resources are factors of production employed to … are factors of production employed to produce...
TRANSCRIPT
Resources
o Are factors of production employed to produce goods and services
o Examples:
Raw Materials
Capital (Machinery)
Labour
Land
Goods
o Tangible products
o Examples:
Fruits
Cars
Services
o Non-tangible products
o Examples:
Banking
Hairdressing
Free Goods
o Are any resources that are not scarce
Needs
o Good or service essential for living
o Examples:
Food
Clothes
Shelter
Air
Wants
o A good or service which people would like to have, but which is not essential for living
o Examples:
Cars
Televisions
Scarcity
o Inability to produce enough goods to satisfy all the wants of people as they are
unlimited
Opportunity Cost
o The real cost of choosing one thing over another
o Measures the benefit one could have had from the next best alternative that they have
gone without
Value Judgements
o Judgements based upon our own opinion
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Economy
o Is an area in which people make, or produce, goods and services
o Examples:
UK Economy
Economy of Europe
Production
o Involves the making and selling of goods and services to satisfy people's wants
Producers
o People who make and sell goods and services
Consumption
o The using up of goods and services to satisfy our wants
Consumers
o People who buy goods and services to satisfy their wants
Consumption Expenditure
o Consumer spending
Market
o Is a group of people who wish to exchange goods and services with each other
Perfect Market
o Where no one producer or consumer alone can influence the price charged for a good
or service
Imperfect Market
o Where perhaps a powerful producer or powerful consumer can affect the price charged
for goods and services to their own advantage
Factors of Production
o Scarce resources available for use in the production of goods and services to satisfy
wants
o Examples:
Land
Natural Resources
o Coal
o Oil
Labour
Human Resources
o Provide physical and mental effort to make goods and services
Enterprise
Business know-how, or the ability to run a production process
Capital
Man-Made Resources
o Machinery
Entrepreneurs
o People who have enterprise and can control and manage firms
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o They are the people who take risks and decisions necessary to make a firm run
successfully
Durable Goods
o Goods that last for a long time
o Examples:
Cars
Non-Durable Goods
o Good which have a short life
o Examples:
Food
Consumer Goods
o Any good that satisfies the consumers' wants
o Examples:
Food
Consumer Services
o Any service which satisfies the consumer's wants
o Examples:
Health Insurance
Capital Goods
o Man-made resources which help to produce other goods and services
o Examples:
Tractor
Capital Services
o Any service which helps other firms to produce more goods and services
o Examples:
Technicians
Public Goods
o Goods and services provided by the government because everyone benefits from them,
even if they do not pay for them
o No private firm would produce them as nobody would pay for their use
o Are non-diminishable, non-excludable and non-divisible
o Examples:
Lighthouse
Police
Merit Goods
o Any good deemed beneficial by society
o Examples:
Education
Healthcare
Demerit Goods
o Any good deemed harmful to society
o Examples:
Cigarettes
Investment
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o Buying of capital goods
Transfer Earnings
o How much a factor of production could earn in its next best use
Economic Rent
o Is the amount of money that a factor earns over and above its transfer earnings
Rent of Ability
o The cost of employing a factor
Private Wealth
o Consists of a stock of goods which has a money value
o Examples:
Cars
Houses
o Entrepreneur's stock of wealth includes:
Land
Factories
Machines
o Includes people's savings in:
Banks
Building societies
Other financial institutions
Social Wealth
o Consists of assets owned by the government for the benefit of the general public
o Examples:
Hospitals
Roads
Schools
National Wealth
o Social Wealth + Private Wealth
o Is the total amount of wealth owned by the general public
o Includes wealth, in and out of the country, of entrepreneurs and the government
Earned Income
o Is money paid to people for the work they do
o Example:
Wage
Salary
Unearned Income
o Is money gained from owning assets or wealth
o Money for which no work has to be done
o Examples:
Interest from banks
Gifts of money
Gross Domestic Product (GDP)
o Measures the total value of output or income of the economy
o Measure of the national income of an economy
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Private Sector
o Made up of all the businesses and owned by ordinary members of the general public
o Also consists of private households in which people live
Public Sector
o Owned and controlled by a government
o Consists of government businesses and firms, and goods and services provided by the
government
o Example:
National Health Service
Public parks
Mixed Economy
o Economy that consists of a private and a public sector
Normative Statement
o Is an opinion, and may be bias
Positive Statement
o Is a fact, and does not include any opinions
Resource Allocation
o Choosing what to produce and finding out how much land, labour and capital is needed
to produce these things
Economic System
o How a country decides to choose what to produce, how to produce and for whom to
produce
Market Economy
o Also known as a market economic system or a free market system
o All resources are privately owned by people and firms
o Every business will aim to make as much profit as possible
This can be done by moving scarce resources away from producing products
that people will not buy to products that people will buy
o Firms will move out of markets that are shrinking as people are buying less
o Firms will move into markets which are expanding as people are buying more o
What is produced depends on what consumers want and are willing to pay for
o Firms will produce in the cheapest possible way as to make the most profit
o Only those who have enough money to buy these goods and services are able to enjoy
them
o Advantages:
Responds quickly to people's wants
Produces a wide variety of goods and services to meet consumer's wants
Encourages the use of new and better methods and machines to produce goods
and services
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Relies on producers and consumers to decide what, how and for whom to
produce and so there is no need to go to the expense of employing a group of
people to take these decisions
Incentives include profit, job security for workers and self interest
o Disadvantages
Factors of production will be employed only if it is profitable to do so
Can fail to provide certain goods and services
May encourage the consumption of harmful goods
Social effects of production may be ignored
Allocates more goods and services to those consumers who have more money
than others
Mixed Economy
o Combines government planning with the use of the free market
o People in the private sector own scarce resources with the aim of making as much
money as possible
o Public sector own scarce resources to produce goods and services that they think their
country, and its people, need and want
o Advantages:
Less unemployment than market economy, as the government may be able to
create jobs for those people who are out of work by employing them in their
own factories or by helping private firms to provide jobs
Provides public goods such as street lights, defence, law and order etc. which
would not be provided in a market economy. They can pay for this by taxing
people's income and spending. In addition, merit goods may be provided
The government may be able to stop or limit consumption of harmful goods
such as drugs buy making them illegal or placing high taxes
The government may be able to stop firms from polluting the environment by
placing high taxes or fines on them
May be able to provide the poorer people who are unable to afford the
products with goods and service, or more money. For example, the government
could provide free health care for the unemployed
o Disadvantages:
Requires large government expenditure which will be mustered through raising
taxes on people and firms discouraging them from working hard as they are
losing a large part of their income
Planned Economy
o When the government plans what they will produce, how they will produce and for
whom they will produce all goods and services
o Do not aim to produce what is profitable
o Produce what the government wants
o Government owns all factors of production
o Incentives for workers are wage differentials, accolades etc.
o Advantages:
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Full employment because government owns all factors of production and they
can create jobs for all people
Provide merit goods
Do not provide demerit goods
As the aim is not to make a profit, prices are very low increasing the standard of
living
As there is a fair distribution of goods and services previously poor people
increase their standard of living
Pollution of environment can easily be stopped
o Disadvantages:
At low prices, there is high demand, but low supply, creating shortages
Consumers do not get what they demand
Lacks innovation as only goods and service that the government wants are
produced
As the aim is not to make a profit, prices are very low increasing the standard of
living previously rich people decrease their standard of living
Poor quality as firms were not required to make a profit
Government needs to provide information to all the firms
Leads to a limited range of goods and services
Less Developed Country
o Nations with problems
o Are becoming a little more prosperous
o Low GDP per head - low average income per person per year
o High infant mortality - many babies out of every thousand die every year
o High adult illiteracy - high percentage of people are unable to read
o Reasons:
High population growth
Available goods and services have to be shared among more and more
people
Dependant on the production and sale of agricultural products
Developing countries produce natural resources which are sold to
developed countries at low prices
Developed countries produce manufactured products which are sold to
developing countries at high prices
Poor infrastructure
Poor transport and communication networks
Lack of capital
Because current profit is being used on basic needs such as food and
shelter, there is no money to buy capital goods
Without capital goods, production will never be able to compete in the
global market
o Cures:
Self Help
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Invest in new roads, transport networks, systems of communication,
power stations and machinery
Foreign Aid
Food Aid
o Developed countries may have surplus food which they donate
to developing countries
This may not benefit the country as the demand for
goods produced by farmers will fall reducing production
and causing the country to rely on food aid
Financial Aid
o Developed countries may give money to developing countries
This may come with strings attached such as spending it
on a particular project
Technological Aid
o Developed countries may help developing countries by
improving their technology such as introducing agricultural
machinery
Requires training to use which may not be available
May reduce employment in countries with high
unemployment
Should be simple such as advising farmers how to grow
crops efficiently using labour
This helps utilise abundant resources; people
Borrowing
Developing countries may borrow large sums from developed countries
to initialise their development
o However, they may not be able to pay it back later
Trade Developing countries should start to produce manufactured products as
their market price is higher
o However, developed countries may not purchase their products
in fear of increasing unemployment in their countries
o Except, if developing countries run into money, they may
purchase goods produced by developed countries reducing
unemployment
Population Control
Developing countries have high populations
High populations means that the resources are divided by more people
o Therefore, each person gets fewer resources
Developed Country
o Well developed road and rail networks
o Modern farms, modern firms producing a large variety of goods and services
o High GDP per head - high average income per person per year
o Low infant mortality - few babies out of every thousand die every year
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o Low adult illiteracy - low percentage of people are unable to read
Overpopulation
o Too few resources to be shared among a large and ever-growing population
Price Mechanism
o High prices tell firms what people want, and what product will make the most profit
o Low prices tell firms what people do not want to buy, and hence, to move their
resources into the production of something more profitable
Market Forces
o Profit motive of firms and changing preferences of consumers determine the allocation
of resources
Commodities
o Goods and services produced in order to satisfy people's wants
Inputs
o Land, labour and capital
Outputs
o Goods and services
Aims of firms
o Maximising profits
o Providing a public service
o Providing a charity
o Non-profit-making organizations
E.g. local clubs
Profit
o When total revenue is greater than total cost
Loss
o When total revenue is less than total cost
Pure Profit
o Total revenue over and above all cost, including opportunity cost
Primary Industry
o Also called extractive industries
o Includes the extraction and collection of raw materials
o Examples:
Mining
Forestry
Farming
Secondary Industry
o Also called manufacturing industry
o The use of raw materials to make other goods
o Examples:
Car manufacturing
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Computer manufacturing
Tertiary Industry
o Mainly consist of services
o Include the selling of goods to the consumer
o Examples:
Banking
Hospitals
Specialization
o Concentration on doing one specific task in the production process
Self-Sufficient
o Each person produces all the things they need and want for themselves
Division of Labour
o Where each worker specializes in doing a particular task rather than being a 'Jack of all
trades'
o Advantages:
More goods and services can be produced
Repetition of the same operation increases skill and speed of the worker
Full use is made of everyone's abilities
People will get to do those things which they are best and which
interest them the most
Time is saved
Switching from different production processes is time consuming
Training someone to understand the complete production process is
time consuming whereas teaching them how to complete one task is
easy
Allows use of machinery
Specialist tasks can be completed faster with less human effort with the
use of machinery
o However, machines may take over the jobs of many
Products are all the same
May be useful when selling raw materials
o Disadvantages
Work may become boring
Doing the same task every day may become boring
Workers may feel alienated
Workers feel unimportant because they can no longer see the final
result of their efforts
People become too dependent upon each other
The incompetency of the primary industry may affect the secondary
industry as they lack raw materials
If one worker in a firm skips work, the whole production process might
stop
Products are all the same
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May be bad in the fashion industry
Standardized
o Out in vast numbers and share the same design
Mass Production
o A production process that aims to use the fewest workers to produce the greatest
number of goods, which may often run into millions of articles, at the lowest cost
possible
Momentary Run
o The period of time during which a firm will not be able to increase production
o This will be no longer than a day
Short Run
o The period of time during which a firm can increase production by employing more
labour because no more land or capital is available
o Labour is a variable factor of production
o Land and capital is fixed in supply
Long Run
o When a firm employs more of all the factors of production
Average Product
o Total Product ÷ Number of Workers
Total Product
o Total output of a firm
Marginal Product
o Change in Total Product ÷ Change in Number of Workers
Increasing Returns to Labour
o As labour increases, marginal output increases
Law of Diminishing Returns
o When land and capital are in fixed supply, extra units of labour are employed and
marginal output decrease
Scale of Production
o When a firm grows in size and more machines and factory buildings are added to
produce more goods and services
Plant or Factory
o Located on one particular site to produce a particular good or service, or perhaps a
range of them
Firm
o A business unit that owns one or more plants
Industry
o Consists of a group of firms all producing similar goods and services for a particular
market
Total Cost
o Fixed Costs + Variable Costs
Fixed Costs
o Costs which do not vary with the number of products produced
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o Examples:
Rent and rates of land
Hire and machines
Heating and lighting
Repayment of bank loans
Variable Costs
o Cost that change with the number of products produced
o Examples:
Materials
Wages
Revenue
o Money earned from selling a product
Total Revenue
o Also known as turnover
o Price per Product * Number of Products Sold
Average Revenue
o Total Revenue ÷ Number of Products Sold
Break-Even Point of Production
o Number of products sold where no profit or loss is made
Average Cost
o Total Cost ÷ Number of Products Produced
Marginal Cost
o Change in Total Cost ÷ Change in Number of Products Produced
Depreciation
o Estimation of the wear and tear of capital equipment
o Is counted as a fixed cost
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Increasing Returns to Scale
o A firm that doubles all its inputs and more than doubles its outputs of goods or services
as a result
o Average cost decreases
Diminishing Returns to Scale
o A firm that doubles all it inputs but does not manage to double its outputs of goods and
services as a result
o Average cost increases
Constant Returns to Scale
o A firm that doubles all its inputs and double its outputs of goods and services as a result
o Average cost stays the same
Economies of Scale
o When a firms makes cost saving from increasing the scale of production by raising
output
o Average cost decreases
Diseconomies of Scale
o When a firm is producing too much and has become inefficient
o Average cost increases
Internal Economies of Scale
o Cost savings that result from a firm being large
o Examples:
Financial Economies
Cost savings that arise from the way large firms raise money
o Can raise money by selling stocks
o Can provide adequate collateral for loans through assets
o Can acquire low interest rates as they borrow larger loans and
because they pose low threat
Marketing Economies
Cost savings resulting from the way large firms sell their products
o Suppliers may sell materials at lower rates as large firms buy in
bulk
o Can employ specialist buyers to buy best quality materials o
Advertising costs get spread over more products reducing
average cost
Technical Economies
Cost savings resulting from the method in which production is used
o Can employ specialist staff to increase output
o Can employ better machinery to increase output
o Can afford research and develop new, faster methods of
production and new products
These costs get divided between a large amount of
products keeping average cost low
o Can use large types of transport as they transport large
amounts of goods
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Risk-Bearing Economies
Cost savings that result from the way in which firms try to reduce the
risk of a fall in demand for some of their products
o Are not dependant on one supplier as they are associated with a
large number of suppliers
o Can diversify into a large number of products to appeal to a
larger market segment
Can rely on sale of other products if demand for one
product falls
Internal Diseconomies of Scale
o Inefficiency due to a firm being too large
o Examples:
Management Diseconomies
Due to many departments and many departmental managers, decisions
will take a long time and there may be disagreements
Labour Diseconomies
Due to specialization, workers may become alienated or bored
o This makes them less co-operative and less attentive to their
work
Quality of products they produce suffers
External Economies of Scale
o Advantages in the form of lower average costs which a firm gains from the growth of
the industry
o Examples:
Skilled Labour
When firms are located near each other, they train local people in the
specific jobs, making them more skilled
o The large skilled force may benefit other firms entering the area
Ancillary firms
When many firms of the same industry are located in the same area,
firms supplying materials to this industry may benefit if they work in the
same area
o Transportation costs also decrease
Co-operation
When firms producing the same products locate together, they tend to
help each other even though they are competing with each other
o However, many firms locating together could cause traffic
congestions, pollution etc.
Diversification
o Producing a whole variety of products
Patent
o Disallows by law any other firm from copying an idea
Small Firm
Has a small share of a market
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It only produces and sells a small amount of a particular good or service
compared to what is produced and sold in total by other firms in the
same line of business
It is managed by its owners in a very personalized way
It is independent,
is not part of a large company
o Why firms stay small:
The size of the market may be small
If there are only few customers, then there is no need for a firm to be
large
o The market is local
It may be the only market in the area
Local monopoly
o A wide variety of goods and service are wanted
Products are not standardized and have many variations
Only small firms can do this
o Luxury items are highly priced
Market may be limited by price
Only a few people can afford this product
o People like personal service
Large firms have many customers and cannot provide
personal service
o A large firm requires component parts
Small firms may survive as they supply a part to a larger
firm
They cannot be copied by another firm if they
are protected by patent
Small firms can co-operate
Co-operations between small firms can lead them to set up jointly-
owned enterprises which allow them to enjoy many of the economies of
scale that large firms have
Government helps small firms
Government provide help to small firms because they are a key provider
of employment and innovation
o Business Link
Nationwide network providing affordable advice and
training to all businesses
o Loan Guarantee Scheme
Encourages banks and other financial institutions to
lend money for periods between two and ten years to
small business projects which they would normally find
too risky to lend to
o Enterprise Allowance
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Financial help and training is available to unemployed
people between 18 and 24 years of age who want to
start their own business
o Tax Measures
Small business making a profit of less than a certain
amount have to pay a lower interest rate
Nationalization
o Refers to the transfer of an industry from private to public ownership by passing of an
act of parliament forcing private owners to sell their shares to the government
o Governments do this:
To control natural monopolies
Monopolies might take advantage of their market power to charge high
prices to consumers
For safety
Some industries, such as nuclear energy, are thought to be too
dangerous to be controlled by private entrepreneurs
To protect employment
Some firms were nationalized because they faced closure as private
sector loss making organizations
o They could be currently employing many workers threatened
from facing redundancy
To maintain public service
Some industries needed by the people but not profitable to operate
would not be operated by private firms
By nationalizing the firm, the government can operate the firm and
incur the loss by using the tax payer's money
Privatization
o Involves private sector firms taking over public sector activities
The sale of public sector assets
This involves a government selling shares in the ownership of
government-owned industries to private firms and individuals
Joint ventures with private firms
This can involve public sector organisations and private firms working
together to supply a public service
Contracting out
This involves a government awarding contracts to private firms to
provide services it formerly provided
Removing barriers to competition
By allowing private firms to compete with public sector organisations
o Advantages:
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If these industries are forced to compete for profit, they will become more
competitive, improve product quality and lower prices
Instead of one supplier, customers can choose from a wide variety of suppliers
Raises revenue for the government which can be used to lower taxes
Private individuals can own shares in these organizations and vote on how they
should be run
o Disadvantages:
Individuals may cut services that are not profitable
If services are kept running, prices or fares may be increased
This will affect the citizens
Holding Company
o The company that buys up 50% of the shares in another company
Internal Growth
o Where the firm increases its own size by producing more under its existing structure of
management and control
Amalgamation
o Also known as Integration
o When firms join together to form a larger enterprise
o Two ways of amalgamation:
Take-Over
Also known as acquisition
When one company buys all or at least 50% of the shares in the
ownership of another company
o Alternatively, an entirely new company may be formed for the
sole purpose of buying up shares in the ownership of a number
of other companies
The company may be able to keep its own name and
management, but their overall policies are decided by
their holding company
Merger
When two or more firms agree to join to form a new enterprise
o This is usually done by shareholders of the two companies
exchanging their shares for new shares in the new company
o Types of integration:
Horizontal Integration
This happens when the firms engages in the production of the same
type of good or service combined
o Forms a very large firm that may dominate the market
Vertical Integration
When firms engaged in different stages of production combine
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o Forward Integration
When a firm integrates with a firm that they supply to
o Backward Integration
When a firm integrates with a firm that supplies to
them
Normal Goods
Lateral Integration
When firms in the same stage of production, for example, primary or
secondary production, but producing different products combine
o Often termed conglomerate merger
Reduces risk of a fall in demand for one of their
products
o Goods that people would cut down on with a decrease in their income
o This includes luxury goods
Inferior Goods
o Goods that people would not buy after an increase in their income
This is because they can now buy normal or luxury goods
Complementary Goods
o Goods and services that consumers want together or which are jointly demanded
o Examples:
Bread and butter
Substitute Goods
o When the purchase of a good or service can replace the want for another good or
service
o Examples:
Tea or coffee
Haagen-Dazs or Baskin Robins
Utility
o Satisfaction of wants by buying goods and services
Subsidy
o Grants or loans offered by the government to producers to lower their costs, boost their
profits and increase supply
o This may be given to firms because:
They are working in a deprived area
This helps the government
o As it increases the population through increase in labour o
By bringing opportunities to the people living in that area o
By offering commodities in an area that does not have it
They are developing new technology or products
Indirect Taxes
o Taxes placed on goods and services
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Ceteris Paribus
o All other things remain unchanged
Demand
o Is the want or willingness of consumers to buy goods and services
Quantity Demanded
o Amount of a good or service consumers are willing and able to buy at each and every
price
Individual Demand
o Is the demand of just one consumer
Market Demand
o Is the demand is the total demand for a product from all its consumers
Extension of Demand
o Also known as increase in quantity demanded
o Refers to the way in which demand changes with a fall in price, with no change in any
other factor that could affect demand
Contraction of Demand
o Also known as decrease in quantity demanded
o Refers to the way in which demand changes when price rises, with no change in any
other factor that may affect demand
Marginal Utility
o The extra utility gained from the consumption of one more product
o Generally accepted, that for most people, marginal utility goes down as their
consumption of any good increases
Law of Diminishing Marginal Utility
o The more of a commodity they have, the less utility they get from consuming one more
of it
Increase in Demand
o Consumers now demand more at each and every price than they did before
Fall in Demand
o Consumers now demand less at each and every price than they did before
Shift In Demand
o Either a fall or increase in demand
o This happens due to:
Changes in people's income
The more money people have, the more they can buy
Changes in income taxes
The higher the tax, the less money people have, the less they can spend
Changes in the population
The more the number of people in an area, the more demand
Changes in price of other goods
If the cost of a complementary good goes up;
o The less complementary goods are bought
Less of the first good is bought
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If the cost of a substitute good goes down;
o More of the substitute goods are bought
Less of the first good is bought
Changes in tastes and fashion
The demand for goods and services can change dramatically because of
the changing tastes of consumers and fashion
Advertising
Carefully-planned advertising campaigns cause consumers to buy more
of a product
Weather
During different seasons, different products are bought
Interest Rates
Higher interest rates cause people to save more and spend less
Price Expectation
If the price of a product is predicted to rise, more of the good is supplied
Number of Suppliers
As the number of suppliers increase, the number of goods and services
supplied increases
Supply
o Refers to the amount of a good or service firms or producers are willing to make and sell
at a number of possible prices
Quantity Supplied
o The amount of a good or service producers are willing and able t make and sell to
consumers in the market
Market Supply
o The supply of all the individual producers competing to supply a commodity
Extension of Supply
o Refers to how supply changes with a rise in the price of a commodity, given that no
other factor affecting supply changes
Contraction of Supply
o Refers to how supply changes with a fall in the price of a commodity, without a change
in any other factor that may affect supply
Increase in supply
o Producers are now more willing and able to supply than they were before
Fall in Supply
o Producers are now less willing and able to supply a commodity at each and every price
than they were before
Shift in Supply
o Either a fall or increase in supply
o This happens due to:
Changes in prices of other commodities
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If the market price of one product rises, producers may allocate their
resources into producing that product causing a fall in demand for the
product they were previously producing
Market Price
Changes in the costs of factors of production
An increase in the cost of capital or land or an increase in wages will
raise cost of production
o Therefore, producers may not be willing to supply a commodity
at the same market price
Technical progress
Improvements in the performance of machinery, labour, production
methods, management control, quality etc. allows more to be produced
at the same cost
o Average cost decreases
Allowing producers to supply more at each and every
quantity
Weather
Especially for primary industry, production varies with different seasons
Governments
They can influence supply by giving subsidies to producers
o The price at which the commodity will be sold at in the market
Excess Demand
o When quantity demanded is greater than quantity supplied
Excess Supply
o When quantity supplied is greater than quantity demanded
Equilibrium Price
o The price at which the amount supplied equals or satisfies the amount demanded
Disequilibrium Price
o When demand does not equal supply
Price Mechanism
o The forces of demand and supply establish the market price of a commodity
Price Elasticity of Demand
o The responsiveness of quantity demanded given a change in the price of a good or
service
o (% change in quantity demanded) ÷ (% change in price)
Less than -1,
Demand is price elastic
Greater than -1,
Demand is price inelastic
Demand is Price Elastic
o When a small change in the price of a product causes a substantial change in quantity
demanded
Demand is Price Inelastic
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o When a change in the price of a product causes a small change in the quantity
demanded
Change in Quantity Demanded
o [(New quantity demanded - Original quantity demanded) ÷ Original quantity
demanded] * 100%
Change in Price
o [(New price - Original price) ÷ Original price] * 100%
Price Elasticity affects Total Revenue
o If a product is price elastic,
And prices are increased,
revenue will decrease
And prices are decreased,
revenue will increase
o If a product is price inelastic,
And prices are increased,
revenue will increase
And prices are decreased,
revenue will decrease
Factors affecting Price Elasticity of Demand
o Number of Substitutes
If consumers have a large variety to choose from, then if any firm increases their
price, they can easily switch to another firm's product
Demand is price elastic
o The Period of Time
If price of a product increases, consumers will look for substitutes
The longer they have, the more likely they are to finding a substitute
o Demand is price elastic in the long run
o The Proportion of Income Spent on a Commodity
If the cost of a product is a small proportion of a person's income, a small rise in
the price will not cause the person to look for a substitute
Demand is price inelastic
Demand is Perfectly Price Inelastic
o If a rise or fall in the price of a commodity causes no change in the quantity demanded
of that commodity
Price Elasticity of Demand = 0
Demand is Infinitely Price Elastic
o If a commodity is demanded at one particular price.
o A small change in price will cause quantity demanded to fall to zero
Quantity demanded will change by and infinite amount
Demand is Price Unit Elastic
o A percent change in the price of a commodity will cause an equal percentage change in
the quantity demanded
Income Elasticity of Demand
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o How much a change in income causes the quantity demanded of a good or service to
change
o (% change in quantity demanded) ÷ (% change in income)
Positive numbers show;
The product is a normal good
Negative numbers show;
The product is an inferior good
Demand is Income Elastic
o When a small change in income causes a substantial change in quantity demanded
o Greater than 1
Demand is Income Inelastic
o When a change in income causes a small change in the quantity demanded
o Less than 1
Cross Elasticity of Demand
o Measures how much quantity demanded will rise or fall given a change in the price of
another product
o (% change in quantity demanded for good X) ÷ (% change in price for good Y)
If the number is positive
The products are substitute goods
o As an increase in price of one good will increase quantity
demanded for the other good
If the number is negative
The products are complementary goods
o As an increase in the price of one good will cause a decrease in
quantity demanded for the other good
Price Elasticity of Supply
o Measure of responsiveness of quantity supplied to a change in price
o (% change in quantity supplied) ÷ (% change in price)
Greater than 1,
Supply is price elastic
Less than 1,
Supply is price inelastic
Factors affecting Price Elasticity of Supply
o Time
Supply at one moment is fixed
At any single point of time, no more factors of production can be
employed
o Most producers cannot immediately supply more of a good or
service no matter what the market price is
Supply is perfectly price inelastic
Supply is price inelastic in the short run
In the short run, only more labour can be employed by overtime or
hiring more workers
o Supply can only be increased by a minimal amount
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Supply in the long run is price elastic
In the long run, firms can obtain more labour, land and capital
o Supply can be increased by a large amount
o The Availability of Resources
To expand production, a firm will need to employ more land, capital and labour.
However, if these resources are scarce, a firm cannot employ these resources
Supply of most goods and resources will be price inelastic
Supply is Perfectly Price Inelastic
o When the quantity supplied of a commodity remains the same whatever its price
o Price elasticity of supply is 0
Supply is Infinitely Price Elastic
o When producers are will to supply as much as they can at one particular price and
supply nothing at any other price
Supply is Price Unit Elastic
o A percent change in price will cause and equal percent change in quantity supplied
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Private Costs
o Costs incurred by an individual or firm when they carry out activities of production or
consumption
o Usually is the hire of machinery, buying of materials, payment of wages etc.
Private Benefits
o Benefits that an individual or firm receives when they carry out activities of production
or consumption
o Usually in the form of revenue
External Costs
o Also known as negative externalities o Are
disadvantageous to a third party
o Occurs when the actions of firms affect a third party
o Includes opportunity cost
External Benefits
o Also known as positive externalities
o Are advantageous to a third party
o Occurs when the actions of a firm benefit a third party
o Are free
No payment needs to be made by the people who receive them
Social Costs
o The total cost to society of an economic activity
o Private Costs + External Costs
Social Benefits
o The total increase in the welfare of society from an economic action
o Private Benefits + External Benefits
Commercial Return
o Profit
Uneconomic Use of Resources
o When social costs are greater than social benefits
o Society would be better off if the resources of land, labour and capital were used to
make something else
Economic Use of Resources
o When social benefits are greater than social costs
o Society would be better off if more resources were put into this use
Market Failure
o There is an uneconomic use of resources
Examples:
Smoking
o There is not enough economic use of resources
Examples:
Schools
Hospitals
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o Not enough public goods are supplied
o When there is imperfect competition
Due to:
Monopolies
Oligopolies
o Pollution
o Unequal income distribution
o Lack of Information
Government Interference into Market Failure
o Taxation
Tax may reduce consumption as less quantity is demanded at a higher price
Tax covers the damage caused by firms such as pollution
o Subsidies
Governments can produce external benefits that private firms would not as it
may not be profitable to do so
Are given to firms in order to encourage them to produce goods and services
that result in external benefits
Sometimes allows suppliers to provide it for free
o Nationalization
By taking over the ownership and running of a whole industry, a government
can allow nationalized industries to act in the public interest, and take account
of any external costs and benefits they cause
o Legal Action
A government can pass laws in order to control firms creating external costs
o Advertising
The government could advertise negative externalities of a product to reduce
consumption
Demand for good falls
Cost Benefit Analysis
o Comparing costs and benefits
o Valuing external costs and benefits
o Coming to a conclusion to see whether a firm is an economic use of resources or an
economic use of resources
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Price Competition
o When firms reduce the price of their products below the price of competing firms
Non-Price Competition
o When firms create a want for their products by advertising or by offering free gifts,
favourable credit terms, quality, loyalty schemes, differentiation, promotion etc.
Cartel
o Price fixing ring of firms
Barriers to Entry or Exit
o When firms cannot freely enter or leave the industry if they wish
Natural Barriers to Entry
o Control of Supply
A firm may own most or all of the supply of raw materials
o Economies of Scale
Larger firms may be able to produce the product at a much lower average cost
as they utilise economies of scale
o Expense
Some industries may require a large amount of capital before starting a firm
o Legal Considerations
When laws have been passed to make it illegal for other firms to start up in the
same industry
This may happen if a firm produces a new product and prevents other
firms from copying it through patent
Artificial Barriers to Entry
o Restrictions on Supply
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Monopolies may threaten their supplier that if they supply to any new firm, the
monopoly will take its custom to another supplier
o Predatory Pricing
When a large firm cuts its price, even if this means losing money in the short
run, in order to force new and smaller competing firms out of business
o Exclusive Dealing
Refusing to sell to shops that stock other firms' brands of a similar product
If monopolists produce well-known and popular goods and services, it gives
them the power to threaten the firms selling its products
Normal Profit
o When profits are at a level just high enough to keep existing firms in the industry, but
not high enough to attract any new firms in search of high profits
Natural Monopoly
o When one large firms can produce and sell all of a particular product required in the
market at a lower average cost per product than a number of small firms put together
Market Structures
o The way that suppliers and demanders in an industry interact to determine price and
quantity
o Examples:
Perfect Competition
Monopoly
Monopolistic Competition
Oligopoly
o How they differentiate
Ease of entry
Forms of competition
Uniformity across firms
Perfect Competition
o Suggests that the perfect or best use of resources is being made by firms in markets
where they face many competing firms
o Characteristics
Homogenous Product
All firms produce the same product
Price Takers
Have to accept the market price
o When no single buyer or seller can buy or sell enough to
influence the price the product is sold at
Perfect Information
All buyers will know about the prices and products on sale, and all seller
have all the information on the latest production techniques
Freedom of Entry and Exit
No barriers to entry or exit
Normal Profits in the Long Run
Abnormal profit in the short run
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o However, other firms enter the market to steal abnormal profit
o How does it make best use of scarce resources:
Low prices
Prices to consumers are as low as possible to attract their custom
Efficiency
Only the best firms making the best value-for-money products will
survive
o Firms using scarce resources to produce poor-quality resources
will be forced out of business so that their resources can be
better used elsewhere
Consumer Sovereignty
Consumers get what they want
o Disadvantages:
Difficult to achieve
Less variety
Monopoly
o Opposite extreme to perfect competition
o In UK, it is when a firm owns 40% or more of the market share in an industry
o Pure Monopoly
Is when a firm is the only supplier of a particular food or service
o Characteristics
No competition
As it is the only supplier, it faces no competition
Abnormal Profits
When a firms earns profits, way above the profits a firm could earn
producing another product in a different market
Barriers to Entry
Are created by monopolist to prevent new firms from entering their
market and taking some of their abnormal profits
o Natural Barriers:
Control of supply
Economies of scale
Expenses
Patent
o Artificial Barriers:
Restrictions on supply
Predatory pricing
Exclusive dealing
Imperfect Information
Suppliers may charge different amounts to different customers
Non-Homogenous Products
Monopolists produce different varieties of their product in order to
make it difficult for other firms to copy them
o Advantages
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Economies of Scale and Natural Monopolies
It is more efficient for one large firm to be the only supplier in the
market, as average costs of production will continue to fall as output
increases
Research and Development
Monopolies may find it worthwhile to spend money on the research and
development of new products and techniques, because it knows that it
can earn high profits and keep these by using barriers to entry to stop
new firms from competing with them and using their ideas
Lower Prices
Due to economies of scale, a monopolist can supply a product at lower
prices as there is a lower average cost
The Ability to Compete in Global Markets
Some firms need to be large so that they have the financial,
technological and marketing resources they need to compete against
huge overseas firms
o Disadvantages
Poor Levels of Service
Firms do not have to worry about losing their customers to other firms
o Less incentive for innovation
Low Output and High Prices
Can charge a high price for their products by restricting supply of their
products in order to force up their market price
Producer Sovereignty
When the producer has control over the use of scarce resources
Monopoly will decide what goods and services to produce for
consumers
Oligopoly
o Where a handful of large companies are able to control the supply of a commodity to a
market
o When 4 to 8 firms own 40% or more of the market share
o Pricing Strategies
Price wars
Predatory pricing
Price leadership
Price collusion
Same price but compete using non-price competition
o Non-Price Competition
Quality
Promotions
Image
Differentiation
Loyalty schemes
Credit terms
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Advertising
o Benefits
Economies of scale
Research and development
Compete in global markets
o Disadvantages
Cut supply to increase price
Monopolistic Competition
o Where the amount of competition is more than under monopoly but less than under
perfect competition
More choice
o Goods are supplied by many different firms
o Product differentiation
Where there are lots of similar goods with slight differences between them
o New firms are free to enter and exit the market
New firms each enter the market as a monopoly in its particular product
There is still lots of competition
o Compete through advertising
This can create a brand name or brand image
o Pricing Strategies
Price wars
Penetration pricing
Expansion pricing
o Non-Price Competition
Promotions
Loyalty schemes
After-sales care
Differentiation
Branding
o Achieved by differences in design and packaging of products as well as in the creation of
brand names and trade marks
Informative Advertising
o Advertisements which give information to the public
o Increases consumer choice by making them more aware of the range of goods and
services available to them
Persuasive Advertising
o Designed to create a want for a product that consumers would not necessarily buy
Control of Monopoly
o Prohibition
Monopolies can be banned or forced to break up
o Regulation
Government can pass laws to make sure it acts in the public interest
o Imposition of Fines
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Can be imposed on firms who are thought to be abusing their market power and
overcharging consumers
o Nationalization
Competition Authorities in UK
o The Office of Fair Trading
Government Agency that watches and investigates the conduct of trade and
protects the consumer against unfair or restrictive practices
o The Competition Commission
Has the ability to ban behaviour which damages the interest of consumers or
which abuses monopoly power
o Industry Regulators
Regulate prices and services quality in these industries because the private
sector firms have considerable regional and national market power over the
supply of their products
o The European Commission
Has the power to investigate and take action against companies thought to be
operating anti-competitiveness practices in more than one European Union
member country
Wages
o Price of labour
Labour Market
o Exists when there is a supply of labour and a demand a labour
o Examples:
Local, National or International
Computer programmers, bricklayers, mechanical engineers, hair stylists etc.
Marginal Revenue Product of Labour
o Value of the worker to the firm determined by the addition to output
Real Wages
o Wages adjusted for inflation
What Determines Demand for Labour
o Is a derived demand
Labour is not demanded for itself, but is demanded to make the goods and
services that consumers want
If consumers demand more goods and services, more labour is demanded to
produce these
o Quantity of labour demanded depends on the wage rate
A profit maximizing firm will only employ a worker if the value of output added
by the worker is greater than, or equal to, the cost of thee worker or the wage
o Quantity of labour demanded depends upon technology
As technology improves
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Demand for some jobs decreases
o Example:
Introduction of word processors reduces the demand
for typists
Demand for some jobs increases
o Example:
Introduction of word processors increases the demand
for computer service engineers
If the wage for workers is too expensive,
A firm will substitute the workers with capital
If the wage for workers is reduced
A firm will employ less capital and more workers
Changes in the Demand for Labour
o If consumers demand more goods and services, more labour is demanded to produce
these
Demand for labour increases at every wage possible
Working Population
o Made up of all the people who are employees, the self-employed and the unemployed
o Made up of all the people who are both able and willing to work in the country
Why Labour Supply Increased
o Real Wages
Wages have grown faster than prices
o Larger Population
More teenagers entering the labour force due to baby boom
Fewer people retire at the age of sixty
o Change in Social Attitude
More women have joined the working force
How Many Hours will an Individual Work
At low wage rates, individual may work for a limited number of hours
At high wage rates, individuals may work for a more number of hours
At very high wage rates, individuals may not work for as many hours
He may get both, more income and more leisure
o More time to enjoy the money
o Hence the curve is backward bending
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What Determines Supply for Labour
Wages
The higher the wage rate, the more people that are willing to work
o Net Advantages
Promotion Prospects
Job Satisfaction
Job Security
What one thinks about the job
Fringe Benefits/Perks
Free life insurance
Company cars
Changes in the Supply for Labour
o Net Advantages
Promotion Prospects
Job Satisfaction
Job Security
What one thinks about the job
Fringe Benefits/Perks
Free life insurance
Company cars
o Supply for labour increases at every wage possible if the net advantages are better
Wage Rate
o When workers are paid an hourly rate and work a fixed a fixed number of hours each
week
Salary
o When workers are paid a fixed amount each month, regardless of the hours they work
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Piece-Rate Working
o Where workers get a fixed amount of money for each unit of output the produce
Quality may be compromised
Wage Differentials Between Jobs
o Differences in wages between different jobs
This is due to :
Different Abilities and Qualifications
o Workers do not all have the same education, training and ability
o If all workers were paid the same amount, very few people
would be willing to undertake the many years of study
People with skills that are in very short supply relative
to the demand for those skills will tend to be offered
high wages
'Dirty' Jobs and Unsociable Hours
o Some jobs may be very dangerous or dirty
Example:
Trash collector
o Some jobs tend to have night shifts
Satisfaction
o Some jobs are thought by some people to give a lot of
satisfaction
People would do them without very high pay
Example:
o Nursing
Lack of Information about Jobs and Wages
o Workers work for less than they could earn simply because they
do not know about better-paid jobs elsewhere
Immobility
o Some people may not be willing to leave their families and
friends and move to a place with a better salary
o Some people be willing to move to a place with a better salary
but may not be able to afford a new house in that area
Fringe Benefits
o Some jobs may offer lower wages than others because they
offer more perks
Labour Force Mobility
o The ease with which workers can move between jobs and different parts of the country
Why People in the Same Job Earn Different Amounts
o Shortage of Workers
There may be a shortage of particular types of workers in parts of the country
Employers will pay more to skilled labour in order to attract a greater
supply of skilled workers
o Length of Service
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Many firms have salary scales that automatically add to worker's pay, the longer
they have worked for the firm
The payment is for having more experience and skill
o Local Pay Agreements
Some workers may have different arrangements around the country
Example:
o A worker might promise to never go on strike for extra pay
Productivity
o Refers to the amount of output that can be produced from a given input of resources
o Output per worker
How Best to Combine Factors of Production Depends on
o The nature of the product
Products that are high in demand will tend to be mass produced using a large
input of automated machinery
o The relative prices of labour and capital
If wages are high, a firm may decide to use more capital instead of labour
o The size of firms
As a firm grows in size, it tends to employ more capital relative to labour
Labour Productivity
o Can be calculated by dividing total output in a given period of time by the number of
workers employed
Average Product of Labour
o Total Output ÷ Number of Employees
o Is a useful measure of how efficient workers are
o Tells us nothing about the quality of work
Why Firms Want to Raise Productivity
o If the same amount of labour, land and capital employed can produce more output for
the same total cost, then the cost of each unit of output will have fallen
How can Firms Raise the Productivity of Labour
o Training workers to improve their existing skills and learn new skills
o Rewarding increase productivity with performance-related pay and bonus payments
o Encouraging employees to buy shares in their organization
Improved productivity will help raise profits and give them better dividends
o Improve Job Satisfaction
By improving the working environment, making jobs more interesting, team
working, involving workers in business decision making and giving regular
feedback on performance
o Replacing old plant and machinery with new, more efficient machines and tools for
workers to use
o Introducing new production processes and working practices designed to reduce waste,
improve quality and increase output
Trade Union
o Is an organization that represents the interests of workers in negotiations about
improving wages and working conditions with employers and government
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o Types of trade union
General Unions
Represent workers from many different occupations and industries
Industrial Unions
Represent workers in the same industry
Craft Unions
Represent workers with the same skill across several industries
Non-Manual Unions and Staff Associations
Represent workers in professional and commercial jobs
Collective Bargaining
o Negotiations about wages of many workers between worker and employer
representatives
How Trade Unions Influence Wages
o Can raise their members' wages by restricting the supply or demand for labour by
Negotiating a single union agreement with an employer
This means that one union will represent all the workers in a particular
place of work
o Employers benefit as they have to negotiate working conditions
and wages with only one union rather than many
Restricting their membership to only those who have served long
apprenticeships and undertaken a long period of training to develop their skills
o May try to raise wages by agreeing to improve productivity
Macroeconomics
o Involves the study of the 'economy as a whole'
Microeconomics
o Examines the economic behaviour of individual consumers, households and businesses
and how individual markets work
Government Objectives
o Low and stable inflation
To achieve a low and stable rate of inflation in the general level of prices
o Low unemployment
To achieve a high and stable level of employment, and therefore a low level of
unemployment
o Economic growth
To encourage economic growth in the national output and income
o Healthy balance of payments on current account
To encourage trade and secure favourable balance of international transactions
o Equal distribution of wealth
To reduce poverty and reduce inequalities in income and wealth
o Protection of the environment
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To reduce pollution and waste, and therefore encourage more sustainable
economic growth
Aggregate Demand
o Total expenditure in a macroeconomy
o C + I + G + (x-m)
Consumption + Investment + Government Spending + (Exports - Imports)
Consumer's expenditure on goods and services
Investment expenditure by firms on new plants and machinery
Government expenditure on goods and services
Spending from overseas on exports of goods and services from the
economy
Aggregate Supply
o All the goods and services supplied in an economy
Demand-Side Policies
o Try to influence the level of aggregate demand in an economy using a number of policy
instruments
The overall level of taxation
The total amount of government expenditure
The rate of interest
o These are effective because;
The amount consumers have to spend on goods and services depends on their
level of disposable income after income taxes have been deducted
Taxes on profits affect the amount of money firms have to spend
As interest rates rise, consumers may save more and/or borrow less to spend on
consumer goods and services
Similarly, firms may cut their borrowing for new investment
A rising interest rate may attract more investment to the economy from
overseas
This will increase demand for the national currency and push up its
exchange rate
o A higher exchange rate will reduce the price at which exports
are sold overseas and help to boost international demand for
them
Governments often spend a significant amount of money each year on goods
and services
`This includes current expenditure on public sector wages and social security
benefits, and capital expenditure on investments in new infrastructure such as
roads, sea defences and public hospitals
Increasing these government expenditures can boost total demand and,
therefore, stimulate higher output and employment in an economy
Fiscal Policy
o Demand-side policy
o Involves changing the level of public spending and/or taxation to affect the level of
aggregate demand
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Expansionary fiscal policy
Usually means running or increasing a budget deficit
Increases public expenditure and/or lowers taxes
Contractionary fiscal policy
Aims to reduce the pressure on prices in the economy by cutting
aggregate demand thorough reductions in government spending and/or
by raising taxes
o Can be used to influence prices, output and employment
Inflation is cause by too much aggregate demand
Unemployment is caused by lack of demand
o Problems
Fiscal policy is cumbersome to use
It is difficult for a government to know precisely when and by how much
to expand public spending or cut taxes in a recession, or cut spending
and raise taxes during a boom
Public spending crowds out private spending
To finance and increase in public spending and/or cut in taxation, a
government may borrow the money from the private sector
Crowding out
o The more money the private sector lends to a government, the
less it has available to spend itself
Raises taxes on incomes and profits reduces work incentives, employment and
economic growth
If taxes are too high, people and firms may not work as hard
This reduces productivity, output and profits
As productivity falls, firms' costs increase and they are less able to
compete on product price and quality against more efficient firms
overseas
As a result, demand for their goods and services may fall and
unemployment may rise
Expansionary fiscal policy increases expectations of inflation
As a result, people will push for higher wages to protect them from
higher prices in the future
Rising wages increases production costs and reduces the demand for
labour
Monetary Policy
o Demand-side policy
o Refers to actions taken by a government to try to control either the supply of money in
an economy or the price of money
o Involves influencing the supply of money and interest rates to control the level of
inflation, unemployment, economic growth and the exchange rate
Growth in the money supply can cause inflation
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If the supply of money increases, people will have more to spend on
foods and services
If the output of goods and services available doesn't not rise as fast as
the money supply, the increase in demand will cause demand-pull
inflation
Changes in the interest rates cause changes in aggregate demand
If interest rates fall, people will find it cheaper to borrow, while other
will be less willing to save money and will spend it instead
o As interest rates fall, more people will want to spend money
Consumer expenditure and firms' investment in new machines and
building will rise
Increases aggregate demand helps to create jobs and reduces
unemployment
Increased investment helps to create economic growth as firms will be
able to price more output in total
Interest rates can be used to affect the exchange rate
Interest rates can be raised to help increase the value of the national
currency compared to other countries' currencies
Supply-Side Policies
o Are aimed at increasing economic growth by raising the productive potential of an
economy
o An increase in the aggregate supply of goods and services will require more labour and
other resources to be employed, help reduce pressure on prices, and provide more
goods and services available for export
o Supply-side policy instruments are aimed at reducing barriers to increased employment
and higher productivity in domestic and international markets, and at creating the right
incentives for firms and workers to increase their output
Tax incentives
Reducing taxes on wages and profits to increase the reward from work
and enterprise
High rates of tax on incomes may reduce incentives to work hard or
even seek paid employment
High rates of tax on profits can reduce entrepreneurs' incentives to start
new businesses, and invest in new products and production methods if
additional profits are highly taxed
Selective subsidies
Using subsidies to help firms fund research and development into new,
more efficient production processes and products
They can be used to help new businesses that might otherwise lack the
finance they need to start up, and to reduce the cost of investing in
research and development by existing firms in new production
methods, machines, materials and products
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Technological advance can increase the efficiency of production, lower
costs and create new markers for new products
Improving education and training
To teach existing and future workers new skills to make them more
productive at work
A government can assist firms by helping them design and finance
training programmes, funding universities and providing access for
more people to attend colleges and higher education
Labour market reforms
Such as minimum wage laws to incentivize people into work, and
legislation to curb the restrictive practices of some powerful trade
unions
Trade unions may use their power to force up the wages of members,
which may simply reduce the demand for labour and raise
unemployment
They may also resist attempts to introduce new, more efficient
production and working methods
Minimum wage laws protect low-paid workers from being exploited by
some employers, and also to encourage more people into work
Competition policy
Legislation to outlaw unfair and anti-competitive trading by large
powerful firms
Helps in stimulating competition, expanding output and lowering prices
Removing international trade barriers
To encourage more free trade between countries
Some goods may be produced much more efficiently and at a far lower
cost by firms overseas
o Governments usually tax imports or simply restrict their entry
into a country to protect their national firms producing the
same goods and services even if they do so at a higher cost
o By removing these barriers, countries can expand by selling to
many more consumers all over the world, and similarly those
countries which restricted free trade can then enjoy lower-
priced goods and services, and use their own resources more
efficiently to produce others
Deregulation
Removing old and unnecessary rules and regulations on business
The removal of such restrictions should help cut business costs, increase
competition and help firms increase output and lower prices
Privatization
The transfer of public sector activities to private sector firms
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The private sector will run the firm more efficiently as they have a profit
motive to do so, and therefore both consumers and the taxpayers will
benefit
Budget
o Refers to the amount a government has to spend each year relative to the amount of
revenue it raises from taxes
Budget deficit
When the government spending exceeds tax revenues
Budget surplus
When the tax revenues exceed government spending
Interest Rates
o Are the price of borrowing money or the reward for lending money
Public Expenditure
o Public sector spending
To provide public goods
As they are of great value to people and an economy
To provide merit goods
As the government and society thinks everyone should benefit from
them, whether they can afford to pay for them or not
To reduce inequalities and help vulnerable people
The public sector can provide a safety net for poor and vulnerable
people through the provision of:
o Social security benefits o
Low cost social housing
o Free healthcare o
Free bus passes
o Other welfare benefits
To invest in the economic infrastructure
As they benefit both individuals and firms and help economic growth
To support agriculture and industry
Grants and subsidies are often paid to farmers and owners of firms to
help them increase production and employment, invest in new plant
and machinery, and pay for new research and development
T control the macroeconomy
As a change in the amount of public expenditure or taxation can have a
big effect on the total level of demand in an economy and therefore on
the level of output, employment, price and national income
To give overseas aid
To help countries in need because they have suffered wars or natural
disaster such as droughts, earthquakes and tsunamis
Current Expenditure
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o Covers the day-to-day running expenses of the public sector
Public sector workers' wages and salaries
Social security benefits paid to the unemployed and those on low incomes
Spending on consumable goods such as medicines for public healthcare services
Paper, pens and electric power supplies for government offices
Capital Expenditure
o Involves government investment in new roads, school buildings, sea defences and
military defence equipment
Transfer Payments
o When large amounts of public expenditure is not spend by the government, but is given
to people in the form of cash benefits such as
Pensions
Unemployment insurance
Other social security payments
o People who receive these benefits can use the money to buy the goods and services
they need and want
o The government is simply transferring money collected through taxes from people in
work to those who are not able to be productive
Inflation
o Refers to a general and sustained rise in the level of prices of goods and services
o Prices of the vast majority of goods and services on sale to consumers just keep on rising
and rising
o Mainly due to consumers' spending increasing faster than suppliers can supply the
goods and services they demand
Hyperinflation
o Type of runaway inflation during which prices rise at phenomenal rates and money
becomes almost worthless
Stagflation
o Used to describe the situation when prices and unemployment rise together
Measuring Inflation
o Rate of inflation is measured by calculating the percentage price increase in goods and
services, usually over a year
Price Index
Shows percentage price rises
Base Year
First year
Is chosen when there is neither very low nor very high inflation, or any
extraordinary occurrences like wars or general strikes by workers which
can distort prices
o Method
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Average price of all the items selected in the base ear is given the number 100
By the end if the first year:
Price Index for the Second Year =
o 100 + Average Percent Rise in Price for the first year
By the end of the second year
Price Index for the Third Year =
o ((Average Percent Rise in Price for the Second Year ÷ 100) *
Price Index for the Second Year) + Price Index for the Second
Year
Thus, in the two years, prices have risen by:
Price Index for the Third Year - 100
Retail Price Index (RPI)
o Calculates the average price increase as a percentage for a basket of 600 different goods
and services
Weighting
o Measures how much a rise in the price of one good matters to people compared to
another
Example:
If food represents 18% of household's spending while tobacco
represents only 3% of household's spending
o Food price rises are given more importance in the RPI
This can be done by weighting the price rise on food six
times more than the price rise on tobacco
o As the pattern of consumer spending changes over time, the RPI will have to change the
weights it attaches to different commodities
RPIX
o Similar to the RPI, however, excludes changes in interest rates charged on money
loaned to buy flats, houses and business premises
o Is more accurate as:
RPI rises as mortgage rises even though prices of other goods and services is not
rising
May people do not have a mortgage to pay
Government Expanding Money Supply
o The government can allow the supply of money to rise in the economy by:
Issuing more notes and coins
Allowing the banking system to create more credit
o The government may expand the money supply:
To increase aggregate demand in the economy in an attempt to reduce
unemployment
In response to an increase in demand for goods and services from consumers
and firms
In response to workers demands for higher wages, or a rise in the other costs of
production
o The affects:
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As money supply expands, people will have more money to spend
This causes an increase in demand for the goods and services
o This cause the prices of goods and services to rise causing
inflation
With a fixed supply, prices must rise
Any increase in the supply of money will cause inflation
to accelerate if there is no growth in real output
Non-Accelerating Inflation Rate of Unemployment (NAIRU)
o Inflation depends on how near the economy is to NAIRU
If resources, such as labour, are unemployed and aggregate demand for goods
and services increases
The resources can be employed to raise output
o As firms increase their output to meet demand for goods and
services, prices will tend to rise very slowly over time
Economy is below its NAIRU
If resources, such as labour, are fully employed and aggregate demand for
goods and services increases
Firms will not be able to expand output as quickly
o Therefore, they will have to raise their prices instead and the
rate at which prices rise will tend to accelerate
Economy is above its NAIRU
Monetary Rule
o Only if the output of goods and services rises should the money supply rise so that
people have enough money to buy up these extra products
o Used by governments to keep inflation low and stable in the economy
Supply of money should only expand at the same rate as the increase in real
output or real GDP over time
Increases in money supply over and above increases in output simply
cause inflation to rise
o However this takes time:
It takes time for consumers' spending to rise, firms to
realize demand has increased, and for firms to raise
their prices
Demand-Pull Inflation
o Inflation caused by an increase in aggregate demand
Increase in aggregate demand can be financed by increasing the supply of
money in the economy
Cost-Push Inflation
o Inflation caused by higher costs feeding into higher prices
Examples:
Workers demand higher wages
Wage-Price Spiral
o As prices rise
Workers will want more wages so they can buy the more expensive products
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These higher wages add to firms' costs and so prices rise even further
o This prompts even higher wage demands
Cost Plus Profit Pricing
o When firms simply calculate how much it costs to produce a product and then add on a
mark-up for profit to obtain a price to sell it for
Imported Inflation
o Occurs when materials and finished goods and services, imported from overseas
increase in their prices
o Occurs when the value of a country's currency falls against foreign currencies
However, price paid for imported products falls if the country's currency rises
against foreign currencies
Purchasing Power
o The real income in terms of what it can buy
Real Income
o Income adjusted for inflation
o Measured by how much it buys
Money Income
o Also called nominal income
o A person's income in terms of money
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Personal Cost of Inflation
o Purchasing power of people's income reduces
o For people on fixed income, their real income and therefore living standards will fall o
For professionals and workers in trade unions, they may get wage or salary increases
that match price rises to protect real income
They may even secure a rise in their income that exceeds the rate of inflation
o People who save or lend money, they may find the interest rate received on their
money to be lower than the inflation rate
Hence the real value of their money will fall
o People who borrowed money, thy will benefit by repaying less in real terms tan they
borrowed
Index-Linking
o Also known as indexing
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o Is when people on fixed income can be protected from inflation by increasing their
money income in line with inflation as measured by the Retail Price Index
Cost of Inflation to the Economy
o Due to inflation demand for goods and services falls
As people cannot afford to buy as many goods or services
As people rather save their money in order to protect the real value of their
savings
Both of these cause unemployment as demand for labour is a derived
demand
o If inflation rate in one country is higher than the inflation rate of other countries:
The country may find it harder to sell their products to other countries
Fewer domestic products will be demanded and spending on imports will
increase
Jobseekers Allowance (JSA) Claimant Count
o Is a count of all those people who are claiming unemployment related benefits at
Employment Service local offices and who have declared they are unemployed, capable
of, available for, and actively seeking work during the week in which their claim is made
Unemployment Rate %
o (Number Unemployed ÷ Working Population) * 100
Hidden Unemployed
o Official figures conceal the fact that many more people are looking for work than the
official unemployment record suggests
o This is because unemployment figures are calculated only for the number of people who
register to claim benefits
o Examples:
Married women who may be looking for work but cannot claim benefits
Workers forced to take an early retirement but may want to carry on working
People who are working part time but may want to work full time
Frictional Unemployment
o Occurs as workers change jobs and spend some time looking for a new one
o Due to:
Redundancy
Moving homes
Moving from a job one dislikes to another possibly due to higher pay
Seasonal Unemployment
o Occurs because consumer demand for some goods and services is seasonal
o Examples:
Number of jobs in the tourist industry tends to expand during the summer
because that is when most people want to take holidays
Cyclical Unemployment
o Occurs when there is too little aggregate demand for goods and services in the economy
during an economic recession
Fall in demand during a slump in the business cycle
Fall in spending on goods and services
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Firms reduce production
Workers become unemployed
Structural Unemployment
o Arises from long-term changes in the structure of the economy as entire industries close
down because of a lack of demand for the goods and service they produce
o As a result, many workers are made unemployed and have skills which are no longer
required
Occupational Immobility
o When workers are unable to move to a different job requiring different skills as they are
not qualified
Geographically Immobile
o When workers are unable or unwilling to move to another area to take up a job
Economics
o Involves the study of firms and advises on how best to allocate resources in order to
satisfy as many wants
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