Year 11 Economics
March 2015
Questions and Answers
Business Costs
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FC + VC = TC
AFC
AVC
ATC
Economic Trade Offs
• A trade-off (or tradeoff) is a situation that involves losing one quality or aspect of
something in return for gaining another quality or aspect. More colloquially, if
one thing increases, some other thing must decrease. Tradeoffs can occur for
many reasons, including simple physics (into a given amount of space, you can fit
many small objects or fewer large objects). The idea of a trade-off often implies a
decision to be made with full comprehension of both the upside and downside of
a particular choice, such as when a person decides whether to invest in stocks
(more risky but with a greater potential return) versus bonds (generally safer, but
lower potential returns).
• In economics the term is expressed as opportunity cost, referring to the most
preferred alternative given up. A trade-off, then, involves a sacrifice that must be
made to obtain a certain product, service or experience, rather than others that
could be made or obtained using the same required resources. For a person
going to a basketball game, their opportunity cost is the money and time
expended, as compared with the alternative of watching a particular television
program at home.
• Many factors affect the trade-off environment within a particular country,
including availability of raw materials, a skilled labor force, machinery for
producing a product, technology and capital, market rate to produce that product
on reasonable time scale, and so forth.
Co-operatives (Advantages)
1. Ease of formation:
It is quite easy to form a cooperative society. Any ten adults can join together and form themselves into a cooperative. Very little time and
money are required to get a cooperative registered. The legal formalities are very few and simple.
2. Open membership:
Any person having a common interest can become members of a cooperative society and can leave the society at his own pleasure. No
discrimination is made on the basis of caste, creed, religion or political affiliation. The cost of a share is low and even poor persons can buy
it.
3. Limited liability:
The liability of every member is limited to the extent of his share in the society's capital. Therefore, the risk faced by every member is limited and
known.
4. Continuity and stability:
After registration, a cooperative society becomes a separate legal entity. The death, lunacy, or insolvency of a member does not affect its
existence. Therefore, it enjoys continuity of operations.
5. Democratic management:
Management of a cooperative society is fully democratic. Every member has an equal vote or voice irrespective of his capital contribution. The
principle of 'one man one vote' is followed. A small group of members cannot dominate the control of the society.
6. Internal financing:
A large part of the profit of a cooperative society is transferred to general reserve every year. Dividend on capital cannot exceed ten per cent.
Therefore, ploughing back of profits facilitates the expansion and growth of the society.
7. Low operating costs:
The office bearers of a cooperative society offer honorary service. Therefore, cost of management is low. Cash trading avoids bad debts and
there is no need to maintain huge stocks.
As customers are primarily the members themselves there is saving in advertising and selling expenses. Elimination of middlemen also adds to
economy of operations.
8. Cheaper and better supplies:
Cooperative societies supply better quality goods at cheaper rates. Due to service motive, the focus is on the welfare of members. Surplus is also
shared by the members on equitable basis.
9. State patronage:
The Government provides several concessions to cooperative societies in the matter of taxes, finance, etc. A cooperative society enjoys special
privileges and exemptions.
10. Social utility:
Cooperatives are non-competitive organisations. They promote personal liberty, social justice and mutual cooperation. They help to prevent
concentration of economic power in a few hands.
Cooperative undertakings also serve as a training ground for self-government. They foster fellow feeling, self help, thrift and moral values among
the members.
Co-operatives (Disadvantages)
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Cooperative societies suffer from the following drawbacks:
1. Limited capital:
A cooperative society is formed usually by people with limited means. The principle of 'one man one vote' discourages
members to invest large amounts in the society. Therefore, a cooperative society often faces shortage of funds. It is not able
to mobilise adequate capital for large scale operations.
2. Inefficient management:
A cooperative society is managed by a managing committee consisting of office-bearers elected by the members. These
office-bearers may not be competent and experienced. A cooperative society cannot afford to employ expert professional
managers at high salaries.
3. Lack of motivation:
Honorary office-bearers of a cooperative society have very little incentive to work hard for the society. There is no direct link
between effort and reward. Members are often ignorant of the principles of cooperation. Office bearers may misuse funds
for personal interests. Lack of competition may slacken efforts.
4. Non-transferability of interest:
The shares of a cooperative society are not transferable. A member who wants to quite the society has to submit his shares
to the society in order to get his money back.
5. Lack of secrecy:
The affairs of a cooperative society are openly discussed in the meetings of its members. Every member is free to inspect the
books and records of the society; therefore, it becomes difficult to keep the secrets of business.
6. Excessive government control:
The day-to-day working of a cooperative society is bound by legal rules and regulations. Keeping of accounts, regular audit
and inspection are essential. Reports have to be submitted to the Registrar. Time-consuming formalities restrict flexibility and
initiative.
7. Rift among members:
The success of cooperatives depends directly on the loyalty and cooperation of members. Quite often disputes arise among
the managing committee and the members.
Some members may want to dominate the working of the society. Members are drawn from different sections of society.
There is often lack of harmony and amity among them.
External Economies of Scale
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External economies of scale occur outside of a firm but within an industry. For example
investment in a better transportation network servicing an industry will resulting in a
decrease in costs for a company working within that industry.
Another example is the development of research and development facilities in local
universities that several businesses in an area can benefit from. Likewise, the relocation
of component suppliers and other support businesses close to the centre of
manufacturing are also an external cost saving.
Agglomeration economies may also result resulting from the clustering of similar
businesses in a distinct geographical location e.g. software businesses in Silicon Valley or
investment banks in the City of London.
Formula One and External Economies of Scale
Britain has a history of providing a base for some of the most successful teams in
Formula One. McLaren are based in Woking but Renault, Honda, Williams and Red Bull
are all clustered in the east Midlands. Partly this is an accident of history - namely the
availability of disused airfields after the war.
But the cluster of F1 teams is also a good example of the external economies of scale
that can be generated when a group of producers develop and expand in a relatively
small geographical area.
Most of the teams currently racing are based in the UK, along with their R&D operations.
A whole network of industries, such as component suppliers, engineering and design
firms, have sprung up in Britain, mostly in central England, to serve the sport both here
and abroad. F1 also helps to support a far larger motorsport industry in the UK, for
example rally car racing and all its associated industries.
Government Budget
• A government budget is a government document
presenting the government's proposed revenues
and spending for a financial year that is often
passed by the legislature, approved by the chief
executive or president and presented by the
Finance Minister to the nation. The budget is also
known as the Annual Financial Statement of the
country. This document estimates the anticipated
government revenues and government
expenditures for the ensuing (current) financial
year
Human Development Index
• DEFINITION of 'Human Development Index - HDI'
• A tool developed by the United Nations to measure and rank
countries' levels of social and economic development based on four
criteria: Life expectancy at birth, mean years of schooling, expected
years of schooling and gross national income per capita. The HDI
makes it possible to track changes in development levels over time
and to compare development levels in different countries.
• INVESTOPEDIA EXPLAINS 'Human Development Index - HDI'
• In 2010, the index ranked Norway, Australia, New Zealand, the
United States and Ireland at the top of its list for "very high human
development." The countries that fell at the bottom of its "low
human development" list were Mozambique, Burundi, Niger, Congo
and Zimbabwe. The index also shows that countries with lots of
income do not always spend that money in ways that create high
life expectancies or education levels.
Fiscal policy
• Fiscal policy refers to government policy that attempts
to influence the direction of the economy through
changes in government taxes or through some
spending.
• The two main instruments of fiscal policy are
government spending and taxation.
• Changes in the level and composition of taxation and
government spending can impact on the following
variables in the economy:
• Aggregate demand and the level of economic activity.
• The pattern of resource allocation.
• The distribution of income.
How Fiscal Policy works?
• Scenario one: High rate of Inflation
• High rate of inflation is caused by too much aggregate
demand in the economy. Government will use deflationary
fiscal policy. Government will try to influence aggregate
demand by reducing its public spending. The government
will spend less on construction of roads, bridges and other
public spending and thus aggregate demand will fall. On
the other hand, Government may increase the tax rates. An
increase in tax rates will take away the extra disposable
income out people’s pocket resulting in a lower demand.
How Fiscal Policy works?
• Scenario two: Low rate of Inflation
• In an economic recession, aggregate demand, output
and employment all tend to fall. Now the Government
wants to increase employment in the economy, it can
attempt to do so by increasing aggregate demand. The
Government will increase the public spending resulting
in a rise in aggregate demand. Government may
reduce the tax rates so that people have more
disposable income to spend and instigate demand in
the economy.
Free Trade & Protectionism
PROTECTIONISM
The restriction of imports into a country by government measures
REASONS FOR PROTECTIONISM
• Protects UK businesses from extra competition
• Helps new UK businesses to develop before they face competition
• Helps protect UK jobs
• Prevents foreign countries ‘dumping’ lots of cheap imports into the UK
• Prevents imports of harmful or desirable goods
TRADE BARRIERS / METHODS OF PROTECTIONISM
- TARIFFS or IMPORT DUTIES These are taxes on imported goods. They raise the price to customers and make them
less attractive
- QUOTAS These are limits on the quantity of a product that can be imported into a country e.g. 100,000 cars
- REGULATIONS This includes laws and safety guidelines
FREE TRADE
Trade without any protectionist / trade barriers between countries
BENEFITS OF FREE TRADE & PROBLEMS OF TRADE BARRIERS
1. Protectionism keeps UK firms away from genuine competition. They may become lazy and inefficient
2. Free trade forces UK firms to produce quality goods and services as they face much foreign competition
3. If the UK puts up trade barriers then other countries are likely to retaliate.
4. Free trade encourages firms to export and import. This should encourage a greater choice for consumers and a
higher standard of living
5. Trade barriers increase the cost of trading. For example, a tariff would mean that UK firms and consumers may
have to pay more for imports of raw materials or consumer goods
economics of market failure (1)
Market failure has become an increasingly important topic for students. There is a clear economic case for
government intervention in markets where some form of market failure is taking place. Government can
justify this by saying that intervention is in the public interest. Basically market failure occurs when markets
do not bring about economic efficiency.
Government intervention occurs when markets are not working optimally i.e. there is a Pareto sub-optimal
allocation of resources in a market/industry. In simple terms, the market may not always allocate scarce
resources efficiently in a way that achieves the highest total social welfare.
EXAMPLES OF POTENTIAL MARKET FAILURE
There are plenty of reasons why the normal operation of market forces may not lead to economic efficiency.
Public Goods not provided by the free market because of their two main characteristics
Non-excludability where it is not possible to provide a good or service to one person without it thereby
being available for others to enjoy
Non-rivalry where the consumption of a good or service by one person will not prevent others from enjoying
it
Examples: Street lighting / Lighthouse Protection, Police services, Air defence systems, Roads / motorways,
Terrestrial television, Flood defence systems, Public parks & beaches
Because of their nature the private sector is unlikely to be willing and able to provide public goods. The
government therefore provides them for collective consumption and finances them through general
taxation.
Merit Goods are those goods and services that the government feels that people left to themselves will underconsume and which therefore ought to be subsidised or provided free at the point of use.
Both the public and private sector of the economy can provide merit goods & services. Consumption of merit
goods is thought to generate positive externality effects where the social benefit from consumption
exceeds the private benefit.
Examples: Health services, Education, Work Training, Public Libraries, Citizen's Advice, Inoculations
economics of market failure (2)
Monopoly
Few modern markets meet the stringent conditions required for a perfectly competitive market. The existence of
monopoly power is often thought to create the potential for market failure and a need for intervention to
correct for some of the welfare consequences of monopoly power.
The classical economic case against monopoly is that
Price is higher and output is lower under monopoly than in a competitive market
This causes a net economic welfare loss of both consumer and producer surplus
Price > marginal cost - leading to allocative inefficiency and a pareto sub-optimal equilibrium.
Rent seeking behaviour by the monopolist might add to the standard costs of monopoly. This includes
high (possibly excessive) amounts of spending on persuasive advertising and marketing.
Libenstein's X-inefficiency may also result if the monopolist allows cost efficiency to drop. An upward
drift in costs because of a lack of effective competition in the market-place can lead to consumers
facing higher prices and a reduction in their real standard of living
Externalities
Any exam question on market failure must make some reference to externalities. What are the potential market
failures arising from externalities?
The social optimum output or level of consumption diverges from the private optimum.
Main problem is the absence of clearly defined property rights for those agents operating in the market. When
property rights are not clearly defined, market failure is likely because producers & consumers may not be
held to account
Don't forget that positive externalities can also justify intervention if goods are under-consumed (social benefit >
private benefit)
Inequality
Market failure can also be caused by the existence of inequality throughout the economy. Wide differences in
income and wealth between different groups within our economy leads to a wide gap in living standards
between affluent households and those experiencing poverty. Society may come to the view that too much
inequality is unacceptable or undesirable.
Note here that value judgements come into play whenever we discuss the distribution of income and wealth in
society. The government may decide to intervene to reduce inequality through changes to the tax and
benefits system and also specific policies such as the national minimum wage
economics of market failure (3)
GOVERNMENT INTERVENTION AND MARKET FAILURE
• Government intervention may seek to correct for the
distortions created by market failure and to improve
the efficiency in the way that markets operate
• Pollution taxes to correct for externalities
• Taxation of monopoly profits (the Windfall Tax)
• Regulation of oligopolies/cartel behaviour
• Direct provision of public goods (defence)
• Policies to introduce competition into markets (deregulation)
• Price controls for the recently privatised utilities
Base Rate
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External Environment: Interest rates - introduction
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An interest rate is the cost of borrowing money or the return for investing money.
For example, a bank charges interest on amounts loaned out or on the balance of an overdrawn bank account.
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A bank will also pay interest to the owner of an account with a positive balance.
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Interest rates vary depending on the type and provider of borrowing.
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The base interest rate in the UK economy is set by the Bank of England. Each month, the Monetary Policy
Committee of the Bank of England to decide what the base rate should be.
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During the credit crunch, the base interest rate has fallen sharply to as low as 0.5%
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The base interest rate set by the Bank of England affects other interest rates in the economy because it is
the rate at which banks can themselves lend from the Bank of England.
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In theory, a lower base rate will lead to lower interest rates on borrowings paid by businesses – but not
necessarily.
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The effect of a change in interest rate will be affected by whether borrowing is at a variable or fixed rate:
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With a variable rate, the interest charged varies in relation to the base rate. So a fall in the base rate to 0.5% in early
2009 should mean that businesses with variable-rate overdrafts pay lower interest.
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A fixed interest rate means that the interest cost is calculated at a fixed rate – which doesn’t change over the period
of the credit, whatever happens to the base rate.
Elasticity
How is Money Created
• In economics, money creation is the process by which
the money supply of a country or a monetary region
(such as the Eurozone) is increased. A central bank may
introduce new money into the economy (termed
"expansionary monetary policy", or "money printing"
by detractors) by purchasing financial assets or lending
money to financial institutions. Commercial bank
lending also creates money under the form of demand
deposits. When banks had sizable reserve
requirements (freezing an important percentage of
their deposits in mandatory reserves at the central
bank) it was said that the process multiplied this base
money through fractional reserve banking.