts, debt/credit cards and

online banking.

4. Exchange foreign currency

5. Have a safety deposit box so items can be stored

6. Help with administration of the customers will

7. Sometimes sell insurance

Aims of commercial banks –

The main aim is to make a profit for shareholders which they mainly do by charging interest on loans.

Liquid assets: Assets which can be turned into cash quickly without incurring a loss.

Commercial banks have to balance liquidity and profitability to enable customers to withdraw money whilst still

making maximum profit

Investment banks (Merchant banks) – Act as bankers to firms. Accept deposits and lend to them. They manage

the issue of new shares (Also IPOS) and sell shares and other financial securities on behalf of the firms. They also

give advice and help on mergers and takeovers etc

Saving banks – Encourage saving particularly among people with low incomes. Make it easy to withdraw cash

with few penalties by investing the money in government bonds and other securities.

Central banks: Single most important bank in the country/region and are owned by the government hence are

responsible to them.

Functions of a central Bank –

o Act as a banker to the government – Tax revenue is paid to their account and they use this account for

government expenditure.

o Operates as a banker to commercial banks – Commercial banks can settle debts between each other

and withdraw cash if its customers are taking more than usual.

o Acts as a lender of last resort – Will lend to banks that are temporarily short of cash.

o Manages the national depth – As time passes, debt tends to build up. Central bank borrows on behalf of

the government by issuing bonds, pays interest on these and repays them when they fall due.

o Holds the country’s reserves of foreign currency and gold – Keeps currency and gold to influence the

exchange rate

o Issues bank notes – Prints notes and destroys those that are no longer suitable for circulation. Also

authorizes the minting of coins.

o Implements the government’s monetary policy – Keep inflation low and steady by controlling the

money supply and interest rates (through changing the interest it charges on its loans. Sometimes

governments instruct the bank on interest rates whilst other times central banks are independent.

o Controls the banking system – Regulates and supervises

o Represents the government – Meetings with other central banks, World bank and IMF

Governments set the target rate of inflation. Independence of central banks means that they won’t be influenced by

politics and they are likely to have more knowledge about the banking system.


Unit 16 Shares = Equities

Stock exchange/bourse : Enables shares and other financial assets to be bought and sold

Only Listed/quoted public limited companies can sell shares on the bourse

Functions of a stock exchange-

Providing a market for the sale of shares (plc) and bonds (governments). Through this they can raise finance

and buyers may make a profit in the form of dividends or capital gains.

Enables firms to grow externally through Mergers and takeovers.

Mobilizing savings for investment – People channel their savings through the purchase of shares and bonds

Protecting those who buy shares- Listed companies have to provide a range of information

Providing an indication of economic performance – Shares prices are likely to be higher if the economy is

performing well

A bull: Someone who buys shares expecting their price to rise

A bear: Someone who sells shares expecting their price to fall

Nominal price: Face value of the share – Price at which it was issued

Market price: Current price of the share

Dividend is expressed is raw terms or as a percentage of the nominal price

Yield is expressed as a percentage of the market price

Reasons why shares are bought-

Dividend – can act as a source of income

Capital Gains – Speculating that their market price will rise

Influence the running of the firm

Merger/takeover

Influences on share prices –

Interest rates – A rise in interest rates would reduce share prices because

1. Demand for shares would fall since opportunity cost of holding money in the bank would be higher

and borrowing to buy shares would be more expensive

2. Demand for firms products would fall since borrowing would be more expensive and people would

rather save. Thus the firm would earn less profit.

3. Firms costs may rise if they have borrowed

Profit record

Government policy – Cut in corporation tax would increase share prices

The issue of new shares – Increases supply

Takeovers and rumors of takeovers – Would increase share prices to own shares in a larger company

Investment finance –

Borrow (External finance) – Commitment to make regular interest payments. Banks may seek to influence

firms decision.

Sell shares (plc only, external finance) – However may reduce their price and is unlikely to be popular with

existing share holders. It also increases the risk of being taken over.

Retained profits (Internal finance) – Firms are more likely to expand when they are making a profit.

Role of profit-


Incentive for entrepreneurs to organize FOP

Payments to shareholders.

Finance for investment

Unit 17 Wage factors (monetary or pecuniary factors) affecting choice of occupation –

Wages

Piece rate system – Only possible if workers output can be easily measured and the product is standardized.

(mainly found in primary and manufacturing sectors) Less supervision would be needed but workers may

focus on quantity at the expense of quality. Health of workers may suffer.

Time rate system – Employers can easily calculate wages. Workers can collectively bargain about wages.

However does not reward hard work as pays lazy workers the same as productive workers.

Overtime pay

Usually paid at a higher rate. Firms can respond to higher demand. It is easier, less costly and less disruptive

to reduce overtime than fire workers. But workers may become tired and thus their productivity would be

affected.

Bonuses

Paid to workers that contribute to higher profit in some way. Incentive to produce more, better quality

output but there may be resentment if they are awarded unfairly.

Commission

Proportion of the total value of sales

Non-wage factors (non monetary and non pecuniary)-

Job satisfaction

Type of work – Manual/Non manual

Working conditions

Working hours – Longer, Shorter, Flexible, Time

Holidays

Pensions

Fringe Benefits

Job Security

Career prospects – Accepting of lower wages if there is a high career prospect

Size of the firm – Smaller firms have better work relations but workers may be attracted to larger firms.

Location

Limiting Factors-

Qualifications they have

The skills they posses

The experience they have

The place where they live

Occupational immobility

Geographical immobility

Unit 18 Wage determination –

Demand and Supply

o Qualifications, Length of training required affect supply

o Skilled workers are demanded more and have a lower supply hence are paid more than unskilled

workers


o Demand for workers is influenced by the amount of output they can produce (Productivity )and the

price for which that output can be sold

o People involved in dangerous jobs are often paid slightly more than their counterparts who are in

safer conditions

o Demand for manufactured products tends to increase at a higher rate than agricultural products

Relative bargaining power of employers and workers

o If part of a trade union, bargaining power of workers is likely to be higher

o Higher if workers are difficult to replace

o Public sector workers tend to belong to trade unions since the Gov may be more willing to negotiate

and they find it easier to get together

Government policies

o Policies which promote economic growth tend to push up wages

o Influences public sector workers wages directly

o Labor market policies affect wages – NMW

o NMW may lead to unemployment but can also raise productivity and demand

Public Opinion

o Wage claims made by workers

o Put pressure on the government to revise the wages it pays

Discrimination

o Discrimination would lower demand hence reducing wages.

o Women tend to be paid less because

They are generally less qualified than men

They are less likely to belong to a trade union

Still discriminated against

Unit 19 People tend to earn more as they get older due to becoming more skilled (through training) and experienced.

However earnings may also fall if people stop working overtime or have a fall in productivity as they get older

Changes in Earnings –

Changes in demand for labour

o Increase in demand for the product (Demand for labour is detived demand)

o A rise in labour productivity

o A rise in the price of capital

Changes in Supply of labour

o A fall in the labour force

o A rise in the qualifications or length of training required to do the job

o A reduction in non-wage benefits of the job

o A rise in the wage/non-wage benefits of other jobs

Changes in bargaining power

Changes in government policy

o Raising NMW

o Supply side Policies – Increase quantity and quality of labour thus raising earnings

o Immigration policy

o Government anti-discrimination laws

Changes in public opinion

Advances in technology – Reduces demand for some manual workers while raises demand for others

(engineers, programmers)

Extent to which earnings change –


Magnitude of change

Price Elasticity of Demand for labour – More inelastic, greater the change in earnings

o Proportion of labour costs in total costs

o Ease with which labour can be substituted with capital – Easier it is, More elastic

o The elasticity of demand for the product produced – More Elastic PED, Greater the elasticity of

demand for workers

o Time period – More elastic in the long run

Price Elasticity of Supply for labour – More inelastic, greater the change in earnings

o The qualifications and skills required – More skills/qualifications needed, More inelastic the supply

o The length of training period – Delay in responding + significant rise in earnings would be needed to

attract workers

o The level of employment – Higher the employment, more inelastic supply since a significant rise in

earnings would be needed to get workers to quit their jobs

o The mobility of labour – Higher the mobility, greater the elasticity of supply

o The degree of vocation – The more attached the workers are to their jobs, greater the inelasticity of

supply

o Time period – Workers can notice wage changes and gain requisite changes making supply more

elastic

Unit 20 Trade unions: The association of workers to represent their interests and improve their pay and working conditions

Types of trade unions-

1. Craft unions – Particular skills

2. Industrial Unions – All workers in a particular industry

3. White collar unions – Represent professions

4. General Union – Range of skills from a variety of industries

Role of Unions –

Negotiate on behalf of their members

Protect or improve workers rights

Provide information about a range of issues

Help with education and training schemes

Measures to increase demand for the product produced (demand for labour is derived demand)

Provide a range of benefits such as strike pay, sickness pay

Encourage firms to increase worker participation in business decision making

Collective bargaining: Negotiations between union officials representing a group of workers and representatives of

employers

Basis of wage claims –

Workers are working harder and have higher productivity

Workers contributed to the rise in industrial profits and the firm and afford to pay workers more

Comparability argument – Wages of similar workers have risen (seek to maintain wage differential)

Workers need to maintain their real income – Rise in costs of living

Factors affecting the strength of a Trade Union –

A high level of economic activity – If the economy is doing well they can afford to improve pay and working

conditions. Firms may be competing for workers thus may give in to union requests.

A high number of members – More funds and the greater the impact on the firm if they do not accept union

demands.


A high level of skill – Workers are difficult to replace and it is expensive to train unskilled workers

A consistent demand for the product

Industrial Action –

Overtime ban – only work for their contracted hours

Work to rule – Only perform tasks required by the workers contracts

Strike - Official (Organized by the union) and Unofficial (Not organized by the union)

o The number of strikes

o The number of workers involved

o The number of working days lost

Preventing workers from joining the firm

o High qualifications requirement

o Closed shop – Only union members can join the firm

If firms and unions cannot come to a resolution, then both parties go into arbitration involving a 3rd party.

Effect of Unions –

Revenue is lost and reputation damaged by industrial action

Costs will rise if an overtime ban or work-to-rule is imposed

Consumers may not receive products on time

Less time consuming, less stressful and less costly to negotiate with workers as a whole than with individuals

Useful channel of communication between firms and workers

Unions encourage workers to get involved in schemes which raise productivity thus benefiting the firms

Unions also benefit non-unionized labour since any improvement applies to them as well

Unit 21 Influences on spending –

Disposable income – as it rises people spend more as a total but less as a proportion of their income

Wealth

o Generates income

o Wealth can be cashed in

o Wealth can be used as security for loans

o Wealth increases confidence

Confidence – The more optimistic people are, the more they are likely to spend

Rate of interest – If ROI rises, expenditure will fall

o Borrowing becomes more expensive

o Increases opportunity cost of saving

o Reduces the amount spent by those that have borrowed in the past

Distribution of income – More even it is, higher the expenditure APC would be higher

Advances in technology – Increases expenditure since new products encourage people to replace older ones.

Average propensity to consume: Proportion of disposable income that is spent

Wealth: A stock of assets

Forms of saving –

1. Contractual saving – Saving a particular amount on a regular basis

2. Non-contractual saving – Varies more with time and is heavily influenced by interest rates

Reasons for saving –

Target savers – Save a sum of money for a particular purpose


For retirement – Saving generates income

To help their children – Finance children’s education and/or leave them an inheritance

For precautionary reasons – To cope with emergencies

To take advantage of unforeseen opportunities

For income – The more people save, the more income it generates both in quantity and as a proportion

Influences on Saving –

Income – As Disposable income rises, so does the amount saved

Wealth – The wealthier people are, the easier they will find it to save

The rate of interest – Higher the rate of interest, Greater the amount saved

Tax treatment of savings – If tax concessions are given on income earned through saving, the savings would

increase

The range and quality of financial institutions – More the quantity saved as well as the amount of people

that save

Age structure – Old and young do not save while people in the middle ages save the most

Social attitude

Influences on borrowing –

The availability of loans and overdrafts – The easier it is to borrow, the more likely people are to borrow

Interest rates – Higher the interest rates, Less would be borrowed

Confidence – The more confident people are about future economic conditions, the more likely they are to

borrow

Social attitude

Unit 22 Gross income: Total income received by a person before any deductions

Disposable income: Income after deductions including direct taxation (eg income tax)

Real Disposable income: Disposable income that is adjusted for inflation

If real disposable income rises, it indicates that people’s purchasing power has risen and they will be able to but

more goods and services.

Sources of income –

Earned income – Employment

Investment income – Profits(entrepreneurs), Dividends(shareholders), Interest(lenders)

State benefits – Unemployed, pensioners

Dissaving: When people spend more than their disposable income – Borrowing or drawing on past savings

As income rises the average propensity to save rises while the average propensity to consume falls( However total

amount consumed rises).

𝐴𝑃𝑆 =𝐴𝑚𝑜𝑢𝑛𝑡 𝑠𝑎𝑣𝑒𝑑

𝐷𝑖𝑠𝑝𝑜𝑠𝑎𝑏𝑙𝑒 𝑖𝑛𝑐𝑜𝑚𝑒

𝐴𝑃𝐶 =𝐴𝑚𝑜𝑢𝑛𝑡 𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑑

𝐷𝑖𝑠𝑝𝑜𝑠𝑎𝑏𝑙𝑒 𝐼𝑛𝑐𝑜𝑚𝑒

Patterns of expenditure –

The poor spend more as a proportion of income on necessities


The rich spend more both as a proportion and in terms of amount on Luxury items, consumer durables,

entertainment and services

The pattern of expenditure varies in terms of household composition, tastes and age.

The retired spend more on heating and healthcare but less on entertainment and transport

People in their late teens spend more on clothing and entertainment

APS + APC add up to 1

The poor have a greater need for borrowing however they do find it harder to borrow since they cannot offer any

security

Unit 23 Industries: All firms that produce the same product

Firms(business entity) can have a number of plants (Production unit)

Stages of production –

1. Primary sector – Extraction and collection of raw material

2. Secondary sector – Processing of raw material into semi-finished and finished goods (both capital and

consumer)

3. Tertiary sector – Provides services

4. Quaternary sector – Collection, processing and transmission of information (ICT)

As a country develops, Workers move away from primary sector production towards Secondary and finally the

Tertiary sector.

Limited liability : Shareholders are only liable for the amount of money they have agreed to pay for the share

Types of business organizations –

1. Sole proprietors –

Owned by one person – Bears risks as well as organizes FOP

Sole proprietors are self employed

Can employ any number of people

Likely to be relatively small since it is difficult for one person to control a large firm

Finance is limited to the amount put in by the owner

Unlimited Liability

Most common type of business organization since they are easy to setup

Flexible – Quick to respond to changes in demand

Incentive to be efficient

Personal contact with consumers can promote sales and with employees can motivate them

Sole proprietor may lack full range of skills needed

Success of the business is dependent upon the health of one person

Lacks continuity since if the sole proprietor dies, goes bankrupt or is unwilling to run the business,

the organization ends

2. Partnerships-

Unlimited liability

Partners are self employed

Can employ any number of workers

Relatively easy to setup

Can raise more finance than sole proprietors, but is still limited

Potentially have more expertise at hand than sole traders

If one of the partners is unavailable, it will hamper the functioning of the firm significantly


Lack continuity since if a partner leaves, the partnership collapses and a new one would have to be

drawn up

Common in professional services

3. Private Limited Companies (ltd) –

Joint stock companies- People can jointly own the business

Financial capital is divided into shares

Continuous existence

Limited liability

Relatively small firms since the public cannot buy their shares

Firm is kept in control of a few select hands

Limited amount of finance that can be raised

Have to provide some information to potential shareholders

4. Public Limited Companies (plc) –

Joint stock companies

Limited liability

Continuous existence

Can sell shares to the general public

Can raise a considerable amount of finance through the sale of shares

Can grow to a large size

Have to provide more information to the public

May be subject to takeover

Shareholders may be too concerned about high dividends at the expense of long term development

of the company.

The role of entrepreneurs is divided between the shareholders and the board of directors (who can

be voted out at the Annual General Meeting)

5. Multinationals -

Operates in more than one country

Reduces the firms transport costs by producing in the country where the products are sold

They can keep in close contact with their various markets

They can get around import restrictions

Gain access to cheaper labour and raw materials

May even receive grants from governments in the host country

Can spread their operation through a number of countries

Effect of Multinationals-

Can increase employment, output and tax revenue

Bring in new technology and management ideas

Help in the development of infrastructure

May pollute

Can put pressure on the governments in the host country to give them concessions

May drive domestic firms out of their home market

Profits may be paid to shareholders in another country

6. Co-operatives-

Owned jointly by their members and functions for the benefit of these members

Worker Co-operatives

Consumer co-operatives buy in bulk thus they can sell at a cheap price

Public can buy shares in these co-operatives and receive interest on these. But the shares can only

be sold back to the co-operatives.

Each member (shareholder) has only one vote at the shareholders meeting irrespective of the

number of shares they own


Housing co-operatives – Buy and manage low cost housing

Trading co-operatives – Businesses join together to share techniques, capital equipment and

workers and to buy raw material in bulk

However there may be a lack of management skills

7. Public corporations –

State owned enterprises, Nationalized industries are owned by the government

No shareholders

Funds come from the government, government approved loans and from the private sector

They do not seek to make a profit, their aim is to work in public interest

o They base their decisions on the full costs and benefits

o Can be used to influence economic activity (eg increase output)

o Corporations would not abuse their market power (useful as natural monopolies)

o Ownership of the entire industry makes planning and co-ordination easier

o Ensure basic industries survive, produce high quality output and at a low price – Other

industries depend on them

o Can be difficult to manage and control – Slow decisions

o May be inefficient due to lack of competition and since they cannot go bankrupt

o If they are making losses, government would have to spend money on them thus incurring

an opportunity cost

Privatization (driven by incentive and threat) -

Private sector firms would produce products demanded by consumers at a low cost

High quality

Greater choice

Can respond more quickly to changes in demand as compared to SOE’s

Less risk of underinvestment – Profitable firms will raise high revenue

No guarantee that private firms will be exposed to market forces (may be monopolies)

o Inefficient

o Charge High prices

o Low quality products

Private firms may not take into account all costs and benefits

Reduces governments control over the economy

Unit 24 The FOP employed are influenced by –

1. Type of product produced

2. Their productivity

If substitutes, a rise in productivity of a FOP will lead to the replacement of the other FOP

If complements than a rise in productivity of a FOP will lead to an increase in the amount of other

resource employed

3. Their cost

If substitutes, a rise in cost of 1 FOP, will lead to an increase in employment of other FOP

If complements, a rise in cost will lead to a fall in the quantity of the other FOP employed

In the short run there is likely to be at least one fixed FOP (most commonly land and capital)

Firms use the combination of factors of production that results in the highest possible productivity

Demand for capital goods is influenced by –

Price of capital good – Rise in price would cause contraction in demand

Price of other factors of production


o If substitutes then a rise in price of the other FOP would raise the demand for capital

o If complements a rise in price would result in a fall in demand for capital

Profit levels – Incentive and ability to buy capital goods

Corporation tax – Affects firms profits

Income – A rise would cause an increase in consumption and hence an increase in demand for capital

Interest rates – A cut in interest rates would raise consumption and encourage investment

Confidence levels –A rise in confidence would increase demand

Advances in technology – More productive, hence higher demand for capital

Demand for land is influenced by –

In agriculture, the most fertile land would have the highest demand

Productive land (city center sites) have high demand

FOP are influenced by the economies industrial structure.

Unit 25 Total cost: Total cost of production (Fixed costs + Variable costs)

Average costs/unit costs: Cost of producing one unit (Total cost/output)

Output ∝ Total Costs

While economies of scale occur: Output ∝ 1/Average costs ; Diseconomies of scale: Output ∝ Average costs

Fixed costs (Overheads / Indirect costs): Costs that do not change with output in the short run

Average fixed costs = Total fixed costs / Output

Output ∝ 1/AFC

Variable costs (Direct costs): Costs of variable factors; changes with output

Output ∝ Variable costs (Tend to rise slower at first due to increased productivity)

Average variable Costs = Variable costs/output

AVC tends to decrease at first (while output increases) and then rises again forming a U shape

In the long run all costs are variable

Average costs = AVC + AFC – This is also a U shaped graph due to economies/diseconomies of scale

Unit 26 Total profit = Total revenue – Total costs

Profit per unit = Average revenue (Price) – Average cost

In a perfectly competitive firm average revenue does not change with output therefore total revenue rises

consistently. However in practice the price is usually decreased to encourage purchase of extra output.

In an imperfectly competitive market:

Output ∝ 1/ AR

Total revenue rises at first and then falls (The price would become to low) as output increases

Goals of firms –

1. Sales revenue maximization

Produce the maximum amount possible (Therefore greatest revenue)


Makes it easier for firms to raise finance – Higher sales will attract external finance

Cheaper to sell in bulk – Profit per unit may be lower but total profit can be the same and/or higher

by distributing it over more units. Most common where fixed costs account for a large proportion of

total costs since then the average costs would fall by producing more. For eg Xiaomi sells a lot at low

profit margins – Sales revenue maximization

2. Growth

Directors, managers etc pay rises in line with size of the firm

leaders of larger firms are held in higher esteem.

Higher job security in larger firms since it can be difficult to replace people that are controlling large

firms.

Linked to Sales revenue maximization since the greater the sales, larger the firm

3. Profit satisficing

Using up some profits for other goals (Improve working conditions etc)

Managers and directors do this because they do not receive most of the profit as it goes to

shareholders.

Achieve minimum amount of profit to keep shareholders happy

4. Improvement of the environment

Cleaning up their production process and not sourcing from firms that employ child labour

5. Social responsibility

May increase costs in the long term but profits in the long term since people may prefer to purchase

from firms that act in an ethical manner.

6. Profit Maximization

Seek to earn the largest possible profit

Pursuing other goals should increase profits in the long run (eg growth- Economies of scale and

reduction of competitors)

Profit = Revenue – Cost

Effects of changes in Profits –

Incentive for entrepreneurs to undertake production – Encourage more firms to enter the market

Provide firms with more finance for investment

Easier to raise external finance

Easier to recruit top managers, directors and workers attracted by the firms success

Ways of increasing profit –

1. Reduce costs of production

Reducing wastages and inefficiency

Increasing productivity of FOP – raises costs in the short run but reduces average costs in the long

run and raise revenue by improving quality.

Increasing the size of the firm through mergers and takeovers – Economies of scale

2. Raise revenue

If inelastic demand, firms should raise prices while in the case of elastic demand firms should lower

prices.

Increase size of the firm, thus capturing a larger market share

Influence demand for the product- Improve quality, diversify, be more responsive to changes in

customer demands by improving market research and Advertising.

Unit 27 Market structure: Conditions which exist in a Market.


Characteristics of Perfect Competition-

Many buyers and sellers – Individual firms are price takers, unable to significantly influence market supply

Low degree of market concentration – Each firm has a tiny share of the market, small contribution to market

supply

No barriers to entry and exit from the market

Product must be homogenous – No branding or advertising

Buyers and sellers must be perfectly informed – Buyers will know where sellers are and about their product

while sellers will have knowledge about production techniques, the availability and price of resources.

Behavior of Perfectly Competitive firms –

Firms are price takers – Cannot raise prices or they will loose all their sales and have no incentive to reduce

prices.

Firms will respond quickly and fully to changes in demand in order to get a competitive advantage

In the long run firms will only earn normal profit. If demand rises (therefore profits), other firms would start

producing the product, increasing supply. If demand falls then some firms will stop producing the product,

reducing supply.

Performance of Perfectly competitive firms –

Efficiency in terms of producing the products that consumers wants at a price acceptable to them. Threat in

the form of bankruptcy and incentive In the form of profit.

Good quality products since firms would want to gain a competitive advantage.

Wider choice in terms of sellers

However the price may not be as low as possible since firms cannot take advantage of economies of scale

Consumers don’t have a choice in terms of variation of the product

Pure Monopoly: The sole supplier of the product having 100% market share

Characteristics of a Monopoly –

The firm is the industry, it has 100% share of the market

High barriers to entry and exit hence it is difficult for other firms to enter the market

Monopoly is a price maker, its supply is the market supply

Occurrence of Monopolies –

In the past a firm may have been efficient thus driven out all other firms

Mergers and takeovers

Existed from the start

Given Monopolistic powers by the government

Patents stopping other firms from producing the product

Monopolies continue because of barriers to entry and exit

Barriers to entry –

Legal barrier – Patent of government act

Scale of production – Can produce at a lower unit cost

Expensive to setup if large capital equipment is required

Brand loyalty through branding and advertising

Monopolies access to resources and retail outlets.

Barriers to exit –

Lon term contract to provide a product


Sunk costs – Unrecoverable costs such as Advertising and Industry specific equipment

Behaviour of a Monopoly –

Can earn supernormal products in the long run

Is a price maker by controlling supply or setting the price, but cant control both

Performance of Monopolies-

Absence of competition may lead to inefficiency – High prices and poor quality products

May fail to respond to changes in tastes and develop new products

Can be efficient due to economies of scale – lower unit costs

Prevents wasteful duplication of capital equipment

High profits can be spent on research and development therefore innovating – Incentive since all the profits

would go to the monopoly

Other firms may try to develop better products to overcome barriers to entry

Unit 28 Measures of the size of a firm –

Number of workers employed

Value of output produced

Value of financial capital it employs

Influences on size of a firm –

The age of the firm – Over time firms can grow to a large size

The availability of financial capital – The more it can invest in its expansion, the larger it is capable of growing

The type of business organization – Public limited companies can sell shares and borrow to finance

expansion while the others cannot sell shares and are likely to find it more difficult and costly to borrow.

Internal economies and diseconomies of scale – Economies of scale promote expansion while the reluctance

to experience diseconomies of scale may limit expansion.

The size of the market – Larger the demand for the product, greater the possibility for the firm to grow to a

large size.

Growth of firms –

1. Internal growth (natural or organic growth)

Increasing the market for its current products or diversifying into other products. Increasing the size of

existing plants of opening new ones.

Internal growth is more controlled.

2. External growth

Joining with another firm through a merger or takeover – Integration

Firms can increase their size more quickly however there may be a loss of control, taking the firm past its

optimum size.

Horizontal Integration –

Joining of two firms at the same stage of production, producing the same product

o To take advantage of economies of scale

o To increase market share through the elimination of a direct competitor

o Rationalization of resources means that firms can sell of redundant (eg duplicate) resources

thus become more efficient.

o However diseconomies of scale may be experienced

o More difficult to control a larger firm

Vertical integration –


Integration with a firm producing the same product but at a different stage of production.

o Vertical Integration forward –

Joins with a market outlet for the firms products

To ensure that there are sufficient outlets for the firms products that are stored and

displayed well in high quality outlets

To help in the development and marketing of new products

o Vertical Integration backwards –

Joins with a firm that is the source of raw materials, components or the products it

sells

To ensure adequate supply of good quality raw materials at a reasonable price

To restrict rival firms access to the supplies

o There may be management problems

o The two firms may have been of different sizes which can require some adjustment

Conglomerate Integration –

Combining of two firms producing different products

o Diversification – Spreading of firms risks

o But management can be very difficult

Effects of integration on consumers –

Can lead to economies of scale, therefore lower prices

High quality products

Innovation

However if diseconomies of scale occur consumers will experience higher prices and poorer quality products

Reduced choice for consumers

Exploitation of market power to push up prices

Reasons for small Firms –

Small size of the market

Preference of consumers – Consumers prefer smaller firms for personal services since they can cater to their

individual requirements and an provide a friendlier and more personal service

Owner’s preference – May not want the firm to grow large since it can become more stressful and may lead

to loss of control.

Flexibility – Can adjust quickly to changes in market conditions since there may not be the need to consult

various levels of authority. Small firms that are in regular touch with their customers can pickup on changes

in demand.

Technical factors – Lower barriers to entry due to no capital required means that smaller firms do not suffer

a cost disadvantage

Lack of financial capital – May lack the finance to expand since it is difficult and more expensive for smaller

firms to raise finance

Location – If transport costs account for a large proportion of total costs, local firms may be more suitable

for supplying the product which are likely to be small.

Cooperation between small firms

Specialization – Small firms may provide specialist services to larger firms

Government support – Governments can provide financial help and advice to small firms since they account

for a high number of jobs, develop the skills of entrepreneurs and have the potential to grow large.

Unit 29 Economies of scale: Advantages in terms of lower long run average costs of producing on a large scale

Internal economies of scale: Lower long run average costs resulting from the firm growing in size


External economies of scale: Lower long run average costs for all the firms in the industry, resulting from an industry

growing in size

Diseconomies of scale: Higher long run average costs due to a firm(internal diseconomy) or industry(external

diseconomy) ‘growing too large’

Due to internal economies of scale and diseconomies of scale, the LRAC curve is U shaped.

External diseconomies of scale cause a shift in the LRAC, a downward shift due to EOS and an upward shift is a result

of DEOS

Types of internal economies of scale –

Buying economies – Firms can purchase raw materials and capital in bulk and receive discount, receive

better quality supplies at a faster speed of delivery.

Selling economies – Transportation costs, processing costs, packing the goods etc does not rise in line with

the number of orders. Also advertisements can be spread over more units thus reducing unit cost.

Managerial economies – Large firms can have specialized staff by spreading their pay over a number of units

therefore lower average costs can be obtained.

Financial economies – Large firms find it easier and cheaper to raise finance. Banks are willing to lend to

them since they are well known and can offer collateral, and the administration costs of processing large

loans is not significantly higher than small loans hence the firm has to pay back less interest, reducing costs.

Large firms (plc) can raise finance by selling shares.

Technical economies – Large firms may find it plausible to use technologically advanced capital equipment

which is likely to be efficient, reducing unit costs.

Research and Development economies – Large firms can invest in R&D thus inventing more efficient

methods of production, reducing average costs and can also invent new products, which raises revenue.

Risk bearing economies – Large firms can diversify to spread their risks over a range of products.

Internal Diseconomies of scale –

Difficulties controlling the firm – Hard to manage and supervise everything therefore a number of layers of

management may be needed which increases administration costs and makes the firm slower in responding

to changes in market conditions.

Communication problems – Difficult to ensure everyone in the firm has full knowledge about their duties

and available opportunities (eg training). Workers may not get to effectively communicate their view and

ideas to the management team.

Poor industrial relations – Lack of motivation of workers, strikes and industrial action since workers would

have less sense of belonging, it may take a longer time to solve problems and more conflicts may arise due

to the presence of diverse opinions.

External economies of scale (economies of concentration) –

A skilled labour force – can recruit workers who have been trained by other firms in the industry

A good reputation – People may prefer to purchase products from that industry.

Specialist suppliers of raw materials and capital goods – Subsidiary industries may be setup that provide for

the needs of the industry.

Specialist services – Universities and colleges may run specialist courses, and transport firms may provide

specialist services catering to the needs of the firms in the industry.

Specialist markets - Specialist selling places that provides a market for firms products.

Improved infrastructure – Encourage governments and private companies to provide better road links,

electricity supplies, build new airports and develop dock facilities.

External EOS are more likely to occur if all the firms in the industry are located in one area.

External diseconomies of scale –

Marketing

economies


Congestion due to increased travelling of both workers and raw materials/finished products – reduced

worker productivity and higher transport costs

Increased competition for resources(key sites, capital equipment and labour) hence pushing up their prices,

therefore costs of production

Unit 30 Government as a producer –

Key Industries – Seek to ensure that these survive and do well since some of them may be (national

champions) world beaters or potential world beaters. The key industries may be run by the government,

receive favoured loans from banks and governments may stop foreign companies from taking over and

merging with them.

Natural monopolies – Governments run these to prevent consumers being exploited by private sector firms

and also because producing at an extremely high output (to reduce average costs) may result in losses for

the monopoly (As output increases, prices decrease)

Essential products – Governments provide these so that they survive and/or people have access to them. Ex

housing, education, healthcare etc; These may be provided to people free of cost or at subsidized rates.

Merit Goods – Consumers would under consume merit goods so firms would under produce. To stimulate

consumption, governments may pay private firms to produce them, provide information about their benefits

and if necessary make their consumption compulsory.

Public goods – Private firms have no incentive to produce them because they are non-rival and non-

excludable. Governments therefore have to produce them or pay private firms to produce them and this is

financed through taxation.

The government as an employer –

Gov employs workers and managers to operate its SOE’s

Can use this to implement their aims (reduction in unemployment, control inflationReduce wage rises of

its workers, set an example in terms of employment practice)

Unit 31 The performance of the domestic economy is affected by the dynamics of the other economies.

Government’s Macroeconomic Aims –

1. Full employment –

o People who are willing and able to work can find jobs

o Those who are not willing and able to work are not part of the labour force, they are

economically inactive and dependent on those in the labour force.

o Unemployment rate = 𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡

𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒× 100

o Economists define full employment a 3% unemployment – Frictional unemployment

2. Price Stability –

o Ensures greater economic certainty

o Prevents countries products from losing international competitiveness

o Gov aims for a stable 2% inflation for 2 reasons

Measures of inflation tend to overstate rises in prices – Informal economy rises at a

slower rate, people may pay less than the official price (sales and second hand

purchases) and price rises hide improvements in products

Slight rise in prices can provide benefits – Producer are encouraged to increase their

output since higher prices may lead to greater profits, firms can cut costs by not raising

wages in line with inflation which is a substitute for a cut in employment.

3. Economic Growth –

o Increase in output in the short run – Actual economic growth


o In the long run for sustainable economic growth, the productive potential has to increase

(increase in the quantity and/or quality of resources(FOP)) – Potential economic growth

o To analyze economic growth aggregate demand (Consumption + Investment + Government

expenditure + net exports) and aggregate supply(total output of producers) diagrams are used. A

rise in aggregate supply indicates potential economic growth while a rise in aggregate demand

implies actual economic growth.

o Producing more goods and services can raise peoples living standards

o Governments want their economies to be working at full capacity and the actual economic

growth rate to coincide with the potential economic growth rate.

4. Redistribution of Income –

o Seek to redistribute income from the rich to the poor since the more money someone has, the

less they tend to appreciate each unit

o Governments redistribute income by taxing the rich at a higher rate and then spending. Some of

the money is spent directly on the poor(unemployment benefits) while some of the other forms

of expenditure particularly benefit the poor who may not be able to afford goods and services

unless they are free of cost or at subsidized rates.

o Governments don’t aim for perfectly even distribution of income since it acts as a disincentive to

effort and enterprise.

5. Balance of Payments Stability –

o Countries want the value of their exports and imports to be equal

o If import expenditure exceeds export revenue then the country will be living beyond its means

and may accumulate debt.

o If export revenue is higher than import expenditure, the countries citizens will not be enjoying as

many products as possible.

o Sudden changes in the BOP can be disruptive to the economy.

Unit 32 Government macroeconomic policies –

1. Fiscal Policy –

o Changes in government expenditure(public expenditure) and taxation

o Public expenditure is spent on a variety of items – benefits, education, healthcare, transport,

defense and interest on national debt.

o A budget statement outlines the amount of money a government plans to raise in tax revenue

and spend. A budget surplus means that public expenditure is higher than revenue therefore the

Gov will have to borrow to finance some of this. A budget surplus outlines that Government

revenue is higher than expenditure. In a balanced budget, public expenditure and revenue are

equal.

o Governments use a reflationary(expansionary) fiscal policy to reduce unemployment and

promote economic growth – Reducing taxation and/or increasing expenditure – raises aggregate

demand

o Governments use deflationary (contractionary) fiscal policies to reduce inflationary pressure –

Reduction in expenditure and/or a rise in the rate of taxation. – Reduces aggregate demand

2. Monetary Policy -

o Changes in the money supply through namely changes in the rate of interest

o A rise in the rate of interest helps to implement a deflationary monetary policy by increasing the

opportunity cost of saving and making borrowing more expensive thus reducing aggregate

demand. Firms and investors will also invest less. A deflationary fiscal policy helps to improve

the balance of payments.

3. Supply-side Policy –


o Measures designed to increase aggregate supply, thus productive potential

o Increase the quantity and quality of resources and raise the efficiency of the market

Improving education and training raises productivity

Cutting direct taxes and benefits increases incentive to work

Reforming trade unions may increase labour productivity

Privatization may increase productive capacity if the private firms are more efficient

Government Microeconomic policies – Deal with individual firms and industries

1. Subsidies

o Subsidies to infant industries and research grants to innovative firms

o Effect of subsidy depends on the size of the subsidy and PED. More inelastic the demand, greater the

quantity of the subsidy that is passed on to consumers. If PED is inelastic, the subsidy has more of an

impact on the price than the quantity sold while a subsidy on a product with elastic demand has

more of an impact on the quantity sold than the price

o There is an opportunity cost associated with the government granting a subsidy

2. taxes

o Protects domestic industries by imposing taxes on rival imported products

o Governments tax firm’ profit which has an impact on the willingness and ability of firms to invest

o Indirect taxes raises firms cost of production while direct taxes reduces disposable income

(therefore demand for products)

o Impact of tax is influenced by the size of the tax and the PED. More inelastic the demand, greater the

impact on the price than the quantity sold

o If a government wants to raise revenue it should tax products with inelastic demand while if it wants

to reduce the consumption of a product, it would be more successful if the product has elastic

demand

3. Competition policy

o Seeks to promote competitive pressures and prevent firms from abusing their market power

o Prevention of mergers that would be harmful to consumers

o Removal of barriers to entry and exit

o Regulation of monopolies

o Prohibition of uncompetitive practices

Predatory pricing – Charging a price below cost of production to drive out other firms

Limit pricing – setting the price low enough to discourage new firms from entering the

market

Price fixing – Firms agreeing to charge the same high price

4. Price controls

o Limit ability of firms to set their own prices

o Maximum ceiling on price – Has to be set below the market price to be effective

May create a shortage therefore a method of its allocation would have to be introduced to

prevent development of informal market

Designed to enable the poor to afford the product

o Minimum price – Has to be set above the market price to have any effect

Designed to encourage production

Problem of surplus will be created that may have to be brought up by the government or

some other official body

Minimum price may be set on labour in the form of NMW

5. Environmental policies

o Designed to improve the environment

o Restriction on the amount of pollutants emitted by firms into land,air or sea. Firms are fined if they

exceed this limit

o Tradable permits – Firms are allowed to pollute up to a certain limit and sell the unused portion of

this limit. Reduces costs of the cleanest firms and increases costs of the most polluting firms.


6. Regulations

o Rules and laws that place restriction on the activities of firms

o May regulate

The target audience of the product

The quality of the product

Mode of staff management

o Easily understood since they are backed up by law

o Government has to check that the regulations are being followed which is difficult and expensive

o Regulation only works if most people agree with it

o Regulations do not directly compensate those that suffer as a result of market failure

o May be too restrictive – reducing market flexibility and creating barriers to entry

Private sectors

Built things demanded by the public sector

Provide services to the public sectors

Provide finance to the public sector

May be in partnerships with the public sector – providing a part of a service

Unit 33 Conflicts between government aims –

Reduction in unemployment and inflation

Balance of payments and economic growth

Unemployment and economic growth benefit from expansionary fiscal and monetary policies while inflation and

balance of payments benefit from deflationary fiscal and monetary policies

Priority –

Relative scale of the problem

Consequences of the problem

Which problem the countries citizens are most concerned about

Supply side evaluation –

All government aims benefit from supply side policies

Economy can grow in a non-inflationary way

Increases aggregate demand since it will involve government expenditure and workers may earn more

Reduces unemployment since workers should become more productive and occupationally mobile

Improves the countries BOP since they will produce better quality cheaper products

There would be a time lag before the effects of some supply side policies

May be expensive and no guarantee that they will work

Ways in which Governments can improve the economy–

Supply side policy

Use a number of policies that address individual aims

Have as much and as accurate information as possible

o Size of the multiplier effect

Implement their policies relatively quickly – a delay may harm the economy

Advances in technology

Increase global competition


Unit 34 Aims of taxation –

Raising Revenue to finance Government expenditure

Redistribute income from the rich to the poor – Higher tax rates charged on the rich, some of which is spent

on benefits

Discourage consumption of demerit goods

Raise costs of firms that impose costs on others – (eg pollution)

Discourage the consumption of imports to protect domestic industries – Tariffs

Influence economic activity – Fiscal policy measures

Direct Taxes Indirect Taxes (Expenditure or outlay taxes)

Levied on a person or firms income or wealth Levied on expenditure

People and Firms have to bear the entire burden of the tax

Atleast some of the burden of the tax can be passed onto other people

Tend to be progressive or proportional Tend to be regressive

Types of Direct taxes –

Income tax

o Charged on income people receive from employment or investment

o All income above the tax allowance is taxable

Corporation tax (corporate tax)

o Tax on the profit of firms

Capital gains tax

o Tax on the profit made on assets when they are sold for a higher price than what they were brought

for (eg shareholders)

o Exemptions are usually made such as the sale of people’s main residence

Inheritance tax

o Tax on wealth above a certain limit that is passed onto others when a person dies

Types of Indirect taxes –

Sales tax

o Tax imposed when products are sold

o VAT (Value Added Tax) is levied on the value added by firms at each stage of production

Excise duties

o Charged on certain domestically produced goods – alcoholic drinks, petrol and tobacco

Customs duties (Tariffs)

o Taxes on imports

Licenses

o License may be needed to use products such as a car

Local taxes: Taxes levied on a local basis and used to pay for local services such as education, fire services, libraries

roads and refuse collection

Types of local taxes –

1. Business rates – levied on the property of local firms and the revenue is then distributed based on the

number of people in each locality

2. Council tax – Based on the value of people’s housing and expenditure

Nature of taxation –

1. Progressive tax


o Rate of taxation rises with income or wealth

2. Proportional tax

o Percentage of income payed in tax remains the same regardless of income or wealth

3. Regressive tax

o The percentage of income payed in taxes falls as income or wealth rises

Total amount of tax received rises in all cases with income or wealth

Unit 35 Tax base: source of tax revenue (things that are taxed)

A wide tax base can enable the tax rates to be low while if the tax rates increase, the tax base is likely to fall (firms

and people may move out of the country)

Tax base ∝ 1/ Tax rate

Tax burden: amount of tax payed by people expressed as a percentage of the country’s GDP

Incidence of taxation: Distribution of the tax burden of an indirect tax between producers and consumers

If demand is inelastic, most of the tax burden is passed onto consumers

If demand is elastic, producers have to bear a greater proportion of the tax burden

If supply is inelastic, producers bear most of the tax

If supply is elastic, consumers bear most of the tax burden

Qualities of a good tax –

Equity – Fairness in the sense that the amount of tax people and firms have to pay should be based on their

ability to pay.

Certainty – Tax should be easy to understand and households and firms should be able to calculate of

amount of tax paid by them.

Convenience – The tax should be easy to pay

Economy – The cost of collecting the tax should be considerably less than the revenue it generates

Flexibility – If should be possible to change the tax if economic conditions change or government aims

change. Some taxes (eg income and sales) are automatic stabilizers

Efficiency – A tax should improve the performance of the market or atleast not significantly reduce it. (eg

Windfall tax charged on supernormal profits of banks)

Impact of direct taxes –

If set too high my discourage effort, enterprise and saving

High rates may stop people from working overtime and taking promotions or prevent some from entering

the labor force, and entrepreneurs from expanding and investing

High tax rates may however encourage those with fixed financial commitments to work harder

High taxes reduce the return from savings hence target savers would have to save more

Can redistribute income and wealth

Act as automatic stabilizers

Good source of tax revenue in with an organized labour market, high literacy rates and high incomes

Impact of indirect taxes –

Since they tend to be regressive, they fall more heavily on the poor

Indirect taxes may raise prices, setting of a trend of rising prices (workers want to maintain their real

disposable income) – Inflation

Indirect taxes are relatively easy and cheap to collect since firms do some of the work

Act as less of a disincentive to effort and enterprise than direct taxes


Can be used selectively to achieve certain government aims

Harder to evade

Easier to adjust

People have a choice, the amount of tax payed by them depends upon the products they purchase.

Useful source of income in countries where there is a large informal sector and with low literacy rates

Flat taxes: Income tax, corporation tax and vat being set at the same rate with no exceptions (proportional tax)

Evaluation of flat taxes –

Simple to administer for governments and firms

Less incentive to avoid paying taxes

Promotes hard work and enterprise

However have a slight regressive nature

Unit 36 Price indices – Seek to calculate the changes in price products that are generally brought by consumers

Stags of constructing a price index –

1. Selecting a base year – A relatively standard year in which there were no dramatic changes. The base year is

given a figure of 100 (100%)

2. Finding out how households spend their money – Decide what items to include in the price index

o Carry out surveys of household expenditure

o Attach weights to items – The percentage of income spent on the product

3. Finding out price changes – Obtained from

o Shops

o Post offices

o Power companies

o Train companies

4. Constructing a weighted price index – Multiply weights of products by the new price index for each category

of products to calculate the change in general price level.

Unit 37 Types of inflation –

1. Cost-push inflation

o Price level is pushed up by increases in the cost of production

i. Labour wages rising more than productivity – wage-price spiral

ii. Increases in the cost of raw materials

iii. Increases in indirect taxes

iv. Higher cost of capital goods

v. Increase the profit margins by firms

2. Demand-pull inflation

o Price level is pulled up due to excessive demand

i. Consumption

ii. Investment

iii. Government expenditure

iv. Net exports

o Demand-pull inflation only occurs if aggregate supply cannot rise in line with aggregate demand

i. Full employment of resources

3. Monetary inflation

o Excessive demand caused by an excessive growth in the money supply


o Monetarists believe that the only cause of inflation is the money supply growing more rapidly than

output

Effects of inflation are dependent on –

1. Its rate

2. Stability of price rises

3. Rate relative to other countries

4. Response of the government

Harmful effects of inflation –

The fall in the value of money may lead to a reduction in confidence

Redistributes income in an unplanned way

o Borrowers benefit while savers loose out – less is paid back in real terms

o Workers with low bargaining power and those with fixed incomes loose out

Extra costs imposed on firms

o Staff time will be taken up calculating future prices

o Menu costs – costs of changing prices in catalogues, price lists etc

o Shoe-lather costs – Money paid to firms will be losing value therefore it will take time and effort to

place the money in financial institutions that pay a rate of interest higher than the rate of inflation.

Uncertainty

o Difficult to plan ahead

o Hard to judge the right prices to be paid

o Firms may be discouraged from investing

Harm the countries balance of payments position

o Countries products become less competitive

o Fall in export revenue and rise in import expenditure

o Rise in unemployment within the country as a result

Fiscal drag

o When governments do not adjust tax brackets in line with inflation therefore people get slotted into

a higher bracket and taxed more.

Beneficial effects of inflation –

Low and stable inflation may encourage firms to expand as they will be attracted by higher prices – higher

profits

Reduces the burden of debt thus preventing households from going bankrupt

Firms can simply not raise workers wages in line with inflation rather than make them redundant

Causes of deflation –

Supply side deflation – Beneficial

o Advances in technology

o Increases in labour productivity

Decline in aggregate demand – Harmful

o Consumers expecting prices to be lower in the future may postpone their purchases

o Firms are likely to reduce their output leading to unemployment and further reduction in aggregate

demand

Consequences of deflation –

1. Supply side deflation

Reduce current account deficit (increase surplus)

Increases in output and employment

2. Demand side deflation


Rise In unemployment and lower output

Discourage investment and reduce productive capacity

3. Burden of debt increased but lenders will gain more back in real terms

4. Increases the purchasing power of money

Unit 38 Workers need to be occupationally and geographically mobile because at any given time some industries will be

declining whilst others expanding

Reasons for working part time –

Fits with their children’s school hours

Enable them to look after elderly relatives

Can pursue other interests

Not able to find full time jobs

Organized sector Unorganized sector

Have access to social security benefits, employment protection and rights

Do not have the same access to social security benefits, employment protection and rights

Can be part of union and collectively bargain Does not include unions

Can be self employed or employees Some are Self employed, migratory workers and casual workers

Pay income tax Do not pay income tax

Tend to have higher productivity and wages Tend to have lower productivity and wages

High quality employment – Skilled work that is interesting and provides people with good working conditions etc

Low quality employment – Unskilled work that consists of poor working conditions, no training etc

Privatization: Selling of SOE’s to the private sector

Public sector workers usually have more job security and other non wage benefits but their productivity tends to be

lower.

Flexible Employment –

Labour force adjusts quickly and smoothly to changes in market conditions

1. Numerical flexibility – Easy to hire and fire workers in order to adjust output.

o Decreases job security

o Increases employment since firms will hire more people if they can be made redundant if market

conditions change

2. Temporal flexibility – Ability to change the number of hours people work

3. Locational flexibility - Ability to change the location where people work

4. Functional flexibility – Ability to change the tasks workers perform

5. Wage flexibility – Ability to change the wages of workers

Both employment and unemployment can increase if the labour force increases in size

Unemployment can fall without a rise in employment if the unemployed reach retirement age, go into full time

education, emigrate or simply stop searching for work.

Size of labour force is influenced by –

1. Population of working age people

o Birth rate

o Death rate


o Immigration/ emigration

2. Labour force participation rate – Proportion of people of working age that belong to the labour force

o The wages on offer

o Social attitudes to working women

o Provision of care for children and elderly

o Social attitudes and provision for the disabled to work

o Proportion of school leavers who go for higher education

Employment rate = Number of people in employment / Labour force

Unit 39 Measures of unemployment –

1. Claimant count – Count those in receipt of unemployment related benefits

o Cheap and quick since the information is gathered by the government anyway

o Tends to understate unemployment since not everyone unemployed at the given time would have

registered for benefits – Those on training schemes, people who stay on at school and those that are

forced to retire early.

2. Labour force surveys

o Can be used to make international comparisons

o Captures unemployment more accurately

o However the sample of labour force needs to be representative of the labour force as a whole

o Takes longer and is more expensive as compared to the claimant count

Causes of unemployment –

1. Frictional unemployment – Workers have to wait some time before joining another job after being fired

from the first

a. Search unemployment – Workers do not accept the first job on offer, instead spend time looking for

an acceptable job

b. Casual unemployment – People are out of work between periods of employment (eg actors)

c. Seasonal unemployment – Labour is not in demand in certain times of the year (eg tourism industry)

2. Structural unemployment – Decline of industries arising from long term changes in demand and supply

i. Another country becomes better at producing the product

ii. Substitute for the product is found

iii. Labour being substituted by capital

a. Regional unemployment – Unemployment concentrated in one area

b. Technological unemployment – Workers are made redundant as a result of ICT

o Persists for longer period than frictional

o Usually affects more workers

Labour immobility (occupational and geographical) plays a key role in the extent of structural and frictional

unemployment. Measures to reduce structural and frictional unemployment involve making labour more

occupationally and geographically (education and training) and increasing the incentive to work (cutting direct taxes

and benefits). Also governments try to encourage firms to move to areas of high unemployment.

3. Cyclical unemployment (demand deficit unemployment)

o More harmful than structural or frictional

o Spreads throughout the economy

o Unemployment decreases the aggregate demand which further causes unemployment

Government will seek to raise aggregate demand (expansionary fiscal and monetary policy)

Consequences of unemployment –


Easier for firms to expand since they can easily employ new workers

Keeps down inflationary pressure by lowering wage rises

Unemployed experience a fall in income and a loss of self-worth that can affect their mental and physical

health, relationships and the children of the unemployed are likely to be worse educated. The longer they

are unemployed, the more difficult it is for them to find a job due to losing out on training in new methods

and technology, lose the work habit and their confidence may dip.

Imposes opportunity cost on the economy since there will be under production, therefore living standards

will also be lower.

Government tax revenue would be lower than possible since reduced revenue from direct taxes (income and

firms’ profit would fall) while due to the lower demand, indirect tax revenue will also fall.

Puts pressure on government expenditure – Opportunity cost

Potentially rising levels of crime

Unit 40 GDP (Gross domestic Output) – The total output of an economy.

Circular flow of income: Income Expenditure Output Income

Methods of measuring GDP –

1. Output method

o Adding up all the output produced by the countries industries

o To avoid counting outputs multiple times (subsidiary industries), economists include the value added

by each firm at every stage of production

2. Income method –

o All income which has been earned in producing a countries output

o Transfer payments are not included since nothing has been produced in exchange for them

3. Expenditure method –

o Adding up all expenditure on the countries finished output

o Expenditure = GDP = Consumption, Government expenditure, investment, net exports

Value added: Difference between sales revenue received and the cost of raw materials used (profit)

Nominal GDP (Monet GDP or GDP at current prices) is not adjusted for inflation.

Real GDP (GDP at constant prices) = Nominal GDP * Price index of base year / Price index of current year

Real GDP per capita (head) = Real GDP / Population

It is difficult to accurately measure GDP because of the informal economy –

Undeclared economic activity – Hidden, Shadow or grey economy

o Illegal activities – eg drug dealing

o Work undertaken by illegal immigrants

o People don’t want to pay tax on the activity

Size

o Number of activities that are declared to be illegal

o Tax rats

o Penalties for tax evasion

o Number of tasks people perform for themselves

o Size of subsistence agriculture

Tax revenue is below what is possible

Official inflation rate overstates actual inflation since prices in the informal economy rise at a slower rate

Causes of Economic growth –


In the short term a rise in aggregate demand may stimulate a rise in output if the economy has unused

resources.

In the long term for a country to continue experiencing economic growth, there needs to be a rise in the

quantity and quality of resources

o Net investment and an increase in the labour force will increase quantity

o Improvements in education and advances in technology would raise the quality of resources

Consequences of Economic growth –

Increase in output would raise living standards – Better healthcare, superior education, luxury items etc

Increases government tax revenue which can be spent on reducing poverty (benefits and

education/training), increase healthcare provisions, improve education

Political and economic standing of the country improvise

If the economy is working at full capacity, some resources would have to be switched to making capital

goods which would reduce living standards in the short run

Higher output can increase pollution, lead to depletion of non-renewable resources and damage the natural

environment

Greater stress on workers to produce more, work for longer hours, learn new skills and some may have to

change their job

Impact is influenced by its rate, means adopted to distribute it and the distribution of its benefits

If productive capacity does not increase in line with aggregate demand, there may be inflation

Stable economic growth increases confidence and encourages investment

Some of the resources can be used to reduce levels of pollution, people may pressurize the government to

follow environmentally friendly policies

If the distribution is unequal than some people may actually be worse off

Some of the products produced may actually harm living standards (eg Tobacco)

A fall in the economic growth rate still means more is being produced, when output falls the economic growth rate

would be negative

Recession: Real GDP declines over a period of 6 months or more – Decrease in aggregate demand and/or Supply

Unemployment would rise

Lower living standards

Investment would be discouraged

Unit 41 Real GDP per head as an indicator of Living Standards –

An increase in Real GDP per capita suggests that living standards have risen

Real GDP per capita is an average and not everyone may equally receive a rise in income

More goods and services would certainly be produced but not all of these add to peoples living standards.

For eg tobacco

Real GDP may understates the level of economic activity due to the presence of an informal economy.

Alternatively Real GDP may overstate economic activity if the quality of output is falling

Living standards are affected by other factors apart from material goods and services (working conditions,

working hours, pollution etc)

Real GDP takes into account inflation and population size therefore is useful

Using an unadjusted currency to compare Real GDP may give misleading results therefore purchasing power party is

more suitable which considers the buying power of a currency in its home country.

Human development Index –


Considers real GDP per head, life expectancy at birth and education (mean years of schooling and expected

years of schooling)

Countries are categorized into very high HD, high HD, medium HD and low HD

Doesn’t take into account political freedom and environment. Also it does not consider differences in life

expectancy, education, and differences in income between population compositions.

Index of sustainable economic welfare –

Adjusts personal consumption for unequal income distribution then makes a number of deductions and

additions.

Items deducted include those that reduce current or future economic welfare (social and environmental

costs)

Items that make a positive contribution to current or future economic welfare are added (net capital

investment, government expenditure, infrastructure, volunteer work etc)

Multidimensional poverty index –

Based on deprivations in education, health and standard of living

Household surveys are taken about health, education and standards of living

Gender inequality index –

Considers gender based disadvantages in terms of reproductive health, empowerment and the labour

market

Health is measured in terms of maternal mortality rate and adolescent fertility rate

Empowerment is measured by the percentage of seats in the national parliament held by women and

relative percentage of men and women with at least secondary education

Labour market is assessed by comparing the labour force participation rate of men and women

Happy Life Expectancy Index –

Found by measuring life expectancy at birth by average life expectancy

Unit 42 Economic development : Economic growth(Improved material living standards) + Reduction in poverty, expanding

the range of economic and social choices and increasing freedom and self-esteem

Developed economies –

High incomes

High living standards

A large proportion of workers employed in the tertiary sector

High levels of productivity

High levels of investment

Measures of development –

1. GDP per capita - Only Material living standards

2. Human Development Index – More comprehensive

Characteristics of Developing economies –

Low incomes per head – (possibly large income inequality)

Low levels of saving due to low income

Low life expectancy and high infant mortality rate

High rates of population growth – High dependency ratio

Low levels of education and healthcare – Poor productivity


Low levels of capital goods and poor infrastructure – Poor productivity

Poor housing and sanitation

Relatively high number of workers, employed in the primary sector

Concentration on a narrow range of exports (Most of which are primary products) – Vicious circle of poverty

Vicious cycle of poverty: Low Incomes Low saving Low investment Low productivity

Seeking to achieve development –

Economic growth – Higher living standards

Distribution of income should not be too uneven so that everyone can experience better living standards

Poor will be better off - Greater productivity and reduction in pollution

Virtuous circle – Income and education Savings and investment Productivity Income

Unit 43 Uneven distribution of income –

Uneven holdings of wealth – Generates income

o Differences in assets inherited by people

o Savings – Wealth creates wealth

o Entrepreneurial skills

Differences in the composition of households – More people to earn, higher the income

Differences in ability to earn – Skills, qualifications and number of working hours

Wealth: A stock of assets that have financial value – Shares, Government bonds etc

Even distribution of income –

Uneven distribution may be socially devices

Everyone has access to certain standards of living

Government influence on Distribution of income –

Taxation – Progressive taxes make distribution more even

Provision of cash benefits – Help maintain a reasonable standard of living

Provision of free state education and health care – Everyone has access to these essential services,

opportunity to improve their living standards

Using labour and macroeconomic policies – Minimum wage, legislation, regional policy, measures to reduce

unemployment

Poverty –

1. Absolute poverty – people do not have access to basic food, clothing and shelter

2. Relative poverty – people are poor relative to others and are unable to participate fully in the normal

activities on the society they live in

Reduces productivity, employment opportunities and income and will affect the prospects of their children

Reasons for poverty –

o Unemployment

o Low paid work

o Falling ill and growing old

Policy measures to reduce poverty –

Improve the quantity and quality of education – Supply side policy

o Increases the job prospects and earning potential of the poor and their children

Increasing aggregate demand – Expansionary fiscal and monetary policies

o Increases output thus benefiting economic growth


Introducing or raising a national minimum wage – To tackle low wages

Encouraging more MNC’s to setup in the country – More employment opportunities

Providing benefits or more benefit state benefits

o Helps to avoid absolute poverty

o May help people in the short term and raises aggregate demand

o Can act as a disincentive to effort

Land reform – Give land to farmers so that productivity is increased (they will make their own land more

fertile)

Measures to raise living standards –

Measures to reduce poverty – Higher output and productivity

Improving healthcare, increasing and improving housing stock, improving working conditions and reducing

pollution

Private sector (Reducing government regulation and taxation) or public sector (legislations)

Lorenz curve measures income inequality through calculating the cumulative % of income and comparing it with the

cumulative percentage of the population

Unit 44 Causes of population growth –

1. Natural increase – Birth rate exceeding death rate

Birth Rate -

o Average age of the population

o Number of women in the population

o Women’s fertility rate (Number of children per women)

1. The age at which women marry

2. The number of women pursuing higher education

3. The labour force participation rate of women

4. The socio-economic status of women

5. The availability of family planning services

6. Availability of government support for families

7. Cost of bringing up children

8. Provision of benefits for the sick and elderly by the government – Lack of care would

mean that women stay at home = have more children. Also families would not need

children to support them in their old age.

Death Rate –

o Nutrition

o Housing conditions

o Medical care

o Lifestyles

o Working conditions

o Involvement or non-involvement in military action

2. Net immigration – More people come into the country to live (immigrants) than people who leave the

country to live elsewhere(emigrants)

o Relative living standards at home and abroad

o Persecution of particular groups

o Extent of control on the movement of people

Sex Distribution –

Preference in gender

Differences in infant mortality rate of males and females


Differences in emigration patterns of males and females

Population pyramids show the age distribution of the country’s population. For a developing country it would be

pyramid shaped (High birth and death rate) while for a developed country it would be more oblong shaped (Reduced

birth rate and death rate)

Dependency ratio = Number in dependent age groups / number in the labour force * 100

Dependents include those below school leaving age and those above the retirement age

Optimum population: The number of people that when combined with the other resources of the country (Land,

capital and technical knowledge) give the maximum output per head of the population.

Overpopulation: Shortage of resources relative to the population size

Under population: country does not have enough human resources to make the best use of its resources

It is difficult to determine the optimum population because the quantity and quality of resources are changing all the

time.

Malthusian theory of population –

Population grows at a geometric rate while food production grows at an arithmetic rate

Checks are needed to keep the population within its means of subsistence

o Positive checks (cause the death rate to rise) – Epidemics, famine, infanticide and wars

o Preventive checks – Moral restraint and contraception

Technology proves this to be false

Overlooks the fact that consumers are also producers

Unit 45 Consequences of a growth in a countries population depend on its

Cause

Size of population relative to optimum population

Rate of population growth

Benefits of an increasing population –

Better utilization of resources if the population was previously below the optimum size

The size of markets will increase – Firms can make use of economies of scale

Increase in factor mobility – If caused by an increase in the birth rate or immigration since they are likely to

be occupationally and geographically mobile. – Training costs will be reduced

Extra demand will be generated – Stimulate investment and development of new technology

Rise in the labour force – Higher dependency in the short term

Disadvantages of an increasing population –

Concerns about famine – If country is currently overpopulated and agricultural production is low they may

not be able to feed more people

Restrictions on improvements in living standards – Resources would have to be diverted away from

improving living standards to producing essential goods and services

Overcrowding – Pressure on housing and social capital and cause traffic congestion

Environmental pressure – Damage to wildlife, water shortages and depletion of non-renewable resources

Pressure on employment opportunities – Gov will have to spend more on education and training, surplus of

labour may occur.

Balance of payment pressure – Increase in imports and diverting exports back to the home market.


Ways of reducing the birth rate –

1. Reduce immigration

2. Reduce the countries birth rate

o Improvement of educational and employment opportunities for women

o Better information and increased availability of family planning services

o Improvement of health care and nutrition – reduces infant mortality and birth rate since people will

be less concerned about their children’s survival

o Setting up pension and sickness insurance schemes – Reduces need for children’s assistance during

old age

o Raise the cost of having children – raise school leaving age, stop any financial support

o Incentives for families who restrict the number of children

o Most extreme measure – Restrict the number of children per family

Consequences of an aging population –

Rise in the dependency ratio

A change in the labour force – Old would be geographically and occupationally less mobile but may be

experienced, reliable and patient

Higher demand for health care – Opportunity cost

Greater need for welfare schemes

Rising cost of state and private pensions

Change in the pattern of demand – Housing for retired people will rise while that for toys will fall

Ways of coping with an ageing population –

Raise the retirement age – Workers would be more healthy and earn more income to be able to save for

retirement, also raises tax revenue and reduces pensions

Encourage or make it compulsory for workers to save for their retirement

Raise the productivity of workers through education and training

Encourage immigration of younger skilled workers by issuing work permits – Reduce the dependency ratio

in the short term

Internal Migration – Workers migrate from rural to urban areas

Supply growing industries

Better allocation of resources

Raise living standards in rural areas if there was overpopulation and if they send money back to relatives

If productive workers migrate, agricultural productivity may fall

May be overcrowding, congestion and increased pressure on social capital in urban areas

Effects of Net Emigration –

Size of working population would be reduced – Most emigrants tend to be of working age

Remaining labour force will have greater burden of dependency

The average age of the population will increase – less mobile

The sex distribution of the population will be affected

Shortage of a particular skill if workers from a particular category emigrate

Under utilization of resources – Under population

Emigrants may send money home to their relatives

Unit 46 Problems facing developing economies –


High growth of population – Resources have to be diverted to producing necessities rather than increasing

the productive potential and living standards

High levels of international debt – Large proportion of income is taken up repaying previously borrowed

loans.

Reliance on the export of primary products – Price of primary products tends to fall with time relative to

manufactured goods so the country spends more on imports but receives less export revenue. Developing

countries use their buying power to keep down prices of primary products. Primary product’s supply is

heavily influenced by the climate and availability of natural resources.

Lack of investment in human capital and capital good – Holds back increases in productivity, introduction of

new technology and international competitiveness.

Emigration of key workers – They seek better paid employment abroad

Trade restrictions on their products – Cant sell their products abroad on equal footing therefore are

discouraged from building up industries.

Unbalanced economy – Underdevelopment in certain sectors.

Measures to promote development –

Import substitution

o Protection of domestic industries against foreign competition

o If successful should increase domestic output, employment and improve the countries balance of

trade

o May raise prices and reduce choice

o Other countries may retaliate and put up their own import laws

o Domestic industries may become reliant on government support without seeking to increase

efficiency

Exposing domestic firms to market forces

o Firms will be forced to become efficient

o Foreign firms may be big, experience economies of scale and consumer loyalty therefore domestics

firms may not be able to compete.

Improve the country’s infrastructure, capital stock, education, training and health care systems – Supply side

policy

o The government may lack revenue to do this

o Attract MNC’s –

Increase employment and wages

Train and educate workers

Bring in new technology

Improve infrastructure

MNC’s may deplete non-renewable resources

Cause pollution

Put pressure on governments to follow policies that harm economic development

o Borrowing from abroad –

Useful if funds are used to increase productivity and earn significantly higher incomes in

order to repay the loan

High interest rates may make borrowing unviable

Countries may accrue debt

Money may be lost due to corruption and spending on unprofitable projects

o Foreign aid –

Can create economic and political dependency

Postpone necessary reforms

Bring in inappropriate technology

Corruption if used for unprofitable projects

Foreign aid –


Given because

o Desire to help people

o Win political support

o Gain a commercial advantage

Tied aid – Receipt can only spend the money on specific products (eg from the donor country)

Bilateral aid – From one government to the other

Multilateral aid – Channeled through international organizations

Forms

o Grants which do not require repayment

o Loans charged on favourable terms

o Supply of goods, services, technical assistance and guidance

More likely to promote development if it is generous, multilateral, untied and geared towards the needs of

the recipient

Effect on the development of one economy on other countries’ economies –

Improvement in one economy generates tax revenue which can be spent as foreign aid

Increased aggregate demand for the other countries productions

Setting up of units in foreign countries

Development of education may make population more concerned about other economies – Tourism and

foreign aid

Investment in other economies

Unit 47 Balance of payments: A record of economic transactions between one country and the rest of the world over a

particular period of time.

Credit: Money coming into the country

Debt: Money going out of the country

Sections of the balance of payments-

1. Current Account – Income earned by a country and expenditure made by it in its dealings with other

countries.

a. Trade in goods

o Exports and imports of goods

o Visible exports and imports or merchandise exports and imports

o If revenue from exports > Expenditure on Imports = Surplus

o If Revenue from exports < Expenditure on imports = Deficit

b. Trade in services

o Records payments for services sold abroad and expenditure on services brought from

foreign countries

o Invisible balance

o If Services receipts > Payments for services = Surplus

Together the first two parts give balance on trade in goods and services

c. Income

o Compensation for employees – wages, salaries and other benefits earned by residents

working abroad minus compensation paid to foreigners working in the country

o Investment Income – Profits, dividends and interest receipts from abroad minus investment

income paid abroad

Direct Investment income

Portfolio investment income


Interest earned from loans

d. Current transfers

o Transfers of money, goods or services which are sent out of the country or come into the

country not in return for anything else.

o Gifts, charitable donations, aid from a government and money sent to relatives.

Current account surplus: Value of credit items > Value of debt items

Current account deficit: Value of credit items < Value of debt items.

2. Capital and Financial accounts

a. Capital Account

o Funds brought in and sent out of the country immigrating/emigrating

o Transfer of funds associated with the acquisition or disposal of fixed assets

o Purchase and sale of patents

b. Financial Account

o Much larger than the capital account

o Records transactions in assets and liabilities

Direct investment – Purchase and sale of businesses or establishment of new

businesses

Portfolio investment – Purchase of shares and government bonds

Other investment – trade credits and loans

3. Official Reserves

a. Items held to settle debts with other countries

b. Foreign exchange, Drawing rights at the IMF, reserve position at the IMF and gold

4. Net errors and omissions

o If everything in the balance of payments has been recorded correctly, the credit items

should match the debt items – A current account deficit would be matched by an equal

surplus on the capital and financial account

o Balancing items are recorded in order to make the BOP balance

Causes of financial account deficit – Investment abroad is greater than foreign investment coming into the country in

a year

Domestic firms may setup in foreign countries

o Lower tax rates

o Lower costs of production

o Expanding markets

o Good factors of production

o Government subsidies

Buy foreign shares

o Profit levels and dividends are high abroad

Buy foreign bonds and lend to foreign companies and individuals

o High foreign interest rates

Consequences of financial account deficit –

In the short term money is leaving the country and potential jobs and incomes are lost to the foreign

economy

In the long term the investment should generate income in the domestic economy

Unit 48 Internal Trade International Trade

Within the country Exchange of goods and services between countries


Smaller market Can reach a wider market

- Take greater advantage of economies of scale

Source products only from the domestic market or import them.

Source products from a wider area

Shorter distances so reduced transport costs Products have to travel greater distances

Likely to be the same language – Not necessarily May have to deal with different languages (Increased cost of advertising and pamphlets)

Same culture Differences in culture will have to be taken into account

Unlikely trade restrictions thus reduced prices Trade restrictions may make it difficult for firms to sell their products abroad

Less competition – Can establish monopolistic power Exposes firms to more competition – May become efficient or struggle to survive

Don’t have to deal with foreign currency – Confidence and reliability

Have to deal with foreign currency – Exchange rates fluctuate

Pattern of international trade –

Seek to buy from countries with good quality products at a low price and sell to countries with a high and

stable demand

Trade with countries close to them in tastes, development and sometimes geography

Trade with countries who share historical links with the source country

Most trading takes place between developed countries in high quality finished manufactured products

Destinations of exports are also the main source of imports for many countries

Changes in Exports and Imports –

The country’s inflation rate – A high inflation rate would increase imports and reduce the competitiveness of

domestic exports.

The countries exchange rate- A fall In the exchange rate will reduce imports (more expensive) while

increasing exports (cheaper)

Productivity – The more productive a country’s resources are, the lower cost per unit. Therefore exports

would increase and imports would fall

Quality – A rise in quality would raise exports and reduce imports

Marketing – The more effective the firm is at marketing their products, the more would be sold (Exports

while imports )

Domestic GDP – If domestic incomes rise, imports would rise and exports fall (They would be diverted to the

home market)

Foreign GDP – If foreign incomes rise, exports would increase

Trade restrictions – An increase in trade restrictions would make the countries products more expensive,

hence exports would fall.

Causes of a current account deficit –

1. Cyclical deficit – low incomes abroad and/or high incomes at home

2. A high exchange rate – Exports are expensive while imports cheap

3. Structural problems – High costs of production, poor quality products, problems in manufacturing and

strategies adopted to market them

Consequences of a current account deficit –

Country would be ‘living beyond its means’

Reduction in inflationary pressure – Low domestic aggregate demand

Output and employment is lower than what is possible

Significance depends on its

1. Size – small deficit would not cause much problem

2. Duration – if it lasts for a short time it would not be too significant


3. Cause –

Self-correcting

o Import of raw materials and capital goods – Would be used to produce at a low cost

o High exchange rate – Exchange rate would fall due to increased imports (Supply of

currency would increase)

o Changes in income (Domestic or abroad) – Recessions abroad will not last

Serious cause

o Lack of international competitiveness - Structural problems; The government may

have to introduce supply-side policies

Causes of a current account surplus –

1. A low exchange rate – Exports will be cheap and imports expensive

2. High quality of domestically produced products

3. High incomes abroad

4. Low costs of production – Internationally competitive

Consequences of a current account surplus –

Rise in real GDP and higher employment – High aggregate demand

More money will come into the country than will leave it – Consuming fewer products than it is producing

May result in an appreciation in a floating exchange rate

Unit 49 Countries specialize on those products that their resources are best at making

Advantage of specialization of countries –

Higher output – Throughout the world consumers can enjoy more goods and services – Better living

standards

Lower costs – Countries can take advantage of economies of scale by producing a high output and can also

buy raw materials from specialist firms.

Spread of ideas and technology – Specialization means countries have to trade

Increase in competition – Efficiency and choice

Disadvantages of specialization of countries –

There can be a decrease in demand – Other countries may become better at producing the product or a

substitute for the product may be developed

There may be supply side products – Eg primary products are affected by environmental conditions

Interdependency – Countries depend on other countries and this supply may be cut of due to natural

disasters or wars

Trade restrictions – Exports may become difficult to sell abroad

Absolute advantage: Country can produce the product using fewer resources than other country

Comparative advantage: Country can produce the product at a lower opportunity cost than other countries.

Changes in comparative advantage –

Discovery of new sources of minerals

Country makes is land more fertile

Adoption of new technology

Increased productivity of workers through improved education and training

Terms of trade: The rate at which one countries products are exchanged for those of other countries -


Terms of trade = 𝐼𝑛𝑑𝑒𝑥 𝑜𝑓 𝑒𝑥𝑝𝑜𝑟𝑡 𝑝𝑟𝑖𝑐𝑒𝑠

𝐼𝑛𝑑𝑒𝑥 𝑜𝑓 𝑖𝑚𝑝𝑜𝑟𝑡 𝑝𝑟𝑖𝑐𝑒𝑠∗ 100

An improvement occurs if export prices rise relative to import prices – Quantity of exports will be exchanged

for a greater quantity of imports

Impact of changes in terms of trade –

If export prices rise due to an increase in demand, the country can afford more imports

If export prices rise due to inflation, less quantity would be sold; lower export revenue; country can afford

less imports

Unit 50 Exchange rate: Price of one currency in terms of another currency (or currencies)

Exchange rate index: Price of one currency in terms of a basket of other currencies, weighted according to their

importance in the countries international transactions

Effect of changes in the exchange rate on export and import prices –

A rise in the exchange rates would reduce import prices (in domestic currency) and raise export prices (in

foreign currency)

Therefore demand for the country’s exports will fall and its effect on revenue will depend on the PED for the

exports. Most exports have elastic demand due to lots of competition.

Fixed exchange rate –

Value is fixed against another currency (or currencies) and is maintained by the government

If the price is being pushed down, the government can buy up some of the currency using foreign currency

or raise the rate of interest (Increasing demand & reducing supply). If the price is being pushed up the gov

can reduce interest rates and increase the supply.

Creates certainty – Know the exact amount of money that will be received

Government may have to use up considerable amount of foreign currency and use macroeconomic policy

measures

Devaluation – Decreasing the value of a fixed exchange rate

Revaluation – Raising the fixed exchange rate

A floating exchange rate –

Determined by market forces

Appreciation – Rise in the value of the currency

Depreciation – Fall in the value of the currency

Helps to automatically eliminate a current account deficit Surplus of currency Exchange rate will

depreciate Raises import prices and reduces export prices

Government can focus on other objectives

Exchange rate can fluctuate, making it difficult to plan ahead

Reasons why currencies are traded –

Demand –

Purchase of domestic goods and services

Foreign based domestic firms sending money back

Investment income earned from foreign assets and liabilities

Foreign investment in the domestic country

Transfer payments to the domestic countries

Foreign governments wanting to hold domestic currency reserves


Bullish Speculators buying the domestic currency in anticipation that the exchange rate will

appreciate/revaluate

Supply –

Purchase of foreign goods and services

Domestic based foreign firms sending money back

Investment income paid to foreigners

Transfer payments to foreign based individuals/firms/governments

Domestic Investment in foreign economies

Domestic government holding foreign currency as reserves

Bearish speculators selling the currency

Foreign currencies are traded with domestic currency – An increase in demand for foreign currency, raises supply of

domestic currency

Unit 51 Changes in the Exchange Rate –

Due to –Changes in the current account balance – Surplus would cause a rise in the exchange rate

Direct and portfolio investment – Increases in investment in the country will cause price to rise

Speculation – Speculators will act in such a way to materialize their expectations

Government action

o Buying and selling the currency – Limited foreign currency in its reserves

o Raise the rate of interest – attracts hot money flows (transferred around the world to take

advantage of interest and exchange rates)

o Measures to increase exports and reduce imports

Consequences of a change in the exchange rate –

Affects exports and imports

May influence economic growth and employment – A fall in the exchange rate raises aggregate demand for

domestic products

Inflation – A fall in the exchange rate will

o Increase imported raw material costs and finished product prices

o Reduces pressure on firms to keep price rise to a minimum in order to remain competitive

Measures to correct current account deficit –

Expenditure switching measures – Make domestic and foreign citizens buy the domestic countries products

rather than foreign products. Eg Tariffs

Expenditure reducing measures – Reduce demand for products in general – Reduces imports and forces

domestic firms to export more. Eg Interest rates, income tax and indirect taxes

Supply side policy measures – Long run – Raises labour productivity, reducing costs of production and raising

quality

International Competitiveness –

A country is internationally competitive when it provides goods and services demanded by consumers at a

price acceptable to them

Indicators –

o Economic growth rate

o Share of world trade

o Level of expenditure on research and development

o Quantity and quality of education and training


o State of the country’s infrastructure

In the short term changes in exchange rate and inflation rate influence international competitiveness – A fall

in both improves competitiveness

Changes in productivity have a long lasting effect – Achieved through supply side policies

Unit 52 Benefits of Free Trade –

No restrictions on the products brought by firms and consumers from abroad or sold by firms to other

countries and no imposition of special taxes

Countries can concentrate on what they are best at producing – Efficient allocation of resources through

exploiting comparative advantage.

Firms can take advantage of economies of scale

Increased competition – Forces efficiency

Cheaper access to high quality raw materials and components

Greater choice of products for consumers

Protectionism: Protection of domestic industries from competition posed by foreign industries

Methods of protectionism –

Tariff (Custom duty or import duty) –

o Tax on imported products – To discourage consumption

o Tariff will be set at a rate that makes the foreign products more expensive than domestic products

A quota –

o Limit placed on the quantity of a good that can be imported

Embargo –

o Complete ban on the import of a product or trade with another country

Exchange control –

o Restrict the availability of foreign currency

Quality standards –

o Requires imports to reach artificially high standards

o This will either dissuade foreign countries from selling their products in the domestic market or push

up the price of the products

Extensive paperwork –

o Make foreign firms fill out a considerable amount of time consuming paper work in order to

persuade them to switch to other markets

Voluntary export restraints (VER’s) –

o Persuade government of exporting country to limit amount of exported units

Agree to the same

Threaten to impose tariffs or quotas if they do not agree

Subsidy

o Protect domestic industries by enabling them to sell at a price below that of foreign imports

Government may also stop exports if the country is experiencing shortages

Arguments for protectionism –

1. Protection of infant industries –

o New industries which have a potential to grow may be eliminated by foreign competition

o Through protection these industries can grow, experience economies of scale and become

internationally competitive


o But there is risk that the domestic industry may become reliant on government protection rather

than seeking to improve efficiency

2. Protection of Strategic industries –

o Industries essential to the survival of the country – Defense, agriculture

o Risk that imports of these supplies may be cut off.

3. Protection from unfair foreign competition –

o Protectionism to prevent dumping – Firms selling at a price below the cost of production to drive out

other firms from the market

4. Protection of declining industries(sunset industries) –

o If labour is immobile, the decline of a major industry can cause significant unemployment

o Through protectionism, these industries can gradually decline and workers can leave of their own

accord and protection can be removed

o But owners of the industry may resist the removal of protectionism

5. Protection of industries from low wage competition –

o Low wages in foreign countries may imply low costs of production (keeping productivity constant)

therefore they can sell at lower prices.

o This should be self-correcting without the need for protection since higher demand is likely to push

up wages in foreign firms

o Also higher wages paid in domestic firms may be offset by higher productivity

6. Raising employment and improving the trade position –

o Protectionism would reduce imports hence increase domestic aggregate demand and

employment/wages

o There is a high risk of retaliation from foreign countries – Will then sell fewer exports

o Restricting imports of raw materials may harm domestic firms cost of production

Disadvantages of protectionism –

Lower choice

Higher prices

Inefficiency

Retaliation

IGCSE Economics Revision

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