Chapter 11
Calculating PED:
Change in demand/ original price x 100
1.
Negative answer : in veered relationship between quantity demanded and price
2.
A rise in price will cause a contraction in demand and price will cause and extension in demand
3.
Size of the figure : shows where it is an extension or contraction in demand .
Elastic VS Inelastic
1.
Elastic demand : when the quantity demanded > price
2.
Inelastic demand : when the quantity demanded < price
What determines price elasticity of demand ?
1.
Availability of substitutes of similar quality and price : -
-
likely to have an elastic demand.
-
a rise in price cause significant fall in quantity demanded as consumers may switch to the substitute.
Substitute of different quality and price :
-
Inelastic demand
-
quantity will not fall much in response to a rise in price as there’s is snot suitable alternative to switch over to .
2.
Proportion of income spent on product :
-is the product a necessity or a luxury
-is the product addictive or not
-can the purchase be postponed
if the product takes up a small proportion of the income,necessity the demand is Inelastic
( when the price changes it is likely to be unnoticed)
-when it takes up a large proportion of income, luxury the demand is elastic ( does not have to be purchased so a rise or
fall in price leads to a greater percentage change)
3.
addictive things such as cigarettes or coffee has an Inelastic demand but if purchase can be delayed it is elastic.
-a rise in price results in a greater percentage fall in the quantity demanded (elastic demand)
-elastic demand: likely to have more substitutes (tea that has different brands)
Difference in PED
1.
Can differ with time
-luxuries may become necessities as people get richer (cars )
:which changes the demand from elastic to Inelastic
2.
Different taste,income levels and cultures varies in different countries.(rice)
-considered Inelastic in Asian countries but elastic in white countries
Different degrees of elastic
1.
Elastic
2.
Inelastic
3.
Perfectly elastic : when a change in price causes a complete change in quantity demands (a yes no kinda thing,
no maybe)
4.
Perfectly Inelastic: when a change in price had no effect on the quantity demanded
5.
Unit elastic : when a change in price causes an equally change in the quantity demanded leaving total revenue
unchanged

CHANGES IN PED
1.
Becomes more elastic as the price of a product rises.
2.
Consumers are more sensitive to price changes, with higher prices(10% in 1000 is more that 10% in 100)
3.
As prices fall on he demand is more Inelastic (10% in 1000 is more that 10% in 100)

4.
Also changes when there is a shift in the demand curve(The more consumers want and are able to buy a product
the less sensitivite they are to the changes in price)
Implication of PED for decision making
1.
Main influence of a change in is its demand
⁃
Consumers are likely to benefit from lower price and higher quality when demand is elastic (producers are
reluctant to raise price as contract by a grater percentage and revenue would fall)
⁃
in price will result in an extension in demand( producer would consider whether to cut the price based on extent
of any rise in demand)
⁃
Make the firm’s produce more distinctive ( discourage consumer switching to other firm’s products ) , inelastic
⁃
Government knowing the responsiveness of the quantity demanded to a change in price (discouraging
consumption of certain products : successful if demand is elastic )
Chapter 12
Price elastic of supply
⁃
To study how responsive supply is to a change in price
: %change in quantity supplied / %change in price
⁃
change in quantity supplied/original quantity supplied x 100
Interpretation of PES
1.
Quantity and price supplied are directive related
2.
Figure ( answer from calculation )
:the degrés if responsiveness of the quantity supplied to a change in price (higher figure= more responsiveness)
Elastic and inelastic supply
⁃
changes in price and supply
1.
Elastic supply:when the quantity supplied>price
-PES is > 1 < infinity

1.
Inelastic supple : when the quantity supplied < price
-PES is < 1 > infinity

Determinants of price elasticity of supply
1.
Time taken to produce product
2.
Cost of altering product supply
3.
Feasibility of storing
⁃
can be stored,quantity supplied can be adjusted easily when price change (a rise in price = greater % change in
⁃
Low when product can be made quickly
⁃
Firmed being able to alter amount offered for sale by using spare capacity , shifting resource and more resources
supply )
by drawing on stocks
⁃
If price falls : cut back on productions remove product
⁃
ANYTHING OPPOSITE IF THE LIST ABOVE = SUPPLY INELASTIC
⁃
Other degrees of PES
1.
Elastic
2.
Inelastic
3.
Perfectly inelastic (when a change in price has no effect on the quantity)
4.
Perfectly elastic(when a change in price caused a complete change in quantity supplied )
5.
Unit PES (when a change in price caused an equal percentage change in the quantity supplied)

Changes in PES
1.
Can very with time (becomes more elastic as the time period increases as producers have more time to adjust to
their supply,new changes (new factories and offices / different products )
2.
Advances in technology reduces production period and lowers cost of production making supply more elastic
Implication of PES for decision making
1.
rises )
Consumers benefit from elastic supply as supply is responsive to consumer demand ( demand increase , price

2.
Elastic supply , quantity supplied %> change in price ( sales will rise )
3.
Produces want an elastic supply ad their profits would be more
4.
Government would want an elastic by encouraging the output and consumption of product and giling subsidies.
Chapter 13
THE Market economic system
1.
Resources move as a result of change in price
2.
Price changer are determined by the interaction of demand and supply
3.
The use of resources is changing daily in response to changes in consumer demand and cost of production
4.
Changes in demand causes price changes.
Importance of competition and incentives
1.
Choice of consumers on which product to choose, producers compete in order to meet their demand
2.
Results in lower prices ( if prices and profits are high , there is pressure to keep the prices low to stay in business
) best : cost low with desirable quality (efficient)
3.
Entrepreneurs who are quick to pick up changes are likely to earn higher profits
4.
Workers may get higher wages by developing skills that are high in demand , hard working , accepting more
responsibility and willing to change place of work and nature .
Private and public sector
1.
Public sectors : the part of economy controlled by the government
2.
State owned enterprises : organisations owned by the government which sel products( prioritises to promote the
welfare of country’s population )
3.
Privatisation : the sale of public sector assets to the private sector
4.
Private sector: covers business organisations which are owned by shareholders/ individuals
the advantages of market economic system
⁃
the market economic system has the potential to provide significant connected advantages
1.
Very responsive to change in consumers demand , consumers determine what is produced
2.
Resources changing quickly and automatically to reflect changes in consumer demand
⁃
price mechanism (the system by which the market forces of demand and supply determine prices ) Provides info
on which products are increasing and falling in demand
⁃
Provides an incentive for resources to move in respond to change in demand
⁃
Market economic system punished firms , workers , Keene’s who don’t respond to changing demand .
3.
Choose : consumers may choose products to buy and firms to buy from ,, what to produce and workers
4.
Lower price and cost ( profit no rice and competition promotes efficiency= lower cost ,, lower prices ,, sell more ,,
earn more ,, more profit) rewards efficiency and punish inefficiency
5.
Higher quality due to pressure of many firms and competition helps to gain more sales and more attractive
products are produced .
Disadvantages of market economic system
Risk that market forces of demand and supply may not work well causing market failure( inefficient allocation of resources)
1.
Consumers and private sector firms take cost and benefits to themselves and not their decision to others ( selling
cigarettes)
2.
Little competition may cause the firms to have market power where consumers are not given choices ( producers
may increase price and produce poor quality goods )
3.
May not be able to respond to the desire of consumers as workers lack proper skills and are geographically
4.
Free riders ( someone who consumes a good or service without paying for it ) the covid 19 vaccine ,, people
immobile
would not pay for it as it would eventually be free even though it cost 1000 before
5.
Advertising can distort consumers choose . Consumers may not buy a product that does not provide sufficient
information on. E.g. buying something in bulks when preferred not
6.
Failure to achieve efficiency resulting in inequitable income . The poor and the rich may be far apart hence some
offal not be able to retire earlier or more difficult to find new job offers due to background etc
7.
People earning higher I comes can afford to save or buy shares and poor may not .. they (rich )can give their
children money. Richer parents may pay for better education and healthcare, able to provide with equipment such as computers to
easily further studies .
Allocative efficiency
⁃
when resources are allocated to produce the right products in the right quantities ( firms produce the product
that consumers demand in the right quantity)
⁃
Market forces , changes in price eliminate shortages and surpluses and move toward allocative efficiency
⁃
1. Competition may help as in a competitive market firms have incentive to allocative efficiency in the form of
profit. More responsive ,, compares to rivals ,, lose sales and driven out of market

productive efficiency
⁃
when products are produced at the lowest possible cost and making full use of resources
1.
Firm having threat of punishment and incentive in a competitive market may capture more sales and gain more
profits with lowered prices ,, if price is higher than rivals it may cause loss of sales
2.
Productively efficient fork (not wasting resources) producing on production possibility curve
dynamic efficiency
⁃
efficiency occurring over time as a result of investment and innovation
1.
The profit incentive and threat of going out of business encourages firms to spend money on research and
development to innovate
2.
Introduces new method of production with improved products and having bigger profits
3.
Without new ideas to produce new products the products is of running out of business increases
Examples of the different economic systems
1.
Most economic systems are mixed economic systems (not including North Korea etc )
Chapter 14
Market failure
: when markets are inefficient; daily to product products that consumers demand at lowest cost and right quantities
Nature of market failure
-
indicators : shortage , surplus , high prices , poor quality & lack of innovation
-
Products are under / over produced or not produced
-
Due to : lack of competitive pressure & difficulties lowering cost
Failure to take cost and benefits into account
:
-
third parties : not directly involved with producing / consuming product
-
Social benefit : total benefit to society of an economic activity
-
Social cost ; but oral cost to society of an economic activity
-
Private benefits ; benefits received by those directly consumer / producing products
-
Private cost : cost by those who directly consumer / produce a product
-
External costs : cost imposed on those who are not directly involved with consuming / producing product (E.g. pollution )
-
External benefits : benefits enjoyed by those who are not directly involved with consuming / producing product
-
Socially optimum output : when level of output is hnow and then social cost = social benefits ; maximising society welfare
-over-production occurs when decision to produce chemicals are based on private cost (supply would shift to the left )
-under-consumption occurs when a decision is based on private benefits ( greater total benefit to society ) ( E.g. more graduates from
university & college allows external benefits .. allowing people to enjoy better quality & quantity of workers & products etc )
this causes demand to shift to the right
-market fail to allocate resources efficiently : gap between total effects on society & effects on direct consumers
-social cost exceeding social benefit : too many resources used & society benefits from reducing output (E.g. many cars on the road
creating pollution , congestion & accidents )
-social benefit exceeding social cost : more resources should be devoted to increase output
Information failure
: causes decision made not in best interest
-
consumers : (high satisfaction , low price ) ; nature of product , benefits & prices
-
Workers : offered jobs , location , required qualifications , best suited skills & nature of job
-
Producers : good quality raw materials at lowest price, products in demand , cost effective production methods
:how market failure occurs
-
lack of information
-
Inaccurate information
-
Asymmetric information : consumers / suppliers don’t have equal information (E.g. mechanic says that car requires
expensive repair )
:merit goods : products that government considers consumers don’t fully appreciate the benefits causing products to be
under-consumed if left to market forces (E.g. regular healthcare checkups )
: how government overcomes
1.
Providing information showing the benefits hence increasing the demand ( demand shifts to the right )
2.
Decreasing the price or giving subsidies causing ( supply shifts to the right )
3.
Compulsory consumption ( making it a law like the vaccine )
4.
Providing the product for free
:demerit goods : products which government considers consumers do not appreciate how harmful they are do which will be
over-consumer if left to market forces (E.g. cigarettes)
-
external cost is generated
-
Over-consumed hence over-produced
: how government overcomes
1.
Raise the prices by imposing tax
2.
Discourage consumption : providing information on harmful effects
3.
Ban : if the product causes serious problems
Public and private good
Public good :product which is non-excludable and nonrival hence needs to be financed by taxations (lighthouses, national defense,
flood control systems, and street lighting.)
-
Free riders ( people who don't pay to consume )
-
Public goods are essential
-
Characteristics
- non-rejectable : can’t reject services ( police )
-cost of supply public goods to an extra person is 0 : one person using a unit doesn't take away from another
-
government produces / pays private sectors to product public goods financed by taxations
Private good : product which is excludable and rival (merit and demerit good)
-
Non-payers do not get to enjoy product (private goods are charged for)
-
If one person consumes a unit , another can’t consume
-
Market supplies private goods
Abuse of monopoly power
:monopoly : single seller
-
Not allocative, productive or dynamically efficient
-
Monopoly cause the lack or competitive pressure to respond to consumer demands , keeping cost low & improving
products
-
Consumers would have to purchase low quality products for high prices
-
Major producers may use price fixing ( firms agreeing to sell products at the same price ) to sell products at high prices
-
How government overcomes :
- removing restrictions for new firms to enter a market (more competition )
-practices such as price fixing illegal
-prevent firms from merging if firms act against interest of consumers
Immobility of resources
:needed to achieve allocative efficiency
-
Moving from products decreasing in demand to products increasing in demand
-
Resources being occupationally and geographically mobile
-
Immobile resources cause : unemployment , under-utilisation of capital equipment & shortages
-
How government overcomes :
-promote occupational mobility : improving education , providing training and investment grants
-promote geographical mobility : easier to rent houses at areas where demand for labour is high & providing financial help
Short termism
-
Insufficient resources devoted to capital goods
-
Private sectors focusing on making quick profits with short-sighted approach causing lack of investment
-
How government overcomes : stimulating private investments
-
Chapter 20
Industry : group of firms producing same products
E.g. : honda , toyota , volvo …
-firms can have multiple branches, offices , factories , farms …
-firms can be classified by : stages of production , ownership of firms & size of firms
Stages of production
1.
Primary sector : involving extraction of raw materials (e.g. Mining , forestry)
2.
Secondary sector : processing raw materials into semi-finished/finished goods (capital/consumer goods) (e.g.
manufacturing , construction)
3.
Tertiary sector : industry that produces services (e.g. banking , tourism & insurance)
4.
Quaternary sector : sub-section of tertiary sector service industries that process, collect and transmit information (e.g.
research and development)
-
Poor countries usually have more output accounted for labour work
Ownership of firms
-
Market economy system : more private sectors
-
Planned economy : more public sectors
-
Mixed economy : both
Size of firms
-
Calculated by = number of workers employed , number of capital employed & total output of sales
-
Factors influencing size of firm
1.
Age of firm : firms g=may grow larger over the years
2.
Financial capital available : more financial capital means larger capability of growth
3.
Type of business organisation : multinational companies and larger than 1 person owned company.(e.g. Larger
companies are more likely to sell/ borrow shares than 1 person owned companies )
4.
Internal economies & diseconomies : (economies) more market share if business experience less average cost for
supplies as expanding ; (diseconomies) limiting firm’s growth due to increase average cost
5.
Market size : larger market= more demand , possibility for firm to grow more
Small firms
Reasons for small firms
1.
Small market size : demand for product is small , firm producing product is small too
2.
Consumer preference: personal services preference , to meet individual requirements , friendlier
3.
Owner’s preference : owner not wanting to grow firm , to avoid stress & worry on expanding and loss of control
4.
Flexibility : better survival changes due to ability to adjust to market changes , can pick up on changes in demand quickly ,
easily making decisions without consultations
5.
Technical factors : little/no capital required making firm easy to set up , technical diseconomies/ economies aren't important
. lower barriers of entry , easier to enter industry
6.
Lacking financial capital: lacking finance needed to expand business
7.
Location : expensive transportation cost for large/valuable goods
8.
Cooperation between small firms : small firms working together ( small farmers and small local market)
9.
Specialisation: small firms producing specialised goods/ services for consumers/firms(training firm)
10. Government support : government providing financial help (as small firms increase employment rate , develops
entrepreneurs & potential to grow)
Causes of growth of firms
2 ways to increase firm size : internal growth & external growth
1.
Internal growth : increasing size of firm by enlarging existing / open new firms
2.
External growth : increasing size by taking over / merging other firms
Mergers
1.
Horizontal merger : merging with another firm producing the same products at the same stage of production
Advantages
Disadvantages
-
Takes advantage of economies of scale , ability to
-
produce at lower average cost
-
To increase market share by eliminating direct
Experience diseconomies of scale
More difficult to control
Difficulty integrating 2 firms due to different management
competitors
-
Rationalisation : eliminates unnecessary equipment /
plant making firm more efficient
2.
Vertical merger : merging with another firm as an outlet for raw materials , components & supplies / products sold
-
Vertical merger backwards : merging with firm that supplies raw materials , components of products sold
Advantage
-
Ensure adequate supply of good quality raw materials
Restrict rival access to product
-
Vertical merger forward ; merging / taking over a market outlet ( tertiary sector)
Advantages
-
3.
Disadvantages
Ensures sufficient outlets to store products
Products displayed well in high quality outlets
Helps development & marketing of product
-
Management problems as managers are
not familiar with running
Different size firms require supplies
adjustment
Conglomerate merger : merging with a firm producing different products
Advantage
-
-
Disadvantage
Diversification
Still having growth in one firm if products in the other
market declijes
-
Can be challenging to merge into a whole new
industry
Some firms may demerge after a few years
Effects of merger on consumer
Advantages
-
Disadvantages
Lower prices as firm experiences economies of scale
Higher quality products and innovation
Increase efficiency of firm
-
May experience high prices and por quality due to
diseconomies of scale
Reduce consumers choice by eliminating competition
Economies & diseconomies of scale
1.
Economies of scale :advantages in terms of lower long run average cost of producing on larger scale
-internal :lower long run average cost from a firm growing in size
1.
Buying economies : large firms buying materials/capital equipment in bulks and receiving discounts ; paying less
for each item. Getting better treatment from small firms (speed of delivery ) as suppliers want to keep large
customers
2.
Selling economies : total cost of processing , packing & transporting goods decreased
-
transportation cost for 1000 products and 5000 products does not vary much
-
Decreasing advertising cost : more profit but same amount of money spent on advertising
3.
Managerial economies : being able to afford to employ specialist staff : increase efficiency , reduce cost of
production , raise demand & revenue
4.
Labour economies : division of labour
5.
Financial economies : easier and cheaper to raise finance
6.
-
bank are more likely to lend money to well know firm with valuable assets
-
Bank would lower interest rates to attract large businesses
-
Large firms selling shares to raise finance (more people buy shares from large companies )
Technical economies :
- more machinery used , more efficient , producing output at a lower average cost
7.
Research and development economies : firm having research and development department
8.
Risk bearing economies
-
more methods to increase efficiency and raise total revenue with new product development
larger range of products , if one product is less profitable , profitability shifts to another product
-external :lower long run average cost from an industry growth in size
1.
Skilled labour force : recruit workers who have been trained by other firms in the industry
2.
Good reputation : gain reputation from height quality products ( Maldives & nice resorts )
3.
Specialist suppliers of raw materials & capital goods : ancillary industries provide for needs in the industry ( tyre
suppliers to car industry)
4.
Specialist services : university/ college having courses for services designer to meet needs of a particular
industry ( accounting )
5.
Specialist markets : large industries with special selling prices and arrangements
6.
Improved infrastructure : market growth encouraging government and private sectors to provide better
infrastructure ( more airports , electricity , dock facilities..)
2.
Diseconomies of scale : disadvantages of firms being too large
-internal : higher long run average cost arising from a firm growing too large
1.
2.
3.
Difficulty controlling firm :
-
Managing large firms may be difficult
-
Complex management
-
Increase administrative costs : slower in responding to market changes
Communication problems
-
difficulty making sure everyone has full knowledge on duties and available opportunities
-
Opportunity to communicate ideas and views decreased
Poor industrial relations
-
Lack of motivation if workers : less sense of belonging
-
Longer time required to solve problem :more conflict due to diverse opinions
-external : nighter long run average cost arising from an industry growing too large
1.
Increased congestion : more transport and vehicles
2.
Higher cost of transportation for firms
3.
Reduced workers productivity
4.
Increase competition : capital equipment and labour costs more
Chapter 21
Firms and production
Demands for factors of production
Factors of production employed
-
influences by : type of product produced , productivity of factors & cost
-
Substitutes products : rise in productivity; fall in cost , change in combination of resources employed
-
Complement products :fall in productivity ; rise in cost ; increase employment
Altering factors of production
-
there’s always one fixed factor of production in the short run
- difficult to alter : capital , office or factory size as it required to expand
-
-easy to alter : labour , quantity of labour
capital equipment and raw materials ( based on demand , availability and contract )
Combining factors of production
-
important to achieve right combination of factors of production
-
when deciding combination of resources , firms seek to achieve highest possible productivity
Factors influencing demand for capital goods
1.
Increase in price for another factor of production ( labour ) , increase demand for capital goods
2.
Rise in substitute price which makes production of a unit output expensive
3.
Complement increase in price , demand for capital decreases
4.
High profits levels : ability and incentive to buy capital goods
5.
Greater incentive/ Cut in corporation tax (tax on profits of the company ) : more profits to help plough back into business
6.
Rise in disposable income : increase in consumption , encourages firms to invest due to expectation of higher output
7.
Cut in interest rates , raise consumption , encourage firms to expand capacity ( less interest rates: more investment) ,
reduce opportunity cost in investment .
8.
Future expectations: rise in sales; rise in investment, pessimism;decline in investment
9.
Advance technology : more efficient machinery increasing productivity of firm; invest more
Demand for land
1.
Agriculture : most fertile land would be highest in demand ; highest rent
2.
City centres : very productive , potential to attract high amount of consumers , more competition, favourable site ; highest
rent
Factors of production & sectors of production
-
demand for factors of production alter as economy changes in different industrial structures
-
Different distribution of resources amount different sectors change with economic development
-
Different industries make use of different factors of production
Labour intensive / capital intensive production
1.
2.
Labour intensive
-
Producers too small to be using capital intensive ( machine produces 500 pairs but producer can only sell 50)
-
Consumers prefer handmade products:higher quality and meeting individual needs
-
Customised products provide greater status as consumer likes personalised attention
-
Workers can be more flexible : labour force can be adjusted by small amounts
-
Labour can be provided with feedback on how to improve method/ quality of production
-
Ability to switch from capital to labour intensive if capital is too expensive
-
cheaper
Capital intensive
-
Advances in technology making capital goods more affordable and productive
-
More products can be produced at a lower average cost
-
Uniform standard products which are unaffected by human error
-
Capital does not require time off & is unaffected by tiredness
Production and productivity
-
Increase in production : Increase output per worker hour & same working hours
-
Unemployment increase : increase in productivity (as skilled workers get to keep their job) & decrease in production
-
Advances in technology & better education : increase in production & productivity ;Total output increases & number of
working hour declines
Chapter 22
Firms , costs , revenue & objective
-average : divided by output
-total : multiplied by output
- in the long run ( time period when all FOP can be changed ) all cost vary as business may increase in size …
1.
Total cost : total amount that had to be spent on the factors of production used to produce a product
= fixed cost + variable cost
2.
Average total cost := total cost / output
/ =(total fixed cost +total variable cost )/ output
3.
Unit / Fixed cost : cost that for not change with output in the short run ;remains unchanged ( interest rates , rent , security )
4.
Average fixed cost : total fixed cost / output
5.
Direct /Variable cost : cost that changes with output ;varies directly with output ( electricity ,profits )
6.
Average variable cost : total variable cost / output ( falls and rises when output increases ) y
7.
Price : amount of money given to obtain a product
8.
Total revenue : the total amount of money received from selling a product
9.
Average revenue : = total revenue / quantity sold
10. Profit per unit / profit margin
Objectives of firms
1.
2.
Survival :
-
main objective is to survive in a competitive market
-
Content to cover cost until becoming better well known
-
Usually the key objective when demand is falling in order to stay in the market in hopes conditions improve
Growth:
-
increase in size to take advantage of internal economies of scale (E.g. finance economies to buy raw materials in
bulks for discount )
3.
4.
5.
-
People who run the firm : pay and status is linked to the size of firm ( pay more with larger size )
-
Larger firms have greater job security: more difficult to be replaced or taken over
-
Merging : Reduce in competition and larger market share
Social welfare :
-
improving social welfare : usually base production decision on social cost & benefits
-
E.g. lower prices for the poor
Profit satisficing : sacrificing profit to achieve other goals
-
Having enough dividends to keep shareholders happy and pursuing other objectives
-
E.g: improve staff facilities / getting raw materials from sustainable sources
Profit maximising : making as much profit as possible
-
Pursue objectives to conflict with profit maximization
-
E.g. -growth : reduce competitors , price elasticity of demand , raise price and revenue
-environmental friendly policies : increased demand and revenue as consumers become increasingly
concerned for the environment
-treating workers better : retaining workers , reduce the cost of recruiting and training workers
- when profit maximisation is achieve
: revenue earned by firm is greater than cost incurred
-total profit > total revenue & cost with noticeable difference
Profit
-
Revenue = profit + cost
Effects of change in profits
-
-
-
Increase in profits
1.
Encourages more first to enter competitive market
2.
More finance for capital equipment and expanding business
3.
Obtaining external finance ad shareholders are more likely to but shares of profitable firms
4.
Banks are willing to give loans
5.
Easy to recruit top managers and directors (attracted to success )
Decrease in profits
1.
Short amount of time : little impact and short lived
2.
Long amount of time : profits continue to decrease / remain unchanged ; cut back or cease production
Ways to increase profits
1.
Reducing cost
2.
Raise revenue
3.
Increase demand of product
-
reducing wastage and inefficiency
-
Increasing productivity of FOP : may raise cost in the short run but reduce average cost in the long run
(E.g. investing in capital and training workers )
-
Increasing size of firm through merger/takeover : take advantage of economies of scale , greater market
share
-
Firms with more power having inelastic demand can increase revenue by raising price ; firms with
elastic demand can raise revenue by cutting down price
-
Increase demand by improving quality , diversify , improve market research & responsive to changes
-
Increase demand in successful advertising
Chapter 23
Market structure
: condition which exist in a market including the number of firms
Competitive market : a market with a number of firms that compete with each other
-
market structure can go from competitive to monopoly ( no direct competition )
-
more sellers = more buyers
-
high amount of sellers : each seller has a market share ( amount of total market supply ) ; change in output of one firm has
little to no effect on price
-
Consumers can switch between rival products
-
Easy for firm to enter / exist the industry ( start/stop producing )
The behaviour of competitive firms
-
pressure to keep prices low ; risk losing sales due o available substitutes
-
seeking competitive advantage : improving products , respond quickly and fully to changes in demand
-
Profit : relatively low in the long run;. enough to keep producing products // profit lower / higher when entering the industry
-
Normal profit : minimum level of profit required to keep a firm in the industry in the long run ( demand rises ; higher normal
profit )
-
Supernormal / abnormal profit : profit above that needed to keep the firm in the market in the long run ( demand increases :
attracts new firms in the industry , increase supply , lower prices , returns profit to normal level ) / (demand falls : firms
makes loss, forces firms out of industry , reduces supply , raise in price , restore normal profits )
Performance of competitive forms
-
promotes efficiency providing incentive and threat to produce according to consumer wants at lower cost
-
Quick respond to consumer demands : competitive advantage & higher profits
-
Inefficient firms : produce at higher cost / not to consumer demands = driven out of market
-
High competition = lowers price to level THAY just covers cost
-
Competitive firms : small & production in larger scale reducing unit cost
Monopoly markets
Monopoly : market with single supplier
characteristics :
-
100% of the market share
-
High Barriers to entry & exit ( difficult to enter the market )
-
Price maker ( output = industry output / supply effects market )
Reasons monopolies arise
1.
Firm is so successful at cutting cost and responding to changes that it drives out rival firms capturing entire market
2.
Mergers and takeovers reduced to 1 firm
3.
Monopoly exist from the start ( E.g. government granting monopolistic powers , illegal for other firms to enter the market )
Reason monopolies continue
1.
Barriers to entry and exit (legal barriers )
2.
Scale of production : size of production units and methods of production used.
-produces large scale at low unit cost ; competing firms face higher unit cost and can’t compete
3.
Expensive to dry up due to large capital equipment required
4.
Barriers to entry such as creating brand loyalty through branding and advertising
5.
Monopoly access to resources and retail outlets
6.
Barriers to exit :firms are reluctant to undertake commitment such as long term contracts ; experiencing sunk cost ( cost
that can’t be recovered if firm leaves industry )
Behaviour of monopoly
-
monopoly can earn supernormal profits for the long run; other industries may not realise the profit however , they are still
kept out by barriers to entry & exit
-
Monopoly has control over supply but not demand
-
Chooses price in which consumers are willing to pay and quantity to be sold based on what consumers are willing to pay
Monopoly performance
bad
-
inefficient due to absence of competition
-
High prices for low quality as there’s no substitute
-
Fail to respond to changes
-
efficient and beneficial to consumers due to large scale of production , lower price and unit cost
-
Prevents wasteful duplication of capital equipment
-
High profits can br invested on research and development ( new and improved variations )
-
more profit earned , encouraging industry to overcome barriers to entry and develop better product
good
Occurrence of monopoly
-
monopolies depend on the way a market is defined
-
Products in geographical area : local monopoly (E.g. one firm (monopoly) supplying gas to several firms )
Chapter 24
the role of the government
-
Some local areas depend particular industries that are state owned ( gov controls how much produces , wages ) directly
affecting local community
-
Some industries in poor areas have subsidies supplied by government to avoid unemployment
-
Some decisions in economic policies are taken on a local rather than national level
-
Local government : government organisation with the authority to administer a range of policies within an area country
(E.g. imposing taxes or charges granted by government for local g&s)
Functions of government at local & national levels
government owns industries and assets
: collects tac , directs level of economy activity , regulator …
Government as a producer
-
produces key importance by natural monopoly (single firm producing st low average cost due to existence of EOS)
-
Produces essential available to all
-
Key industries : strategic industries (important for safety and development of the economy) & national champions (world
leader industries)
-
Government not allowing key industries to merge to prevent consumers from being exploited due to private sectors
charging high prices
Government producing essentials : housing , merit & demerit goods Public sector contrast and partnerships between the public &
private sectors
-
private sectors produces range of products and services for public sectors
-
Private sectors may provide finance for state projects and government rents & operates buying back over time
Public and private sectors provide part of service (E.g. government builds and manufactures train but is run by private sector
)Government as an employer
-
government employs workers and managers to operate state owned enterprises
-
Allows to decrease unemployment , control prices, price charges by other enterprises and limit wage rise
-
Gives workers good quality training , prevents discrimination & ensures good pension
The role of the government at an international level
-
promote free trade or restrictions of free trade
-
Multinational companies (to attract them as they generate jobs and increase output or reject them as they may run
domestic firms out of business )
-
Trade blocs : regional groups of countries that remove trade restriction between themselves
-
Free international trade : exchange of goods and services between countries without any restrictions
Chapter 25
The macroeconomic aims of government
Government main aim : economic growth, low unemployment, price stability, balance of payment stability & redistribution of income
1.
economic growth : increase in output of the economy in the long run increasing productive potential
-
actual economic growth :increase in the output of an economy
-
Economic growth causing a rise in quantity or quality of factors of production
-
potential economic growth : an increase in an economy’s productive captaincy
-
Aggregated demand : total demand for for country’s product at a given price level
=expenditure + investment + government spending + (exports - imports )
-fall in country’s price level causes extension in aggregate demand
-increase in aggregate demand : increase population, lower interest rates , lower exchange rates , greater confidence
-
Aggregated supply : total amount of goods and services domestic firmed are willing to supply at a given price level
-perfectly inelastic supply : when economy had a significant number of unemployed resources
- elastic supply : economy reaches full employment , firms competing , cost pushed up , high prices
Reasons for governments aim for economic growth
-
more goods and services can raise living standards ( good health care , housing and nutrition )
-
helps government reach economic aims : increasing output : reducing unemployment , improved countries trade position
with more exports , extra revenue for poor who get jobs
Criterias government set for economic growth
-
using countries economic growth rate (level of output ) in relations to current maximum possible output and growth in
productive capacity
2.
Low unemployment
-
government tries to achieve full employment(lowest level of unemployment possible)
-
Having the people who can work go to work
-
Have children and negate in full time education
-
Economically active : being a member of the labour force
-
Unemployment rate : unemployment/ labour force x 100%
Reason to government aims for low unemployment
-
unemployment is a waste of resources
-
Unemployed suffer from disadvantaged if those with low income
-
Government spends more tax revenue supporting unemployed
Criteria that government set for unemployment
-
it is impossible to achieve 0% unemployment.. there’s always oriole changing jobs or being unemployed for an amount of
time
-
Government aims for low rate of unemployment
3.
Price stability :price level in economy not changing significantly over time
-
Not having prices fall and rise even though most households buy products of stable price
Reason why government aims for price stability
-
ensure greater economic certainty
-
Prevents country’s products from losing international competitiveness
Criteria that government set for inflation
-
governments have a target inflation rate which increases
-
Reason why unchanged prices aren’t the goal : (1)measures of inflation tends to overstate rise in price, )prices rise can hide
improvement in products (2) rise in price can provide benefits , encourage producers to increase output , assuming higher
price = higher profits
-
Avoid fall in price cause by fall in aggregate demand : decline in output and rise in unemployment
4.
Balance of payment stability : the record of a country’s economic transaction with other countries
-
government wants value of export and import to be equal so country earns from exports as much as spends on imports
Reason why government aims for balance of payment stability
-
Country would be in debt if imports exceed exports for a long time
Criteria that government set for balance of payments stability
-
government aims for import and export to be equal on have more import than export
-
Surplus in export is ok for a short amount of time
-
Deficit cause by increase in import of raw materials , increasing economy’s ability to produce more goods and services
nationally
5.
Redistribution of income
-
redistributing income from the rich to the poor through taxations and spending
-
Rich are taxed more than the poor
-
money raised is used for housing / unemployment benefits , education , health etc
-
These may not be accessible without subsidies
Reason government redistributes income
-
inequality in income abs wealth
-
Reducing poverty and hardships
-
Rich tend to associate with rich hence gap between social classes giving sense of social injustice
Criteria that government set for income redistribution
-
not fully equal redistribution of income as everyone has different needs
-
Not being to tax the rich to heavily
Conflicts between macroeconomic aims
-
full employment conflicts with stable prices due to difficulty increasing output matching aggregate demand
-
Low unemployment pushed up wages as firms compete for workers hence more cost of production end inflation increases
-
Full employment and economic growth conflicts with balance of payment stability as producing higher output means more
exports , increase employment, oncredrr incomes
-
Spending on imports msg increase by more export revenue : to produce high output imports from metro raw materials and
capital goods
Priority
-
government having to decide which aims based on which problems country citizens are more concerned with
Chapter 26
Fiscal policy
Budgets : relationship between government spending(public expenditure ) and government revenue
Budget deficit : government spending is higher than government revenue
Budget surplus : government revenue is higher than government spending
Balance budget (rare) : government spending and government revenue is equal
Government spending reasons
1.
Influence economic activity : increase spending to increase aggregate demand for higher demand causing higher output ;
economic growth
2.
Reduce market failure : spending on public goods not financed by private sector; spending in merit goods as market forces
would not allocate sufficient resources in their products ; spending money regulating markets of diff priv and social cost
and benefits
3.
Promote equity : provide benefits and products to vulnerable groups and unemployed (pension to retired , housing
subsides , free education)
4.
Pay interest in national debt : government on tax and spending to pay interest rates
-multiplier effect : final impact on aggregate demand being greater than the change
Reasons for levying taxes
1.
Redistribution income from rich to poor : high income groups paying more tax than poor hence raised revenue benefits the
poor
2.
Discourage consumption of demerit goods : products that is more harmful to consumers than they realise
3.
Raise cost of firms that impose cost on others : when causing air pollution…
4.
Discourage consumption of imports and protect domestic industries : buy less foreign products and more domestic
products
5.
Influence economic activity : change in tax changes aggregate demand ( more unemployment, less tax to increase
consumption and investment)
6.
Taxations
Main category of taxes
-
Direct tax : taxes in income and wealth
-
Indirect tax : taxes on expenditure
1.
Progressive tax : takes larger percentage of income of wealth of the rich
2.
Proportional tax : takes same percentage of income or wealth of all tax payers
3.
Regressive tax : takes larger percentage of income or wealth from the poor
total amount of tax paid differed with income/wealth and percentage paid
Types of tax
1.
Income tax : tax on income that is received from employment and investment ; tax allowance ( certain amount of income
receiving free tax )
2.
Corporation tax : tax on firms profits
3.
Capital gains tax : tax on profits made by assets when sold at higher price than bought ( capital gain )
4.
Inheritance tax : tax on wealth passed on when person dies
5.
Local tax : used to pay for local services (education, libraries , roads ..)
-
based on local firm
-
Based on value of household property
Indirect taxes
-
sales tax when product it sold
-
Excise duties : racers charged on certain domestically produced goods (demerit goods )
-
Custom duties : taxes in import (tariffs)
-
License needed to sell a range of products
Taxation principles
1.
Equity : fairness in tax based on peoples ability to pay
2.
Cerainity : easy to understand and calculate tax payed
3.
Convenience : easy to be paid
4.
Economy : cost of collecting tax lower than revenue
5.
Flexibility : possible to change tax based on change in economic activities (economic booms and slumps )
6.
Efficiency ; improve performance of markets not reduce efficiency or market
Impact of tax
-
tax base and tax burden : tax base (source of tax revenue ) the wider tax base , more range of items and people taxed .
Wider tax base means less tax rates ; small tax base means higher tax rates :: tax burden ( amount of tax paid by people
and firms ) used as % to express countries income (GDP)
-
Impact of taxations: distribution of burden of indirect tax shared between consumers and producer): producers (higher
prices when tax increases , elastic demand products bear most taxes as the demand would change with price )
-
Impact of taxations : elasticity of supply influenced incident of taxation . ( supply elastic : more tax on consumer)
Taxes can have various direct impacts on consumers, producers, government and thus, the entire economy.
The main purpose of tax is to raise income for the government which can lead to higher spending on health care and education. The
impact depends on what the government spends the money on. For example, whether it is used to fund infrastructure projects or to
fund the government’s debt repayment.
Consumers will have less disposable income to spend after income tax has been deducted. This is likely to lead to lower levels of
spending and saving. However, if the government spends the tax revenue in effective ways to boost demand, it shouldn’t affect the
economy.
Higher income tax reduces disposable income and can reduce the incentive to work. Workers may be less willing to work overtime or
might leave the labour market altogether. However, there are two conflicting effects of higher tax:
Substitution effect: higher tax leads to lower disposable income, and work becomes relatively less attractive than leisure – workers
will prefer to work less.
Income effect: if higher tax leads to lower disposable income, then a worker may feel the need to work longer hours to maintain his
desired level of income – workers feel the need to work longer to earn more.
The impact of tax then depends on which effect is greater. If the substitution effect is greater, then people will work less, but if
income effect is greater, people will work more
Producers will have less incentive to produce if the corporate taxes are too high. Private firm aim on making profits, and if a major
chunk of their profits are eaten away by taxes, they might not bother producing more and might decide to close shop.
Fiscal policy is a government policy which adjusts government spending and taxation to influence the economy. It is the budgetary
policy, because it manages the government expenditure and revenue. Government aims for a balance budget and tries to achieve it
using fiscal policy.
A budget is in surplus, when government revenue exceed government spending. While this is good it also means that the economy
hasn’t reached its full potential. The government is keeping more than it is spending, and if this surplus is very large, it can trigger a
slowdown of the economy.
When there is a budget surplus, the government employs an expansionary fiscal policy where govt. spending is increased and tax
rates are cut.
A budget is in deficit, when government expenditure exceeds government revenue. This is undesirable because if there is not enough
revenue to finance the expenditure, the government will have to borrow and then be in debt.
When there is a budget deficit, the government employs contractionary fiscal policy, where govt. spending is cut and tax rates are
increased.
Fiscal policy helps the government achieve its aim of economic growth, by being able to influence the demand and spending in the
economy. It also indirectly helps maintain price stability, via the effects of tax and spending.
Expansionary fiscal policy will stimulate growth, employment and help increase prices. Contractionary fiscal policy will help control
inflation resulting from too much growth. But as we will see later on, controlling inflation by reducing growth can lead to increased
unemployment as output and production falls.
Chapter 27
Monetary policy
The money supply is the total value of money available in an economy at a point of time. The government can control money supply
through a variety of tools including open market operations (buying and selling of government bonds) and changing reserve
requirements of banks. (The syllabus doesn’t require you to study these in depth)
The interest rate is the cost of borrowing money. When a person borrows money from a bank, he/she has to pay an interest (monthly
or annually) calculated on the amount he/she borrowed. Interest is also be earned on the money deposited by individuals in a bank.
(The interest on borrowing is higher than the interest on deposits, helping the banks make a profit).
Higher interest rates will discourage borrowing and therefore, investments; it will also encourage people to save rather than consume
(fall in consumption also discourage firms from investing and producing more).
Lower interest rates will encourage borrowing and investments, and encourage people to consume rather than save (rise in
consumption also encourage firms to invest and produce more).
The monetary authority of the country cannot directly change the general interest rate in the economy. Instead, it changes the interest
rates of borrowing between the central bank and commercial banks, as well as the interest on its bonds and securities. These will
then influence the interest rate provided by commercial banks on loans and deposits to individuals and businesses.
Monetary Policy
Monetary policy is a government policy controls money supply (availability and cost of money) in an economy in order to attain
growth and stability. It is usually conducted by the country’s central bank and usually used to maintain price stability, low
unemployment and economic growth.
Expansionary monetary policy is where the government increases money supply by cutting interest rates. Low interest rates will
mean more people will resort to spending rather than saving, and businesses will invest more as they will have to pay lower interest
on their borrowings. Thus, the higher money supply will mean more money being circulated among the government, producers and
consumers, increasing economic activity. Economic growth and an improvement in the balance of payments will be experienced and
employment will rise.
Contractionary monetary policy is where the government decreases money supply by increasing interest rates. Higher interest rates
will mean more people will resort to saving rather than spending, and businesses will be reluctant to invest as they will have to pay
high interest on their borrowings. Thus, the lower money supply will mean less money being circulated among the government,
producers and consumers, reducing economic activity. This helps slow down economic growth and reduce inflation, but at the cost of
possible unemployment resulting from the fall in output.
Chapter 28
Supply side policy
Supply side policies are microeconomic policies aimed at increasing supply and productivity in the economy, to enable long-term
economic growth. Some of these policies include:
Public sector investments: investments in infrastructure such as transport and communication can greatly help the economy by
making the flow of resources quick and easy, and facilitate faster growth.
Improving education and vocational training: the government can invest in education and skills training to improve the quality and
quantity of labour to increase productivity.
Spending on health: accessible, affordable and good quality health services will improve the health of the population, helping reduce
the hours lost to illnesses and increasing productivity.
Investment on housing: as more housing spaces are built, the geographical mobility of the population will increase, helping increase
output.
Privatization: transferring some public corporations to private ownership will increase efficiency and increase output, as the private
sector has a profit-motive absent in public sector.
Income tax cuts: reducing income tax will increase people’s willingness to work more and earn more, helping increase the supply in
the economy.
Subsidies are financial grants made to industries that need it. More subsidies mean more money for producers to produce more,
thereby increasing supply.
Deregulation: removing or easing the laws and regulations required to start and run businesses so they can operate and produce
more output with reduced costs and hassle, encouraging investments.
Removing trade barriers: the govt. can reduce or withdraw import duties, quotas etc. on imports so that more resources, goods and
services may be imported to increase productivity and efficiency in the domestic economy. It can also reduce export duties to increase
export of resources, goods and services to other nations, thereby encouraging domestic firms to increase production.
Labour market reforms: making laws that would reduce trade union powers would reduce business costs and increase output.
Minimum wages could be reduced or done away with to allow more jobs to be created. Welfare payments like unemployment
benefits could be reduced so that more people would be motivated to look for jobs rather than rely on the benefits alone to live.
These will not only increase the incentive to work but also increase the incentive to invest.
For example, India, in the early 1990’s undertook massive privatisation, liberalisation and deregulation measures; abolishing its heavy
licensing and red tape policies, allowing private firms to easily enter the market and operate, and opening up its economy to foreign
trade by reducing the excessive trade tariffs and regulations. This led to a period of high economic growth and helped India become
the emerging economy it is today.
Supply-side policies have the direct effect of increasing economic growth as the productive capacity of the economy is realised. In
doing so, it can also create more job opportunities and help reduce unemployment. Trade reforms will also enable to it to improve its
balance of payments.
However, the reliance on public expenditure and tax cuts mean that the government may run large budget deficits. Deregulation and
privatisation will also reduce government intervention in the economy, which may prompt market failure.
Chapter 29
Economic growth
:the annual increase in the level of national output
GDP : measures the monetary value of goods & services produced within a country for a given period of time (usually 1y)
(consumption , investment,government spending , & net exports )
-
Gdp can cause economic growth
-
Increases long-term productive capacity of the economy
-
This makes PPC move outward
Measuring economic growth
Nominal gross domestic product ( nominal GDP ): measures monetary value of goods and services produced within a country during
-
a given period of time
-
Formula : C + I+ G+(X-M)
-
Consumption C : total spending on g & s by individuals & households
-
Investment expenditure I : the capital spending of firms used to increase production & expand the economy’s productive
capacity
-
Government spending G : total consumption and investment expenditure of the gov ( infrastructure )
-
Export earnings X : the monetary value of all exports sold to foreign buyers (earning from exports )
-
Import expenditure M : the monetary value of all payments for imports
Real GDP : value of national income ( GDP) adjusted for inflation to reflect true value of g & s
GDP per head (per capita ) : the average value of annual GDP per capita
Causes and consequences of recession
Business ( trade) cycle : the fluctuations in the economic activity of a country over time , creating a long-term trend of economic
growth in the economy
Causes of recessions :
-
High unemployment
-
High interest rate ( discourage investments , encourage saving )
-
Economic uncertainty
-
Low disposable income rates & fall in consumer spending
-
Low government expenditure
-
Low export demand
-
Low consumer & business confidence
Causes and consequences of economic growth
Reasons for different economic growth rates :
-
Factor endowment : quantity & quality of country’s factor of production ; natural resources allow countries to have
specialised production on large scale ( benefit from EOS ) and export at lower prices
-
Labour force : size , skill & mobility of economy’s workforce ( occupational & geographical mobility )
-
Labour productivity : amount of g & s \workers produce in a period of time ( output )
-
Investment expenditure : component of overall demand in the economy and affects GDP ; boosts country's productive
capacity in the long term
Positive consequences of economic growth
-
Improved standards of living : higher income levels allowing people to spend more on their wants and needs
-
Employment : higher employment raises consumption & encourages capital investment
-
Tax revenues : higher spending indicates more tax revenues generated ; more funds for government to sustain economic
growth
Negative consequences of economic growth
-
Environmental consequences : create negative externalities ( pollution congestion , climate change ,
-
Inflation risk
-
Income & wealth of inequalities
-
Resources depletion
Policies promoting economic growth
Economic growth promoted with policies by increasing demand , boosting productive capacity
-
Fiscal : using taxation to control economic spending
Cutting taxes /increasing expenditure to increase demand & economic activity
Positive impact on employment
-
Monetary : central bank changing interest rates
Used to control demand level and economic activity
Low interest rates : more spending/borrowing ( more consumer expenditure & business investments)
-
Supply side : increase productive capacity
Increasing competition & innovation
E.g. more training & education offers , less corporate taxes
Chapter 30
Employment , unemployment , full employment
Employment : use of factors of production in the economy ( e.g. labour )
-
High employment : higher living standards
-
Promotes economic growth
-
Increase tax revenues : more spending due to more income , government ha more financing
-
Reduce welfare benefits usage , less financial burden and opportunity for government
-
Less people leaving a country to find jobs
-
Less income & wealth inequalities
Unemployment : people that are able and willing to work but can’t find employment
Full employment : everyone in a country willing & able to work is employed
-
Ideal situation where economy makes the most of its human resources
Changing patterns and levels of employment
Employment patterns change in economic trends
-
Employment sector : more people working in a particular sector due to development ( from primary to tertiary )
-
Delayed entry to workforce : people graduating later , entering the workforce later to receive an education that allows
them to work in the tertiary sector
-
Ageing population : lower birth rates and longer life spans due to development . thus lower labour supply and firms are
more willing to employ older people
-
Formal sector employment : more recorded employments where workers pay income tax , contributing to the countries
GDP
-
Female participation rates : more proportion of women that are active in the labour force ; women have less children and
may opt to pursue professional careers
-
Public sector employment : less people working in public sectors due to more market economies with less government
intervention
-
Flexible working patterns : firms are more flexible in terms of employment to compete internationally ( more part-time
workers , working from home …)
Measuring unemployment
Claimant count : measures number of people out of work and claiming unemployment benefits
-
Must prove they are actively seeking employment
-
Limits : some unemployed individuals are not eligible for unemployment benefits
Labour force survey (LFS) : household-based survey collecting work-related stats
-
E.g. employment status , education , training ..
-
People who are : willing but unable to find work , able / waiting to start a job within 2 weeks , actively looking for work (
within 4 weeks )
Unemployment rate : measures % of country’s workforce out of employment
-
Calculation : [(no. of unemployed )/ workforce ]x 100
Causes and types of unemployment
Frictional unemployment : transitional unemployment , occurs when people change/ are in between jobs
-
This type of unemployment always exist within an economy as labour market takes time to watch jobs with people looking
Structural employment : when demand for a product in an industry falls due to competition
-
People who experience this type of unemployment find it difficult to find a new job as they need to work in a different
industry
Cyclical unemployment /demand-deficient unemployment : caused by lack of demand causing fall in national income affecting every
industry in the economy
-
Demand curve shifts to the left
-
Occurs during economic downturn ( recessions , slumps )
Consequences of unemployment
-
Unemployed individuals :stress, depression, homelessness , low self-esteem ..
-
Suffer from lower incomes affecting friends and families
-
Mass unemployment occurs in local communities causing poverty resulting in falling asset values and increased crime
rates
-
Firms: loss due to low consumer spending , investments and profits causing business failures and bankruptcies
-
Government : increasing government debts due to higher expenditure on welfare benefits & healthcare
-
Taxpayers : opportunity cost of unemployment due to increased reliance on taxpayers to finance unemployment & welfare
benefits
-
Economy : less internationally competitive due to less spending and national output
Policies reducing unemployment
Fiscal : taxation & gov spending policies to influence economic activity (short term)
-
Improves demand issues avoiding cyclical & structural unemployment
-
Expansionary fiscal policy ( less tax , more spending ) : boost economic consumption & investment
-
Increase GDP & employment opportunities
Monetary : interest rates to influence economic activity (short term)
-
Lowered interest rates ; borrowing cost decreases ; spending & investment increases
-
Demand curve shifts to the right
Protectionist measures : used to protect domestic jobs from international competition
-
E.g. tariffs & quotas
Supply side :reduce unemployment caused by supply factors (long-term)
-
Improves supply issues avoiding cyclical & structural unemployment
-
Investment in education & training : gain new skills to employment
-
Reduction in trade union powers :more employment as here is less demand for annual pay rise
-
Incentives : offering incentives to train and hire long-term unemployed individuals to reduce training and hiring costs
-
Reducing welfare benefits : offering incentives to find a job rather than relying on state welfare benefits
Chapter 31
Inflation and deflation
inflation
-
Inflation : the sustained rise in the general level of prices of goods & services over time , as measure by a consumer price
index
-
Not all prices increase but on average prices are rising
-
Inflation reduces value of money & spending power (individuals , gov & firms)
-
Chart data : inflation is above 0
Deflation
-
Deflations : the sustained fall in the genera; price level in an economy over time ( negative inflation rate )
-
Caused by demand or supply factors
-
Deflation is a concern when demand is falling (economic recessions & increased unemployment )
-
Benign deflation ::deflation caused by higher levels of goods and services , increases productive capacity ; decrease prices
and increases national income
-supply side policy ; increasing supply and productivity in the economy, to enable long-term economic growth. ; greater
raise national income , greater level of capacity ; reducing general price level
-
Malign deflation :deflation caused by lower levels of demand in an economy over time (harmful to the economy)
-
-e.g. Lower consumption of goods and services during economic recession : lower GDP per capita & increased
unemployment
-
Fall in demand reduces national income ; decrease general price levels
Measuring inflation and deflation
Consumer price index : a weighted index of consumer prices in the economy over time used to measure the cost cost of living for an
average household ( to calculate inflation rate )
-
Changes in CPI represent changes in cost of living for the average households in the economy
-
Based on the proportions of an average household’s spending on items in goods & services
-
Used for international comparison of inflation rates
-
Important as a benchmark when central banks sets interest rates
Calculating the CPI
-
Base year : starting year when calculating price index
-
CPI compares price index of buying goods & services with the base year
Calculation of price index : (1) total basket price / base year - 100% (difference in % indicates difference in average price )
(2)calculating difference between 2 periods : (difference in %/ earlier year %) x 100%
-
Weighted price index : more accurate in measuring changes in the cost of living ; inflation
Calculation : price index x weight
Causes of inflation and deflation
-
Cost push inflation : cause of inflation , triggered by higher cost of production , thus increase in prices
-high cost of production ; higher selling prices to maintain profit margin
-
Demand pull inflation : cause of inflation triggered by higher levels of demand in the economy ; thus increase price
-
-higher demand ; higher price for goods & services
-
-increase national income whilst increasing prices
-
Monetary causes : increased money supply for easier access to credit ( loans & credit cards )
-
Imported inflation : cause of inflation triggered by higher import prices , increasing cost cost of production ; causing
domestic inflation
Consequences of inflation and deflation
Inflation
-
Menu cost : changes in price needs to be updated causing firms to change catalogues , pricelist & menus ,,, & paying
workers for repricing goods & services
-
Consumers :purchasing power goes down due to inflation (e.g. inflation causes fall in real income ,consumers need more
money to buy same amount of goods & services)
-
Shoe leather cost : inflation causes fluctuation in price levels thus customers want to find the best deals ; customers would
look for the cheapest option thus creating opportunity cost
-
Savers: savers will lose out during inflation ; without changes in interest rates their money could be worth less than before;
thus the increase in inflation is the same as interest rates money does not increase ; inflation can act as a disincentive to
save
-
Lenders : lenders lose from inflation this is because the money left would be worth less than before inflation
-
Borrowers : borrowers gain from inflation as the money repaid is worth less than when borrowed
-
Fixed income earners :fixed income earners ( income is constant) have a fall in real income . thus their purchasing power
would decrease; if income increases , inflation reduces the value
-
Low income earners low income earners have high price elasticity of demand thus are affected more than high income
earners
-
Exporters : international competitiveness of a country decreases with domestic inflation; in the long term ; high prices make
exporters less price-competitive thus decreasing profits , export earnings & economic growth and increases unemployment
-
Importers : import becomes more costly due to decline in purchasing power of money ; this causes import inflation ( higher
import prices increasing factors of production causing domestic inflation ) ; concern for countries w less natural resources
-
Employers : workers would demand increases in pay to maintain real income level ; labour cost increases ; profit margin
falls. Skilled workers would be more likely to have an increase in income as their jobs are in short supply & high demand .
creating wage spiral ( high demand for wages to keep up w inflation causing more inflation ) ; affects employers in
expensive areas as wages there are high to attract workers
-
Business confidence levels : inflation causes uncertainty & lower real rate of investment thus lower amount of planner
investments
Deflation
Depends if the deflation is benign or malign
Benign deflation
-
Boost national income and employment without increase in price
-
Boost international competitiveness
Malign deflation
-
Unemployment bankruptcies : fall in demand for goods & services thus a fall in demand for labour
-
Bankruptcies : consumers spend less ; lower revenue and sales ; difficult to repay cost & liabilities causing bankruptcies
-
Wealth effect : profits & valuation falls ; dividends & capital returns on holding share falls thus reducing shareholders
wealth
-
Debt effect : cost of debt ( borrow) increases ; real interest rate rises when price falls thus deflation & increase in real value
of debt causing a fall in consumer & business confidence level adding to the economic problem
-
Government debt : bankruptcies , unemployment & low economic activity level ,cause a fall in tax revenue ; thus increase
gov spending ; creates a budget deficit thus gov needs to borrow money although real cost of borrowing increases w
deflation
-
Consumer confidence : fall in consumer confidence due to fear the economy gets worst ; thus postponing spending
causing downward deflation spiral
Policies controlling inflation & deflation
inflation is controlled using policies
Fiscal policy :
-
-involves taxation and gov spending to control the level of economic activity
-high demand (demand-pull inflation) would cause tiger fiscal policy by increasing taxes / reducing expenditure to reduce
economic activity
-gov cut direct taxes to break out of downward deflation spiral thus increasing real income ; increasing demand ; greater
economic activity ; positive effect on employment & economic growth
Monetary policy
-
-involves central bank changing interest rates to control economic activity
-high interest rates reduce consumer & investment expenditure due to cost of borrowing
Low interest rates reduce deflation as interest rates are reduces exchange rates
Foreign investors receive lower return investment thus decreasing exchange rate ; fall in import prices ; increase demand
for exports
Supply-side policy
-
-used to increase the economy's productive capacity
-
Seek to increase competition , productivity & innovation for lower prices
-
Boost productive capacity of an economy without cost of inflation
Chapter 32
Indicators of living standards
-
Standard of living : the social & economic wellbeing of individuals in a country at a particular point
-
2 indicators of living standards : GDP per capita & Human Development Index (HDI)
GDP per capita
-
High GDP per capita : people have more to spend on goods & services
-
HOWEVER : GDP ignores size of the population thus GDP per capita is a better indicator of standard of living
-
Inflation is considered in GDP(real GDP) : money falls with inflation ( if inflation & GDP increases ; GDP remains constant )
-
Real GDP : when the monetary value of GDP is adjusted
human development index (HDI)
-
A composite indicator of living standards considering 3 factors
1. Healthcare: measures life expectancy at birth ; better healthcare: greater social & economical wellbeing
2. Education :(expected) years of schooling in the country ; better education : greater degree of human development
3. Income levels : higher national income ( GDP) indicates better human development
-
Limitations in using HDI
1. Qualitative factor : HDI ignores qualitative factors that affect SOL (inequalities )
2. Income distribution : HDI ignores inequitable distribution of income & lacks accuracy
3. Environmental issues : ignores environmental & resource depletion from economic growth
4. Cultural differences : ignores cultural variations & interpretation of the meaning of standard of living
-
Strengths in using HDI
1. Considered few indicators of standard of living
2.Improvement in the (3) indicators indicate better social wellbeing
Comparing living standard and income distribution
-
Productive levels : different productivity levels indicate different wages . skilled workers , more productive , higher salary ,
higher standard of living
-
Role of government : gov use direct taxer to redistribute income ; improves standard of living for most of the population
-
Size of population :direct impact on living standards , densely populated (limited space : high demand for rent ‘ congestion
& pollution) have higher living cost
-
Distribution of national income : high national income may not be distributed well. (.g. Large wealth gaps ); composition of
GDP is an important factor to consider ( high gov spending on military does not indicate better SOL for all)
-
Regional differences : regional income & wealth disparities within countries ( different income based on region)
-
general price level :inflation increase cost of living thus increases prices : negative impact on standard of living
-
Level of education : more education suggest more qualifications thus being more skilled ; likely to have a higher earning
and higher standard of living
-
Level of freedom : consideration of civil liberties , political rights , religious freedom & economic rights
Chapter 33
Poverty
Poverty : condition that exists when people lack adequate income and wealth to sustain a basic standard of living
-
Hunger & malnutrition
-
Ill health & mortality from illness
-
Limited or lack access to education & other basic services
-
homeless ness & inadequate housing
-
Unsafe environments
-
Social discrimination & exclusion
Absolute poverty
Absolute poverty : exists when there is extreme outright poverty,
-
Income entirely spent on basic human needs for survival ( bare minimum )
-
Income threshold/poverty line : to calculate the number of individua;s living below a certain level of incomes
Relative poverty
Relative poverty : a comparative measure of poverty, referring to those who have a lower standard of living in comparison to the
average member of society
-
Have lower standard of living in comparison to an average person in society
Causes of poverty
-
Unemployment : people in poverty are likely unemployed ( low literary , lack of skill / illness) thus labour productivity in
less developed countries are low ; it is difficult to break out of poverty
-
Low wages : lower GDP per capita indicates lower wages due to higher proportion of unskilled workers ; decreases
consumption & investment
-
Illness : reduced life expectancy due to malnutrition and lack of healthcare . lower life expectancy indicates greater degree
of poverty
-
Age : child labour can be caused by extreme poverty ; elderly are living longer yet have no income to sustain their SOL
-
Poor healthcare : lack of healthcare investment prevents a country from getting out of poverty : healthcare expenditure is
usually low in LEDCs
-
Low literacy rates : measure of the proportion of the population aged 15 above who can read and write . low literacy rates
may indicate lack of investment in education which affects employment , production & productivity : resulting in lower GDP
making it difficult to eradicate poverty
-
High population growth : measures the % change in the population of a country. Higher population growth ( poorer
countries ) due to : lack of sex ed & family planning , lack of contraceptions & cultural norm. Thus limited amount of
resource can hinder the country’s ability to eradicate poverty
-
Poor infrastructure :the transportation: communications networks
-
Low foreign direct investment ( FDI) : lack of capital resources limits ability to create income and wealth. FDI ( investment
made by multinational companies ) , lack of economic growth & poor infrastructure don’t attract FDI due to high risk & low
financial returns
-
High public debt : the money owed by the government , low-income countries are likely to borrow money to finance
expenditure thus lower standard of living ; due to government having to repay loans w interest payments
-
Reliance on primary sector output : low income countries over-rely on the production & export of primary sector output
-
Corruption & instability : high degree of corruption & instability in a country ; opportunity cost of civil war , dishonest gov … ;
thus this results in greater inequalities in income distribution & create poverty
Policies to alleviate poverty and redistribute income
-
Promoting economic growth :expansionary policy ( lower taxes/ interest rates encourage consumer spending & investment
expenditure ; this helps to create more jobs and alleviate the problem of poverty : lower exchange rates increases export
sales as the prices for foereign buying decreases
-
Improving education : improving access to education narrows the gaps between the rich and poor ; level of education
affects potential earning : policies increase quantity & quality of education improving human capital & productive capacity
thus more economic growth and lowering poverty ; provision of increased access to other services ( health care & housing )
-
Providing more generous state benefits :gov provision of welfare benefits gives financial assistance to enable the
unemployment & disadvantaged to meet their needs ; redistribution of income , reducing unemployment , government
funded job
-
Progressive taxation : progressivie tax systems reduce gaps between the rich & poor : this is to alleviate poverty &
redistribution income & wealth in society
-
Introducing/increasing a national minimum wage : improve the standard of living for low-income households thus alleviate
poverty in economy
Chapter 34
Population :total number of inhabitants of a particular country (essential for the economic prosperity )
Population growth : rate of change in the size of a country’s population
-
Change in population size can have huge & long lasting effects
Factors that affect population growth
-
Birth rate: measures the number of live births per thousand of the population in a year
-Calculation : dividing total no. of births / population size
-fertility rate :the average number of birth per woman used as a component to measure population
-replacement fertility rate : the number of children that the average woman must have to maintain a stable population size
-
Death rate : measures the number of deaths per thousand of the population in a year
-lower death rate indicates greater population growth
-death rate depends on the factors affecting quality of life (healthcare , income levels..)
-
Net migration rate : measures the difference between immigration & emigration rates for a country ; thus indicating the
physical movement of people moving in & out of a country
-immigration : people enter a country to live/work
-emigration : people leave a country to live/work
-calculation : net migration rate = immigration - emigration
- net immigration : more people enter a country than leave in a year
- net emigration : more people leave a country than they leave in a year
Reasons for different rates of population growth in different countries
-
Birth rate :
-MEDCs have lower birth rates than LEDCs due to education & access to contraceptives -women choose to pursue careers opting to have fewer children /have children later in life
-High costs of raising children
-
Death rate :
-
- better-quality education , healthcare , nutrition & sanitation in MEDCs people live longer
-
-famine poverty , poor housing , high infant mortality rates & diseases reduces life expectancy in LEDCs
-
Net migration :
-better job opportunities
-taking advantage of lower taxes
-Avoid civil unrest
Effects of changes in the size and structure of population on different countries
Optimum population : exists when the output of goods & services per head of the population is maximised
Under-populated : does not have sufficient labour to make the best use of resources
-
GDP per capita would increase with more human resources
-
Can be caused by fertility rates below replacement levels; cause economic decline
-
Gov would encourage immigration to increase population size
Over-populated:the country is too large given the available resources
-
fertility rates above replacement level
-
Cause negative economic consequences : famine , housing shortage , energy shortage & diseases
-
GDP per capita falls s insufficient resources can sustain the population
-
Gov would introduce measures to reduce population / boost investment & productivity in the economy
Population distribution
Population distribution : the composition & structure of a countries population
Demographics : the study of population distribution & trends (e.g. difference in gender & age distributions )
-
Gender distribution : number of males compared to number of females in a population ( usually evenly split)
-
Age distribution : number of people in different age groups in the population
-low income countries have larger young age groups (people have more children)
-high income countries have larger ageing population ( people have less kids )
-population pyramids : graphical representation of the age & gender distribution of a country’s population
-
Dependency ratio : a comparison of the number of people who are not in the labour force with the number of people in
active paid employment
-
-dependant population :includes full-time students & unemployed
-
-Working population: the active labour force age 15-65 , people willing & able to work. Consisting of those in paid
employment , self employment & unemployed
-
-calculation :dependency ratio = dependant population - working population
-
-higher dependency ratio : higher tax burden
-
Increase of dependency ratio: (1) higher birth rates , occurs in LEDCs
(2) higher compulsory school leaving age ; raising number of people in dependent n
population
(3) social changes : high demand for education cause workers entering the workforce later /
early retirement
Effects of population changes
Population growth
Why population won’t exceed food output
1.
Population growth rates are slower than expected especially in MEDCs due to high opportunity cost of raising children
2.
Geometric progression in food production advances in food technology ( machinery , fertilisers , genetics ..)
Population distribution
-
Consumer : demand of goods & services changes w more variation in population trends (different groups having difference
preferences )
-
Firms : demand for supply of labout=r changes following long-term changes in population trends ( to change number of
labour based on population )
-
Government : gov benefits as they can collect more tax revenue from larger workforce
-
-HOWEVER : pressure to provide more public services , welfare benefits & state pensions rises ; gov may introduce
compulsory pension saving schemes & increase retirement age
-
The economy : more pressure on economy’s scarce resource
-inflationary pressures / increase demand for countries imports if country cant produce enough to meet the needs & wants
of the population
-
Natural environment : increased population puts a strain on environment ; non-renewable source depleted in production
process increasing level of production & straining environment
Chapter 35
Economic development
Economic development : an intangible concept that considers both quantitative and qualitative variables in standard of living in a
country
Factors accounting for differences in economic development
Differences in income (GDP) :
-
higher real GDP per capita indicates greater economic development
-
Wealthier country : higher standard of living
-
LEDCS have lowever income per head due to low GDP & higher birth rate
-
Inequalities of distribution of income : shows higher GDP per capita does not indicate higher standard of living
-
Economic growth can cause pollution , climate change & environmental damage
Differences in productivity :
-
Economic development vary based on productivity ( low income countries unable to be more productive due to lack of
access to technology)
-
Efficiency and productivity can lead to economic development
-
Countries able to attract FDI can be more productive as there’s an increase in quantity & quality of physical capital in the
country thus increase productive capacity & productiveness ; resulting in more job opportunities & economic development
Difference in population growth
-
Rapid population group can limit increase in GDP as it reduces GDP per capita
-
Rapid growth limits the ability to develop economically
Differences in size of primary , secondary and tertiary sectors
Primary :output concerns extraction of raw material & other natural resources
-
Dominates in terms of output & employment in LEDCs
-
E.g. oil exploration , farming , mining …
Secondary: output involves manufacturing ( use of natural resources to produce man-made resources)
-
Machinery . vehicles , buildings ..
-
Predominant sector in industrialising /developing countries
Tertiary : provision of services
-
Accountants , teachers , doctors …
-
More important in high-income economies
Differences in saving and investment
-
Saving requires to give banks sufficient funds to lend to firms for investment purposes
-
In LEDCs most are unable to have savings due to lack of money for basic needs
-
In MEDCs most are able to save money
-
Firms borrow saving funds via banks to pay for investments ; thus more savings means more investment to economic
development
Difference in education
-
Education is an indicator of economic development
-
Measured by mean years of schooling & adult literacy rates
-
Greater education indicates greater standard of living
Difference in healthcare
-
Healthcare in an indicator of economic development
-
Better healthcare : better social & economical well being
-
How quality of healthcare is measured : (1) life expectancy at birth: number of years a person is expected to live
(2) country’s annual expenditure on healthcare % of GDP
(3) child mortality rate : number of death of children age 5 & below per thousand
of the population
Chapter 36
International specialisation
Specialisation : when individual , firms , regions or countries concentrate on the production of a particular good or service
Specialisation at a national level
-
Individuals : allows workers to become more skilled and efficient at their jobs ; increasing quality & quality of goods and
services provided
-
Firms ; specialise in the output of goods and services ( e.g. fast food , delivery services..)
-
Regions ; a certain area that specialises in specific goods and services (e.g. silicon valley , financial districts ..)
-
Countries ; international specialisation is when a country concentrates on the product of certain goods and services due t
cost advantages or abundance of resources
Advantages and disadvantages of specialisation at national level
Advantage
1.
Efficiency gains : specialisation makes better use of scarce resources ; increasing productivity ; increasing countries GDP ;
increase standards of living
2.
Labour productivity : more skilled workers as they concentrate on what they do best; improves labour productivity ; better
quality products produced. Benefits firms , regions & countries
3.
Increased productive capacity : increase productive capacity, shirts PPC outwards ; increased national output
4.
Economies of scale : increases GDP & global trade ; increase cost-saving benefits & large-scale operations (financial ,
buying and technical economies ; keeps prices down thus controls inflation)
5.
Improved competitiveness : enhance international trade & exchange ; competitive prices which improve international
competitiveness , thus improves economic growth ; improves standard of living
Disadvantage
1.
Overspecialisation : cause regional & structural unemployment (30) ; causing economic downturn due to lack of variety of
goods and services to survive
2.
Lack of variety for consumers : specialisation leading to standardised mass-produced goods ; domestic consumers
alternate to imported products from foreign suppliers ; reducing competitiveness of overspecialised domestic firms
3.
High labour turnover : workers choosing to leave their jobs in search for a better one . higher turnover rate : costly for firms
to hire and train new workers ; low wages for low-skilled workers
4.
Low labour mobility : structural unemployment : low-skilled & poorly paid workers receiving little training thus unable to
find alternative jobs / highly skilled & specialised workers having difficulty finding alternative professions or careers . laco of
labour market flexibility : reduce efficiency & international competitiveness
5.
Higher labour cost : higher salary demands when employing workers with highly specialised skills . causes negative
impact on profits & reduce competitiveness
Chapter 37
Globalisation , free trade & protection
Globalisation : process which the world’s economies become increasingly interdependent and interconnected
-
Increases exchange of goods & services ( fast food , financial market , motor vehicles …)
-
Has increased with social media and MNC expansions
Impacts ( positive / negative ) of globalisation:
-
Increased international trade , more wealth & jobs
-
Free capital , labour , g & s
-
Benefits from economies of scale ( larger scale , lower average cost )
-
More choices of g & s
-
Greater cultural understanding & appreciation
-
Globalisation leads to greater dependence on global economy
-
Increases income and wealth gap ; poor are poorer , rich are richer
Role of multinational companies
MNCs : an organisation that operates in 2 / more countries
Advantages of MNCs
-
MNC improves living standards ; increases employment
-
Benefit from economies of scale , saves cost
-
Operating in overseas market allows to generate more profits as customer base is arger
-
Spread of risks ( e.g. if business in one country isnt working out there's still the other )
-
Avoid trade restrictions
-
Access to new markers by locating overseas ; reduced transportation costs as products are not required to be exported
-
Benefit from lower corporation tax in other countries
Disadvantages of MNCs
-
MNCs criticised for unethical and cost-cutting practices ( e. G. poor working conditions , low wages..)
-
Make domestic firms less competitive ; exploiting economies of scale affecting domestic jobs
-
MNCs earn higher sales rev than the host country’s GDP ; exploiting foreign gov with business location and finance access
-
Consequence of overreliance on MNCs in low income countries
-
Issues of different legal systems, tax regulation & environmental guidelines
-
Difficulty managing overall business due difficulty to communicate effectively with different languages , cultures and time
zones
-
Exchange rotates ; difficulty comparing and measuring value of sales and profits
-
Difficulty providing goods and services that appeal to domestic taste and customs
Free trade & international trade
International trade : exchange of g&s beyond national borders (sale of imports and exports )
Free trade : international trade takes place without protectionist measures
Benefits of free trade :( vice versa for protection)
-
Access to resources : producers and consumer access to g & s they cant produce themselves
-
Lower prices : free trade reducing cost of trading
-
Economies of scale : firms operating at large scales in global markets ; cheaper prices for consumers / more profits for
producers
-
Greater choice : larger access to variety of goods & services from different producers
-
Efficiency gains : foreign competition from free trade allows domestic producers to improve quality and be more efficient
-
Improved international relations : trade barrier absence encourage international trade and cooperation between countries
Protection
Protection : trade barriers to restaurant foreugn trade thus limiting overseas competition
Methods of protection :
-
Tariffs : tax on imports ,increasing production cost for foreign firms
-
Import quotas : quantitative limit on sale of foreign goods , thus increases market price of foreign goods ( supply perfectly
inelastic )
-
Subsidies : government financial assistance to help cut production cost of domestic firms helping to compete with foreign
produces , lowers cost of production and protects domestic jobs (supply curve shifts to the right )
-
Embargo : ban on trade with a certain country due to trade/political dispute
-
Rules & regulations : rules regarding food safety , environmental standards , product quality … protects domestic
consumers
Protection Benefits
-
Safeguard infant industries ( new businesses ) from foreign competition
-
Protect domestic jobs
-
Prevents dumping : foreign firms selling products in large quantities below domestic firm’s prices to eliminate competition
-
Government revenue : increasing tax revenue for government from import tax
-
Balance of payment deficit : imports exceeding exports ( country spends more than it earns )
-
Strategic arguments : prevent country from being too dependent on goods & services from other countries
-
Distorts market signals : global misallocation of resources , domestic firms are reliant on protection becoming more
Limits :
inefficient
-
Increased cost of production : lack of competition and incentive to be innovative , higher cost for imported raw
materials/component causing higher domestic prices
-
Other countries retaliating and imposing trade barriers as well , hindering global economic growth
Chapter 38
Foreign exchange rates
Exchange rates : price of 1 currency measured in terms of other currencies
Determination of exchange rates in foreign exchange markets
-
Demand for export of g & s increase if exports are cheaper ; vice versa
-
Exchange rates are fundamental in facilitating international trade
-
Currency value increase ; demand for import increase ; demand for export decrease ( vice versa )
-
Price inelastic imports :essential products not readily available to all domestic economies ;thus firms spend more on
essential imports when exchange rate falls
-
Exchange rate changes affect tourism revenue & profitability of business , thus impacts unemployment & economic growth
Floating & fixed exchange rate systems
Floating exchange rate system: currency is allowed to fluctuated against other currencies according to market forces without gov
intervention
-
Currency value determined by market force demand for the currency and supply of the currency
-
E.g. tourist selling domestic currency and buying foreign currency ( currency changes based on tourism )
-
Higher interest rates , more investments , increasing price/exchange rates ( vice versa)
-
Appreciation : increase in currency value relative to another currency operating in a floating exchange rate system
-
Depreciation : decrease in currency value relative to another currency operating in a floating exchange rate system
Fixed(pegged) exchange rate system : when central bank buys & sells foreign currency to ensure its currency stays at the pegged
value
-
Exchange rate remains at predetermined level
-
Reduces uncertainty for international trade
-
Certainty on future cost and prices , thus encourages international trade and exchange
-
Raise currency value : increase demand for currency to prevent currency from falling ; buy currency ( vise versa)
-
Limits: reduces ability to use monetary policy to affect economy ; opportunity cost to foreign exchange reserves
-
Pegged rate can be changed overtime
-
Devaluation : when the price of currency in fixed e.r.s. Is officially lowered
-
Revaluation : when the price of currency in fixed e.r.s. Is officially increased
Causes of exchange rate fluctuations
-
Change in export demand : increase export demand ; increase demand for country’s currency ; increase exchange rate
-
Change in import demand : increase import demand ; increase foreign currency value
-
Price & inflation : increased g & s price ; decrease export demand ; decrease exchange rate
-
Foreign direct investment FDI : globalisation & MNCs indicates overseas production & use of foreign currencies ..
Inward FDI ( entry of MNCs) ; increase currency demand // outward FDI (departure of MNCs) ; increase currency supply
-
Speculation : speculation of the ability to take advantage of the currency for example with interest rates can change the
value of currency due to change in investment ( short term)
-
Government intervention : selling or buying of currency by the government affect the currency rate
Consequences of exchange rates fluctuations
-
Consumer : currency increase ; purchasing power increase ( less money to buy more with other currencies )
-
Exporters : currency increase ; exports decrease ( goods are more expensive for foreign consumers , less exports)
-
Importers : currency increase ; import increase ( foreign raw materials & component are cheaper )
-
Balance of payment : currency appreciate ; b.o.p. worsen ( increase currency indicates more imports and less exports thus
net export can decrease )
-
Employment : net export decrease ; profits decrease ; jobs loss in export-oriented business ; unemployment increase
-
Inflation : unemployment increase ; spending decrease ; inflation rate reduced // import relying country can benefit from
higher exchange rates
-
Economic growth : exchange rates increase ; economic growth decrease due to low export and high unemployment
Coping with a strong exchange rate
-
Cutting exports : maintain price competitiveness against foregin competition however profit margins are low
-
Alternative overseas suppliers : cheaper raw materials/components
-
Improve efficiency : control labour cost
-
Supply price inelastic & income inelastic products
-
Focus on non-price factors such as brand awareness & social responsibility
-
Relocating production where cost of production is low
Chapter 39
Current account of balance of payments
The current account of the balance of payment
Balance of payment : financial record of a country’s transaction with the rest of the world for a given time period
-
Trade in goods & services with other countries
-
Imports (spending) , exports ( earning )
Current account : largest component of balance of payment ; records all exports & imports of g & s between a country and its trading
partners + net income transfers from abroad
Calculation : current account = balance of trade + primary income + secondary income
-
4 parts : trade in goods , trade in services , primary income & secondary income
Trade in goods
-
Visible balance :Record of import & export of physical goods ( raw materials , semi-manufactures products & manufactures
goods )
-
Visible exports : goods sold to foreign customers with money flowing to the domestic economy
-
Visible imports : goods bought by domestic customers with money flowing out of the domestic economy
Trade in services
-
Invisible balance : record of exports and imports of services ( intangible products)
-
E.g. tourism , insurance , shipping …
-
Invisible export : export earnings (foreign customer on domestic airline)
-
Invisible imports : import earnings ( domestic customer on foreign airline )
Primary income
-
Primary income : investment income , record of net income earning from investment abroad
-
E.g. ; -interest received from loans & deposits from foreign banks
-dividends from foreign investment / overseas business ventures
- money sent domestically from people working abroad
-profits earned by subsidiary company in foreign country
Secondary income
-
Secondary income: net income transfers per time period , transfer between resident & non residents
-
E.g. :-donation to charities abroad
-
-foreign aid
-
-subsidies / grants paid to companies based in foreign countries
-
-scholarships to students in foreign universities
Current account deficits & surpluses
Current account deficit :when country spends more than it earn , negative balance
Current account surplus : exports exceed imports , positive balance
Cause of current account deficits
-
Low export demand : manufacturing competitiveness decrease due to increase labour cost //income in foreign market
increase due to recession thus consumers are less able to spend on exports // high exchange rates , more expensive
products , less consumers
-
Higher demand for imports: cheaper and higher quality imports (e.g. increase exchange rates , more able to buy foreign
currency) // domestic inflation , imports are cheaper , increase purchase of foreign goods
Consequences of current account deficits
-
Reduced demand : economy is spending more than earning ; economy demand decrease , recession occur , increase
economic problems
-
Unemployment : labour has derived demand , fall in overall demand causing cyclical unemployment , lower wages/less
employed
-
Lower standard of living : negative net incomes , more capital outflow than inflow ; lower standard of living //households &
firms reduce spending
-
Increase borrowing : country would borrow more or attract more fdi to rectify current account deficit //opportunity cost as
government uses money to pay debt instead of stimulating economic growth
-
Lower exchange rates : export demand decrease/ import demand increase can reduce exchange rate , lower exchange rate
; more price competitive exports // expensive imports & essential impots causing inflation
Causes of current account surpluses
-
High export demand : caused by improved manufacturing competitiveness due to higher labour productivity domestically //
high income in foreign market indicates foreign consumers are able to spend on exports / lower exchange rates , less
expensive for foreign buyers , higher demand
-
Reduced import demand : fewer import purchases due to low quality/costly products compared to domestic products //
foreign inflation causing expensive imports thus more purchase of domestic g & s
Consequences of current account surpluses
-
Employment : higher export sales helps create more job opportunities // creates more job losses in foreign countries
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Standard of living : higher incomes as domestic firms has high competitive advantage ; higher standard of living
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Inflationary pressure : high export demand , demand-pull inflation ; current account surplus diminish international
competitiveness , overtimes increasing export prices due to inflation
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High exchange rates : high export demand causing currency value to appreciate , more expensive for foreign buyer to
import products
Policies to achieve balance of payment stability
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Fiscal; : higher taxes & lower gov spending .; decrease money spent on imports decreasing current account deficit
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Monetary : higher interest rates , loans are more expensive ; reduced import demand // devaluation of exchange rates ;
improve competitiveness ; reduce export price ; increase import price
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supply side : increase productive capacity
-education & healthcare investment improving human capital , productivity & international competitiveness
-infrastructure investment supporting business & industries ( export market)
-gov subsidies & tax incentives encouraging export-oriented businesses / industries
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.
Protectionist measures : reduce competitiveness of imports with tariffs , quotas etc