IGCSE Economics

Economics - The study of how scarce resources can be allocated to satisfy peoples unlimited wants.

Scarcity - When there are not enough resources to satisfy our wants and needs.

Resources - The inputs that are used in the production process to produce goods and services. These

are also called Factors of Production. Resources are limited.

Capital - Human-made goods that are used in the production of other goods. Payment

comes in Interest

Entrepreneurs (Enterprise) - The person who takes the risk and has the skills to combine the

other factors of production to produce goods and services. Payment comes in Profit

Labour - Human work or effort and the people who offer their services to businesses in

exchange for wages. Payment comes in Wages

Land - Any resource that exists as part of a natural process. Can be renewable or non-

renewable. Payment comes in Rent

Geographical mobility the resource is capable of changing location

Occupational mobility the resource is capable of changing use

Opportunity Cost - The next best alternative foregone e.g. Mary could buy lettuce or chips with her

$5 and she chose chips. Lettuce would be Marys opportunity cost.

Production possibility curve - a curve showing the maximum output of 2 products and combinations

of these products that can be produced given existing resources and technology.

This company used to produce 8

Computers and 35 Books (A) with the

resources it had, but now it sells only 5

computers but 60 books (B).

Therefore, this business has an

opportunity cost of 3 computers as it

decided to make more books.

A

B

Consumer people or firms who need or want goods and services

Producers use resources to make goods and services to satisfy consumers needs and wants

Wants what we desire but do not necessarily need to survive e.g. games, bags

Needs what we must have in order to survive e.g. food, clothing, shelter

Renewable resources resources that will regenerate naturally within a reasonable time frame e.g.

Fruit, Trees, Vegetables

Non-renewable resources resources that will not regenerate naturally within a reasonable time

frame e.g. Coal, Oil, Ores

Free good goods that are available without limits e.g. air, sunlight

Economic good goods that are scarce in comparison to peoples wants and need and therefore

must be paid for e.g. television, paper, electricity

Public (collective) good goods that are non-excludable and non-rival

Non-excludable once paid for, it is impossible to stop people from using the good or service. This

creates the free rider problem

Non-rival consumers do not have to rival each other for use of the good; it will not run out

Merit good a commodity or service that is regarded by society or government as deserving public

finance e.g. education

Demerit good a commodity or service that is regarded by society or government as not deserving

public finance e.g. cigarettes, alcohol

Consumer good goods that are used and paid by individuals or groups in the household sector

Normal goods - goods we demand more of as our income increases e.g premium steak

Inferior goods - goods we demand less of as our income increases e.g second hand goods, budget

brand goods

Durable goods goods that can be used more than once

Non-durable goods goods that are perishable and do not last very long

Positive good beneficial to society e.g. clean water, medicine

Negative good a cost to society e.g. pollution, waste products

Disposable Income the money remaining after taxes are paid. If taxes increase, disposable income

decreases

Semi-finished goods goods that are used to produce other goods e.g. leather, wool

Demand - The quantity of a good or service that a consumer is willing and able to purchase at

various prices at a certain time.

Law of Demand - as price increases, quantity demanded decreases, ceteris paribus and vice versa.

Demand Schedule a table showing the quantity of a commodity consumers are willing and able to

buy at a range of prices.

Demand Curve - a graph showing the quantity of a commodity consumers are willing and able to buy

at a range of prices.

Market Demand - the total demand that all the individual consumers in the market are willing and

able to buy at various prices.

What changes demand? (Non-price factors of Demand)

Taste - things we like. They may be influenced by fashion, values, media, weather, seasons.

Income - the money we gain from labour. When we earn more income we are more able to

purchase goods and services, therefore we demand more normal goods, and demand a

lesser amount of inferior goods.

Complements - a good which is used in conjunction with another good

Substitutes - a good which can be used in place/instead of another.

Supply The quantity of a good or service that a producer is willing and able to produce at various

prices at a certain time.

Law of Supply as price increases, quantity supplied increases, ceteris paribus and vice versa.

Supply Schedule a table showing the quantity of commodity producers are willing and able to

produce at various prices

Supply Curve a graph showing the quantity of a commodity producers are willing and able to

produce at various prices

Market Supply the total supply that all the individual producers in the market are willing and able

to produce at various prices

What changes supply? (Non-price factors of Supply)

Productivity output per unit of input

Environmental natural conditions which affect output

Taxes payments made to govt., Subsidies payments from govt. to firms for support

Restrictions on trade Tariffs = tax on imports; Quotas = restriction on number of imports

Other related goods different goods that can be produced using same resources/inputs

Legal rules and regulations set by the government

Costs of production costs that a firm/producer incurs during the production process

Making a Curve:

Title - Who, What, When

Origin - Your graph must start from zero

Axes - Price on vertical, Quantity on horizontal (must be labelled)

Do the D/S Place a D or S next to the line to show it is a demand curve or a supply curve

Scale - Graph must be even and consistent

Movements along the Curve:

A movement along the Curve occurs when a price factor changes

Draw dotted lines from both points to the axes

Draw arrows from the dotted lines to show the movement

Label the dotted lines: P, P1, Q, Q1, with P1 and Q1 on the dotted lines with new point

Shifts of the Curve:

A shift of the curve occurs when a non-price factor changes

A shift to the left means the Demand/Supply has decreased

A shift to the right means the Demand/Supply has increased

Draw dotted lines from where the change has occurred to the new axes

Draw arrows from the line indicating where the line has shifted

Label the new line D1 or S1 and Label the new and old quantities Q1 and Q

e.g.

P

P1

Q Q1

Decrease in Price Decrease in Demand

Q1 Q

P

D1 D

P1

P

Q1 Q

Increase in Price Increase in Demand

Q Q1

P

D D1

D

D

Price Elasticity of Demand - measures the responsiveness of the quantity demanded of a good or

service to a change in its price

Elastic Demand a change in price brings about a large change in the quantity demanded. These

have a coefficient greater than 1

Inelastic Demand a change in price brings about a small change in the quantity demanded. These

have a coefficient between 0 and 1

Factors of Price Elasticity of Demand

Proportion of Income small proportion = inelastic; large proportion = elastic

Addictiveness addictive = inelastic; not addictive = elastic

Necessity or luxury necessity = inelastic; luxury = elastic

Time period short time period = inelastic; long time period = elastic

Substitutes not many substitutes = inelastic; many substitutes = elastic

Price Elasticity of Supply - measures the responsiveness of quantity supplied of a good or service to

a change in its price

Elastic Supply when quantity supplied changes by a smaller percentage than price. These have a

coefficient greater than 1.

Inelastic Supply - when quantity supplied changes by a greater percentage than the change in price.

These have a coefficient between 0 and 1

Factors of Price Elasticity of Supply

The cost of altering its supply not easy to produce = inelastic; easy to produce = eslatic

The ability to store the good not storable = inelastic; storable = elastic

Time long time to produce = inelastic; short time to produce = elastic

Inelastic Supply Elastic Supply

Inelastic Demand Elastic Demand PED =

% Change in Quantity

Demanded

% Change in Price

PES =

% Change in Quantity

Supplied

% Change in Price

Special Price Elasticity Curves

Perfectly Elastic - a change in price brings about an infinite response (a tiny price change will cause a

huge change in quantity demanded/supplied) giving a coefficient of infinity ()

Perfectly Inelastic a change in price brings about no response (even if price drastically changes,

Qd/Qs will stay the same) giving a coefficient of 0

Unitary Elasticity - this occurs when a percentage change in the price results in an equal change in

demand giving a coefficient of 1.

Revenue

Total Revenue total receipts of a firm from the sale of any given quantity of a product

Total Revenue = Price x Quantity

Inelastic Demand Elastic Demand

If price increases, the quantity demanded will decrease a little

If price increases, the quantity demanded will decrease by a lot

If price decreases, the quantity demanded will increase a little

If price decreases the quantity demanded will increase by a lot

Perfectly

Inelastic

Perfectly Elastic

Unitary

Elasticity

TR1 < TR2 TR2 < TR1

TR2 < TR1 TR1 < TR2

Market a place/situation where buyers and sellers exchange goods

Resource Market where money is exchanged for inputs

Goods Market where output is exchanged for money

Price Equilibrium the price where quantity supplied and quantity demanded are equal

Surplus when the quantity supplied exceeds the quantity demanded. In order to sell the excess

stock, the producers lower the price and therefore raising the consumers demand. These market

forces keep bringing the price down until equilibrium is reached and the market is cleared.

Shortage when the quantity demanded exceeds the quantity supplied. Consumers who have

missed out on the good, bid the price up so producers increase the quantity supplied due as the

good is now more profitable. These market forces will push price up until equilibrium is reached and

the market is cleared.

e.g.

Change in Equilibrium:

A change in the Equilibrium occurs when Demand or Supply has increased or decreased.

From both Equilibriums, draw dotted lines to both axes

Label the new points PEq1 (on Price Axis) and QEq1 (on Quantity axis), and the old points PEq,

and QEq

Draw arrows from the old points to the new points (e.g. QEq to QEq1)

Draw arrows from the old Equilibrium to the new Equilibrium

Equilibrium

S

D

Shortage

Surplus 800 200 = 600

At $7, there is a surplus of

600 as producers are

producing more than

demanded.

At $3 there is a shortage of

600 as producers are

producing less than

demanded.

200 800

7

3

Producers

Private Sector where scarce resources are owned by private individuals and are used in order to

maximise profit

Firms businesses owned by individuals or groups in the hope of making profit

Voluntary Organisations driven by the fact that there is a need in the community they can

satisfy

Public Sector Producers: where scarce resources are owned by the government and are used to

produce goods and services that they believe are good for the country

Central Government These are the elected representatives who meet in Parliament and

are concerned with the country as a whole. They are not driven by profit. They may provide

goods and services e.g. public health and education.

Local Government These are made up of officials and representatives that are elected by

local communities. They provide public goods for the local area to look after the local

peoples welfare e.g. libraries, swimming pools.

Economic Systems

Free Market Economy when the private sector decides on the three economic questions. They will

only produce goods and services that people will want to buy in the hopes of gaining a profit.

Advantages Disadvantages

The consumer is sovereign. The market will provide goods depending on what the customers demand.

Scarce resources will only be employed if there is a profitable use.

The market responds quickly to changes in demand.

Not all goods and services are provided in the free market e.g. public goods

Efficient use of resources, better machinery and better methods are encouraged.

The effects of production on society and the environment (such as pollution) can be ignored

High incomes provide an incentive for people to work hard and for entrepreneurs to set up and expand business

There may be encouragement to buy harmful goods (such as drugs and weapons). The government has to pass laws to stop this.

Merits of the Market System

Resources are allocated by price If the demand increases, price is increased and producers

will allocate more resources to the production of this good.

Competition and Incentives In a free market there are many firms competing with each

other for market share and profits. This encourages innovation. Innovation will result a wide

variety and high quality of goods being produced

Allocative Efficiency when resources are allocated towards goods that reflect consumer

demand. This consumer is said to be sovereign

Productive Efficiency In a free market, firms will produce at the lowest possible cost per

unit to earn high profits and avoid being pushed out of the market.

Dynamic Efficiency arises when resources are used efficiently over time. The profit

incentive will drive firms to innovate and continue to develop new, improved products that

consumers desire

Market Failure

Market Failure where the market mechanism fails to allocate resources efficiently. It occurs where:

Differentiation of goods and services; tricking the consumers into paying for the good

o Branding: designer labels cost three times as much but may not be that much better

o Labelling and Product Information: may be inaccurate

Market Power; other firms cannot enter in market, main firms can abuse price raise

o Monopolies where one firm is the sole supplier of a product.

o Oligopolies where there are a few firms who supply the product.

Insufficient quantity of goods and services provided

o Public goods may not be provided at all

o Merit goods may be provided but be charged high prices or shortage

o Demerit goods will be provided but will be over demanded and over produced

External costs and benefits exist

o External Costs/Benefits the costs or benefits to a third party due to the consumption

and production activities of others

o Private Costs/Benefits the costs or benefits on those who are directly involved in the

decision to produce or consume a product

o Social Cost = private cost + external cost

o Social Benefit = private benefit + external benefit

o Uneconomic use of resources if the social costs exceed the social benefits

Inequality exists; if without skill, one will find themselves unemployed

o Poverty

o Unequal distribution of factor ownership

o Unequal distribution of income

o Large income and wealth gap

Measures to correct Market Failure

1. Laws and Regulations

o The Government can intervene by making it so producers may not charge above a

maximum price or below a minimum price

2. Subsidies

o The Government offers subsidies to encourage production of merit goods so they take

into account external benefits.

3. Taxation

o The Government will place tax on demerit goods so they take into account external

costs.

o On goods with inelastic demand, the price change will not affect it that much and

consumers will still wish to purchase the good. Therefore Indirect taxes are ineffective

on goods that have inelastic demand.

o On goods with Elastic demand, the price change will affect it a lot and consumers will no

longer wish to purchase the good. Therefore Indirect taxes are effective on goods that

have Elastic demand.

Mixed Economy when the public sector and private sector decide on the economic questions for

them solely. They do not have much influence over each other.

Employment In a mixed economy, the government can create jobs and provide incentives

to private firms to employ people. If it were a free market economy, there would be high

unemployment from market economies.

Provision of Public Goods In a mixed economy, the Government raises tax to provide

public goods. If it were a free market economy, they would not be provided as it would be

impossible to pay.

Harmful Goods In a mixed economy, the government can make the production and

consumption of harmful goods illegal or make it less attractive to use the good by placing a

tax on it.

Social Costs In a mixed economy, the government can use laws, taxes and fines to prevent firms from polluting the environment. If it were a free market economy, the costs to society

(such as pollution) can go un-checked in a market economy because private firms will only

take into consideration their own costs of production.

Equity - in a mixed economy the government can provide benefits or free healthcare for

those that cannot afford to pay. If it were a market economy, many people on low incomes

would be unable to buy many of the goods and services provided.

Planned Economy when the public sector decides on the three economic questions. There are no

private firms and very little consumer choice.

Allocation of Resources

Public Sector Private Sector

Money Usage Public Goods Merit Goods

Supporting vulnerable groups Helping private sector industries

Managing the economy Cover losses incurred by SOEs

Private Goods A mixture of merit and demerit goods

Sources of Income Taxation this depends on the willingness of consumers to pay, rates

in other countries, income of the country and the reactions of firms and

workers to tax changes Privatisation raises revenue in the

short term but if the asset was profitable

Borrowing from Overseas this will depend on the governments credit

worthiness at home and abroad

Profits this will depend on how profitable the business is

Loans this will depend on the firms credit worthiness and size

Advantages Ensures resources are allocated to merit goods/public goods

Ensures fewer resources are allocated to demerit goods

Resources are used to produce goods and services of a high quality

Low cost methods of production are used, less waste of resources Higher levels of productivity,

therefore more output gets produced in less time

Disadvantages If firms know the government is paying, no incentive to keep costs

down State Owned Enterprises may lack expertise to complete projects on

time Time consuming decision making

The firm may be a monopoly and therefore have less incentive to keep costs down. Resources will be wasted Resources may be over allocated to

demerit goods and under allocated to merit goods

Disadvantages of Consuming Resources Advantages of Consuming Resources

Burning of fossil fuels for energy release harmful emissions.

Employment rates will increase with higher rates of production and consumption

Deforestation destroys natural habitats for animal and plant species

The government will earn more tax revenue with higher production which can be used to finance new facilities for education and healthcare etc.

Pesticides and fertilisers used in crop production have polluted rivers and waterways clean water supplies are becoming short in supply

As some resources become low in supply, the cost of these will increase forcing firms to look

for alternative means and methods anyway

Overfishing has depleted fish stocks and harmed other marine animal populations

The trade position of the country may improve

Growing air pollution has increased breathing problems for many people

Money a unit of measurement that allows us to value different goods.

Functions of Money

Deferred Payment allows for purchases on credit (loans) that can be paid back later

Unit of Account money can be used to measure value

Medium of Exchange money can be used to carry out transactions between buyers and

sellers. People are happy to accept it and know they can use it to buy something else.

Store of Value money can be kept and used later and still retain its worth

Characteristics of Money

Scarce An increase in money supply can lead to a decrease in its value. For money to be

valuable, it must remain scarce

Portable It must be easy to carry

Acceptable It is given legal status by the government

Recognisable It must be easily recognized, yet forgery must be difficult. Copying will cause

problems with money supply

Durable It must be long lasting so it can be saved

Divisible It must be easily divided up into small amounts for smaller transactions

History of Money

1. Self-sufficiency everything that someone needed, they produced themselves. However it was

difficult to produce everything they needed as people had different skills,

2. Specialisation when a person or group focuses on producing one main good or service.

However, people were no longer independent and they had to trade with each other to get

everything, thus people became Interdependent.

3. Barter exchanging goods and services for goods and services. However Barter required a

double coincidence of wants and people did not have a proper exchange rate and had no proper

value of each good. It was also difficult to save goods and for people to bring all their goods and

services to markets to trade.

4. Commodity Money earliest form of money was goods e.g. pots, shells, etc. People were willing

to accept goods in exchange for their produce.

5. Precious Metals precious metals such as gold, and silver were scarce enough to make them

possible money. Weighing and cutting tools were necessary so rates of exchange could be

fixed. Portability was a major problem.

6. Coins precious metals of predetermined weight were moulded and stamped with the face of

the ruler and the coins value. To stop shaving the edges of the coins ribbed coins were

developed. Rulers would often debase the value of by mixing cheap metals with them, resulting

in the precious metal content of coins to be virtually worthless today but people still accept such

coins because they are generally acceptable.

7. Goldsmiths first paper money was issued by goldsmiths, who accepted deposits of precious

metals for safe-keeping in return they issued paper receipts to the owner. The receipts were

then often exchanged for goods or services.

8. Banks Goldsmiths gave receipts for deposited precious metals and would be accepted as

payment as the first paper money.

Banks

Commercial Banks private sector banks which aim to make profit by providing a range of banking

services. Their functions are:

To accept payments: people can deposit their money into a Current or Savings Account.

To lend: banks make profit from charging higher interest rates on borrowing than saving.

People can borrow from banks in the form of Overdrafts and Loans.

To enable customers to make payments: there is a range of ways people can receive money

and make payments e.g. credit card

Exchanging foreign currency

Storing important documents of customers

Providing advice: e.g. completing tax forms, and the purchase and sale of shares

Selling insurance

Current Account easily accessible account for everyday use

Savings Account interest is paid and funds are not easily withdrawn

Overdrafts customers can exceed their account limit up to an agreed amount

Loans money borrowed for a particular purpose and paid back over a certain time period and

when taken out, customers are usually required to provide collateral.

Collateral something pledged as security for repayment of a loan, to be forfeited in the event of a

default.

Central Banks government owned banks which aim to maintain stability of the national currency

and money supply. There functions are:

To act as a banker to the Government

To act as a banker to Commercial Banks: Commercial Banks have accounts at the central

bank to settle debts between each other and draw out cash

To act as a lender of last resort: the central bank will lend to banks which are temporarily

short of cash

To manage national debt: when government debt builds up, the central bank can issue

government securities e.g. government bonds

Holds the countrys reserves of foreign currency and gold

Issue bank notes: to central bank both prints and destroys notes

Operates monetary policy: this involves controlling the money supply to influence interest

rates to keep inflation low and steady.

Mortgages borrowing to purchase land/property that is secured against the land/property

Islamic Banks specialise in banking services that are compliant with Sharias Law which forbids

interest charges and payments. Instead they charge fees and share profits.

Investment Banks specialise in helping large firms raise finance from the stock market

Stock Exchange

Shares a unit of ownership interest in a corporation or financial asset. People buy them because of

the dividends, capital gain and to influence the running of a company.

Stock Exchanges an organization for the sale and purchase of shares and other securities

Listed/Quoted Companies companies who sell shares to generate finance

Stock Brokers those who trade on stock exchanges

Functions of Stock Exchanges:

To provide a market enabling individuals, firms and governments to buy and sell shares on

the global stock market

To enable companies to grow by merging or taking over another company

Mobilising savings for investment

To supervise the conduct of firms and brokers. Any firm that wishes to be quoted on the

stock market has to meet certain requirements such as providing a range of information for

prospective buyers

To provide up to date information on the market price of different stocks

Bear Market when share prices are falling

Bears someone who sells shares expecting their price to fall

Bullish Market when share prices are rising in general

Bulls someone who buys shares expecting their price to rise

Factors that Affect Share Prices

Takeovers buying up shares to gain control of a firm will usually drive up the price

Interest Rates if increased, people will want to save more in banks so less money is

available for investment in shares. If people are saving more, they are spending less. This will

reduce profit for firms; share prices for firms will decrease.

Profit record a firm with high/rising profits will see an increase in their share price

Issue of new shares an increase in the supply of shares of a firm will decrease the share

price

Government policy if governments cut corporate taxes, firms will have lower costs of

production. If governments cut income taxes, consumer expenditure will increase

Dividends and Yields

Dividend a share in the profits of a company that is earned by a shareholder. They can be

expressed as the nominal price or market (current) price of the share.

Nominal Price the price at which the share was issued

Yield the dividend expressed as a percentage of the market price and represents the return on the

money paid for a share.

Occupations and Earnings

What influences a persons choice of occupation?

Wage Factors firms advertise a wage rate for jobs to attract people to supply their labour.

They can be paid for in many ways:

o Time rate rate of pay per hour worked

o Piece rate rate of pay per unit of output produced. A worker who produces lots of

output will earn more than worker who does not. This can be used to create an

incentive for workers to increase productivity.

o Fixed annual rate/salary an agreed amount between the employer and employee

will be divided into equal monthly/fortnightly payments regardless of the number of

hours actually worked.

o Performance related payments usually offered to individuals or teams or workers

who are highly productive. The more sales someone makes, the more commission.

Non-wage Factors some jobs dont necessarily offer high wages yet people are still

attracted to them for other reasons such as:

o Work Environment, Travel Distance/Benefits, Job Security, Training Opportunities,

Qualifications required, Holidays, Fringe Benefits, Pension Entitlement, Job

Satisfaction

Why do some occupations earn more than others?

Different abilities and qualifications some jobs (e.g. an accountant) require more training

and qualifications than those that dont. As supply is likely to be more limited due to the

necessity of training, the wage will be higher.

Dirty/Risky jobs and unsociable hours this type of work usually offers a high wage to

attract a supply of labour.

Job Satisfaction a job that is viewed by many as a rewarding occupation (e.g. nursing),

attracts a large supply of labour. This results in low market wage rates.

Lack of information about jobs and wage some workers may work for less than they could

in other jobs as they are unaware of better paid jobs elsewhere.

Labour Mobility when workers can move easily between countries. If a worker can move

easily, they can easily move to the job that offers that most pay.

Changes in Earnings Over Time

Entry to the workforce: A young employee will receive relatively low earnings, This is largely

because of a lack of work and skills and experience. They can gain skills through

apprenticeship, management training schemes or other training opportunities.

Skilled workers: The more experience an employee has, the more opportunities there are to

increase earnings as the more skilled a worker becomes, the greater the demand: more

skilled employees will be in shorter supply and they will be able to command higher

earnings. Higher wages must be offered to attract highly skilled workers.

End-of-career empoyees: Employees may not keep up to date with changing trends or

technologies and therefore have outdated skills, and there wages may decrease. Due to

their long-time commitment to a business, they may continue to get high wages.

The Labour Market

Demand for Labour Supply of Labour

Firms need labour to produce goods and services for consumers.

The supply of labour for a job will depend on how many people are willing to do that job.

Influenced by the amount of output workers can produce and the amount its sold for

The higher the wage is the more expensive it is for firms to higher labour, therefore when wage

increases, quantity demand for labour decreases

It is likely as the wage rate increases, more people are attracted to doing the job, therefore

when wage increases, quantity supplied of labour will increase

Differences In Earnings Between Groups

The Public-Private wage gap

o Public Sector may be expanding and therefore causing more demand for labour,

causing wages to be high. It may also be contracting causing less demand for labour,

causing wages to be low. There may be a greater supply of labour due to non-wage

factors of choosing an occupation and thereforefore wages will be low.

o Pirvate Sector will offer high wages to attract the most skilled individuals who can

work as efficiently as possible. However, a large number of unskilled labour is in the

private sector and thus earn low wages due to the large supply and small demand.

Wages in private sector may also appear lower as fringe benefits are no included.

The Male-Female wage gap

o Females generally work in lower paying jobs and often take breaks to raise children

which limits career progression

o Males generally work full time rather than part-time to look after children

The Skilled-Unskilled wage gap

o In LEDCs many low-skilled workers are willing to work for low wages.

o In MEDCs firms are competing for skilled workers and offer high wages to attract

them

The Industry wage gap

o Agricultural Industry: In many Asian and African countries, there is a surplus of

agricultural workers, resulting in low wages

o Manufacturing Industry: This is bigger than agricultural industry, resulting in more

demand for labour and therefore higher wages

o Services Industry: This has the highest demand for workers, thus the highest wages.

S

D

Wage that will

be offered in

the market

Wages ($)

Quantity

Trade Unions

Trade Unions an association which represents the interests of a group of workers. It exists to

negotiate on behalf of their members. There are four types:

Craft Unions they represent workers with particular skills e.g. plumbers and electricians

working in different industries.

General Unions they represent workers with a range of skills in a range of industries

Industrial Unions they represent workers in a particular industry e.g. railways

White Collar Unions represent professional workers e.g. teachers, pilots

Functions of Trade Unions

Negotiate wages and other non-wage benefits on behalf of their members

Provide educations and training schemes

Protect workers rights

Provide recreational facilities

Fixing national minimum wage

Why will workers make wage claims?

Workers working harder and have increased productivity

The firm is making higher profits

Maintain wage differentials e.g. if a Nurse gets paid 60% the Doctors pay, and the Doctors

get a pay rise, Nurses will want a pay rise to be back at 60% and restore the differential.

Keep up with the cost of living (inflation).

Collective Bargaining the process of negotiating wages and other working conditions between

union members and employers. Collective bargaining exists as individual employees may not have

the skill, time, willingness or bargaining power to negotiate with employers

Factors affecting the strength of a trade union

Number of members more members means more funds to finance activities

High level of output and activity when output and incomes are high, firms compete for

existing workers. Therefore they are more willing to agree to union requests.

High level of skills unions representing skilled workers are in a better negotiating position

as it is costly to replace skilled labour

Consistent demand for the product unions representing workers who produce goods and

services essential to consumers and where there are few substitutes in a strong bargaining

position.

High level of public support if the public supports employees, the firm may lose credibility

Arbitration needed when trade unions and employers fail to resolve a dispute. The Government of

an independent third party will join negotiations.

Benefits of a Trade Union to employers

Short Time Consumption it is cheaper for firms to negotiate with a union than with

individual workers as it is less time consuming

Increase in Productivity Unions encourage workers to undertake education and training.

This encourages productivity.

Reduction in Conflict provided outlets for workers to channel their anger.

Industrial Action

Overtime ban workers refuse to work more than their normal hours

Strike workers withdraw labour

Go-slow working deliberately slowly to reduce production

Work To Rule workers deliberately slow down production by following every rule and regulation

Effects of Industrial Action on:

Firms

o Higher costs, less output, less revenue and lower profits

o Lose customers to rival firms

o Damages the firms reputation

Union Members

o Employees will lose pay and may even lose their jobs due to a decrease in demand

for their product caused by losing customers

Consumers

o Unable to obtain goods and services they need

o Pay higher prices if firms pass on their increased costs

Union Influence the Supply of Labour

Unions can restrict the entry of new workers by insisting that new workers have high

qualifications or skills

Closed Shop all workers in a place of work must belong to a trade union. This is outlawed

in a number of countries.

Open Shop where firms are able to employ workers that are or are not involved in a trade

union.

Single-union Agreement where a firm agrees a single union can represent all its workers.

Because this will give considerable bargaining power to a union, a firm will only agree to this

in return for commitments by the union on pay, productivity improvements and not to

strike.

Consumers

Spending the purchase of goods and services to satisfy wants and needs and to improve standards

of living. It is influenced by:

Disposable Income when consumers have higher incomes, they are likely to spend more.

Wealth the more wealthy a person is, the higher their spending will be.

Consumer Confidence if consumers are confident about their jobs and future income, they

are encouraged to spend more now. It can change over an economic cycle.

Interest Rates when interest rates are high, consumers are more likely to save than spend

Taste, Age, Gender, Family Circumstances, Religion

Savings a reduction in the use of disposable income now to use at a later time. People save

because of:

Consumption people may save now to make big purchases in the future

Interest Rates when interest rates are high, people earn more interest from saving so

people will save more

Consumer Confidence if people believe circumstances will change they will save more now

Availability of saving schemes the more ways to save, the more likely people are to do so

Borrowing the lending of money or items to someone else and paying them back later. People

unable to repay their debts are declared bankrupt or insolvent. Their personal assets may get

repossessed by the lenders or creditors.

Why do people borrow?

To finance necessities or luxuries

To purchase houses when people buy houses, they typically take out a mortgage to do so.

However, property is an asset so it can be considered a form of saving.

To start a business entrepreneurs will borrow money to start their business and will repay

the loan with future revenue

To fund education and training schemes people will borrow for these and repay the loan

with a higher income job in the future, which they get from their new skills.

Factors that influence borrowing

Interest Rates when interest rates are high, the cost of borrowing is high and loans will

take longer to pay. People are therefore less likely to borrow.

Wealth wealthy people may be more likely to borrow for certain purchases as they are

confident in their ability to repay the debt they can sell off assets if needed. A bank is also

more willing to lend to wealthy individuals as they are less likely to default on the loan.

Consumer Confidence confidence in a persons future financial situation will influence

their decision to borrow.

Availability of Credit the more available credit is the more likely people are able to

borrow. These days, people can organise overdrafts and loans over the internet and can also

buy goons on hire purchase in easy monthly instalments.

Business Organisations

Sole Trader/Proprietor a business organisation owned and controlled by one person. It may

employ other people to work in the business but will only ever have one owner.

Advantages Disadvantages

It is easy to set up. Most sole traders need little capital to start up with. This is because they have few legal formalities, modern technology has reduced the cost of set up and it can be run from home.

Sole traders lack capital. It is difficult to expand as sole traders may have little capital, used up their loans and find it difficult to raise finance through savings. Banks consider sole traders risky as they face competition.

It is a personal business. The owner has close contact with customers and staff meaning they can easily find out peoples wants.

Unlimited Liability. If the sole trader is unable to repay any business debts, they are personally responsible for these and may lose possessions.

The sole trader is their own boss so can make all the decisions on their own and will receive all the profits.

Full responsibility for the business. The sole trader is responsible for running the business. This means working long hours

Partnerships a legal agreement between two or more people (usually no more than twenty) to

own and run a business jointly and to share any profits.

Advantages Disadvantages

It is easy to set up. As with a sole trader, there are few legal requirements in drawing up a partnership agreement. Most partnerships are not required to publish annual financial accounts

Partnerships lack capital. Many countries place a limit on the number of partners allowed in a partnership. With fewer people able to put forward capital, expansion can be difficult

Partners can invest new capital to finance expansion. New partners can buy shares in the ownership of the business which can be used to expand the business in return for a share of the profits which motivates owners to work hard.

General partners have joint unlimited liability. As with a sole trader, general partners may lose personal possessions if the business is unable to repay its debts. Each partner can be held responsible for the actions of other partners.

There are more ideas and skills than a sole trader Slow decision making due to disagreements. Some may be more lazy/inefficient than another.

Sleeping Partner a partner who usually supplies the business with capital, however they do not

have an active role in running the business. These have limited liability.

Joint Stock Companies people and organisations who invest in shares become part owners of the

company. They can sell stocks/shares to raise capital.

Private Limited Companies have one or more shareholders but can only sell shares to people that

are known to the existing shareholders.

Advantages Disadvantages

Easy to raise finance. Compared to a sole trader or partnership, private limited companies can raise finance more easily through sale of shares.

Cannot sell shares to the public. Shares can only be sold privately and will place a limit on the amount of finance able to be raised.

Only the board of directors, as elected by shareholders (not shareholders), are concerned with everyday management.

Required to disclose financial information. In some countries, they are required to publish details of their financial performance by law.

Limited Liability. Only the money invested is at risk of being lost.

Public Limited Companies has at least two shareholders and can sell shares to anyone through a

stock exchange.

Advantages Disadvantages

Shares can be sold publicly. This allows the company to raise large amounts of finance to fund its operations

Expensive to form. Many legal documents and company investigations are needed. Advertising of shares can also be costly.

Shares can be advertised. This can be published in newspapers and magazines. This creates interest and attracts many investors.

Management diseconomies. Disagreements between managers and owners can occur and slow down decision making.

Must hold Annual General Meetings. These are held to keep shareholders informed of the position of the business. These can be expensive and time consuming to set up.

Vulnerable to takeovers. Original owners may lose control of their company if one company buys the majority of the shares.

Divorce of ownership from control. Owners/shareholders can lose control of the company e.g. large shareholders can out vote minor shareholders

Required by law to publish detailed annual reports and accounts

Multinational Corporations a firm that has business operations in more than one country, but

usually has its headquarters based in one country. Advantages of being a multinational corporation

include:

A large market will increase revenue

Can avoid trade barriers by setting up operations in countries that impose tariffs and quotas

Minimise transport costs by producing in countries close to resources or consumer markets

Minimise wage costs by producing in countries with low wages

Can raise large amounts of capital for expansion, research and development or attract highly

skilled labour

Reduce the average cost of producing each unit of output because they produce on such a

large scale

Positive Economic Impacts Negative Economic Impacts

Increase investment in modern equipment and cutting edge technologies

Some multinationals may exploit workers in low-wage economies

They provide jobs and incomes for local workers Natural resources can be exploited and cause damage to natural environments

They bring new knowledge and skills which can help domestic firms to improve their own productivity

Multinational may use their power to obtain generous subsidies and tax advantages from governments.

They pay tax on profits which boosts government revenue

Profits may be switched between countries so that multinationals avoid paying taxes

They can increase export earnings through international trade

Local firms may be pushed out of the market as they are unable to compete

Cooperatives business organisations owned and controlled by a group of people to undertake an

economic activity for mutual benefit. There are two types of cooperatives.

Worker cooperatives the people who work in the business own it, make the decisions and

share the profits

Consumer cooperatives retail enterprises owned and controlled by their customers

Advantages Disadvantages

Owned and controlled by members May be badly run as workers have little business experience

Members of consumer cooperatives enjoy profit dividends or lower prices

May find it difficult to attract new members and raise additional capital for the business

Workers in worker cooperatives take business decisions and share profits

Many consumer cooperatives have been forced out of business by larger companies

Members have limited liability

Public Sector Organisations organisations owned and controlled by governments

Advantages Disadvantages

Decisions are based on social costs and benefits Can be difficult to manage and control

Will not abuse market power May become inefficient and produce low quality products and charge high prices as there is no competition

Planning and coordination of an industry is easier if it is done by one party

Industries which provide basic necessities e.g. healthcare will charge low prices if run by the government

Will need to be subsidies if they are making losses. Government revenue used for subsidies will have an opportunity cost

Privatisation the sale of public sector assets to the private sector

Benefits Non-Benefits

Private sector producers are motivated by profit and are therefore more efficient

In the absence of competition, private firms may exploit market power

Private sector firms more likely to invest and encourage economic growth

Private firms dont consider external costs or benefits

Goods will be produced at lower costs and sold for lower prices

The enterprise may have been a good source of revenue for governments. Profits from the SOEs could have been used to fund other areas of the economy

Goods will reflect consumer sovereignty

Stages of Production

Primary Sector involved in the collection and extraction of raw materials e.g. Agriculture, Mining,

Forestry, Fishing, Quarrying

Secondary Sector processes the raw materials into semi-finished and finished goods e.g. leather

hides leather handbags

Tertiary Sector provides services e.g. banking, insurance, tourism, education, advertising

Productivity

Productivity the amount of output that can be produced from a given amount of input/resources

PRODUCTIVITY =

Labour Productivity the amount of output that can be produced from a given amount of labour

AVERAGE PRODUCTIVITY OF LABOUR =

Production the act of processing raw materials. Production is measured in units of output

Labour-Intensive firms that use more labour than capital

Capital-Intensive firms that use more capital than labour

Factors that influence the demand for Capital and Labour

The Productivity of Labour and Capital when there is a high productivity of capital or a low

productivity of labour, there is a higher demand for capital and lower demand for labour,

and vice versa.

Market Prices for Labour and Capital Labour and Capital are substitutes so when the price

of labour increases, the demand for capital increases and vice versa.

Profit Levels if profit levels are high, they are able to buy expensive capital which is more

efficient than labour, therefore demand for labour will decrease and demand for capital will

increase

Business Confidence If a firm has high business confidence, meaning confidence in

business for the future, demand for both labour and capital will increase and vice versa.

Demand for Goods and Services when there is a high demand for goods and services,

there is a high demand for labour and capital as the firm will want to produce as much of the

good as possible so they can earn a higher total revenue through the sale of more output

and therefore gain more profit

Interest Rates when interest rates are high, loans are more expensive to pay off and

therefore firms are less willing to get loans for expensive capital. This causes demand for

capital to decrease and demand for labour to increase.

Factors that influence Land

Productivity the greater the output from land the higher will be the demand for it

Location city centre sites can attract a large number of customers so there is a higher

demand for land there and therefore rent increases

Country Wealth as countries become richer, the demand for water increases. Water is

needed for domestic, agricultural, industrial, and energy production purposes

Costs of Production

Fixed Costs costs which do not change with output. These must be paid even when output is zero

e.g. electricity bill, rent

AVERAGE FIXED COSTS =

Variable Costs costs of variable factors that do change with output. E.g. wages, raw materials

AVERAGE VARIABLE COSTS =

Total Costs all costs required in the production process

TOTAL COSTS = Fixed Costs + Variable Costs

Average Costs the cost required to produce one unit of output

AVERAGE COSTS =

Revenue total receipts of a firm from the sale of any given quantity of a product

TOTAL REVENUE = Price x Quantity

AVERAGE REVENUE PER UNIT =

Profit/Loss how much money the firm has made once costs of production have been taken into

account

PROFIT/LOSS = Total Revenue Total Cost

Breaking Even the level of output where total revenue is equal to total cost

Long Run Average Cost Curve a graph showing the average costs of a business or firm in the long

run. These curves are U-shaped because as firms increase their scale of production they will first

experience economies of scale. After reaching a certain level of output they will experience

diseconomies of scale.

Total Costs

Variable Costs

Fixed Costs

Total Revenue

Break Even

Point

$

Output

Economies of Scale

Economies of Scale when average costs decrease as a result of producing on a large scale

Internal Economies of Scale average costs per unit decrease as scale of production is expanded

within a firm.

Purchasing Economies larger firms buy their supply in bulk. Suppliers generally offer price

discounts for bulk purchases as delivery is cheaper.

Marketing Economies large businesses may buy their own vehicles for distribution. This

will reduce costs as they do not have to pay the profit margin or another firm. Fixed costs

will be spread over a larger amount of output.

Financial Economies large firms can generally borrow money at lower interest rates as

banks view them as less risky than small firms.

Technical Economies large firms generally have sufficient finance for investment in new

machinery, training/recruiting skilled workers, and research and development.

Risk-bearing economies as larger firms tend to have more customers, they are safe from

being too reliant on one customer. Diversification allows large firms to spread their risk over

a range of products.

External Economies of Scale when the expansion of an entire industry benefits all firms within that

industry

Access to a skilled workforce Large firms may have access to a skilled workforce because

they can recruit workers trained by other firms within the industry

Ancillary firms firms which develop and locate near large firms in particular industries to

provide them with specialised equipment and services

Joint Marketing Benefits firms locating in the same area well known for producing high

quality produce may benefit from reputation

Shared infrastructure the growth of one industry may persuade firms in other industries to

invest in new infrastructure

Diseconomies of Scale

Diseconomies of Scale when firms experience an increase in average costs as they try to increase

production and expand too much and too quickly

Management Diseconomies if a firm has offices in different locations, produce many

products and have many different layers of management, this can slow down the decision

making process

Labour Diseconomies large firms generally employ computer-controlled equipment and

machines. Workers operating this machinery may become bored and become less

productive.

Agglomeration Diseconomies this can occur when a company merges with too many

different firms at different stages of production. It can become difficult to coordinate all

different activities of the merged firms.

Goals of Producers

Profit Maximisation

o Profit is maximised when the gap between total revenue and total cost is maximised.

Firms can achieve this by reducing costs (by training workers or upgrading equipment) or

increasing revenue (by raising price or increasing demand).

Growth

o Firms try to increase their size and share of the market, typically by providing goods at a

lower price than their competitors and will contribute to the goal of profit maximisation

Social Responsibility

o Some firms may choose to donate to charities or ensure they source their materials from

countries who produce goods fairly e.g. using child labour

Environment

o Some firms may use production methods that conserve the natural environment. This

may increase costs, but is likely to also increase revenue as consumers are becoming

increasingly concerned with buying environmentally friendly products

Profit Satisficing sacrificing some profit to achieve other goals

Effects of changes in profits

Increasing Profits Decreasing Profits

Make it easier for a firm to obtain external finance e.g. shareholders are more likely to want to buy shares/banks are more likely to give loans

If the decrease in profit is short lived, it may not have significant impact

Provide firms with more finance to update their capital equipment and technology

Firms may have to lower production, or stop production altogether

May attract more experienced workers/managers/directors to the business

Firms may find ways to cut costs e.g. letting go of workers

May encourage other firms to enter the market

Size of Firms

Number of Employees

o Small Firms generally have less than fifty employees

o Large Firms may employ hundreds or thousands of workers

Organisation

o Small Firms owners and employees carry out all function between them

o Large Firms divided up into specialised departments to carry out different

functions

Capital Employed

o Small Firms generally have little amounts of capital due to lack of finance

o Large Firms more capital means a firm can increase its scale of production

Market Share the share of total market sales for a good that one firm is able to capture

o Small Firms difficult to keep up with output of large firms so small market share. If

market is small, then a small firm may be able to gain a large market share.

o Large Firms have the ability to produce large amounts of output

Growth

Internal Growth a firm expanding its scale of production through an increase in factors of

production, financed by profits, loans and the sale of shares

External Growth integration through a merger or takeover

Merger one or more firms agree to join together

Takeover one company buys enough shares in another company so it can take overall control

Horizontal Integration a merger/takeover of firms that produce the same type of good or service

Advantage Disadvantage

Fixed costs spread over a larger number of units average costs decrease

Larger firms may dominate the market and abuse market power

More specialised machines and labour

Bulk buying

Vertical Integration a merger/takeover of firms at different stage of production

Forward integration when a firm in an initial sector joins with a final sector e.g. primary

sector secondary sector, secondary sector tertiary sector

Backward integration when a firm in a final sector joins with an initial sector e.g. tertiary

sector secondary sector, secondary sector primary sector

Advantage Disadvantage

Firms can ensure they have access to raw materials

May be management problems operating in a new sector of economy

Firms can ensure they have access to sales outlets

Conglomerate (Lateral) Integration a merger/takeover of firms making different products

Advantage Disadvantage

Diversification if demand for one product decreases, firm can still earn profit from another product

Management problems in producing a range of products

Why do some firms remain small?

A small market if there is only a small number of customers there is no point in expansion

Limited access to capital small firms find it difficult to get loans from banks as they cant

compete with larger firms

New technology has reduced scale of production needed easier for small firms to get

access to modern equipment and internet allows firms to reach suppliers and customers

worldwide

Personal Preference expansion can be time consuming and stressful or require more skills

Market Structures

Perfect Competition a market structure with the highest level of competition.

Monopoly a sole supplier of a product. It is formed through mergers/takeover, access to resources,

or if a firm has been very successful in cutting costs and responding to changes in consumer

demand, making it able to drive competitors out of the market.

Structure Perfect Competition Monopoly

Product Homogenous Only supplied by one

No. of buyers and sellers Many are perfectly informed of business activity

One

Share of market Small 100%

Entry into Market Free Difficult to enter because of legal barriers, new firms unable to compete, expensive to set up firms, existing brand loyalty

Exit out of Market Free Difficult to leave because of long-term contracts to provide a product of because Sunk costs cant be recovered if firm leaves industry.

Price Maker/Taker Price Taker will not raise price as sales will be lost to their competitors

Price Maker changes in supply affect market price

Profits for Firm Normal Supernormal

Efficiency Competition gives incentive to be productive and efficient

Absence of competition can lead to inefficiency

Access to Resources Many firms wanting same resources

Can gain access to all resources. Government can make it illegal for other firms to enter the market and a patent can stop other firms from producing the product.

Macroeconomic Aims of the Government

Macroeconomics concerned with the whole economy (not just individual producers and

consumers)

1. Full Employment when people who are willing and able to work can find work. People who do

not want to work are not part of the labour force e.g. children, students, housewives

UNEMPLOYMENT RATE =

2. Price Stability encourages greater economic growth and prevents a countrys products from

losing international competitiveness. If people can anticipate what the price level is going to be

they will not act in a way that will cause prices to rise. A common target for inflation is between

1-3%.

3. Economic Growth when there is an increase in the output of the economy and in the long run,

when there is an increase in the economys productive potential

Aggregate Demand the total demand for an economys products

AGGREGATE DEMAND = Consumer Expenditure + Investment + Government Expenditure + Export

Receipts Important Payments (AG = C + G + I + X M)

Aggregate Supply the total output of producers in the economy. The AS curve starts out as elastic

as the economy has many unemployed resources, letting them increase production without raising

prices. The AS curve becomes more inelastic as the economy approaches full employment of

resources as firms will have to compete with each other for the use of resources, impacting prices.

Actual (short run) economy growth there is an increase in the output of the economy

Potential (long run) economy growth the total output of the economy has increased

B

A

Capital

Goods

Consumer Goods

Price

Level

Real GDP

AS

AD1 AD

At point A, 100 capital goods and 100 consumer

goods are being made. At point B, 200 capital

goods and 200 consumer goods are being made.

The countrys output has increased.

Capital

Goods

Consumer Goods

Price

Level

Real GDP

100 200

200

100

When Aggregate Demand increases, it shifts to

the right. This causes the countrys output to

increase.

PPC PPC1 AD

AS AS1

The productive potential of the economy has

increased. This can be achieved through a rise in

the quality or quantity of factors of production.

The maximum output that the economy can

produce (AS) has increased.

4. Balance of Payments a record of a countrys economic transaction with the rest of the world.

In the long run, governments want export revenue and import payments to be equal.

This is because if import expenditure exceeds export revenue the country will go into debt, and

if export revenue exceeds import expenditure, consumers will not be enjoying as many products

as possible as standard of living is lower.

5. Redistribution of Income governments can redistribute money from the rich to the poor

through taxation (rich are taxed more than poor) and spending (government can spend more to

provide more benefits to the poor).

Conflicts between Government Aims

Full employment vs. Price Stability policy measures to reduce unemployment, can increase

inflation. E.g. the Government may raise expenditure on pensions to raise consumption. Firms will

increase production to meet extra demand and more jobs are created. However the increased

aggregate demand may lead to higher inflation.

Balance of Payments vs. Economic Growth policy measures to reduce expenditure on imports may

reduce economic growth. E.g. the government may raise income tax to reduce household

expenditure on imports. Less disposable income may also cause demand for domestic products to

decrease causing a fall in aggregate demand and therefore economic growth.

A governments choice on which aim to pursue will depend on: the relative size of the problem, the

consequences of the problem, and the degree of concern from the countrys citizens.

Macroeconomic Policies

Fiscal Policy refers to changes in government spending and taxation.

Expansionary/reflationary fiscal policy involves increasing expenditure and/or decreasing taxation.

This helps to achieve:

Economic Growth firms are able to produce more due to paying less tax

Full Employment more jobs available due to increased business activity wanting labour

Price Stability during a recession the government will wants people to buy more

Balance of Payments if economy has been in state of surplus for a long time, lower taxes

may encourage consumers to buy more imports

Redistribution of Income government spending could be spent on supporting the poor

Contractionary/deflationary fiscal policy involves decreasing expenditure and/or increasing

taxation. This helps to achieve:

Redistribution of Income more money given to the government to give to the poor

Full Employment with more from the government, the poor could get trained to get a job

Price Stability during an inflation of prices, the government will want to lower prices

through less demand for the product

Balance of Payments if economy has been in a state of shortage for a long time, higher

taxes may encourage consumers to buy less imports

Monetary Policy includes changes in the money supply and interest rates.

Demand for Money

Expansionary/reflationary monetary policy involves lowering interest rates or increasing the

money supply. This helps to achieve:

Price Stability during a recession, the Government will want people to buy more by

lowering the interest rates so people save less

Economic Growth firms can borrow more and increase the level of output

Full Employment firms will require more demand with an increase in output

Contractionary/deflationary monetary policy involves increasing interest rates or lowering the

money supply. This helps to achieve:

Price Stability during an inflation of prices, the Government will want to reduce the prices

by having more people save than spend

Supply-side policies designed to increase the productive potential of the economy. E.g. education

and training will increase labour productivity, reforming trade unions may make labour more

productive, and privatisation may increase productive capacity as private firms generally invest more

and work more efficiently than State Owned Enterprises.

Increasing the effectiveness of Macroeconomic Policies

Multiple Policies governments should use one policy measure for each of its objectives

Accurate Information a vital piece of information is the size of the multiplier effect of any

increase in aggregate demand. This is when the final impact on aggregate demand is greater

than the initial change

Quick Implementation of Policies if policies are delayed, economic activity can change and

the policy may no longer be useful

MSd MS MSi

Interest

Rates

Quantity of Money

MD

Taxation

Progressive Tax takes a higher percentage of the income or wealth of the rich

Proportional Tax percentage paid in tax stays the same as income or wealth change

Regressive Tax percentage paid in tax falls as income or wealth rises

Qualities of a good Tax

Equity the amount of tax people/firms have to pay should be based on their ability to pay.

A rich person has a greater ability to pay tax than a poor person.

Certainty a tax should be easy to understand

Convenience a tax should be easy to pay

Economy the cost of collecting a tax should be less than the revenue it generates

Flexibility it should be possible to change the tax is economic activity changes or

government aims change

Efficiency a tax should improve the performance of markets, or at least not reduce the

efficiency of markets.

Direct Tax a tax that is taken directly from income, profits and wealth

Impact of Direct Taxes

Advantages Disadvantages

Redistribution of income and wealth

Good source of tax revenue

Many are progressive and help to reduce inequalities in incomes after tax

They take into account peoples ability to pay

If set too high, can discourage effort, enterprise and saving

High tax rates can also encourage people to work harder if they have fixed financial commitments

High taxes on income earned from saving reduce the return on saving therefore people will save less.

Indirect Tax a tax paid by consumers when they buy goods and service e.g. GST

Advantages Disadvantages

Easy and cheap to collect

A wide tax base. Anyone who buys goods and services will pay some indirect taxes.

Can be used selectively to achieve aims e.g. reduce consumption of alcohol

Harder to evade and easier to adjust

Useful source of income in countries where it is difficult to raise income

Are regressive and fall proportionately more heavily on the poor

Increased indirect taxes increase prices

Can lead to workers asking for wage increases, thus costs of production would increase so inflation can occur

Tax revenues are less certain because they depend on spending patterns

Incidence of Indirect Taxes

Inelastic Demand Elastic Demand

With Inelastic Demand, the producers are able to increase the price of their product without much change in the quantity demanded. This increase in price would make the consumers pay a higher proportion of the indirect tax.

With Elastic Demand, the producers cannot increase the price of their product without the quantity demanded increasing a lot. Therefore the producers must pay for the majority of the tax by themselves.

Key:

Government Tax Revenue

Per Unit Amount of Tax

Inflation

Inflation a general increase in prices and fall in the purchasing value of money.

Demand-Pull Inflation occurs when aggregate demand exceeds current supply in the economy.

Increased aggregate demand

does not always cause

inflation. If the economy is

producing low levels of output

and has lots of spare capacity,

there will be no impact for the

price level, yet output can

increase.

As resources begin to get used

up, firms are in greater

competition with each other

for the use of them. Increases

in aggregate demand will

therefore increase the price

level but also increase output.

If the economy is at full

capacity, an increase in

aggregate demand will only

cause an increase in the price

level, and no extra output can

be made.

Real GDP Real GDP Real GDP

Price Level Price Level Price Level AS AS AS

AD

AD

AD AD1

AD1

AD1

P1

P

Price

Q1 Q

D

S

S1

P1

P

Price

Q1 Q

D

S

S1

Quantity Quantity

Consumer Consumer

Producer Producer

Cost-push Inflation occurs when the price level is pushed up by increases in the costs of

production. Firms will increase their prices to maintain their profit margins.

Monetary inflation occurs when an economy increases the money supply. It can be classified as a

form of demand-pull inflation. Increases in the money supply cause a decrease in interest rates.

Decrease in interest rates cause an increase in aggregate demand.

Quantity Theory of Money Money Supply x Velocity of Circulation = Price Level x No. of

Transactions

Velocity of Circulation how many times $1 travels around the economy

Harmful Effects of Inflation

The value of money decreases in the case of hyperinflation, value of money decreases so

severely and people may lose confidence in the currency

Redistributes income workers with strong bargaining power may be able to negotiate

wage increase, while those with few skills may be unable to get pay rises. Borrowers pay

back less in real terms than what they borrowed. High income earners can take steps to

avoid the effects of inflation.

Extra costs on firms time spent anticipating future price changes and reprinting prices

Shoe leather costs these are costs involved with moving money between financial

institutions searching for interest rates above inflation rates

Decreases business confidence fluctuating inflation rates affect firms confidence about

the future. This affects investment decisions and may stagnate long run economic growth.

May harm the balance of payments position if a country has high levels of inflation, their

exports will be expensive. This makes them lee competitive and sales overseas will decrease.

As imports are cheaper, consumers will want to buy these over domestic goods.

Beneficial Effects of Inflation

May encourage firms to expand a low, stable level of demand-pull inflation makes firms

optimistic about future sales

Can prevent unemployment workers may accept a percentage increase in their wages less

than the percentage increase in the price level. This will ensure firms maintain profit margins

and keep employees.

AD

AS AS1

Prices

Price Indices used to show the change in the general price level over time. The two main types of

price indices are The Consumer Price Index and The Retail Price Index.

Consumer Price Index a measure of price inflation affecting consumers. It is calculated from the

movement in the average price of a basket of goods and services purchased by the typical

household in a country from a sample of different retail outlets.

Constructing a Price Index

1. Select a base year this is a standard year with no dramatic changes in price. The base

year is always allocated a value of 100.

2. Find out how households spend their money this is done by a government administrated

Family Expenditure Survey. Certain goods and services are selected to make up the

basket. Weights are allocated to reflect the proportion of income spent on each good or

service.

3. Find out price changes this is done by government officials gathering information from

companies, outlets etc. Government then creates estimates of price changes based on this

information

4. A weighted price index is constructed

PRICE INDEX =

5. Calculate the rate of Inflation

INFLATION RATE =

Example:

Year Products Average Price Weighting Weighted Average Price Total WAP

Base Year

Food Travel Clothing

$60 $20 $40

60% 10% 30%

0.60 x $60 = $36 0.10 x $20 = $2

0.30 x $40 = $12

$36 + $2 + $12 = $50

Year 2

Food Travel Clothing

$70 $40 $48

60% 15% 25%

0.60 x $70 = $42 0.15 x $40 = $6

0.25 x $48 = $12

$42 + $6 + $12 = $60

Price index

Inflation rate

Employment

Unemployment not having work, but currently actively seeking work

Unemployment rate the number of people in the labour force who are unemployed

Labour force the employed and the unemployed

Labour force participation rate the number of people of working age who are in the labour force

LABOUR FORCE PARTICIPATION RATE =

Factors influencing the size of the labour force

Wages high wages will act as an inventive to seek work

Social attitudes more accepting countries will have larger labour forces

Provision for the care of children and the elderly greater provision of these services will

increase the size of the labour force

The proportion of school leaves who go for higher education more school leaves in higher

education will decrease the size of the labour force in short term, but long term the labour

force will be of higher quality and more productive

Changing Patterns of Employment

Industrial Structure as economies develop, employment moves from the primary sector to

the secondary sector and finally to the tertiary sector

Employed vs. Self-Employed in many countries people work for someone else. However

the number of self-employed workers is rising.

Private Sector vs. Public Sector Employment the proportion of workers in the public and

private sector may vary from time to time. A major reason people may like to work in the

public sector is because it often has greater job security and higher non-wage benefits. A

major reason for the decline in the proportion of public sector workers is privatisation.

Types of Unemployment

Frictional Unemployment occurs when it takes time for the labour market to match available jobs

with those seeking work e.g. redundant workers, people joining labour market for the first time

Cyclical Unemployment involuntary unemployment due to a lack of aggregate demand

Seasonal Unemployment occurs when people are unemployed at certain times of the year,

because they work in industries where they are not needed all year round e.g. tourism, fruit picking

Structural Unemployment arises from changes in the structure of the economy e.g. consumers

demand move away from domestic firms and toward more competitive foreign producers, the good

is not demanded anymore

Technological Unemployment workers are made unemployed as they have been replaced by

machinery and technology in modern production

The Measures of Unemployment

The Claimant Count measures those people who are receiving the unemployment benefit

Advantages Disadvantages

Cheap and quick Some people may falsely collect the benefit

A number of unemployed may not collect the benefit e.g. people on government training schemes, people with a spouse who earns over a certain level of income

Labour Force Survey a document created by the International Labour Organisation to measure

unemployment

Advantages Disadvantages

Can be used for international comparisons Takes time to collect

More accurate measure of unemployment Accuracy can depend on:

How questions are phrased and interpreted

Whether the survey sample is representative of the labour force as a whole

Measures to reduce Unemployment

1. Frictional Unemployment increase labour mobility or increase the incentive to work

2. Structural Unemployment increase labour mobility or encourage firms to move to areas of

high unemployment

3. Cyclical Unemployment government will raise aggregate demand by reducing income tax

or increasing expenditure

Consequences of Unemployment

On the Unemployed

o A fall in income

o A loss of self-worth

o A decline in the mental and physical health

o May have an adverse effect on the education of the children of the unemployed e.g.

cannot afford to pay for education beyond school leaving age

o A reduction in chances of being employed in the future. The longer people are

unemployed, the more they lose out on training with new methods and technology.

On the Economy

o Less goods and services are produced as the economy is not using all of its resources

o Government tax revenue falls

o Incomes and firms profits fall

o Expenditure on unemployment benefits increased. Opportunity costs incurred

o Possible increased health spending due to poorer mental and physical health

o Rising levels of crime

Gross Domestic Product

Gross Domestic Product the total output produced in a country. Methods to calculate GDP include:

The Output Method measures GDP by adding up the output produced by all industries in

the country. Output must not be counted twice e.g. the output of the car industry includes

the output of the steel and tyre industries also. To avoid this, only the added value will be

included in the calculation of GDP

The Income Method measures all incomes which have been earned in producing the

countrys output. Transfer payments and unemployment benefits are not included.

The Expenditure Method measures all the expenditure on the countrys finished output

Added Value the difference between the sales revenue received and the cost of raw materials used

Nominal GDP GDP is valued in terms of current prices. It does not take into account inflation and

therefore may overestimate changes in output.

Real GDP GDP is valued in real terms e.g. the effect of inflation has been removed

Measuring Welfare

Welfare well being of different individuals or countries

Recession a period of negative economic growth at the trough of the trade cycle. A recession is

usually defined as two consecutive quarters of negative economic growth.

GDP per capita measures the average income per head or per person

Advantages Disadvantages

Takes into account population changes Does not take into account what people can buy with their income

Does not take into account the distribution of income

Human Development Index takes into account gross national income per capita, education

(measured by average years of schooling) and health (measured by life expectancy).

Advantages Disadvantages

Can be used to make international comparisons Fails to take into account other factors measuring welfare such as environmental quality, crime rates and political freedom

Genuine progress Indicator takes the following items into account however may be trying to

measure too much at once or many of the measures depend on individual opinions

Average income, debt and distribution of income

Pollution, noise and traffic levels

Physical health and mental health

Social aspects e.g. crime rates, divorce rates

Political religious and individual freedoms

Economic Growth Cycles

Economic boom (or peak) aggregate demand sales and profits peak. There is low

unemployment or even a shortage of labour. There may be rising inflation as aggregate

demand exceeds currently supply. With rising inflation, consumer confidence and spending

may eventually begin to decline.

Economic recession (or downturn) there is a slowdown in economic activity. Demand for

goods and services fall, sales of firms decline. Firms cut back production and workers are

made redundant.

Economic recovery (or upturn) business and consumer confidence starts to recover.

Spending begins to rise, as does sales and profits for firms. Output levels start to increase

and firms begin to employ more workers.

Development

Characteristics of Developed and Developing Countries

Developed Developing

High incomes Low incomes and savings