CH 11 - PRICE ELASTICITY OF DEMAND
Price elasticity of demand (PED): a measure of the responsiveness of the quantity demanded to a change in
price.
PED = Percentage change in quantity demanded / Percentage change in price
This is often abbreviated to: PED = %ΔQD / %ΔP
The percentage change in quantity demanded is: Change in demand / Original quantity demanded × 100
The percentage change in price is: Change in price / Original price × 100
Most of the time the PED sign is a minus. This means there is an inverse relationship between the quantity
demanded and price – a rise in price will cause a contraction in demand and a fall in price will cause an
extension in demand. The size of the figure indicates the extent by which demand will extend or contract
when price changes. A figure of –2, for example, indicates that a 1% change in price will cause a 2% change
in quantity demanded.
Elastic demand: when the quantity demanded changes by a greater percentage than the change in price.
Inelastic demand: when the quantity demanded changes by a smaller percentage than the change in price.
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The availability of similar-quality substitutes and price determines whether demand is elastic or inelastic. If
a product has a close substitute, it likely has elastic demand, causing a significant decrease in quantity
demanded as consumers switch to the substitute. Conversely, if there is no substitute, demand is likely
inelastic, with no significant decrease in quantity demanded due to price increases.
The other influencing factors are all linked to the availability of substitutes. These factors include the
proportion of income spent on the product, whether the product is a necessity or a luxury, whether the
product is addictive or not, whether its purchase can be postponed, how the market is defined and the time
period under consideration.
The price of a product, which takes up a small proportion of people's income, can affect demand in an
inelastic manner. For instance, a 20% rise in salt price would result in a smaller percentage change in the
quantity demanded, while a larger proportion of people's income would result in elastic demand, such as a
20% increase in the price of a new car.
Luxury products have elastic demand, meaning a price increase may lead to a decrease in quantity
demanded. Conversely, necessities like soaps have inelastic demand, meaning people cannot significantly
reduce their use despite price increases, unlike luxuries that do not require purchase.
People also find it difficult to cut back on their purchases of products which are addictive, such as cigarettes
and coffee. This means that such products have inelastic demand.
Delaying product purchases leads to elastic demand. A higher price leads to a decrease in demand as people
postpone purchases, hoping for future price drops. If price drops, demand increases, resulting in increased
sales.
The more narrowly defined a product is, the more elastic its demand is. Demand for one brand of tea is more
elastic than demand for tea in general and even more elastic than demand for hot drinks in general. This is
because the narrower the definition, the more substitutes a product is likely to have.
Demand also becomes more elastic, if the time period under consideration is long. This is because it gives
consumers more time to switch their purchases. In the short term if the price of a product rises, customers
may not have enough time to find alternatives and if it falls, new customers will not have sufficient time to
notice the change in price and switch away from rival products.
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PED for products can change over time, as luxuries become necessities as people become richer, causing
demand to shift from elastic to inelastic. This variation also extends to different tastes, income levels, and
cultures across countries.
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OTHER DEGREES OF PED:
Perfectly elastic demand occurs when a price change leads to a complete change in the quantity demanded.
A firm can sell any quantity at the market price, but nothing above it. For example, a wheat farmer raising
their price may lose all sales, leading to a horizontal straight line representing infinity.
Perfectly inelastic demand is when the quantity demanded does not change when price changes.
Consumers buy the same quantity despite the alteration in price and PED is zero.
Unit elasticity of demand is found when a percentage change in price results in an equal percentage change
in quantity demanded, giving a PED of one (unity). When PED is unity, the area under the demand curve
stays the same as price changes, showing that total revenue and total spending remain unchanged as price
changes.
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Economists study the impact of price changes on a product's demand, as consumers benefit from lower
prices and higher quality when demand is elastic. Producers are reluctant to raise prices as demand contracts,
leading to decreased revenue. High quality may be achieved due to close substitutes, requiring producers to
provide high-quality products to remain competitive. A price fall can extend demand, but producers must
consider the extent of the rise in demand. If demand is small, reducing the price may not be profitable.
Producers can make their products more distinctive to discourage consumers from switching to other firms'
products. This makes demand more price inelastic and gives producers more power to raise prices.
Governments must also consider the responsiveness of the quantity demanded to price changes. If demand is
elastic, a tax on a product may not be effective in achieving its aim.
CH 12 - PRICE ELASTICITY OF SUPPLY
Price elasticity of supply (PES): a measure of the responsiveness of the quantity supplied to a change in
price.
PES = Percentage change in quantity supplied / Percentage change in price
The abbreviated form of this is: PES = %ΔQS / %ΔP
The percentage change in quantity supplied is: Change in quantity supplied / Original quantity supplied ×
100
The percentage change in price is: Change in price / Original price × 100
As the quantity supplied and price are directly related, PES is a positive figure. The figure indicates the
degree of responsiveness of the quantity supplied to a change in price. The higher the figure, the more
responsive supply is. A PES of 2.6, for example, means that a 1% rise in price will cause a 2.6% extension
in supply.
Elastic supply: when the quantity supplied changes by a greater percentage than the change in price.
Inelastic supply: when the quantity supplied changes by a smaller percentage than the change in price.
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The three main factors which determine the PES of a product are:
1. the time taken to produce it
2. the cost of altering its supply
3. the feasibility of storing it
Product production and storage are key factors in supply and demand. Quick production reduces the cost of
altering supply, while long production times make it expensive to change production. Inelastic supply is
more difficult to adjust due to the inability to store products. For example, agricultural products are inelastic
due to the time required for crops to grow and animals to mature. The short shelf-life of apples makes it
unlikely that the quantity offered for sale will decline significantly. However, if apples can be moved to
different areas or countries due to a difference in demand and price, they may be relatively elastic. In
summary, production, storage, and supply are crucial factors in determining a product's demand and supply.
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OTHER DEGREES OF PES:
Perfectly inelastic supply means the quantity supplied remains constant with price changes, with PES zero.
For instance, higher demand for a cinema may increase ticket prices but not increase seating capacity. In the
long run, high demand may lead to cinema size expansion.
Perfectly elastic supply is when a change in price will cause an infinite change in supply, giving a PES of
infinity. PES may come close to infinity in very competitive markets. In this case, firms would supply
whatever quantity people want to buy at the given price. An increase in demand would not cause a change in
price. If demand and price were to fall, supply would fall to zero.
Unit PES occurs when a given percentage change in price causes an equal percentage change in supply.
Unit PES is illustrated by any straight line that goes through the origin (the point where the vertical and
horizontal axes intersect).
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PES (Product Availability and Supply) varies over time, with more elastic supply due to producers having
more time to adjust production. Advances in technology, such as reduced production periods and lower
costs, have made supply more elastic. In recent years, production of magazines has become easier and
cheaper, increasing the number of titles available and decreasing the popularity of declining titles.
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Efficient supply is beneficial for consumers as it responds to consumer demand, resulting in higher prices
and sales. Producers aim for elasticity to increase profits and adjust their supply more quickly. Governments
can encourage product output and consumption by providing subsidies to producers with elastic supply. To
promote flexibility in production, governments use various policy measures, such as changing laws to make
it easier for firms to hire and fire labor.
CH 13 - MARKET ECONOMIC SYSTEM
Resources move automatically as a result of changes in price. In turn, price changes are determined by the
interaction of demand and supply. The use of resources is changing all the time in response to changes in
consumer demand and the costs of production. Resources move towards those products whose demand is
rising and away from those which are becoming less popular.
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The private sector comprises shareholder-owned businesses, driven by profit, while the public sector,
controlled by the government, includes government-run services and state-owned enterprises, focusing on
promoting population welfare and addressing market changes.
Public sector: the part of the economy controlled by the government.
State-owned enterprises (SOEs): organisations owned by the government which sell products.
Privatisation: the sale of public sector assets to the private sector.
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ADVANTAGES OF THE MARKET ECONOMIC SYSTEM
● A market economic system should be responsive to consumer demand, with consumers being
sovereign and having the power to determine what is produced.
● The market economic system automatically adjusts resources to reflect consumer demand due to
three reasons: the price mechanism (the system by which the market forces of demand and supply
determine prices) provides information on increasing and falling products, the system incentives
resource movement, and penalizes firms, workers, and owners of capital and land who fail to
respond. For instance, if demand for books increases while cinema tickets decreases, profits and
wages in the publishing industry will rise, while in the film industry, they will fall.
● There is choice. Consumers can choose which products to buy and which firms to buy from. Firms
can also decide what they want to produce and workers can choose who to work for.
● The profit motive and competition in the market economic system encourage efficiency. Firms that
produce at the lowest costs and charge the lowest prices are likely to sell more and earn more profit,
while those producing the same quality at a higher price are likely to go out of business. This system
rewards efficiency and punishes inefficiency.
● Quality may be high. Market forces can promote the improvement of methods of production and a
rise in the quality of products made. It does this by putting competitive pressure on firms, and by
providing them with the profit incentive to try to gain more sales by making their products more
attractive to consumers.
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DISADVANTAGES OF THE MARKET ECONOMIC SYSTEM
There is a risk that the market forces of demand and supply may not work well. In fact, market failure
(market forces resulting in an inefficient allocation of resources) may occur, with market forces failing to
ensure the maximum benefit for society. There are a number of reasons for this.
● Consumers and private sector firms may only take into account the costs and benefits to themselves,
and not the costs and benefits of their decisions to others.
● Firm competition is essential for efficiency, but in practice, it may be minimal, leading to a market
being dominated by a few firms with significant market power, limiting consumer choices and
allowing them to raise prices and produce poor quality products.
● Firms may struggle to meet consumer demands due to inability to attract workers with the right skills
or geographical mobility.
● Private sector firms often produce products unless they can charge for them, such as defense, which
is popular but not universally available. This allows people to act as free riders (someone who
consumes a good or service without paying for it), benefiting from the product even if they don't pay.
Without this financial incentive, firms may not produce the product.
● Advertising can influence consumer choice by persuading people to buy products they wouldn't
otherwise, and by promoting large quantities, consumers and producers may make inefficient
choices.
● Market forces can sometimes fail to achieve efficiency and result in inequitable outcomes. In a
market economic system, some consumers may lack income, leading to an uneven distribution of
wealth. The sick, disabled, and old may struggle to earn income, while some workers may become
unemployed and find new jobs.
● Income differences will increase over time, with high-income individuals investing in savings and
shares, earning interest and dividends. Poor individuals cannot save. Children of the rich are more
likely to earn high incomes due to their parents' spending on education and better home equipment,
leading to high hopes for success.
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Allocative efficiency: when resources are allocated to produce the right products in the right quantities.
Productively efficient: when products are produced at the lowest possible cost and making full use of
resources.
Dynamic efficiency: efficiency occurring over time as a result of investment and innovation.
CH 14 - MARKET FAILURE
Market failure occurs when market forces fail to produce products consumers demand in the right quantities
and at the lowest possible cost. Indicators of market failure include shortages, surpluses, high prices, poor
quality, and lack of innovation. Market failure can lead to under-production, over-production, or even
non-production. High prices may be due to lack of competitive pressure and difficulty in lowering costs.
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Third parties, those not directly involved in the consumption or production of products, may experience
social benefits (the total benefits to a society of an economic activity) and social costs (the total costs to a
society of an economic activity). These costs are greater than private benefits (benefits received by those
directly consuming or producing a product) and private costs (costs borne by those directly consuming or
producing a product). For instance, a chemical company producing chemicals will incur social costs for both
the firm and nearby residents. External costs (costs imposed on those who are not involved in the
consumption and production activities of others directly), such as raw material, fuel, and wages, include
noise, air, and water pollution. If decisions to produce chemicals solely based on private costs lead to
over-production.
The demand for a product based solely on its private benefits can lead to underconsumption and
under-production if the total benefit to society is greater. For example, university degrees provide students
with career choices, higher earnings, lifelong interests, and lifelong friends. Social benefits include external
benefits (benefits enjoyed by those who are not involved in the consumption and production activities of
others directly), such as higher output and quality. Markets fail to allocate resources efficiently when there is
a gap between the total effects on society and those directly consuming and producing the products. The
socially optimum output (the level of output where social cost equals social benefit and society’s welfare is
maximised) occurs when the social benefit of the last unit produced equals the social cost of that unit.
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Merit goods are products that offer significant benefits to consumers and external benefits for those not
directly involved, often leading to under-consumption and under-production. For instance, healthcare can be
a merit good, as people may not recognize its importance. Governments can address this issue by providing
information on the benefits of consuming merit goods, which could increase demand. If this doesn't work,
another approach may be needed, such as providing the product free or making consumption compulsory.
Demerit goods are products which the government considers consumers do not fully appreciate how
harmful they are and so which will be over-consumed if left to market forces and such goods generate
negative externalities. For example, cigarettes are a demerit good due to health damage and air pollution.
Governments can combat this by raising prices, providing information about harmful effects, or banning
certain products. Public smoking bans, health campaigns, health warnings, taxation, and advertising bans are
some measures to discourage smoking and protect non-smokers' health.
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Public good: a product which is non-rival and non-excludable and hence needs to be financed by taxation.
Private good: a product which is both rival and excludable.
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Market failure can occur when producers have more market power than consumers, leading to inefficiencies
and poor quality products. Monopolies, where one firm dominates a market, may not be allocatively,
productively, or dynamically efficient, resulting in consumers having no choice but to buy from them.
Additionally, abuse of market failure can occur when there are multiple firms producing a product, leading
to price fixing (when two or more firms agree to sell a product at the same price). Governments can
promote competition and prevent firms from abusing their market power by removing restrictions on new
firm entry, making uncompetitive practices illegal, and preventing mergers if they are believed to act against
consumer interests by charging high prices and producing poor quality products.
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Allocative efficiency requires resources to move from decreasing to increasing demand, requiring both
occupational and geographical mobility. Some resources may be immobile, leading to shortages,
unemployment, and under-utilization of capital equipment. Governments can promote occupational mobility
by improving education and training, providing investment grants for firms to change land and building use,
and encouraging workers to buy or rent housing in areas with high demand. This can be achieved through
construction of more houses or financial assistance for workers moving to these locations.
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Market forces may not lead to sufficient resources being devoted to capital goods, potentially resulting in a
lack of investment. High consumer product production can lead to a high living standard, but diverting
resources for capital goods may be necessary. Private sector firms may prioritize quick profits, leading to a
lack of investment. Governments may need to stimulate private sector investment.
CH 15 - MIXED ECONOMIC SYSTEM
Mixed economic system: an economy in which both the private and public sectors play an important role.
A mixed economy combines market and planned advantages, allowing private sector production to generate
choice, increase efficiency, and create incentives, while also benefiting from state intervention. Such benefits
include:
● The government should consider both costs and benefits of decisions, such as maintaining a railway
line and station if the state's benefit to society outweighs the cost, even if it doesn't generate profit in
the private sector.
● The government can promote healthier consumption by offering subsidies, providing information, or
enacting legislation that benefits both consumers and the environment.
● Government can finance the production of products that cannot be charged for directly, for example,
defence.
● Government can seek to prevent private sector firms from exploiting consumers by charging high
prices.
● Government is likely to seek to make maximum use of resources, including labour, and hence try to
ensure that those people willing and able to work can find jobs.
● There is a possibility that the government will plan ahead to a greater extent than private sector firms
and hence may devote more of its resources to capital goods.
● Government can help vulnerable groups, ensuring that they have access to basic necessities. It can
also create a more even distribution of income, by taxing the rich at a high rate.
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Maximum pricing, also known as price ceiling, is a government rule that limits the price a firm can sell a
good, allowing poor people to afford basic needs. This can lead to shortages and illegal markets. To prevent
these issues, governments may introduce rationing or a lottery system, which limit consumption or allocate
customers based on lottery draws.
To stimulate production, governments or producers set minimum pricing, also known as price floors,
allowing firms to charge the lowest possible price. These floors are above the equilibrium level, resulting in
a surplus and eventually lowering prices. To prevent this, the government or official company must buy the
surplus, such as minimum wage for labor.
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GOVERNMENT INTERVENTION FOR MARKET FAILURE
● Government subsidies influence firms' profits, investment willingness, production costs, and
consumer demand, with indirect taxes increasing costs and income taxes reducing disposable
income.
● Competition policy prevents firms from abusing market power by promoting competitive pressures,
preventing mergers, removing entry barriers, regulating monopolies, and prohibiting uncompetitive
practices like predatory pricing and limit pricing.
● Government policies like tradable permits limit pollutants and fines for polluting firms, allowing
cleaner firms to sell more permits and reduce pollution, thereby capturing more market share.
● Regulation enforces rules and laws restricting firms' activities, such as price controls and pollution
limits, but can be costly, time-consuming, and may not directly compensate affected parties.
● Nationalisation and privatisation are strategies to improve economic performance by transferring
state-owned enterprises to the private sector, but are criticized for challenges like market forces and
pollution.
● Governments produce essential goods and services, pay private sector firms, and make consumption
compulsory, ensuring non-rival enjoyment of public goods.
● Governments intervene in market economies to correct market failure and ensure fair income
distribution, providing financial assistance and essential products free to the poor through taxation.
Government intervention can mitigate market failure but may overestimate private benefits, delay
decision-making, and reduce economic efficiency. Both public and private sector expenditures have
advantages and disadvantages, and cost-benefit analysis is crucial for resource allocation.
CH 16 - MONEY AND BANKING
Money: an item which is generally acceptable as a means of payment.
The functions of money. Money carries out four functions. It acts as a:
• medium of exchange
• store of value
• unit of account
• standard of deferred payments.
Money does not require intrinsic value, but it must possess several characteristics to function as money.
The most important is its general acceptability, which requires it to be in limited supply. Other
characteristics include being durable, portable, divisible, homogeneous, and easily identifiable. For example,
silver and bank notes can act as money, but silver is preferred for various purposes.
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Commercial banks: banks which aim to make a profit by providing a range of banking services to
households and firms
ROLE AND IMPORTANCE OF COMMERCIAL BANKS
Commercial banks serve three main functions: accepting deposits, lending, and enabling customers to make
payments. They accept deposits into two types of bank accounts: current accounts, which are easy to access
and use for payments, and deposit or time accounts, which require notice before withdrawal. Banks can
borrow through overdrafts or loans, with interest charged on the borrowed amount. Customers may be asked
to provide collateral to secure repayment.
Banks act as financial intermediaries, accepting deposits from those with more money than they currently
want to spend and lending it to those with an immediate desire to spend more. They make most of their
profit by charging higher interest rates to borrowers than they do to people who save their money with them.
Lastly, banks enable customers to receive and make payments through various payment methods, such as
credit cards, standing orders, direct debits, debit/credit cards, and online banking.
OTHER FUNCTIONS OF COMMERCIAL BANKS
Over a period of time, commercial banks have built up a range of other services that they offer their
customers. Most commercial banks now provide and change foreign currency. Customers can leave
important documents, such as house deeds and small valuables, with their banks, and the banks are also
likely to be willing to help with the administration of customers’ wills. They can provide advice and help
with a number of financial matters, such as completion of tax forms, and the purchase and sale of shares.
Many banks also now sell insurance and offer a wide variety of savings accounts, with a range of conditions
and interest rates. Some now offer mortgage loans, which are loans to buy houses.
AIMS OF COMMERCIAL BANKS
A commercial bank's primary goal is to generate profit for shareholders through loans, known as advances.
However, liquidity (being able to turn an asset into cash quickly without a loss) is crucial for meeting
customer withdrawal requests. Banks maintain a certain amount of liquid assets, which can be converted
into cash quickly. They earn most of their interest through long-term loans, but must balance profitability
and liquidity to ensure cash withdrawals.
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Central bank: a government-owned bank which provides banking services to the government and
commercial banks and operates monetary policy
ROLE AND IMPORTANCE OF CENTRAL BANKS
The role a central bank plays in an economy means that it can have a significant impact on households, firms
and the performance of the economy. Its functions include:
● Acts as a banker for the government. The central bank transfers tax revenue into the government’s
accounts and makes payments for goods and services.
● Operates as a banker to the commercial banks. Enabling them to settle debts and withdraw cash
from their branches if customers exceed their usual withdrawals.
● Acts as a lender of last resort. This means it will lend to banks which are temporarily short of cash.
● Holds the country’s reserves of foreign currency and gold. The central bank keeps foreign
currency and gold to influence the exchange rate.
● Issues bank notes. The central bank is responsible for printing notes and destroying notes which are
no longer suitable for circulation. It also authorises the minting of coins.
● Controls the banking system. Many central banks play a key role in regulating and supervising the
banking system.
● Represents the government at meetings with other central banks and international organisations
such as the World Bank and the International Monetary Fund.
● Manages the national debt. National debt represents the government's total owed amount, which
accumulates over time. The central bank borrows on behalf of the government, issuing government
securities, paying interest, and repaying them.
● Implements the government’s monetary policy. The central bank's primary goal is to maintain low
inflation by controlling the money supply and influencing interest rates, with the government
potentially instructing or implementing these changes.
INDEPENDENCE OF CENTRAL BANKS
Governments often give central banks the authority to decide the rate of interest, with the Bank of England
aiming to achieve an inflation target of 2%. Central banks have advantages over national governments, as
they are unlikely to lower rates to gain public support and have extensive knowledge of the banking system.
CH 17 - HOUSEHOLDS
INFLUENCES ON SPENDING
Disposable income (income after income tax has been deducted and state benefits received) is the primary
factor influencing expenditure, with wealth, confidence, the rate of interest (a charge for borrowing money
and a payment for lending money), income distribution, and technological advancements also influencing it.
Wealth (a stock of assets including money held in bank accounts, shares in companies, government bonds,
cars and property) generates income, can be cashed in, and affects confidence, while the rate of interest may
make borrowing more expensive and encourage saving. A more even distribution of income and
technological advancements can also increase expenditure.
INCOME AND CONSUMPTION
Disposable income refers to the amount of money people can spend or save. In poorer situations, it is used to
buy basic necessities, such as food, clothing, and housing. As income increases, people can spend more and
save more, but the proportion spent tends to decrease.
Average propensity to consume (APC): the proportion of household disposable income which is spent.
Consumption: expenditure by households on consumer goods and income.
PATTERN OF EXPENDITURE
Disposable income is a crucial factor in determining a person's spending habits. The rich tend to spend more
on food and clothing, while the poor spend less. For example, a rich US family may spend $400 a week on
food and clothing, while a poor family may spend $40. The rich, on the other hand, spend more on luxury
items, consumer durables, entertainment, and services. This difference in spending patterns also exists
between countries, with higher spending on necessities in poorer countries and a greater share on luxuries in
richer countries. Household composition, tastes, and age also influence spending patterns.
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INFLUENCES ON SAVING
Disposable income is the main influence on saving, as it increases the total amount saved and proportion
saved. Wealthier individuals tend to save more easily. Rising interest rates may reduce target saving, but
increase non-contractual saving. Tax treatment of savings, such as tax-free schemes, encourages saving.
Financial institutions' range and quality also play a role. Age structure and social attitudes also influence
saving habits. The older, especially the very old, tend to save more to ensure a reasonable living standard.
INCOME AND SAVING
Saving is disposable income which is not spent. As already noted, it is not possible to save below a certain
income level. As disposable income rises, both the total amount saved and the proportion of disposable
income saved increases.
Average propensity to save (APS): as savings ratio, it is the proportion of household disposable income
that is saved.
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BORROWING
Borrowing is a financial strategy where individuals borrow money to cover expenses beyond their current
income, such as living standards, car purchases, travel, education, or healthcare. It incurs interest costs and is
temporary, with the poor facing greater difficulties due to less security and lenders' concerns. Factors
influencing borrowing include loan availability, interest rates, confidence, and social attitudes. Confidence in
the future increases borrowing, while social attitudes also influence borrowing decisions.
Mortgage: A loan to help buy a house.
CH 18 - WORKERS
FACTORS THAT AFFECT CHOICE OF OCCUPATION:
WAGE FACTORS:
An important influence on what jobs a person decides to do, is the pay on offer. The total pay a person
receives is known as his earnings. In addition to the basic wage, earnings may also include overtime pay,
bonuses and commission.
● Wages, also known as pay or salaries, are based on the number of hours worked or the output of
workers. Time rate systems benefit employers and workers, while piece rate systems pay workers
based on output. However, they may not be suitable for services or health.
● Overtime pay benefits both employees and employers by allowing employers to respond to higher
demand without hiring new workers. However, it may lead to fatigue and decreased output,
potentially impacting employee performance.
● Bonus is an extra payment for high-quality output or firm retention. However, fairness is crucial to
avoid resentment and demotivation. Those with confidence in their abilities may be attracted to
bonuses.
● Commission is often paid to the sales people. It involves them receiving a proportion of the value of
the sales they make. Sometimes, this is in addition to a standard wage and sometimes it makes up
their total payment.
NON-WAGE FACTORS:
People consider factors like job satisfaction, work type, conditions, hours, holidays, pensions, fringe
benefits, job security, career prospects, firm size, and location when choosing a job.
● Job satisfaction. Nursing and teaching are not well-paid but offer high job satisfaction, while other
professions like brain surgeons, TV presenters, and football players offer high pay and satisfaction.
● Type of work. People prefer non-manual work due to its physical and mental stimulation, better pay,
high status, and safety, with some being prepared for dangerous tasks.
● Working conditions. Working conditions are an important determining factor. People like to work in
pleasant surroundings, with friendly colleagues and enjoying regular breaks.
● Working hours. Occupations vary in hours and timing, with managers and senior officials working
longer hours. Some offer part-time or flexible work, while others, like nurses and emergency
plumbers, work unsociable hours or in shifts.
● Holidays. Law sets minimum holiday entitlement for full-time workers in some countries, but varies,
with teaching being a popular occupation due to its long holiday benefits.
● Pensions. Occupational pensions are increasingly important as people live longer, with variations in
provision, with public sector workers generally receiving more generous pensions.
● Fringe benefits. Fringe benefits are additional benefits offered by employers, such as free meals,
health schemes, and social facilities, which can be particularly beneficial for football players.
● Job security. High job security in occupations with high demand and long-term contracts attracts
workers, while casual workers face less security and can be dismissed quickly.
● Career prospects. People accept low wages initially for promotion to well-paid, interesting
positions, such as trainee accountants, barristers, and doctors, expecting higher pay and more
challenging work.
● Size of firm. Large firms attract people due to higher pay, better career prospects, and benefits, while
smaller firms offer a more friendly atmosphere and better labor relations.
● Location. People may choose an occupation which is close to their home. This will mean that they
do not have to spend much money or time on travelling to and from work.
LIMITING FACTORS
● Occupational choice and oppurtunity cost. Workers may choose one occupation over others based
on their priorities, sacrificing well-paid jobs for less satisfying ones, such as a merchant banker
resigning for a teacher position.
WAGE DETERMINATION AND WAGE DIFFERENTIAL
● Demand and supply. The higher the demand for and the lower the supply of workers in an
occupation, the higher the pay is likely to be. The supply of various jobs, including doctors, cleaners,
unskilled workers, agricultural workers, and public sector workers, varies across countries. Doctors
have a low supply due to limited qualifications and training, while cleaners have a high supply due to
low training requirements. Skilled workers are highly productive but pay is lower.
● Relative bargaining power of employers and workers. Wages are higher in occupations with
strong bargaining power, such as those with trade unions or professional organizations. Public sector
workers are more likely to belong to these organizations, as governments are more willing to
negotiate with them. Government labor market policies also affect public sector workers, potentially
raising wages or restricting wage increases.
● Government policies influence wages through public and private sector wage policies, promoting
economic growth and increasing labor demand. Labor market policies like the national minimum
wage (NMW) impose a wage floor, potentially causing unemployment. However, higher wages boost
motivation and productivity, leading to increased labor demand.
● Public opinion influences wage rates and public sector workers' pay. High-esteem occupations like
engineers and doctors are highly regarded in different countries. Public opinion can also pressure
governments to revise wages, especially for women in the nursing profession, due to social attitudes
against working women.
CHANGES IN EARNINGS OF OCCUPATIONS
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Changes in demand and supply of labour.
Changes in the stage of production.
Changes in bargaining power.
Changes in government policy.
Changes in public opinion.
Changes in the earning of individuals over time.
EXTENT TO WHICH EARNINGS CHANGE
Elasticity of demand for labour: a measure of the responsiveness of demand for labour to a change in the
wage rate.
● The proportion of labour costs in total costs.
● The ease with which labour can be substituted by capital.
● The elasticity of demand for the product produced.
● The time period.
Elasticity of supply of labour: a measure of the responsiveness of the supply of labour to a change in the
wage rate.
● The qualifications and skills required.
● The length of training period.
● The level of employment.
● The mobility of labour.
● The degree of vocation.
● The time period.
SPECIALISATION AND DIVISION OF LABOUR
Specialisation means the concentration on particular products or tasks. Instead of making a wide range of
products, a firm may specialise in manufacture of one or a few products. A doctor may concentrate on
treating patients with heart problems, rather than on treatment of patients suffering from a number of
illnesses.
Division of labour involves workers focusing on a specific task, leading to lower unit costs and increased
output. This can result in faster training, time savings, and better machinery design. However, specialisation
may lead to higher unit costs, boredom, and decreased productivity. Workers may also face difficulties in
finding new jobs due to specialized skills. The benefits of division of labour depend on the economy's cost
of production and product quality, potentially enabling more goods and services to be produced and
exported.
CH 19 - TRADE UNIONS
Trade union: an association which represents the interests of a group of workers.
• Craft unions. These represent workers with particular skills, for example plumbers and weavers. These
workers may be employed in a number of industries.
• General unions. These unions include workers with a range of skills and from a range of industries.
• Industrial unions. These seek to represent all the workers in a particular industry, for example, those in the
rail industry.
• White collar unions. These unions represent particular professions, including pilots and teachers.
THE ROLE OF TRADE UNIONS
COLLECTIVE BARGAINING:
Representatives of workers negotiating with employers’ associations.
A trade union can argue for a wage rise based on several factors. These include workers' increased productivity, the
industry's increased profits, the comparability argument, and the need to maintain wage differentials. Nurses may
demand a wage rise to restore their wage differential, while doctors may seek a higher pay to maintain their wage.
Additionally, workers may need a wage rise to meet the increased cost of living, such as maintaining their real income.
FACTORS AFFECTING STRENGTH OF TRADE UNION
A high level of economic activity, high number of members, high level of skill, consistent demand for
essential products, and favorable government legislation can all contribute to a strong union. Firms are more
likely to agree to union requests for higher pay and better working conditions when output and income
increase. Unions representing skilled workers have a strong position, as they can negotiate better wages and
conditions.
INDUSTRIAL ACTION
In cases of wage disputes or working conditions disputes, unions can initiate various industrial actions, such
as overtime bans, 'work to rule', and strikes. Strikes can be official or unofficial, and can be measured by the
number of strikes, workers involved, and working days lost. Governments often encourage arbitration to
prevent strikes by involving a third party to reach an agreement, either a government body or an independent
third party chosen by both parties.
INFLUENCE ON SUPPLY OF LABOUR
Trade unions can raise wages by restricting new workers' entry into industries, occupations, or crafts,
requiring high qualifications or operating a closed shop, where employers can only employ union members
or those willing to join, versus an open shop.
ADVANTAGES AND DISADVANTAGES OF TRADE UNIONS
Trade unions can harm firms through industrial action, such as strikes, overtime bans, and 'work to rule'
actions. However, they can also provide benefits such as reduced time and stress, better communication, and
increased productivity. Unions encourage education, training, and better health and safety, while also
reducing conflict and benefiting non-unionized labor through improved pay and working conditions.
TRADE UNIONS AND THE GOVERNMENT
Trade unions play a significant role in various countries, with some being illegal and others restricting their
effectiveness. Mauritius has a high percentage of union membership, with around 20% of workers in a
union. European countries like Finland and Sweden have strong union membership. UK union membership
declined in the 1980s and 1990s due to reduced rights and increased unemployment. However, membership
has grown among women workers and public sector workers. France has one of the lowest union densities in
Europe, but its unions exert considerable power due to public support, willingness to take strike action, and
secure laws.
CH 20 - FIRMS
Industry: a group of firms producing the same product.
STAGES OF PRODUCTION
The primary sector is the first stage of production, involving industries like agriculture, coal mining, and
forestry. The secondary sector processes raw materials into semi-finished goods, including capital and
consumer goods. The tertiary sector includes services like banking, insurance, and tourism. The quaternary
sector covers information technology.
CLASSIFICATION OF FIRMS:
Ownership: In a market economic system, most firms are in the private sector, whereas in a planned
economy, they are in the public sector (state-owned enterprises). In a mixed economic system, they are in
both the private and public sectors.
Size of firms: The size of a firm is determined by three main measures: the number of workers employed,
the value of output produced, and the value of financial capital employed. Factors influencing firm size
include the age of the firm, the availability of financial capital, the type of business organization, internal
economies and diseconomies of scale, and the size of the market. Firms with larger financial capital, larger
business organizations, lower average costs, and large demand for their products can grow to a larger size.
WHY FIRMS STAY SMALL
Small firms in any country have a significant presence due to various factors. These include the small
market size, consumer preference, owner's preference, flexibility, technical factors, lack of financial capital,
location, cooperation between small firms, specialization, and government support. Small firms can adapt to
market changes more quickly, as they can easily adapt to changes in demand and make decisions without
consulting other owners. Technical factors, such as low capital requirements, make it easier for new firms to
set up, and lack of financial capital can hinder expansion. Location can lead to local markets, and
cooperation between small firms can lead to the emergence of local markets. Specialization can also occur,
as small firms can supply specialist products to larger firms. Governments often provide financial support to
small firms, as they create jobs, develop entrepreneurial skills, and have the potential to grow into large
firms.
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Internal growth: an increase in the size of a firm resulting from it enlarging existing plants or opening new
ones.
External growth: an increase in the size of a firm resulting from it merging or taking over another firm.
Horizontal merger: the merger of firms producing the same product and at the same stage of production.
Rationalisation: eliminating unnecessary equipment and plant to make a firm more efficient.
Vertical merger: the merger of one firm with another firm that either provides an outlet for its products or
supplies it with raw materials, components or the products it sells.
Vertical merger backwards: a merger with a firm at an earlier stage of the supply chain. Vertical merger
forwards: a merger with a firm at a later stage of the supply chain.
Conglomerate merger: a merger between firms producing different products.
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ECONOMIES AND DISECONOMIES OF SCALE
Internal economies of scale: lower long run average costs resulting from a firm growing in size.
External economies of scale: lower long run average costs resulting from an industry growing in size.
Internal diseconomies of scale: higher long run average costs arising from a firm growing too large.
External diseconomies of scale: higher long run average costs arising from an industry growing too large.
TYPES OF INTERNAL ECONOMIES OF SCALE
Large firms can achieve various economies of scale, including buying economies, selling economies,
managerial economies, labour economics, financial economies, technical economies, research and
development economies, and risk-bearing economies. Buying economies involve buying raw materials in
bulk and placing large orders for capital equipment, leading to discounts and better treatment from suppliers.
Selling economies involve processing orders, packing goods, and transporting them in line with the number
of orders, reducing costs and securing discounts. Managerial economies involve hiring specialist staff to
increase efficiency and reduce production costs. Labour economics involves division of labor among staff.
Financial economies involve raising finance easier and cheaper due to banks' willingness to lend to large
firms due to their well-known status and valuable assets. Technical economies involve using large,
technologically advanced machinery, while research and development economies involve developing new
products and reducing average costs. Risk-bearing economies involve producing a range of products,
allowing firms to spread trading risks and shift resources to more profitable ones.
TYPES OF INTERNAL DISECONOMIES OF SCALE
Growing a large firm can increase average costs due to difficulties in controlling the business,
communication problems, and poor industrial relations. This can result in increased administrative costs and
slower response to market changes. Additionally, it can be challenging to ensure everyone in the firm has
full knowledge about their duties and opportunities, and to address the lack of motivation and diverse
opinions that may lead to conflicts.
TYPES OF EXTERNAL ECONOMIES OF SCALE
A larger industry can reduce costs by developing a skilled labor force, a good reputation, specialist suppliers
of raw materials and capital goods, specialist services, specialist markets, and improved infrastructure. This
can be achieved through training programs, ancillary industries, specialist services, specialist markets, and
improved infrastructure. External economies of scale, also known as economies of concentration, are more
likely to arise when firms are located in one area, allowing them to access better resources and services.
TYPES OF EXTERNAL DISECONOMIES OF SCALE
Just as a firm can grow too large, so can an industry. With more and larger firms in an area, there will be an
increase in transport with more vehicles bringing in workers and raw materials, and taking out workers and
finished products. This may cause congestion, increased journey times, higher transport costs for firms and
possibly reduced workers’ productivity. The growth of an industry may also result in increased competition
for resources, pushing up the price of key sites, capital equipment and labour.
CH 21 - FIRMS AND PRODUCTION
Factors of production are influenced by the product type, productivity, and cost. Substitutes, such as capital
goods, can change resource combinations, while complements, like aircraft, can increase employment. For
example, a fall in aircraft prices could increase the number of pilots, cabin crew, and takeoff and landing
slots in an airline.
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Firms can change resource quantities based on factors like factory size and output reduction. However, fixed
factors like production size and building size are difficult to alter quickly. Labor quantity can be changed by
adjusting overtime and raw material orders, depending on contract length and spare capacity availability.
Short-term changes to labor may require time and effort.
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The right combination of production factors is crucial for businesses to achieve maximum productivity. For
instance, a hairdressing salon with ten hair dryers and two hairdressers or a farmer with a large land and few
cattle would not be efficient.
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The demand for capital goods is influenced by various factors such as the price of capital goods, other
factors of production, profit levels, corporation tax, income, interest rates, confidence levels, and advances
in technology. Increased prices can cause contraction, while lower prices can increase demand. Confidence
levels and technological advancements also play a role in investment decisions.
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Factors of production and sectors of production can change with an economy's industrial structure. As
agricultural reforms progress, resources shift from low-cost manufacturing to higher value-added
manufacturing, with the service sector becoming the most important. In 2016, the service sector accounted
for 63% of global output. Different industries use different factors of production.
LABOUR INTENSIVE OR CAPITAL INTENSIVE PRODUCTION:
Labour-intensive production is often used by producers due to a large labor supply, small production sizes,
and the desire for handmade products. This approach offers flexibility, adjustable labor force sizes, and
feedback for improving production methods. However, firms often switch to capital-intensive production
due to technological advancements, such as online university degrees, which make capital goods more
affordable and productive.
PRODUCTION AND PRODUCTIVITY:
There are clear links between production and productivity, but they are not the same thing. If output per
worker hour increases and the number of working hours stays the same, production will increase. It is
possible, however, that productivity could rise and production could fall. This could occur if unemployment
increases. Indeed, a rise in unemployment may increase productivity as it is the most skilled workers who
are likely to keep their jobs. As economies develop, both production and productivity tend to increase due to
advances in technology and improvements in education. These developments can result in productivity
rising so much that total output can increase while the number of working hours declines.
CH 22 - FIRMS, COSTS, REVENUE AND OBJECTIVES
Total cost: the total amount that has to be spent on the factors of production used to produce a product.
Average total cost: total cost divided by output.
Fixed costs: costs which do not change with output in the short run.
Average fixed cost: total fixed cost divided by output.
Variable costs: costs that change with output.
Average variable cost: total variable cost divided by output.
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The money received by firms from selling their products is referred to as revenue. Total revenue is, as its
name suggests, the total amount of money received by firms through the sale of their products. Average
revenue is found by dividing total revenue by the quantity sold and is the same as price. In very competitive
markets each firm’s output may have no effect on price. In this case, total revenue rises consistently as more
quantity is sold.
Price: the amount of money that has to be given to obtain a product.
Total revenue: the total amount of money received from selling a product.
Average revenue: the total revenue divided by the quantity sold.
OBJECTIVES OF FIRMS
Firms may pursue a range of objectives including survival, growth, social welfare, profit satisficing and
profit maximisation.
Profit satisficing: sacrificing some profit to achieve other goals.
Profit maximisation: making as much profit as possible.
Survival. When firms are started, their initial objective may be just to survive in what may be a very
competitive market. A firm may be content to just cover its costs until it can become better known. During
difficult times when demand is falling, even large firms may have survival as their key objective. They will
try to stay in the market in the hope that conditions will improve.
Growth. Firms can achieve growth by increasing their size, which can lead to advantages such as increased
sales, internal economies of scale, and reduced costs. Managers, directors, and chief executives may
prioritize growth due to their higher pay, job security, and difficulty in acquiring other firms. Merging with
other firms can also reduce competition and increase a firm's market share.
Social welfare. State-owned enterprises aim to improve social welfare by charging low prices and focusing
on social costs and benefits. Private sector firms are also addressing environmental and social effects by
sourcing raw materials from non-child labor-employee firms and reducing production processes.
Profit satisficing. In some cases, firms may engage in what economists call profit satisficing. This involves
making enough dividends to keep shareholders happy while pursuing other objectives. For example, a firm
may be prepared to sacrifice some profit, at least in the short run, in order to improve staff facilities or to get
their raw materials from more sustainable sources.
Profit is achieved when a firm's revenue exceeds its costs. Profit maximisation is a common objective for
private sector firms. Profit is the positive difference between total revenue and total cost, and it is
maximized when the gap is greatest. Profits encourage entrepreneurs to produce, enter competitive markets,
and obtain external finance. Profits also attract top managers and directors.
However, the impact of a fall in profit may vary over time. Some firms may cut back on production or cease
production. To increase profit, firms can reduce production costs by reducing wastages and increasing
productivity. Increasing the size of the firm through mergers or takeovers can also increase total revenue and
profit per unit. Firms with market power often have inelastic demand for their products, which can be
increased by raising prices or cutting down prices. To increase demand, firms can improve product quality,
diversify, and be more responsive to consumer demand.
CH 23 - MARKET STRUCTURE
Market structure: the conditions which exist in a market including the number of firms.
Competitive market: a market with a number of firms that compete with each other.
Normal profit: the minimum level of profit required to keep a firm in the industry in the long run.
Supernormal profit: profit above that needed to keep a firm in the market in the long run. Monopoly: a
market with a single supplier.
Barrier to entry: anything that makes it diff icult for a firm to start producing the product.
Barrier to exit: anything that makes it difficult for a firm to stop making the product.
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Monopoly markets
The usual meaning of a monopoly is a sole supplier of a product having 100% share of the market. This is
oft en referred to as a pure monopoly and we will concentrate on this definition. Some governments define a
monopoly as a firm that has 25% or more share of the market, and a dominant monopoly when a firm has a
40% share of the market.
Characteristics of a monopoly
• The firm is the industry. It has a 100% share of the market.
• There are high barriers to entry and exit, making it diff icult for other firms to enter the market.
• A monopoly is a price maker. Its output is the industry’s output and so changes in its supply affect the
market price.
Why do monopolies arise?
It may be worthwhile to consider the causes which lead to a firm having total control of a market. In some
cases, a monopoly may develop over time. One firm may have been so successful in cutting its costs and
responding to changes in the consumer tastes in the past, that it has driven out rival firms and captured the
whole of the market. Also, mergers and takeovers may result in the number of firms being reduced to one.
Alternatively, a monopoly may exist from the start. One firm may own, for example, all the gold mines in a
country or it may have been granted monopolistic powers by a government, which makes it illegal for other
firms to enter the market. A patent would also stop other firms from producing the product.
Why do monopolies continue?
Another important question to be asked is ‘What stops new firms from breaking into the market and
providing competition to a monopoly?’ It is the existence of barriers to entry and exit. One type of barrier is
a legal barrier. As mentioned above, this may be in the form of a patent or a government act.
Another important barrier to entry is the scale of production. If the monopoly is producing on a large scale,
it may be able to produce at a low unit cost. Any new firm, unable to produce as much, is likely to face
higher unit costs and therefore will be unable to compete. It can also be expensive to set up a new firm, if
large capital equipment is required. Other barriers to entry include the creation of brand loyalty through
branding and advertising, and the monopoly’s access to resources and retail outlets. Barriers to exit can also
stop new firms from entering the market. One barrier to exit may be a long-term contract to provide a
product. Some firms may be reluctant to undertake such a commitment. A significant barrier to exit is the
existence of sunk costs. These are the costs, such as advertising and industry-specific equipment, which
cannot be recovered if the firm leaves the industry.
Why do monopolies continue?
Another important question to be asked is ‘What stops new firms from breaking into the market and
providing competition to a monopoly?’ It is the existence of barriers to entry and exit. One type of barrier is
a legal barrier. As mentioned above, this may be in the form of a patent or a government act. Another
important barrier to entry is the scale of production. If the monopoly is producing on a large scale, it may be
able to produce at a low unit cost. Any new firm, unable to produce as much, is likely to face higher unit
costs and therefore will be unable to compete. It can also be expensive to set up a new firm, if large capital
equipment is required. Other barriers to entry include the creation of brand loyalty through branding and
advertising, and the monopoly’s access to resources and retail outlets. Barriers to exit can also stop new
firms from entering the market. One barrier to exit may be a long-term contract to provide a product. Some
firms may be reluctant to undertake such a commitment. A significant barrier to exit is the existence of sunk
costs. These are the costs, such as advertising and industry-specific equipment, which cannot be recovered if
the firm leaves the industry
The behaviour of a monopoly
The existence of barriers to entry, means that a monopoly can earn supernormal profits in the long run.
Firms outside the industry may not be aware of the high profits being earned. Even if they do know about
the high profits and want to enter the industry, they are kept out by the high barriers to entry and exit. A
monopoly has control over the supply of the product, but although it can seek to influence the demand, it
does not have control over it. In fact, a monopoly has to make a choice. It can set the price, but then it has to
accept the level of sales that consumers are prepared to buy at that price. If, on the other hand, it chooses to
sell a given quantity, the price will be determined by what consumers are prepared to pay for this quantity.
Figure 23.1 shows that if a firm sets a price P, the demand curve determines that it will sell amount Q. If it
decides to sell amount Q1 , it will have to accept a price of P1 .
Occurrence of monopoly.
The number of firms that can be defined as monopolies depends, in part, on the way markets have been
defined. The more narrow the definition, in terms of the product and geographical area, the more examples
will be found. For example, a country may have only one firm supplying gas, but several firms in its energy
industry. There may be a relatively high number of food retailers in a town, but only one food shop on an
estate, making it a local monopoly.