LESSON 1 AN INTRODUCTION TO ECONOMICS

CERTAIN IMPORTANT CONCEPTS

Unlimited Wants
Human beings, in order to survive need a lot of things. Some of these things are very important for our
existence. For example, food, clothing, water, shelter and air. These things can be classified as Needs.
Apart from this there are things which are needed by us but they are not important for our survival and we
can live without them also. For example, going on an expensive holiday, owning a 57 inches Plasma TV.
These are known as Wants. This list is never ending and is continuously increasing.

Limited Resources
On the other hand, we have limited resources to produce these goods and services we want. There are
not enough car factories to provide cars to everybody on earth. Everything on this planet has some limits
except for our Wants. When unlimited wants meet limited resources, it is known as Scarcity.

Alternative Uses
All the resources we have on this planet can be utilized in a number of ways. They have alternative uses.
For example, a piece of land can be used for making a factory, or doing farming or constructing a school
and so on. Therefore, we have to choose what is best for us. If we talk from an economist point of view
it means making the optimum use of resource available.

Opportunity Cost
Though we have alternative uses, we have to select the best way to use these resources. When we
choose best alternative, the next best alternative which is left out is known as the Opportunity cost of
making a choice. In other words, the benefits we lost and could have achieved from the next best
alternative.

Examples of Opportunity Cost

A person who invests $10,000 in a stock denies themselves the interest they could have earned by
leaving the $10,000 dollars in a bank account instead. The opportunity cost of the decision to invest in
stock is the value of the interest. If a city decides to build a hospital on vacant land it owns, the opportunity
cost is the value of the benefits forgone of the next best thing which might have been done with the land
and construction funds instead. In building the hospital, the city has forgone the opportunity to build a
sports centre on that land, or a parking lot.

Economic Problem
The problem then becomes how to determine what is to be produced and how the factors of production
(such as capital and labour) are to be allocated. Economics revolves around methods and possibilities of
solving the economic problem.

Production Possibility Curve/Production Possibility Boundary/Production Possibility Frontier

From the point of view of an Economy, there is an opportunity cost of using its resources. Production
Possibility curve (PPC) shows the maximum combinations of goods and services that can be produced
by an economy in a given time period.

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 In the graph, if all the resources are used to produce Schools then there will be no Hospitals. If you move
to the other end then all the resources would be used to produce Hospitals and not Schools will be there
in the economy. Government has to move along this curve and decide the best possible combination of
goods to produce. For example Z, shows the possible combinations of School buildings and Hospitals.
Thus, it is impossible to build more Schools without also building fewer Hospitals. Any point outside the
curve is unattainable unless there is an outward shift of the PPC. This can only be possible if there is an
improvement in the quantity and/or quality of factors of production. This is known as economic growth. It
is a process of increasing the economys ability to produce goods and services.

1. Define economics. Explain the concept of scarcity, choice, economizing and investment.

Ans. Economics is the study of the satisfaction of wants which are unlimited and which involves the
consumption of goods and services which are produced with scare resources. Scarcity means it
is rare and that there is not enough of it to completely satisfy everyones wants so all economic
goods have an opportunity cost.

Investment: Investment is used to describe the production of real capital. Gross investment is the
total output of capital goods during a given period of time, usually one year. Net investment is the
annual increase in the total stock of capital which is less than gross investment from which
depreciation is deducted. Depreciation is the extent to which a stock of capital loses its value
owing to wear and tear and obsolescence. Therefore Gross investment depreciation = Net
investment.

2. Explain opportunity cost with examples private expenditure (individual, firm level) and
public expenditure (government level)

Ans. Opportunity cost is the next best alternative given up by choosing another item.
Private expenditure: A customer had $40 to spend. She wanted to buy both a pair of shoes and
a radio, but as she could not afford both she decided to buy the radio. The benefit that she could
have gained from the pair of shoe becomes the opportunity cost of the radio.

Public expenditure: Governments experience opportunity cost when they spend money on projects,
e.g. giving up building a new motorway in order for pay for the purchase of new army tanks.

3. What are economic and free goods? Give examples

Ans. If there were an unlimited supply of economic resources, unlimited amounts of every commodity
could be producedand human wants could be fully satisfied. There are relatively few free goods
for e.g. air. Free goods are those goods for which payment or exchange of money does not take
place. The economic resources like land, labour, materials, fuel, factories, machinery which are
needed to produce goods and services are limited in supply and are called economic goods.

4. Explain the activities in an economy.

Ans. There are variety of activities which takes place in an economy. These can be classified into three
main types that are production, consumption and exchange.

Production: This takes place so that peoples wants can be satisfied. Any kind of work which
helps to satisfy peoples wants, and for which they are prepared to pay a price, is production. This
includes the output of services as well as goods.

Consumption: It is described as the using up of goods and services in order to satisfy our wants.
The goods are divided in to two: Durable consumer goods and Non-durable consumer goods.
Durable consumer goods are the goods which have a long life like household furniture, domestic
appliances, etc. Non-durable consumer goods are the commodities which are used up immediately
or which have a short period of life like food, drinks, soap, etc. Consumption also consists of
services which form a large part like telephone, education and health services.

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 Exchange: In all societies some kind of exchange must take place to satisfy peoples wants. This
system of exchange depends upon the use of money. Services are exchange for money which in
turn purchases other goods.

5. Distinguish between wealth and income with example. Also explain wealth private
wealth, social wealth and national wealth

Ans. Wealth consists of a stock of goods which have a money value. It includes such assets as land,
houses, factories, shops, machines and many kinds of personal possessions. Wealth can be
divided in to three types: Private wealth, Social wealth and National wealth.

Private wealth is described as the possessions of individuals. This includes financial assets
such as notes and coin, bank deposits, building society deposits and company shares.

Social wealth consists of those assets owned by the community as a whole that is by central and
local government. It includes such things as roads, hospitals, schools, parks and libraries.

National wealth is the sum of all the wealth possessed by the citizens of a country, whether it is
privately owned or publicly owned.

Income refers to the amount of money earned or received during a given period of time usually one
year. An individual may receive income in various forms such as wages, salaries, interest on
savings, rent from the ownership of property, profits on shares, or social security payments.

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 LESSON 2 ECONOMIC RESOURCES

1. Discuss the four factors of production. How can you increase the supply of labour and
efficiency of labour?

Ans. Factors of production are those resources needed to produce goods and services. There are four
factors of production and they are in limited supply.

Land: This term is used to cover all of the natural resources provided by nature and includes fields
and forests, oil, gas, metals and other mineral resources.

Labour: This is the efforts of people needed to make products.

Capital: This is the finance, machinery and equipment needed for the manufacture of goods.

Enterprise: This is the skill and risk taking ability of the person who brings the other resources or
factors of production together to produce a good or service. For example, the owner of a business.
These people are called entrepreneurs.

A countrys supply of labour depends upon the following:

- The size of the total population
- The proportion of the total population which is available for work and is willing to work, and
- The average number of hours worked by members of the working population.

The efficiency of labour is taken to mean its productivity and this is usually measured in terms of
output per worker hour. The productivity is influenced by:

1. Education and training facilities: The standard of general education and the variety and
quality of the training facilities available influences the efficiency of labour.
2. Working conditions: Damp, cold, badly ventilated places of work will not encourage the
people working in them to give of their best.
3. Management and equipment: Workers in firms which are well organized, managed and
equipped will generally be more efficient.

If the above factors are taken into consideration the efficiency of labour can be improved.

2. What is meant by depreciation of capital?

Ans. Capital goods are the goods that help firms to increase their outputs of consumer goods like
machines, factories, roads, etc. Capital is classified into two

Fixed capital: Fixed capital is the capital that long last and consists of things which do not
change their form in the process of production like machines, tractors, etc.

Working capital: Working capital includes those things which are used up in the process of
production that is they are changed into some other form like for a shoe manufacturer stock of
leather is working capital.

Capital goods are always wearing out or becoming out of date. Some part of the total output of
capital goods will be required to replace the worn-out and outdated equipment. Depreciation is the
extent to which a stock of capital loses its value owing to wear and tear and obsolescence.

3. Discuss why a company might change its use of different factors of production.

Ans. A company might change its use of different factors of production for the following reasons:

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 1. Reduction in costs: A company may change its factor of production to reduce their costs of
production. For example: A company may shift from use of capital to labour
because it will reduce their costs to repairs.
2. Increase productivity: Substituting a factor of production with another can take place if it is
increasing the productivity. For example: Substituting capital with labour will help in increasing
productivity because machines have a better output as compared to human beings.

3. Maximise profits: Factors may be changed if it affects profitability of the firm. A firm may try
to achieve optimum utilization of its factor of production as it can raise the profits and reduce
the costs.

4. What are the questions every society must answer?

Ans. All communities have to deal with the same basic economic problem that is they have limited
amounts of land, labour and capital which cannot produce enough goods and services to satisfy all
the peoples wants, and they have to decide how these limited resources are to be used. This is a
problem of resource allocation, because decisions have to be made on the way in which the
resources are to be distributed to different industries and occupations. The questions every society
must answer are:

1. What goods and services should be produced and in what quantities?

A country can also produce some of the goods and services its people want. It must find some
method of choosing which particular goods and services to produce.

2. How should the goods and services be produced?

Many commodities can be produced by using different methods of production. Some manufactured
goods can be produced either by small firms using a lot of skilled labour or by mass-production
methods in which a lot of capital equipment is used.

3. For whom should the goods and services be produced?

This is the problem of distribution as to how the produced things should be distributed. In a modern
economy, goods and services have money prices. This means that people with larger incomes can
claim larger shares of the national output of goods and services; they will have higher real incomes.
The basic problem is to decide how the total real income should be shared out. To find solution to
the above problems the question which could be asked are :
a. Should there be equal share for all?
b. Should those who produce have larger share than those who produce less?
c. Should skilled workers receive more than unskilled workers?
d. Should each persons share be based on his or her needs?

These questions affect the way in which a society uses its economic resources which every
society must answer.

5. Explain Capital and Labour Intensive techniques of production. Why are some
organizations capital intensive while others labour intensive?

Ans. Labour intensive method of production means a company employing many workers for production.
These gives low output levels and use little capital equipment. Firms where production is carried
out by very few people and more automated machines are used are known as Capital intensive
company. The output levels are very high and these are automated factories which uses the latest
computer controlled equipment. They use a great deal of capital equipment to produce their output.

Some organisations are capital intensive and others labour intensive due to following reasons:

- Some organisation are large so they may go for capital intensive method and small organisation
may go labour may go for capital intensive method.

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 - The production method which a firm sometime depends on the nature of where if more manual
work is required firms will for labour intensive methods whereas if more of technical work is
required firms will go for capital intensive methods.

- If the amount of finance available is less and the country in which the firm operates has less
introduction of new technology then firms may go for labour intensive production method rather
than capital intensive methods.

- If the country in which the firm is operating is developed then organizations may pefer to go for
capital intensive production methods as the country will be technically advanced in machinery.

- If the cost of labour is more organizations may prefer to go for capital intensive production
methods.

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 LESSON 3 ECONOMIC RESOURCES

1. Discuss the features, merits and demerits of market economy.

Ans. A market economic system is where businesses are owned by private individuals and there is very
less government interference.

The features of a market economy are:

i) All resources are owned by private people.
ii) The main aim of the people is to make profit.
iii) In a market economy only those goods are produced which consumers are willing to pay for.
iv) In a market economy only those people who have enough money are able to enjoy the goods
and services produced.

The advantages of a market system are:

1. The free market responds quickly to peoples wants. This means that if people want good or
service then resources are quickly sent to the market to produce such goods and services.
However if the good or service is not in demand the resources are put to other use.
2. The market produces a wide variety of goods and services to meet consumer demands.
3. Workers are encouraged to work hard as they can keep most or all of their incomes because of
non-existent taxes.
4. Businesses compete with each other and this could keep prices low.
5. The market system encourages the use of new and better methods and machines to produce
goods and services. The aims of firms in a market economy are to make as much profit as
possible. New methods and machines often reduce the costs of producing goods and services
thus increasing the profit and encouraging new firms to set up.
6. The market system relies on producers and consumers to decide what how and for whom to
produce.

The disadvantages of market system are:

1. Factors of production will be employed only if it is profitable to do so.
2. There are no government-provided goods or services, such as health and education services,
available to everybody. Only those who can afford to buy theses important services will benefit
from them.
3. The free market may encourage the consumption of harmful goods.
Some people may wish to buy the injurious drugs if they can afford to buy then the free market
find it profitable to provide these goods.
4. The social effect of production may be ignored such as pollution, destroying plants etc.
5. Businesses might be encouraged to create monopolies in order to increases prices. Consumers
would have limited choice.

2. Define planned economy. Also discuss its advantages and disadvantages.

Ans. A planned economy is an economy which is controlled only by the government. The government
decides how all scarce resources are to be used. The main aim is not to make profit but look after
the welfare of the people.

The advantages of planned economies are:

1. The Government provides public goods such as street lighting, defense etc. because no private
firms will provide these services free of cost. Moreover the government also provides merit
goods like education and health for those who cannot afford private firms.
2. The main aims of private firms are making profit thus making the prices of goods and services
high, for the benefit of the common man the government also provides these goods and services
at a lower price because their aim is not profit but social welfare.
3. Government control can eliminate any waste resulting from competition between firms.
4. There can be work for everybody.

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 The disadvantages of planned economies are:
1. The government produces what they want not what the people want.
2. The goods that are produced are of poor quality.
3. Firms do not have an incentive to do a good job because they are not required to make a profit.
4. There is scarcity because limited range of poor quality goods are produced.
5. Since it is a public sector, more of political intervention may be there as it is under government
control.
6. There will not be any competition as governmentt may enjoy monopoly in those goods / services.

3. Why are countries opting for mixed economy system?

Ans. If an economy has a private sector and public sector it is called a mixed economy.
1. In the market economic system there is high unemployment because it may not be profitable
to employ people. Whereas in a mixed economy the government creates job for those people
who are out of work.
2. Public goods such as defense, law and order, street lighting are not provided by private firms.
So the government provides these and raise the money necessary by taxing peoples income
and spending. The government also provides merit goods such as education and health.
3. In a mixed economy the government can stop people from consuming harmful goods by making
them illegal. For example hard drugs by placing high taxes on alcohol, cigarettes etc.
4. Private firms often pollute the environment causing harm. The government may use laws or
high taxes and fines on firms to try and prevent them from polluting the environment.
5. One of the main problems of a market economy is that poor people are unable to buy many of
the goods and services. In a mixed economy the government provides these goods and services
like unemployment benefits and free health care and education for those who cannot afford to
pay.

4. Discuss whether a community should always exploit rather than conserve its resource?

Ans. The production of capital goods makes possible a greater future output of consumer goods. But the
production of capital goods also means that the present output of consumer goods is less than it
might have been. Resources should be allocated between the production of consumer goods and
the production of capital goods. Another problem is the choice between the present and the future.
Many of the resources are non-replaceable. Modern civilization is very dependent upon non-
replaceable minerals such as oil, copper, zinc, tin, lead and so on. Also if the resources are being
utilised in the short run then it may get exhausted at a faster pace leaving almost nothing for the
future generations. The community can use resources in a balanced way that is using just what is
required and reducing the wastage of resources.

5. What do you understand by resource allocation, full employment of resources. Define

with examples private cost, social cost, external costs, private benefits, social benefits,
merit goods and services, public goods & services. With examples.

Ans. All communities have to deal with the same basic economic problem that is we have limited
amounts of land, labour and capital which cannot produce enough goods and services to satisfy all
the peoples wants, and they have to decide how these limited resources are to be used. This is
called as a problem of resource allocation as decisions have to be made on the way in which the
resources are to be distributed to different industries and occupations.

The costs incurred by a firm for producing goods and services are described as Private costs. In
a market economy, these are the only costs which influence a firms decision to produce. Sometimes,
however, the production of a commodity imposes costs on society as a whole; these costs are not
borne by the producer. For example, the price of a good produced by a firm which pollutes the
atmosphere with smoke from chimneys or with unpleasant smells does not include the costs of
the nuisance and dangers suffered by the people in that neighborhood.

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 The benefits gained by a person who buys a good or service are described as private benefits
where the market price of a product does not give a true indication of the total benefits provided by
that product. For example, the price paid by an electricity authority for the removal of unsightly
pylons and overhead lines and their replacement by underground cables would not be a good
measure of the total benefits from this work. The community as a whole would place a high value
on the improvement of the countryside when these ugly structures were removed. The value of
this benefit would not be included in the price paid for the work done.

In planning projects such as airports, motorways and underground transport systems, governments
and now try to take into account all the cost incurred which is called as Social cost. They also try
to estimate the value of all the benefits derived which is called social benefits.

6. Discuss economic arguments against a ban on the sale and consumption of cigarettes and
alcohol.

Ans. The social costs of the sale and consumption of alcohol exceed its social benefits, then a ban
would be economically efficient. If the social benefits of alcohol exceed its social costs (the sum
of private costs and external costs) then a ban would not be economical. The private cost of
alcohol can be measured by how much people measure of how much people enjoy alcohol and are
prepared to pay for it. The consumption of alcohol by one person can impose many negative
externalities on others. For e.g. a loss of national output due to working days lost through alcohol
abuse and healthcare costs imposed on others might suggest the sale and consumption of alcohol
should be banned. However, drinking in moderation is enjoyable for many people and can lower
stress and reduce stress-related health problems. The production and sale of alcohol also employs
many people, and their incomes, the profits of alcohol producers and sellers, and excise duties on
the sale of alcohol, all provide tax revenue for the government to spend on publicity provided goods
and services that can benefit many more people and the economy. These economic arguments
suggest a ban may not be economically beneficial because if a ban is imposed then the revenue
collected from there on reduces and it may become difficult for the government to provide public &
merit goods to the people.

The revenue that a government gets from sale of alcohol can be utilized for building more hospital,
rehabilitation centers, schools & so on.

Also if a ban is imposed it will lead to high level of unemployment and redundancy in the economy
as the people working in these industries and bars will be out of their jobs. This will adversely affect
the overall economic growth and standard of living in the economy. This may also lead to an
increase in anti social elements as people will not have money to satisfy their basic needs.

7. The government decides not to introduce a ban on it but instead considers either raising
indirect tax on alcohol or banning the advertising of alcohol. Discuss which of the two
approaches you would favour.

Ans. Alcohol is a demerit good (habit forming good). Many people are addicted to its consumption. If the
government decides to ban the advertisement of alcohol it will not serve the purpose of reducing
the consumption level of alcohol in the society. Alcohol drinking is a social activity and even if its
advertisement is banned people will come to know about the new alcoholic products available in
the market through the social circle people belong to. Also if a ban is introduced it will directly
affect the revenue of advertisement companies who get their bread & butter from this. This may
lead to increase in redundancy of workers. It may lead to lot of violent activities from the unemployed
people.

On the other hand if the government decides to increase the indirect taxes it will prove to be more
beneficial fro the economy for the following reasons.

- If indirect taxes are raised it will directly influence the price of alcohol i.e. it will increase. If the
prices increase not many people will cut down in its consumption because its a habit forming
good. Only that segment of the population who may not be able to purchase alcohol at an
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 increased price will cut down on their consumption. But the segment of population which is well
off will not reduce their consumption of alcohol. So both the aims of the government: reducing
the consumption & increasing the revenue generation can be achieved.
- This will provide government with good revenue which the government can utilize to build more
hospitals where not only drunkards will be treated but it will provide services to other people as
well, rehabilitation centers, schools for children, maintaining the law and order and for other
developmental purpose.
- Also raising the indirect taxes will not affect the population working in these industries as their
jobs remain secured.
- If prices of alcohol rises the there will be reduction in the drinking population which the main
aim of the government as in any society there will be some people who may not be able to
afford the price rise. This will directly reduce the governments expenditure on alcohol related
activities for ex: police patrolling can be reduced instead some more productive work can be
assigned to the police officials rather than keeping a watch on activities of drunkards.
- If consumption goes down then it will lead to a healthy population who can work efficiently and
effectively yielding better results both to the company they are working, in particular and to the
entire economy, in general. This will lead to an increase in the overall standard of living in the
economy.

Hence, I feel that raising the indirect taxes will be a better option for the government because
economy gains whether people reduce their consumption levels or not.

8. A healthy workforce is a productive one. Whose responsibility should it be to provide for

health care and education and training- the employers or the government?

Ans. Providing health care facilities to its employees and their family members is usually the responsibility
of employers. A healthy workforce provides following benefits to the employer.
- Productivity increases as the absenteeism rate falls down due to good health.
- Workers become more efficient and productive which increases the profit of employer.
- It motivates the worker with a feeling of honesty and loyalty as they feel they are important to
the organization.
- If the health of the family members of employees is taken care, it would have direct impact on
absenteeism and productivity as workers will work without any tension.

This would increase the cost of employers but the impact of it will be in long run. Government can
also share this responsibility by forcing the employers to start with a health care unit in their own
organization.

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 LESSON 4 Consumers Spending and Saving

1. What is the effect on spending and savings as income rises.

Ans. Real disposable income is the quantity of goods and services which disposable income can buy. It
is the purchasing power of the money income. Personal disposable income can be either spent or
saved. An increase in total disposable income leads to an increase in total consumer spending
mostly durable consumer goods. But consumer spending does not usually increase as fast as
income increases. They also tend to save a larger percentage of their income. When income is
low, there will be no savings as whole of disposable income will be required to buy the basic
necessities of life.

The above figure helps to understand the way in which consumption and saving changes as
income increases. It shows that Household B with the much higher income, still consumes
more than Household A, with the lower income, even though it spends a smaller percentage of
its income. As peoples income increase, consumers spending and saving increases.

2. Discuss the expenditure pattern of spending and saving between high and low income
earners.

Ans. Lower income households spend a greater proportion of their income than households with larger
incomes do. That is a policy which transfers income from the better off to the less well off will
tend to increase total consumer spending. E.g. if one pound is taken, in the form of taxation,
from a high-income household and transferred, in the form of a social security benefit, to a much
poorer household. The high income household might have spend 60% of the pound and saved
40%; the poorer household is more likely to spend the whole of the pound.

3. Explain the factors affecting consumers spending and saving? OR What are the
motives behind a person to save rather than to spend?

Ans. Although the amount of money spend on consumer goods and services depends mainly on the
level of disposable income, it is also influenced by other factors.

- Wealth: The income households receive is not their only source of money for spending. The
ability to spend depends upon the amount of wealth held as well as on the amount of income
received.

- Borrowing: Schemes which allow people to borrow, such as hire-purchase facilities and bank
loans, make it possible for households to spend more than their current income. This is only
possible over a fairly short period, because the loans have to be repaid.

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 - Changes in the rate of Income tax: The ability to spend depends mainly on the level of
peoples disposable income. Any changes in the rate of income tax or national insurance
contributions, therefore, will change the amount available for spending.

- Changes in the distribution of Income: Lower income households spend a greater proportion
of their income than households with larger income do.

That part of personal disposable income which is not spent is saved. There are many factors
that motivates the person to save rather than to spend.

- Income: The main influence on personal saving is the level of disposable income, because
this determines the ability to save.

- The Social Attitudes towards saving: In some societies, saving is regarded as a good social
habit, and is thought to be a sensible and correct way of dealing with part of ones income.

- The Desire to provide for future needs: Many people save because we live in a world of
uncertainity. They wish to build up a reserve of money which will help them cope with any
misfortune which may befall them in the future for e.g. illness. People also save to make their
years of retirement more comfortable.

- Saving for a particular objective: Some saving is carried out in order to accumulate a sum
of money to pay for a particularly expensive item, such as for the deposit on a house, the
purchase of a motor car, or a holiday abroad.

- The Number and variety of savings schemes: The availability of a large number of attractive
and convenient savings schemes will tend to encourage people to save.

- The rate of Interest: For some people, it is likely that the amount of interest they receive on
their savings will have some effect on the amounts they save.

The ability to spend depends mainly on the level of peoples disposable income. Borrowing enables
people to spend more than their current disposable income. It does, however, involve a cost in the
form of interest which has to be paid. It is also usually a temporary situation as loans and overdrafts
have to be repaid. The poor, whilst sometimes having a greater need to borrow, are likely to
experience greater difficulty in borrowing. This is because they will have less security to offer for
any loan and lenders may be more worried about their ability to keep up interest payments and
repay any loan.

4. How savers can be benefited by high interest rates and reduced inflation and also changes
in taxes and tax allowances.

Ans. Changes in the rate of interest do have some effect on the amounts saved, but that the influence
is not very strong. This is probably because a large part of personal saving is contractual. This
means that people have made agreements to save a given amount of money every week or every
month with organizations such as insurance companies and pensions funds. They have committed
themselves to saving these amounts whatever happens to the rate of interest. This account of
savings has dealt with personal saving. This is not the only form of saving. Companies save by
keeping some of their profits in the business, rather than paying out the whole of their profits to
shareholders. Governments too can save. They can do this by arranging things so that revenue
from taxation is greater than government spending.

5. What might be the result of general increase in the level of consumer spending in an
economy?

Ans. If the level of consumer spending in an economy increases, it will be advantageous in following
ways

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 - This spending of consumer will create a demand for goods and services in market which will be
a great opportunity for business as then production will increase and thereby sales.
- This spending would lead to extra income for others like business.
- It would increase the employment opportunity with increase in income of an individual.
- Government also will be beneficial as the production / income increase, the revenue of
government will increase in form of tax.
- It would also affect the balance of payment as more imports and exports will take place.
- Inflation is also an effect as if the spending increase it would increase demand with rise for
demand for raw materials.

6. Analyse what might happen to income and employment if consumer spending decreases.

Ans. If the income of an individual falls his spending as well as savings will be reduced this will bring a
fall in demand. This fall in demand will reduce the sales of businesses resulting an decrease in
production. If production is reduced the employer will go for cut down of employees which will
increase unemployment. Further reduction in sales might result with this decreased employment.

7. Explain the connection between changes in interest rates and housing prices.

Ans. Interest rate and changes in house prices are inversely related to each other. That is a rise in
interest rates will result in more saving and less borrowing of loans so the house prices will have a
fall and vice versa. If there is increased borrowing for housing then there would be higher demand
for house purchase, which means that price of housing is likely to rise and vice versa.

13
 LESSON 5 PRODUCTION & PRODUCTIVITY

1. What do you mean by production and productivity?

Ans. Production refers to the making of goods and services which satisfy peoples wants. Production
includes, the output of all goods and services for which people are prepared to pay a price e.g.
production of steel, sugar etc.

Productivity refers to the amount of output that can be produced from a given input of resources.
It is a measure of the efficiency with which goods and services are produced.

2. Explain what is meant by primary, secondary & tertiary sectors of production and describe
how the importance of each sector changes as the country develops.

Ans. Types of Industry

(1) Primary Industry: The primary sector of industry extracts and uses the natural resources
of the earth. For e.g. coal mining, farming.

(2) Secondary Industry: The secondary sector of industry manufactures goods using the
raw materials provided by the primary sector. For e.g. car production, making tables.

(3) Tertiary Industry: The tertiary sector of industry provides services to consumers and
the other sectors of industry. For e.g. hairdressing, banking.

Importance of Different Sectors

In some countries, primary industries such as farming and fishing employ many more people than
manufacturing or service industries. These tend to be developing countries where manufacturing
industry has only recently been established. As most people still live in the rural areas with low
incomes, there is little demand for services such as transport, hotels and insurance. The levels of
both employment and output in the primary sector in these countries are likely to be higher than in
the other two sectors.

In countries which started up manufacturing industries many years ago, the secondary and tertiary
sectors are likely to employ many more workers than the primary sector. The level of output in the
primary sector is often small compared to the other two sectors. In very wealthy countries, it is
now common to find that many manufactured goods are bought in from other nations. Most of the
workers will be employed in the service sector. The output of the tertiary sector is often higher than
the other two sectors combined.

3. What is Division of Labour or specialization? Discuss its merits and demerits to both
workers & the firm.

Ans. Division of labour is when the production process is split up into different tasks and each worker
performs one of these tasks. It is also known as specialisation.

Advantages of Specialization / Division of labour

To the business:

- Specialist workers become quicker at producing goods: When the work is specialised
each worker only needs one set of tools and these will be in constant use to make the work
quicker.
- Production becomes cheaper per good as less time is spent moving the material from one
place to another.

14
 - Production levels are increased as the worker becomes more efficient in handling the tools and
operations.
- Each worker can concentrate on what they are good at and build up their expertise, thereby
increasing their skill.

To the worker:
- Higher pay for specialised work: With division of labour the worker becomes expertise in
performing a job and handling the machinery. Since he alone handles the machinery other
workers may not know the details about the machinery and so he can demand higher salary for
specialised work.
- Improved skills at that job: - By repeating the operations daily the worker becomes friendlier
with the equipments thereby increasing the efficiency and skill of the worker.

Disadvantages of Specialization/ Division of labour :

To the business:
- Greater cost of training workers as each worker is to be trained specially for a single activity.
- Quality may suffer if workers become bored by the lack of variety in their jobs

To the worker:
- Workers may fine it boredom as they do the same job repeatedly with no new innovation in
production or equipments.
- Their quality and skills may suffer as they become experts in a specific job and if the company
is closed the demand for these workers is restricted to specific job only.
- May eventually be replaced by machinery if the job does not require more skills.

4. Explain the types / extent of specialization, with examples.

Ans. Types of specialisation:

- Specialization by industry
An economy is made up of many industries, each of which tends to specialise on a particular
product or process.

- Specialization by firms
The individual firms, which together make up an industry, often specialise by making one part
of the final product or by carrying out one of the several processes of production.

- Specialization by workers
This is specialisation of workers in different occupation like printing, weaving, designing and
so on.

- Specialization by region
Certain areas have specialised in certain industrial production e.g. coal mining in Yorkshire,
pottery in Stoke.

- International Specialization
Certain countries have advantages in producing certain goods. They may have natural resources
or they may be able to produce goods more cheaply.

15
 LESSON 6 PRODUCTION AND THE COST OF PRODUCTION

1. What are the fixed and variable factors of production? How do they change in short and
long run?

Ans. The factors of production are classified as variable factors and fixed factors. Variable factors are
those factors whose supply can be quickly and easily changed. They include most types of labour,
raw materials, fuel, power, and so on. Fixed factors are the factors, the supply of which cannot be
easily and quickly changed. They take a relatively long time to build, erect and install e.g. factory
buildings, machinery.

The short run is the period of time over which at least one of the factors of production is fixed in
supply. In this situation a firm can only change its output by using more or less of the variable
factors because acquiring fixed factors of production needs huge capital and time. The long run is
the length of time a firm needs in order to change the amounts of all the factors of production it
uses both fixed and variable.

2. How does an increase in output increases productivity but after sometime decreases it.

Ans. Productivity increases as more workers are employed. As the number of workers continues to
increase, there comes a point where the average product begins to fall. This is because the fixed
amounts of land and capital are now insufficient to keep all the workers operating at their full
capacity. Employing more workers will increase the total output but the output per worker will be
falling. These changes in the average product of labour have important effects on the costs of
production. If we assume that all the workers receive the same wages and that other things do not
change still
- Increasing productivity means that the cost per unit will be falling
- Falling productivity means that the cost per unit will be rising.

3. Discuss how an organization can sell many products at low prices inspite higher fixed
costs.
1. If an organisation has higher fixed costs it means that it has a big plant or factory. Building
large number of people employed in the factory for which it may be incurring expenses regarding
insurance, rent, salaries, etc.
2. Higher fixed costs directly relates to large number of fixed assets which may help the firm to
produce on a larger scale. Also it is easier for a big firm to diversify its product time.
3. Large scale production enables the firm to get the benefits of economies of scale in terms of
cost reduction which can be passed on to the customers in the form of low priced goods and
services.
4. A diversified product line implies that the firm is dealing in more than one product at a time.
This is beneficial for the firm as it defuses its risk on all the different products it is dealing in
rather than concentrating the risk on a single product. It is also beneficial for the customers as
they get different variety of produced from the same organisation which can widen the chance
of earning profits.
5. This profit can be again reinvested in the business which will enable the organization to sell
many products at low prices inspite higher fixed costs.

4. How changes in output affect costs, emphasize on how an increase in output reduces
average cost of firm?

Ans. To explain the changes in output that affects cost lets assume the following example :-

An individual firm with a fixed amount of land and capital steadily increases its output by employing
more of the variable factors. Following table shows how the different costs might be affected by
the change in output.

16
 Units FC VC TC MC AC

(Output per week)

0 1000 0 1000 0 0
1 1000 350 1350 350 1350

2 1000 560 1560 210 780

3 1000 740 1740 180 580

4 1000 1000 2000 260 500

5 1000 1400 2400 400 480

6 1000 2000 3000 600 500

7 1000 2850 3850 850 550

8 1000 3960 4960 1110 620

Following table shows:-

- When output falls to zero, the total cost does not fall to zero. As long as the firm remains in
business, it must meet its fixed cost even if it temporarily ceases production.
- As output increases, the total cost continues to increase. As more goods are produced, more
labour, materials, fuel and power, and other resources will be used, so the total cost must
increase.
- As output increases these costs tend to fall because productivity increases. As output continues
to increase, there comes a point where productivity begins to decline, and marginal and average
costs begin to rise.
- The table shows that the fixed costs are being spread over a larger output. The greater the
number of units produced, the smaller the amount of fixed cost per unit.
- There are various reasons why, as the output increases, the average cost will begin to rise.
* Increasing the amounts of the variable factors will eventually lead to the fixed factors being
overloaded, and productivity will begin to fall.
* It may be necessary for the firm to introduce overtime, at higher wage rates.
* Less efficient labour may have to be recruited and less efficient stand-by equipment may be
pressed into use.

5. Explain the meaning with formula Fixed, Variable, Total, Average, Marginal costs,
Depreciation, Total revenue, Total profit, Profit per unit.

Ans. Variable cost: These are the costs of the variable factors. They are sometimes referred to as
direct costs because they vary directly as output varies. They increase as output increases, and
decrease as output decreases. Variable cost include raw material, fuel and so on.
Fixed cost: These are the costs of the fixed factors of production. When a firm increases or
decreases its output, fixed costs remain unchanged. Fixed costs include such expenses as rent,
rates, insurance, interest on loans, and depreciation. These costs are called as indirect or overhead
costs.
Depreciation: This represents the loss in the value of a firms capital assets due to wear and tear
and because they gradually become out of date. It is treated as a fixed cost because plant and
machinery are assumed to lose value as time goes by, regardless of the use made of them. For
e.g. If a firm buys a new machine for 10000 and the life of the machine is 5 years. This means the
depreciation will be calculated using following formula:
Cost of machinery - Residual value / life of the asset
Total cost: When variable costs are added to fixed costs, we obtain the total cost of production
VC + FC = TC.
Marginal Cost: This is a measure of the amount by which the total cost changes when the output
changes by one unit. For e.g. Total cost of producing 20 units = $100 and Total cost of producing
21 units = $106. So the marginal cost of 21st unit is $6.
17
 Average cost: This is the cost per unit of output. It is obtained when the total cost is divided by
the number of units produced. Therefore Average cost = Total cost / Number of units produced.
Total Revenue: This is calculated by multiplying the number of units sold by the price.
Total Profit: If the total cost is deducted from the total revenue, we obtain the total profit
Profit per unit: If the average cost is deducted from the price of the product, we obtain the profit
per unit.

6. Discuss what might happen to fixed cost, variable cost and average total cost if the firm
replaces labour with machines.

Ans. Fixed cost is the cost which does not change with the output whereas variable cost is the cost
which changes with the number of unit manufactures. Total average cost is the sum of fixed cost
and variable cot divided by the total number of units produced. Machine comes under fixed cost
and labours under variable cost.
1. If the firm replaces labour with machines, in the short run the fixed cost will be high as the firm
will have to bear the cost of installing the machines in the beginning but the variable cost will
be relatively low as fewer labours will be required.
2. In the long run the fixed cost will be stable as the cost of installing the machine is a one time
investment whereas the variable cost will increase due to the need of having to purchase fuel
and so on for the machines and also the maintenance cost which the firm will have to bear.
3. The total average cost will reduce as the number of units produced by the machine will tend to
cover all the costs as machines produce on a larger scale.

7. What is profit? How can a firm improve its profit levels? Why are profits needed? Explain
what is meant by the principle of profit maximization.

Ans. Profit is a reward to successful business owners, or entrepreneurs, for taking the risk of setting up
a firm. Entrepreneurs must pay in advance for the services of land, labour and capital in order to
make their chosen good or service. Selling goods and services earns revenue for a firm. Profit is
the left from revenue after all costs have been deducted. This is the opportunity cost of production,
or the cost of the next best alternative foregone. Pure profit is the amount of revenue over and
above all costs, including opportunity costs. To calculate the profit we take away the total cost
from total revenue that is TR TC = profit. So if the firm has to improve its profit levels, it has to
- Improve its sales.
- Reduce Cost: If the firm has to reduce cost and has to keep the same price in the market then
the firm has to improve/increase sales so that the total revenue improves which increases
profit. If the sales cannot be increased, as there is perfect competition then the firm will have
to reduce the cost so that total cost decrease, increasing the profit.
Profit maximization means getting maximum profit by increasing sales or increasing the difference
between total costs and total revenue.

8. Explain what might cause profits to fall.

Ans. A firm gains profit only if its revenues are more than its costs. There can be many reasons as to
why there might be a fall in profits. These are as follows.
1. If the costs of the firm are more than their revenue then the firm will be facing losses or a
reduction in profits. Costs may rise if machineries or equipments are underutilized.
Underutilization can lead to lower productivity which in turn reduces the revenue and increases
the costs of the firms.
2. The costs can also increase if the labour used is inefficient. Wages form a major part of the
costs of a firm and paying wages to inefficient or unskilled labour can seriously affect a firms
profits.
3. The revenue of the firm may change if the goods and services provided by the firm are no
longer demanded by the people. In this case revenue generated will be lower than the costs
and hence the profits will tend to fall.

18
 LESSON 7 LARGE FIRMS AND SMALL FIRMS

1. What do you mean by economies & diseconomies of scale? What is the effect on average
cost with economies of scale and why?

Ans. As firms grow in size, they acquire certain advantages that are known as economies of scale. In
other words economies of scale are the benefits enjoyed by a firm because of large scale production.
These can be classified into five categories:

Purchasing economies: When business buys in large quantities, they are able to get discounts
and special prices because of buying in bulk. This reduces the unit cost of raw materials and a firm
gets an advantage over other smaller firms.

Marketing economies: The cost of advertising and distribution rises at a lower rate than rises in
output and sales. In proportion to sales, large firms can advertise more cheaply and more effectively
than their smaller rivals.

Financial economies: A larger company tends to present a more secure investment; they find it
easier to raise finance. Banks and other lending institutions treat large firms more favorably and
these firms are in a position to negotiate loans with preferential interest rates. Further, large
companies can issue shares and raise additional capital.

Managerial economies: A large company benefits from the services of specialist functional
managers. These firms can employ a number of highly specialized members on its management
team, such as accountants, marketing managers which results in better decision being taken and
reduction in overall unit costs.

Technical economies: In large scale plants there are advantages in terms of the availability and
use of specialist, indivisible equipment which are not available to small firms. Large manufacturing
firms often use flow production methods and apply the principle of the division of labour. This use
of flow production and the latest equipment will reduce the average costs of the large manufacturing
businesses.

Diseconomies of Scale : These are the drawbacks of being a big business. In other words, all the
factors those lead to an increase in average costs as a business grows.

Diseconomies include the following:

Human relations: It is difficult to organize large number of employees. The business might find
itself spending too much on communication. There might be long chains of command and
instructions will take a long to reach the desired destination. Moreover there might be distortion in
the message. There will be less personal contact between decision makers and staff, which can
lead to low level of morale, lack of motivation and ultimately industrial relations problems.

Decisions and co-ordinations: There could be coordination problems. With a larger hierarchy,
both the quality of information reaching from the management to the workers and vice versa could
lead to poor decision making. There would be considerable paperwork and many meetings.

External economies : Recently, consumers have become more conscious of the activities carried
out by big firms. Therefore, big firms have to spend a lot of money on environmental issues and
social responsibility act. These ultimately lead to higher average cost per unit.

Effect of Economies of Scale on Average Cost :There is the reduction in the unit (average)
costs of producing and distributing a product as the size of the firms operations is increased. The
ability to supply a product at a low cost (and hence a low price) represents an important source of
competitive advantage over rival companies in markets where price competition is the main form
of rivalry. This reduction in average costs is shown in the graph below. This is known as the
average cost curve.
19
 Average cost

60.00

50.00
Average cost

40.00

30.00

20.00

10.00

0.00
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
units

2. How can economies of scale be achieved, discuss internal and external economies?

Ans. As firms grow in size, they acquire certain advantages that are known as economies of scale. In
other words economies of scale are the benefits enjoyed by a firm because of large scale production.
These can be classified into:
a. Internal economies
b. External economies

A. Internal economies
- Purchasing economies: When business buys in large quantities, they are able to get discounts
and special prices because of buying in bulk. This reduces the unit cost of raw materials and
a firm gets an advantage over other smaller firms.
- Marketing economies: The cost of advertising and distribution rises at a lower rate than rises
in output and sales. In proportion to sales, large firms can advertise more cheaply and more
effectively than their smaller rivals.
- Financial economies: A larger company tends to present a more secure investment; they
find it easier to raise finance. Banks and other lending institutions treat large firms more favorably
and these firms are in a position to negotiate loans with preferential interest rates. Further,
large companies can issue shares and raise additional capital.
- Managerial economies: A large company benefits from the services of specialist functional
managers. These firms can employ a number of highly specialized members on its management
team, such as accountants, marketing managers which results in better decision being taken
and reduction in overall unit costs.
Technical economies: In large scale plants there are advantages in terms of the availability
and use of specialist, indivisible equipment which are not available to small firms. Large
manufacturing firms often use flow production methods and apply the principle of the division
of labour. This use of flow production and the latest equipment will reduce the average costs of
the large manufacturing businesses.

B. External economies of scale

When a whole industry expands the firms in the industry may find themselves benefiting from
external economies of scale. These are advantages in the form of lower average costs which a
firm gains from a growth in the industry. They are especially important when there is inertia (or
when firms of the same type tend to locate in the same place). In this case it is called economies
of concentration. External economies can be gained from the following:
- Skilled labour: When firms involved ion the same type of activities locate near to one another,
they employ and train local people in the skills they need. A large skilled labour force emerges
which could benefit other firms moving into the area.
20
 - Ancillary firms: In areas where similar firms locate, other firms may join them in order to cater
for their needs.
- Co-operation: When firms locate together to produce one particular good or service they tend
to help each other even though they are also competing against each other. An example of this
is the formation of a trade association.

3. Why firms want to grow / what are the benefits or reasons for integration?

Ans. Growth means that the business is becoming larger; this may be an objective for the business. It
can grow in a number of ways;
1. Internal Growth
This means that it grows without joining with another business. It could
build new premises
take on more employees
2. External Growth
In this case it has some involvement with another business
Benefits of Growth
Increased profits
Increased market share
Gain new ideas from the other business
Avoid having to compete with the other business
Gain from economies of scale
The new business may not need all of the workers. They could remove some workers to
become efficient and make more profit

4. What are the various methods of integration? OR How do companies grow?

Ans. Firms may wish to become larger for many reasons. An increase in the scale of a firm can lower
its average costs of production and therefore benefit from economies of scale such as buying in
bulk. A firm may wish to become larger and more powerful so that it can push up its prices and stop
smaller firms from competing with it. It may want to build up control of a large share of the market,
therefore making its rivals go out of business (like Microsoft), or, it may simply want to increase its
profits in the future.

There are two ways a firm can grow.

Internal growth (also known as organic growth)
External growth (also known as inorganic growth, integration or amalgamation)

Internal growth
This involves the expansion of the existing firm. It happens naturally, as a business becomes
successful. A profitable firm can afford to grow as it can reinvest its profits. Also, a firm with a
good track record will find it easier to obtain finance in the form of loans. With these additional
resources the firm can grow. It is a slow process but it is easier to manage.

External growth
This involves acquiring other firms either by merger or takeover.

Takeover
A takeover occurs when one company buys all, or at least 50%, of the shares in the ownership of
another company. In this way, the firm being taken over by another company often loses its own
identity and becomes part of the other company.

Merger
A merger occurs when two or more firms agree to join together to form a new business. This is
usually done by shareholders of the companies involved exchanging their shares for shares in the
new company.

21
 Types of Merger
There are four main ways in which firms can join together (or integrate) either willingly or unwillingly.
These are:

Horizontal integration
This is found where firms engaged in the production of the same type of good or service combine.
Around 83% of all integration is of this type. This provides a number of economies of scale, for
example more specialized labour and machinery or bulk buying. Examples are if Ford and Honda
were to merge, or when Nestl took over Rowntrees (two confectionery firms). The major criticism
of horizontal integration is that very large firms are formed which can hold monopoly powers.

Vertical integration
This is found when firms engaged in different stages of production combine. This would be the
case if an oil refinery combined with a chain of petrol stations. This is called forward integration. In
this way the oil refinery is assured of a place to sell its product. Firms can also undertake backward
integration, for example, a chain of sweet shops combing with a chocolate factory. In this way the
firm can assure a supply of materials.

Conglomerate
This is the merger or takeover of firms in totally unrelated markets. Examples are Unilever, which
is famous for making detergents but also has business dealing in paper, plastics, transport and
animal feed. A conglomerate benefits greatly from risk-bearing economies of scale, as, if one area
of the business experiences a downturn in demand, the other areas will be able to support it.

5. How can you say whether the size of the company large or small?

Ans. In the world around us there are some businesses which are small and some are big. But how do
we categorize these businesses as big or small. We can consider the following factors:
- The number of employees but business which use more machinery and technology i.e.
capital intensive may have few employees but they still might be big. Example Microsoft has
less employees but still it the biggest business on earth.
- The amount of capital invested: A business which might not use a lot of investment in
machinery but and involves less investment may still be big. Take the example of software
companies and consultancy firms like McKenzie & Co.
- The sales turnover: A business may be going through a bad phase and may not have huge
sales. Does it make the business small?
- Market capitalisation: Markets are very volatile and share prices change every day. Does it
alter the size of the business every day?
Market share: A business may not be a market leader but still may be huge whereas if the
market is itself very small, a major market share wont make a business big.

So while deciding the size of business as big or small a combination of factors needs to be
considered.

6. Inspite of competition from large companies, small firms are still surviving. Why?

Ans. In some cases, firms remain small because the proprietor may not want to take on the additional
worries and responsibilities of running a larger business. There are, however, circumstances where
the small firm has distinct advantages over the larger firm like:

- The size of the market: Small firms will tend to do well where the market for a particular good
or service is relatively small. In such cases, firms cannot take advantage of the economies of
large-scale production. There are several reasons why the markets for some goods and services
may remain small:
1. There are some goods and services like clothing, jewellery etc where people prefer to have
something different. For products such as these, the market for any one design or fashion
will be small, and producers cannot employ the techniques of mass production.

22
 2. Repair work is another example of an industry where the product cannot be standardised;
each job tends to be different. Hence, in trades such as the repair of property, watches etc
we find a large number of small firms.
3. Personal services tend to be supplied by small firms because people prefer to deal with
one person. The family doctor, the family solicitor etc, provide examples of services where
people demand individual attention.
4. Sometimes the size of the market is restricted by geographical factors. The small isolated
community cannot provide a market large enough to support retail organisations such as
departmental stores and supermarkets. This accounts for the survival of the small village
store.
5. There are small markets for very expensive goods such as luxury yachts, high-quality
sports cars etc. In these cases, the market is restricted to those with very high incomes.

Specialist producers and distributors: The process of dis-integration has enabled many
small firms to prosper in manufacturing industry. Such firms supply standardised parts to large
assembly parts. Small firms also distribute the products of large firms. Television sets, washing
machines etc, for example, are manufactured by large firms, but then they are installed and
maintained by small firms.

Cooperation between small firms: It is possible for small firms to enjoy economies of scale
through schemes of cooperation. They can join together in ways which enable them to obtain
some of the benefits enjoyed by larger firms. A number of small manufacturing firms may
operate jointly-owned research laboratories-as in the footwear and pottery industries, for example.

Technical factors: In some industries, the units of capital equipment are still relatively small,
so it is not possible to achieve very great technical economies of scale.

Flexibility: A most important advantage of the small firm over the large organization is its
flexibility. It can adapt itself much more quickly to changes in the customers requirements.

Government assistance: The government has several schemes which are designed to help
smaller firm.

23
 LESSON 8 PRICES AND MARKETS

1. What is demand?

Ans. Demand is defined as want or willingness of consumers to buy goods and services. In economics
willingness to buy goods and services should be accompanied by the ability to buy (purchasing
power) and is referred to as effective demand.

Law of demand
It states that when price increases, the amount demanded will fall and when prices fall, the amount
demanded will rise.

This phenomenon when plotted on a graph is known as Demand Curve.

Movement along the demand Curve

Extension of demand
Extension of demand is the increase in demand due to the fall in price, all other factors remaining
constant.

24
Contraction of demand
Contraction of demand is the fall in demand due to the rise in price, all other factors remaining
constant.

Shift in the demand curve

Usually demand curves are drawn based on the assumption except for price all other factors
remain the same. But there might be instances when demand may be affected by factors other
than price. This will result in the change in demand although the price will remain the same. This
change in demand may cause the demand curve to SHIFT inwards or outwards.

Shift of demand curve OUTWARDS shows an increase in demand at the same price level. It is
known as INCREASE IN DEMAND.

Shift of demand curve INWARDS shows that less is demanded at the same price level. It is
known as a FALL IN DEMAND.

Factors affecting demand

Change in peoples income: More the people earn the more they will spend and thus the demand
will rise. A fall in income will see a fall in demand.

Changes in population: An increase in population will result in a rise in demand and vice versa.

25
 Change in fashion and taste: Commodities for which the fashion is out are less in demand as
compared to commodities which are in fashion. In the same way, change in taste of people affects
the demand of a commodity.

Changes in Income tax: An increase in income tax will see a fall in demand as people will have
less money left in their pockets to spend whereas a decrease in income tax rates will result in
increase of demand for products and services because people now have more disposable income.

Change in prices of Substitute goods: Substitute goods or services are those which can replace
the want of another good or service. For example margarine is a substitute for butter. Thus a rise in
butter prices will see a rise in demand for margarine and vice versa.

Change in price of Complementary goods: Complementary goods or services are demanded

along with other goods and services or jointly demanded with other goods or services. Demand for
cars is affected the change in price of petrol. Same way, demand for DVD players will rise if the
prices of DVDs fall.

Advertising: A successful advertising campaign may affect the demand for a product or service.

Climate: Changes in climate affects the demand for certain goods and services.

Interest rate: A fall in Interest rate will see a rise in demand for goods and services.

2. What is Supply?

Ans. Supply refers to the amount of goods and services firms or producers are willing and able to sell in
the market at a possible price.

Law of Supply

It states that when the price of a commodity rises, the supply for it also increases.
The higher the price for the good or service the more it will be supplied in the market. The reason
behind it is that more and more suppliers will be interested in supplying those good or service
whose prices are rising.

26
Movement along the Supply Curve

Extension of supply
It refers to the increase in supply of a commodity with the rise in price, other factors remaining
unchanged.

Contraction of supply
It refers to the fall in supply of a commodity when its prices fall, other factors remaining unchanged.

Shift in Supply Curve

When factors other than price affect the supply it results in the shift of supply curve. The supply
curve may move inward or outward.
A shift of supply curve outwards to the right will mean an increase in supply at the same price
level.
When the supply curve moves inwards to the left it means that less is being supplied at the
same price level.

27
 Factors affecting Supply

Price of the commodity: A rise in price will result in more of the commodity being supplied to the
market and vice versa.

Prices of other commodities: For example if it is more profitable to produce LCD TVs then
producers will produce more LCD TVs as compared to PLASMA TVs. Thus the supply curve for
PLASMA TVs will shift inwards i.e. a fall in supply.

Change in cost of production: Increase in the cost of any factor of production may result in the
decrease in supply as reduced profits might see producers less willing to produce that commodity.

Technological advancement: Improvement in technology results in lowering of cost of production

and more profits for the producer and thus more supply of that commodity.

Climate: Climate and weather conditions affect the supply of commodities especially agricultural
goods.

28
 LESSON 9 ELASTICITY OF DEMAND AND SUPPLY

1. Define price elasticity of demand and explain how various types of elasticity of demand
are calculated.

Ans. Elasticity of demand describes the responsiveness of the quantity demanded to a change in price.
If a small change in price causes a relatively large change in the quantity demanded, the demand
is elastic. If a small change in price causes a relatively small change in the quantity demanded,
the demand is inelastic. Elasticity of demand can be measured by the following formula:

Elasticity of demand = Percentage change in the quantity demanded / Percentage change in the
price.

Types of Elasticity of demand:

Demand is elastic when the percentage change in the quantity demanded is greater than the
percentage change in the price i.e. when Percentage change in the quantity demanded /
Percentage change in the price is >1.
Price
20p
18p

Demand

0
100 150 Quantity
The above figure is a situation where a fall in price from 20p to 18p causes the quantity
demanded to increase from 100 units to 150 units.

29
 Percentage change in the quantity demanded = 50 / 100 x 100/1 = 50%

Percentage change in the price = 2/20 x 100/1 = 10%

Elasticity of demand = 50 /10 = 5. Therefore, in the price range 20p to 18p the demand is
elastic.

- Demand is inelastic when the percentage change in quantity demanded is less than the
percentage change in price, i.e. when Percentage change in the quantity demanded / Percentage
change in the price is <1.

Price
$6

$4

Demand

0 160 200 Quantity

The above figure is a situation where a rise in price from $4 to $6 causes the quantity demanded
to fall from 200 units to 160units.

Percentage change in the quantity demanded = 40/200 x 100/1 = 20%

Percentage change in the price = 2/4 x 100/1 = 50%

Elasticity of demand = 20/50 = 2/5. Therefore, in the price range $4 to $6, the demand is
inelastic.

- Demand is perfectly inelastic where a change in price has no effect on the quantity demanded.

The same amount is demanded whatever the price.

Elasticity of demand = 0

Price Demand

0 Q Quantity
- Demand is perfectly elastic when at the price OP, people are prepared to buy all that they
can obtain. They would buy an infinite amount if it were obtainable.

30
 Elasticity of demand = infinity.
Price

P
Demand

O
Quantity

2. What are the factors affecting price elasticity of demand?

Ans. The factors affecting price elasticity of demand are:

- Number of substitutes: If a product has many substitutes it is likely that the demand for
the product is price elastic.

- Whether the product is a necessity or a luxury: Demand for goods and services which
are considered as a necessity is more likely to price inelastic.

- Period of time: Most products demand is less elastic in the short run than in the long run.
In the long run, if the price of a product rises consumers will search for cheaper substitutes.
- The proportion of income spend on a commodity: If the proportion of income spent on
the product is small, then even a substantial change in price of that commodity may have
little effect on its demand.

3. What is price elasticity of supply and explain its types.

Ans. Elasticity of supply refers to the way in which the quantity supplied responds to a change in price.
The measurement of elasticity of supply is through the following formula

Percentage change in the quantity supplied / Percentage change in the price

31
 There are different types of elasticity of supply:

- Supply is elastic when the percentage change in the quantity supplied is greater than the
percentage change in price i.e. Percentage change in the quantity supplied / Percentage change
in the price >1

Price
$ 11 Supply
$ 10

O 1000 1300 Quantity

In the above figure when the price increases from $10 to $11, the quantity supplied increases
from 1000 units to 1300 units. Percentage change in the quantity supplied = 300/1000 x 100/
1 = 30%. Percentage change in price = 1/100 x 100/1 = 10%. Elasticity of supply =
30/10 = 3. Therefore in the price range $10 to $11, the supply is elastic.

- Supply is inelastic when the percentage change in the quantity supplied is less than the
percentage change in the price i.e. Percentage change in the quantity supplied / Percentage
change in the price <1

Price

$5 Supply
$4

O 1000 1300 Quantity

In the above figure a fall in price from $5 to $4 causes the quantity supplied to fall from 200
units to 180 units. Percentage change in quantity supplied = 20 /200 x 100 /1 = 10%. Percentage
change in price = 1/5 x 100/1 = 20%. Elasticity of supply = 10/20 or 0.5. Therefore in the price
rage $5 to $4, the supply is inelastic.

32
 - Supply is perfectly inelastic: It is a situation where a change in price has no effect on the
quantity supplied. The amount offered for sale is the same at all prices.
Elasticity of supply = 0

Price Demand

0 Q Quantity
Supply is perfectly elastic: This is a situation where at the price OP, firms are prepared to
supply whatever quantities are demanded an infinite amount if necessary. Elasticity of
supply = infinity.

Price

P
Demand

O
Quantity

4. What are the factors affecting the price elasticity of supply?

Ans. The factors affecting price elasticity of supply are:

Time: In the short run firms will only be able to increase input of labour to increase supply
of commodities may not be able to increase the supply in response to the price change but
the supply change will be little because other factors of production may not be increased in
the same proportion and may limit the supply. However, in the long run a firm will increase
the input of all factors of production and thus the supply becomes more price elastic.

Availability of resources: If the economy already using most of its scarce resources then
firms will find it difficult to employ more and so output will not be able to rise. The supply of
most of goods and services will therefore be price inelastic.

33
 LESSON 10 DISTRIBUTION & ADVERTISING

1. Discuss the services of wholesalers and retailers.

Ans. The wholesale stage is a most important link in the chain of distribution. The wholesaler helps to
solve the basic problem of distribution. Wholesaler provides a number of important services.

1. Breaking Bulk: Wholesalers buy large quantities from a variety of producers and divide these
into smaller quantities for distribution to retailers. The existence of the wholesale stage leads
to a saving in transport costs.

2. Holding stocks: By holding large stocks, wholesalers make it possible for retailers to obtain
supplies when they require them.

3. Information and advice: The wholesalers warehouse is an important source of information

to retailers. They can visit the warehouse and inspect the range of goods available, obtain
advice on these goods and keep themselves informed of new development.

4. Bearing risks: The holding of large stocks can be a risky undertaking. The value of goods
may fall while large stocks are being held. A change of fashion, the development of a superior
product or, in some cases, deterioration may reduce the value of goods held by the wholesaler.
On the other hand, if prices rise, the value of the stocks held will increase, and the wholesaler
will enjoy higher profits.

Retailers are the last link in the chain of distribution. They provide the following services:

They make a variety of goods available in locations convenient to the consumers.

They provide producers with a large number of market outlet for their products.
They perform an important advertising function for producers by displaying goods and offering
advice on them.
When goods are bulky and heavy, they normally offer a delivery service.
For products of a technical nature, they offer after sales- service.

2. Explain various types of retail outlets used in the distribution of goods.

Ans. Retailers are the last link in the chain of distribution. Retailing covers all the activities which
supply goods directly to the general public. Apart from retail shops, it includes public houses,
petrol stations, street markets, door to door selling and so on. The different types of retail
outlets are:

- Independent retailers: These are usually sole traders or One shop firms. There are far
more independent retailers than any other form of retail outlet. They often remain open for
longer hours than other types of retail shop, and usually offer a personal service which is
sometimes lacking in larger stores.

- Multiple Shops: These are shops which belong to chains of very similar shops that are owned
by large companies. Each of the organizations has its own particular style of shop front and
interior layout. They are easily identifiable in the centres of the larger towns such as Burton.

- Voluntary Groups: Severe competition from the multiples and supermarket forced independent
wholesalers and retailers to form voluntary associations such as retailers to form voluntary
associations such as Spar. To qualify for membership of such a group a shop usually has to be
of a certain minimum size. Retailers undertake to obtain supplies from the group wholesalers,
who can then place large orders with producers and obtain important discounts. They also
offer advice and assistance to retailers on matters relating to the management and organization
of their shops.

34
 - Department stores: These shops carry a wide range of goods which are sold in specialist
departments. For e.g. Furniture, carpets.

- Supermarkets: A supermarket is defined as a self- service food store with a sales area in
excess of 2000 sq.fts. In this type of store, the techniques of self-service and self selection
have enabled retailers to obtain impressive gains in productivity. A further development of the
supermarket is the hypermarket, which is defined as a single storey retail outlet with at least
50000 sq.fts of selling space.

- Discount stores: They are large Retail warehouses. They usually occupy large single
storey premises away from city centres and sell on a cash and carry basis. They deal in
durable consumer goods, many of them specializing in electrical appliances.

- Mail order houses: They sell a range of goods very similar to those found in department
stores. All transactions are carried out by post. Customers are offered the convenience of
shopping in their own homes. Although postal distribution is relatively expensive, mail-order
firms obtain economies of scales by bulk buying and they obtain the wholesalers and retailers
profit margins.

3. Why the trend of retailing shifting to increasing number of multiples and supermarkets?
Compare a small business say food shop with large supermarkets.

Ans. The increasing importance of the multiples and the increase in size and number of the supermarkets.
There are several reasons why such changes have taken place.

Price Competition: The freedom to engage in price competition greatly benefited the multiples
and supermarket.

Improvements in the methods of marketing goods: The introduction of cheap, lightweight,

transparent wrapping materials has had a great influence on the retailing of many goods. It has
made to standardize and pre-pack goods so that consumers can make their own selection.
The result has been a great saving in labour costs. Large scale advertising, the familiarity of
brand names and the pre-packing and labeling of all kinds of goods have made possible a great
expansion of self-service retailing.

Social Changes: Bulk buying has become a feature of household shopping. There has been
a steady increase in the number of married women who go out to work. For many working
women, a weekly visit to the supermarket is more convenient than the older custom of shopping
for small quantities in a variety of local shops every day. The second important development
has been the increasing extent of car ownership. One shopping expedition to the supermarket,
using the car as the means of transport, is sufficient for a family to satisfy its demands for
groceries and household goods for a week or even longer.

4. What are the benefits of advertising?

Ans. Advertising aims to increase demand. People will not continue to buy a well advertised commodity
unless it lives up to their expectations. Its purpose is to increase brand loyalty by trying to
convince consumers that competing brands are not close substitutes. Its aim is to educate or
create awareness among the consumers about the availability of a product.

Some advertising is essential. It is necessary to inform consumers of the existence and features
of new products when they become available. The government itself has to undertake a great deal
of informative advertising in order to make people aware of new regulations, changes in the law,
changes in taxation and social security benefits, etc.

Also there are some persuasive advertising which make exaggerated claims which can mislead
consumers rather than help them to make a sensible choice.
35
 5. What are the various Medias of advertising available?

Ans. Potential customers have to be made aware of what goods are available and then they should be
persuaded to buy them. It is the function of advertising to inform and persuade. There are different
forms of advertising like:-

Television and Radio: Television advertising is powerful and effective, since it reaches millions
of people within their own homes. It is helpful even if it is seen by illiterate people.

Newspapers and Magazines: Advertisements in the press have the great advantage that
they can be read and re-read at leisure.

Posters: These are one of the oldest forms of advertising where their effectiveness depends
very much on their location and also their design and structure.

Samples: Samples are very effective type of advertising as people get to use the product
before they actually buy it.

Circulars: Door to door delivery of circulars, which usually advertise special offers for various
goods, is a very popular form of advertising.

Packaging: Many manufacturers package their goods in attractive cartons or wrappers which
give prominence to the name of the product.

Transport: Advertisements appear on the sides of buses, and many firms use the sides of
their lorries and vans as a means of advertising their products.

Exhibitions: Trade fairs and exhibitions are staged in large exhibition halls to advertise the
products of certain industries.

36
 LESSON 11 TYPES OF BUSINESS ORGANISATION

1. Describe the main types of business organization and also discuss its advantages and
disadvantages.

Ans.

Types of Business
Organisation

Public Ownership Private Ownership Co-operatives

Public Corporations Municipal Sole Trader Partnerships Limited Companies Worker Co- Consumer Co-
Enterprises operatives operatives

Private companies

Public companies

Sole traders
The sole trader is the most common form of business organization. It is a business owned and
operated by just one person- although the sole trader can employ others the owner is the sole
proprietor.

Advantages of a sole trader

- There are few legal regulations for a sole trader to set up the business.
- The sole trader is his own boss. He has complete control over his business and there is no
need to consult with or ask others before making decisions.
- He has the freedom to choose his own holidays, hours of work, prices to be charged and whom
to employ.
- He has close contact with his own customers, the personal satisfaction of knowing his regular
customers and the ability to respond quickly to their needs and demands.
- The sole trader has an incentive to work hard as he is able to keep all of the profits, after he
pays tax. He does not have to share his profits.

37
 - He does not have to give information about his business to anyone else - other than the Tax
Office. He enjoys complete secrecy in business matters.

Disadvantages of a sole trader

(Note: Limited liability means the owner of the company - the shareholders - cannot be held
responsible for the debts of the company they own. Their liability is limited to the investment they
made in buying the shares.)

- The sole trader has no one to discuss business matters.

- He does not have the benefit of limited liability therefore he is fully responsible for any debts
that the business may have.
- The sources of finance for a sole trader are limited to the owners savings; profits made by the
business and small bank loans hence it is difficult to expand the business. .
- The sole traders business is likely to remain small because capital for expansion is so restricted
therefore he cannot benefit from economies of scale. The size of the business is one of the
reasons he finds it difficult to recruit specialist or good workers as he cannot offer much
training or opportunities for their future careers.
- If the sole trader is ill, there is no one to take control of his business. He cannot pass on the
business to his family members - when he dies the business will legally not exist any longer.
This is because there is no continuity of the business after the death of the owner.

Partnerships

A partnership is a group or association of between two and twenty people who agree to own and run
a business together. The partners will contribute to the capital of the business, will usually have a
say in the running of the business and will share any profits made.
Before starting a partnership business, all the partners should draw up a legal document called a

Partnership Deed of Agreement:

Partnership Deed of Agreement which is a written and legal agreement between business
partners. It usually contains the following information:

- Names of included parties - includes all names of people participating in this contract
- Commencement of partnership- includes when the partnership should begin. The date of the
contract is assumed as this date, if none is given.
- Duration of partnership - includes how long the partnership should last. It is automatically
assumed that the death of one of the contracting parties breaks the contract, unless otherwise
stated.
- Business to be done - includes exactly what will be done in this partnership. This section
should be very particular to avoid confusion and loopholes.
- Name of firm - includes the name of the business entity.
- Initial investments includes how much each partner will invest immediately or by installments.
- Division of profits and losses - includes what percentages of profits and losses each partner
will receive. If it is not a limited partnership, then there is unlimited liability (each partner is
responsible for all partners debts, including their own).
- Ending of the business - includes what happens when the business winds down. Usually this
includes three parts: 1) All assets are turned into cash and divided among the members in a
certain proportion; 2) one partner may purchase the others shares at their value; 3) all property
is divided among the members in their proper proportions.
- Date of writing - includes simply the date that the contract was written.

Advantages of a partnership

- Partners can bring in more capital from their savings and this would allow expansion of the
business.
- Partners bring new skills and ideas to a business.
- Decision making can be much easier with more brains to think about a problem.
38
- The responsibilities of running the business are shared. Absences and holidays will not lead to
major problems as one of the partners will always be available
- Both partners will be motivated to work hard because they would both benefit from the profits
made. In addition, any losses made by the business could be shared by the partners

Disadvantages of a partnership

- The partners do not have limited liability. If the business fails, then creditors can still force the
partners to sell their own property to pay business debts
- The business does not have a separate legal identity. If one of the partners dies, then the
partnership will end. (Both sole traders and partnerships are said to be UNINCORPORATED BUSINESSES
because they do not have a separate legal identity from the owners.)
- Partners can disagree on important business decisions and consulting all partners takes time.
- If one of the partners is very inefficient or: actually dishonest, then the other partners could
suffer by losing money in the business.
- Most countries limit the number of partners to 20 and this means that business growth would
be limited by the amount of capital that 20 people could invest.

Limited companies

Limited companies are also known as Joint stock companies. These are businesses where a
number of owner (shareholder) pool in their resources to do a common business and to share the
profits and losses proportionally. In a limited company, the debts of the company are separate from
those of the shareholders i.e. the personal assets of shareholders will not be at risk of being seized
by creditors. Ownership in the limited company can be easily transferred, and many of these
companies have been passed down through generations.

Private limited companies

These are closely held businesses usually by family, friends and relatives. Private companies may
issue stock and have shareholders. However, their shares do not trade on public exchanges and
are not issued through an initial public offering. Shareholders may not be able to sell their shares
without the agreement of the other shareholders.

Advantages of a private limited company

- Shares can be sold to a large number of people - friends or relatives.The sale of shares can
lead to much larger sums of capital to invest in the business than the original partners can
manage to raise themselves. The business can therefore expand more rapidly.

- All shareholders have limited liability. It means that if the company fails with debts owing to
creditors, the shareholders cannot be forced to sell their possessions to settle the debts. The
shareholders can only lose their original investment in the shares - their liability is limited to
that original investment. This is a major benefit compared to the position sole traders and
partners can find themselves in if their business fails. Limited liability encourages people to
buy shares, knowing that the amount they pay is the maximum they can lose if the business
is unsuccessful.

- (The people who started the company - Mike and Hartairr an example - are able to keep control
of it as long as they do not sell too many shares to other people^)

Disadvantages of a private limited company

- There are significant legal matters which have to be dealt with before a company can be
formed. In particular, two important forms or documents have to be sent to the Registrar of
Companies.

1. Articles of Association: This contains the rules under which the company will be managed
and states the rights and duties of all of the directors, the rules concerning the election of
39
 directors and the holding of official meetings, and the procedure to be followed for the issuing
of shares.

2. The Memorandum of Association: This contains very important information about the
company and the directors. The official name and the address of the registered offices of the
company must be stated. The objectives of the company must be given and also the amount
of share capital that that directors intend to raise. The number of shares to be bought by each
of the directors must also be made clear.

Both of these documents are intended to make sure that companies are correctly run and to
reassure shareholders about the purpose and structure of the company. Once these documents
have been received by the Registrar of Companies, then a Certificate of Incorporation will be
issued to allow the company to start trading.

- The shares in a private limited company cannot be sold or transferred to anyone else without
the agreement of the other shareholders. This rule can make some people reluctant to invest
in such a company because they may not be able to sell their shares quickly if they require
their investment back.

- The accounts of a company are much less secret than for either a sole trader or a partnership.
Each year the latest accounts must be sent to the Registrar of Companies and members of the
public can inspect them.

- The company cannot offer its shares to the general public therefore it is not possible to raise
really large sums of capital to invest back into the business.

Public limited companies

Limited companies which can sell share on the stock exchange are Public Limited companies.
These companies usually write PLC after their names. Minimum value of shares to be issued (in
UK) is 50,000.

Advantages of a public limited company

- This form of business organisation offers limited liability to shareholders.

- It is an incorporated business and is a separate legal unit. Its accounts are kept separately
from those of the owners and there is continuity even after one of the shareholders dies.
- There is opportunity to raise very large capital sums to invest in the business. There is no limit
to the number of shareholders a public limited company can have.
- There is no restriction on the buying, selling or transfer of shares.
- A business trading as a public limited company usually has high status and, if properly managed,
will find it easier to attract suppliers prepared to sell goods on credit and banks willing to lend
to it than other types of businesses.

Disadvantages of a public limited company

- The legal formalities of forming such a company are quite complicated and time consuming.
- There are many more regulations and controls over public limited companies in order to try to
protect the interests of the shareholders. This includes the publication of accounts, which
anyone can ask to see.
- Some public limited companies grow so large that they become difficult to control and manage.
- Selling shares to the public is expensive. The directors will often ask a specialist bank, a
merchant bank, to help them in this process and they will charge high commission for their
services. Also, the publication and printing of thousands of copies of the prospectus is an
additional cost.
- There is a very real danger that although the original owners of the business might become rich
by selling shares in their business they may lose control over it when it goes public.

40
 Co-operatives

Co-operative societies are of 2 types:

- Worker co-operatives are owned and controlled by the people who wok in them.
- Consumer or retail co-operative societies are owned by the members who, in this case, are the
customers. Members elect a management committee to run the enterprise. Profits are shared
out according to the value of a customers purchases, and members receive additional benefits
in the form of bonuses or special offers.

Public corporations

Public corporations are organizations which manage the day-to-day operations of the nationalized
industries and are owned by the state. So there are no shareholders, and the members of the
boards of management are appointed by a Minister of the state. These corporations do not try to
maximize profits, but they are expected to cover their costs and to earn a reasonable surplus to
help finance their new investment.

Advantages of public corporation

- Some industries are considered to be so important - strategically necessary - that government

ownership is thought to be essential. In many countries the state airline is still in the public
sector and electricity generation is rarely in the private sector.
- If industries are controlled by monopolies because it would be wasteful to have competitors -
two sets of railway lines to a certain town, for example - then these natural monopolies are
often owned by the government. It is argued that this will ensure that consumers are not taken
advantage of by privately owned monopolists.
- If an important business is failing and likely to collapse, the government can step in to nationalise
it. This will keep the business open and secure jobs. If the business becomes profitable again
the government has the option of privatising it.
- Important public services, such as TV and radio broadcasting, are often in the public sector.
The BBC is a good example of a public corporation in this industry. Non-profitable but important
programmes can still be made available to the public.

Disadvantages of public corporation

- There are no private shareholders to insist on high profits and efficiency. The profit motive
might not be as powerful as in private sector industries.
- Subsidies can lead to inefficiency as managers will always think that the government will help
them if the business makes a loss. It is also considered unfair if the public corporation receives
a subsidy but private firms in the same industry do not.
- Often there is no close competition to the public corporations. There is therefore a lack of
incentive to increase consumer choice and increase efficiency.
- Governments can use these businesses for political reasons for example just before an election
they could create more jobs. This prevents the public corporations being operated like other
profit-making businesses.

2. What is a multi-national company? Why do firms become multi-national?

Ans. A multinational company is a firm that operates in more than one country, although its headquarters
may be in one particular country. These companies are some of the largest firms in the world,
often selling goods and services, and employing many workers around the globe.

Advantages of multinational companies to developing countries:

- Multinational companies are able to sell far more than any other type of company.

41
 - These companies can avoid transport costs by producing in different countries and selling to
those countries. It can also locate its factories near to the raw materials it needs.
- Multinationals can take advantage of different wage levels in different countries.
- Multinationals can achieve great economies of scale by purchasing raw materials in bulk
quantity and producing in large quantities.
- Multinationals have less chance of going bankrupt than smaller companies as they tend to
produce a wide variety of goods, so if demand for one product falls they have other products
they can fall back on.

3. What are the advantages and disadvantages of multi-national operating in a country?

Ans. Advantages of multinationals operating in a country

- Jobs are created, which reduces the level of unemployment.

- New investment in buildings and machinery increases output of goods and services in the
country.
- Some of the extra output may be sold abroad, which will increase the exports of the country.
Also, imports may be reduced as more goods are now made in the country.
- Taxes are paid by the multinationals, which increases the funds to the government.

Disadvantages of multinationals operating in a country

- The jobs created are often unskilled assembly-line tasks. Skilled jobs, such as those in research
and design, are not usually created in the host countries receiving the multinationals.
- Local firms may be forced out of business. Multinationals are often more efficient and have
lower costs than local businesses.
- Profits are often sent back to a multinationals home country and not kept in the country
where they are earned.
- Multinationals often use up scarce and non-renewable primary resources in the host country.
- As multinational businesses are very large they could have a lot of influence on both the
government and the economy of the host country. They might ask the government for large
grants to keep them operating in the country.

42
 LESSON 12 COMPETITION AND MONOPOLY

1. State the forms and features of competition.

Ans. Competition between firms, is not confined to price competition, it can take many other forms.
Firms may compete by
- Branding their goods and making the brand name familiar by means of advertising
- Using attractive packaging
- Offering improved services to customers, such as better after sales service and better
guarantees
- Creating more attractive retail outlets.
- Offering free gifts, special offer (e.g. gifts in exchange for collections of packet tops) or the
chance to win prizes in competitions
- Providing easier and cheaper hire purchase facilities.

Features of Competition:

- Firms are not free to set any price they wish.

- If the competition between firms is very fierce, prices will be forced downwards to levels which
are very close to the firms costs of production
- Consumers will have a choice
- Competition may force firms to cut the quality of their goods
- If a market is being supplied by many small firms, each trying to produce something slightly
different from the products of other firms, there may be an excessive variety of products and
small scale production could mean relatively high average costs.
- It forces firms to be efficient.

2. What is a monopoly? State its features. Also discuss arguments in favour and against
setting up of monopoly.

Ans. A monopoly exists when there is a sole supplier of a good or service. In this type of market there
is an absence of competition. Features of monopoly are:
- Monopoly means that there is only one supplier of a particular good or service.
- A monopolist does not have to worry about the prices.
- A monopoly can control the supply of a good or service, but it cannot control the demand for it.
- A monopoly is free to set either the prices of its product or the quantity it sells.
- A monopoly can control the quantity supplied to the market which means that it can influence
the price.
- A monopoly can only continue to exist if other firms are prevented from entering the market.

There are arguments for monopoly:

- Competition would lead to a wasteful duplication of capital equipment.

- A large dominant firm will be able to obtain economies of scale which could not be achieved by
small competing firms. The fact that a monopoly can produce at lower cost, however, does not
necessarily mean that prices will be lower; it could mean higher profits.
- It has a greater incentive to spend money on research, since it will obtain all the profits of any
successful invention

But there are arguments against monopoly:

- A monopoly is capable of restricting consumers the supply of a product. It can, therefore, raise
prices well above the average cost of production.
- Lack of competition could well result in them being less efficient than firms which have to
compete with other firms

43
 - The variety of goods available to consumers will tend to be less than that which would be
supplied by a number of competing firms.
- The fact that monopolies can prevent other firms from entering an industry means that the flow
of new ideas and new products will probably be restricted.

3. Should a country go for public or private ownership?

Ans. The term Nationalisation describes the process of transferring industry from private ownership to
public ownership. The state buys the companies in an industry by paying shareholders a price
which approximates to the market value of their shares.

Privatisation: The public corporations which ran these industries were converted into limited
companies, and the shares were sold to the general public.

But there is always an argument for nationalism due to following reasons:

- To avoid wasteful competition: To allow several firms to compete with one another in such
industries would lead to a wasteful duplication of overhead and underground equipment.
Monopolies should be publicly owned because the goods and services they supply are so
important to the economy that they should be run in the national interest and not for private
profit.
- Economies of scale: Benefits of economies of scale can only be obtained if there is one
large firm in each industry. Many people believe that the quickest and most certain way of
achieving a monopoly in these industries is to nationalize them.
- To help manage the economy: The ownership and control of major industries gives the
government a powerful instrument for influencing the performance of the economy.

While the argument for nationalism go on the critics of nationalization follows the same path:

- It does not encourage efficiency

1. Lack of competition: Many nationalized industries are protected from competition by law
which reduces consumers choice and make them more inefficient.
2. No fear of Bankruptcy: Nationalised industries cannot go bankrupt because the government
is obliged to cover any losses they may make.

- It is difficult to measure the efficiency of nationalized industries: If nationalized industries

make profits, it does not follow that they are efficient, because they may be using their monopoly
powers to raise prices. If they are making losses, it may be due to government forcing them to
hold down their prices.

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 LESSON 13 LOCATION OF INDUSTRY

1. What are the factors influencing the location of a firm?

Ans. One of the most important decisions to be taken when an entrepreneur is setting up in business, or
thinking about expanding the firm, is where to locate the firm. There are many factors which may
influence a firms choice of location.

1. Availability of land: The availability of land is the most important decision. The price of land
will have an important influence on the choice of location.

2. Access to raw materials, power and water raw materials: Some industries process heavy,
bulky raw materials which are costly to transport. The products of these industries generally
weigh much less than the raw materials from which they are made.
Where heavy and bulky raw materials have to be imported, locations at or near major ports will
have obvious advantages.

3. The locations of the main markets: A site near the major markets for the product will obviously
reduce the costs of transporting the finished product. It mat not, however, minimise the total
transport costs. If the raw materials are very costly to transport, a site near the source of these
materials may still be the most favourable location. Products which are heavy or bulky in
relation to their value will also tend to be produced near to their markets.

4. Labour: All firms need a supply of labour. Firms will be attracted to areas which have a surplus
of labour. Firms deciding on their location will also take into account any differences in the
costs of labour in different parts of the country.

5. Transport facilities: Many firms assemble finished products from parts and components
manufactured by several different firms located in different parts of the country. This means
that good transport links are likely to play a large part in the choosing of a location for an
assembly plant.

6. Regional specialisation: Once an industry becomes well established in a particular region,

that area acquires advantages from which all the firms in that industry can benefit. Firms
wishing to enter the industry, therefore, tend to be attracted to this particular location.

7. The government: In most other countries the government exerts a great influence on the
location of industry.

2. Why and how do the governments influence the industrial location?

Ans. The following are the ways government influences the industrial location:

1. Regional differences in unemployment rates: The government influences location of

industries by encouraging firms to start up their industries in areas where the rate of
unemployment is very high. This would help these areas to develop and also solve the problem
of unemployment. In return the government gives those firm grants and subsidies such as
lower tax rates etc.

2. Industrial concentration makes a region too dependent on one industry: The concentration
of an industry in one region means that the prosperity of that region depends mainly on the
success of that industry. If the industry declines, it will have a kind of snowball effect - not
only will the workers in that industry loss their jobs, but workers in local firms which supply the
industry with materials and services will also suffer unemployed.

45
 3. Urban sprawl: Heavy concentration of industry lead to the growth of sprawling built up areas.
These conurbations as they are called create heavy social costs in the form if congestion and
pollution.

3. What are the main features of regional policy? How does government help private
producers & assisted areas?

Ans. The governments regional policy aims to:

reduce the differences in regional unemployment rates,
reduce an areas dependence on the prosperity of one major industry, and
restrict the growth of the great conurbations.

Regional unemployment
There are two possible ways of dealing with this problem.

1. Taking workers to the work: The movement of unemployed people from areas which have
high unemployment rates to more prosperous areas is a difficult task.

2. Taking work to the workers: Most of the governments attempts to deal with regional
unemployment concentrate on persuading firms to move to, or set up new branches in, the
areas of relatively high unemployment.

Assisted areas
Certain parts of the country, where unemployment is much higher than the national average, have
been identified as being in need of special government aid.

The following are the government help to assisted areas:

- Capital Grants: These are intended to help towards the cost of purchasing land, buildings,
machinery and equipment. Additional grants are available in development areas.
- Training grants: Firms setting up in or expanding in assisted areas can obtain grants to cover
part of the cost of training local labour.
- New Factories: The government has built new factories in the assisted areas. These are
made available to firms for rent or sale on very favourable terms.
- Preferential Treatment: Firms in assisted areas are sometimes given preference when
government contracts are being awarded.
- Enterprise zones: Firms setting up in enterprise zones are offered tax allowances on industrial
buildings, exemptions from local rates and a relaxation of certain planning controls.
- New Towns: As a means of restricting the growth of the large conurbations, a number of new
towns have been built. These have sited so as to draw people and industry away from the
more densely populated region.

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 LESSON 14 MONEY & BANKING

1. What are the various functions performed by money?

Ans. Money is anything which is generally acceptable in exchange for goods and services.
Money has four main functions:

A. A medium of Exchange: Because money is a commodity that is generally acceptable in

exchange for all other goods, money overcomes the problem of needing a double coincidence
of wants. Therefore, trade is brought about by two transactions with money being used in each.

B. A measure of value: Using money helps traders to avoid the problems of fixing prices of
goods and services in terms of all other goods and services.

C. A store of value: Money generally does not lose its value over time and so acts as a store of
value. In other words, it allows people to save in order to make purchases at a later date. With
a continued rise in prices, or inflation, money is unable to be such a good store of value.

D. A standard for deferred payments: When a person buys goods on credit the consumer has
the use of the goods but does not have to pay for them immediately. The consumer can pay
some time after he or she receives the goods. In the case of hire purchase, payment is made
by installments spread over a number of months or years.

2. Inspite of high interest rates in the stock market, people still prefer to keep money in the
bank. Why?

Ans. Even though banks offer low interest rates, the money put there is safe. But on the other hand the
money invested in stocks is speculative and one may become a millionaire overnight or a pauper.
If a person is prepared to bear risk he may prefer to invest in stocks but if people are not prepared
to bear risks, they prefer to keep their money in the bank even though the interest rate is low.
Banks also offer additional services like Current Account suitable for businesses. In developing
countries, the middle class who form a larger proportion of the population prefer to keep their
money in banks for security reasons and also not willing to bear risks. This is the reason why
people prefer to keep money in banks even if stock market offers higher rates of interest

3. What are the functions / services of a commercial bank?

Ans. Bank is an institution which deals in money. A commercial bank is a financial institution that
accepts deposits and lends money to industry, trade and consumers.

1. Commercial banks keep money safely for their customers

A current account is used to make payments from. A customer can deposit and withdraw
money from this account without giving any notice. To help make payments customers holding
a current account are given cheque-books.

Deposit accounts are used for savings and do not offer a cheque-book. Interest is offered to
encourage people to save and because notice of withdrawal has to be given.

2. Commercial banks help their customers to make and receive payments

Cheques are the most important method of payment. Commercial banks can also relieve
customers from having to remember when to pay their bills. By filling in a standing order or
direct debit.
Credit cards are another important means of making payments.

3. Commercial banks lend money to customers

Individuals, firms and the Government can borrow this money and banks make profits by
charging interest on these loans.
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 4. Commercial banks provide many other services
They can arrange insurance for life, houses, cars and other property. They also operate pension
funds, help with buying and selling shares, advise on making tax payments or even writing a
will. Night safe facilities allow shops to deposit their takings in bank safes after normal banking
hours. Many banks will also look after valuable documents like house deeds and property like
items of jewellery.

4. What are the features / role of the Central bank in a country?

Ans. A central bank may be defined as the bank in any country which has been entrusted the duty of
regulating the volume of currency and credit in that country.

1. It is the Governments bank.

It is responsible for looking after the money received by the Government, for example, tax
revenues, and managing its payments, for example, its spending on hospitals, schools, social
security benefits.

2. It stores the nations gold and foreign currency reserves.

The amount of gold and foreign currency stored at the central bank for the government is
known as the exchange equalization account.

3. It has the sole right of note issue.

It is responsible for the printing and issue of banknotes.

4. It manages the national debt.

This involves repaying money the Government has borrowed in the past, and raising new loans
for the Government.

5. It is the bankers bank.

The central bank acts as a supervisor to the banking system.

6. It is the lender of the last resort.

The central bank will lend money to the banking system to try to prevent banks from going
bankrupt if they run out of money.

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 LESSON 15- BUSINESS FINANCE

1. State the functions of Stock Exchange?

Ans. The stock exchange is a market place for the buying and selling of shares.

The Functions of the Stock Exchange

1. It helps the government and companies to borrow on a long-term basis.

2. It influences the way in which savings are invested

The prices of shares in companies which are successful or which are believed to have good
prospectus will tend to rise as the demand for them increases. The opposite will happen to
prices of shares in companies which are performing badly.

3. It provides a means of valuing financial assets

Shares, debentures and government securities are sold on the stock exchange. The prices of
these securities are published daily. It is always possible, therefore, to find their present value.

49
 LESSON 16 INCOMES

1. What is Income (Gross and Net), Personal Disposable Income (PDI) and Real Income.

Ans. Income refers to money earned by an individual by offering his services (both mental and
physical).
Gross is the amount of income a person earns before taxes.
Net is the amount of income left with a person after taxes.
Personal Disposable Income is the amount of income available with an individual after deduction of
income tax and national insurance contribution.
Personal Disposable Income = Original Income (Gross Income) - Income Tax - National Insurance
Contributions.
Real Income is the amount of money income that can be used to buy goods and services. It is also
known as the purchasing capacity of money.

2. What are the different types of personal income?

Ans. The different types of personal income are:

1. Income from employment: These are payments for the services of labour, and take the form
of salaries and wages.
2. Income from self-employment: This is the income received by people who work for
themselves, that is, who are in business as sole traders. E.g. window cleaning, plumbing etc.
3. Income from the ownership of wealth: People have to pay a price for the use of other
peoples money and property. These prices are incomes to the owners of wealth:
- Owners of land and buildings receive rent from their tenants.
- Lenders of money receive interest from borrowers.
- Owners of businesses receive income in the form of profits.
4. Social security benefits: For a large number of people, a part or all of their income consists
of various social security benefits paid by the government. E.g. unemployment benefit,
supplementary benefits etc.

3. Why do people earn differently in different occupations?

1. Skills: Different occupations call for different skills required on the part of the workers e.g. a
doctor would require high level of skills for operating a patient whereas a sweeper may not
require skills upto that level. Hence doctor would be paid a higher salary as compared to a
sweeper.
2. Qualifications: Different jobs need different kinds of qualification and training to be acquired
by the people e.g. a pilot requires special qualification and training whereas an actor requires
training in the field of acting. Hence both the people get different amounts of pay.
3. Hardships / Dangers: Certain jobs have large amounts of risk involved in it e.g. A fire fighter
may get a higher pay as compared to a clerk because a fire fighter may lose his life while
performing his duty.
4. Age factor: There are certain jobs for which the age of a person matters a lot for instance an
old person may not be in a sound state of health to deal with heavy equipments whereas it will
be very easy for a young person to do the same. So old people may not be employed for such
a work and hence may not be able to get paid well.
5. Profitability of the business: Different industries have different profit earning capacities and
hence people employed in different industries will be paid differently.

4. Why some people earn more than others in the same occupation?

1. Designation of the person: Often people employed at a higher post are paid higher salary as
compared to those at a lower post.

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 2. Hard working: An employee would be paid higher as compared to others if he is hard working
and sincere with his work.
3. Promotions: The earning ability of a person increases as and when he gets promoted.
4. Skills and talent: People with more skills are paid higher as compared to people with less or
no skills.
5. Seniority: A person who has been working with the organisation for quite a long period of time
will be paid a higher amount of salary as compared to new joinees.
6. Sex of the worker: Generally female employees tend to get low wages as they take breaks
from work quite often due to many reasons.

5. Why do you think a worker might be prepared to work for very low wages?

Ans. Workers might be prepared to work fpr very low wages because:
- The worker may lack the skills required for a highly paid job. The worker may not be well
educated to secure a high paid job. He may also lack the experience required to set a highly
paid job.
- A worker may be looking at a low paid job as a part time offer until he is able to secure a good
job.
- Sometimes age factor also plays an important role in choosing jobs. An old aged worker may
not be able to undertake the responsibilities of a highly paid job.
- Some workers restrict themselves to particular place as they are not ready to travel a long
distance which deprives them for working for a high paid job.
- The low paid job might be offering good working conditions, fringe benefits etc due to which the
worker might be motivated to work even at low wages.

6. Why does a worker decide to move to another job at same rate of pay?

- If the working conditions makes the worker feel more comfortable.

- Better prospects is also another factor which makes the worker feel that their work will be
appreciated in the new company and they may have better prospects.
- Location is another important factor as the most number of workers prefer a working place
which is near, so that the time and the cost of traveling is saved.
- If the wage rate is the same but the other company has lesser working hours as compared to
this company.
- If the new work is offering better working conditions and fringe benefits then the worker might
decide to switch over to this job although the rate of pay will be the same.

7. How is the expenditure of an old skilled worker likely to be different as compared to a

young worker?

Ans. The expenditure of an old skilled worker is likely to be less as compared to a young worker. An
older worker may have good savings accumulated throughout his life. Also an older worker would
like to save more as they may not have a good level of income. They may be provided with social
security benefits or pensions which would barely be enough to meet their day to day expenses.

A young skilled worker will have more expenses and will have less tendency to save. This is
because a young worker has a different life style. Also he might have many expenses for example
a loan to be taken care off. The loan can be either for a house, car, education etc. A young worker
may not be able to save like an old worker because he is likely to use most of his income to satisfy
his needs and wants.

8. State the factors that might determine an individuals choice of occupation?

- Location of his work area: This factor plays an important role in choosing a workers occupation.
If the work area is nearby, with less pay scales too, some workers may be ready to work as
they dont have to travel a long distance.
- Pay scale: If an individual gets more pay scale in one occupation than another than he might
choose to work there.
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 - If the working condition is good and the working hours less then a person might be ready to
even at low pay scale.
- If a person has more opportunities of being promoted in one company than another he might
choose to work there.
- Size of company along with its goodwill also matters as an individual might prefer to work in a
large organization with a good reputation as they can be benefited from this in terms of high
salary, fringe benefits and so on.
- If the management is good a worker might be attracted to work there as he might be motivated.

9. Analyse how a persons earnings are likely to change during their working life.

- If an individual acquires additional qualification on training during his working life, his career
progresses with his earnings. For e.g. individuals opt for MBA courses which they can complete
while working and then they go for higher position.
- If a person switches his occupation from one sector to another or in same sector with different
occupation his earnings increases. For e.g. an individual changes his occupation from farming
to service, then his earning may change.
- If a person is promoted to a higher position with additional responsibility his salary will increase.
- If the company earns huge profits, it gives a hike in salary of the employees which again
increases the earnings of an individual.

10. What is a trade union and what are its functions?

Ans. A trade union is a group of workers who have joined together to ensure their interests are protected.
A union is able to press for improvements in a wide range of matters which an individual would find
difficulty in obtaining.

The following are the functions of trade unions

1. Collective bargaining and job protection- A union undertakes the following:
- Negotiates over wages, terms of employment and conditions of work with management,
- Seeks to achieve security for workers as regards their job, pay and work conditions. Hence
unions:
a. Try to influence governments to introduce legislation which will improve the pay, status
and work conditions of their members, e.g. Health and Safety at Work Act (1974)
b. Makes rules about the type and length of training needed for a particular skill and about
who should perform them.

2. Social and welfare benefits- These vary greatly from one union to another, and include:
- Social activities such as clubs and outings.
- Giving legal help on employment matters.
- Providing rest centres, making payments to cover illness/accidents, strike pay.

3. Industrial democracy- A union strives to achieve more say or participation in decision-making

through subordinate aims such as:
- Public control of the means of production.
- Workers co-operatives, possibly with government aid, as in the case of the Meriden Motor
Cycle Factory in 1974.
- Appointment of worker directors to the boards of large businesses.
- Job enrichment- e.g. allowing workers greater say on the shop floor in the way they work.
Volvo created successful self contained teams responsible for the assembly of part of a
car.

4. Political activities
- The majority of trade unions are affliated to the Labour Party.
- The bulk of the Labour Party funds comes from the political levy which each union member
pays as part of his subscription, unless he chooses not to. Officially the trade union
movement supports the Labour Party and also finances its own Labour MPs in Parliament.

52
 - The trade unions have a substantial representation on the policy-making National Executive
Committee of the Labour Party.

11. Discuss the extent to which the relative strengths of trade unions influence the level of
earnings in different occupations OR How does trade union affect the wages?

- An increase in the cost of living: Unions are to maintain the real wages of their members,
and will ask for wage increases to cover any increase in prices.
- An increase in productivity: Where the productivity of labour has increased, the trade unions
will press for some of the benefits to go to the workers, in the form of higher wages.
- An increase in profits: If the profitability of an industry is increasing, the unions will try to
ensure that the workers obtain a share of the increased profits.
- Comparability: Trade unions will not want the wages of their members to fall out of line with
the wages of workers in other industries. A pay rise to one group of workers will probably lead
to demands for pay increases by other groups of workers who do not want to be left behind
A trade union in a competitive industry is able to enforce a minimum wage which is higher than
the free market wages.

12. How far do you think the change in the provision of housing is likely to affect a workers
choice of occupation?

- According to me before joining a work a worker already has his own house where he lives in so
it might not matter to him if the company does not provide provide him with housing facilities
especially if he is living nearby the work place and he is able to earn a descent salary.
- If the workers house is at a far distance from the place where he is working he might opt to
work somewhere else even job because he at present he has to spend a lot of time and money
to travel to his work place. However the worker could still decide to continue there if the
company provided him with a housing facility near the company.
- If the company provides the worker with a housing facility there call still be chances for him to
be demotivated if the house provided by the company is at a far of distance.
- Also if the company provides him with a rent then again a person would prefer to work in an
organization as he may be able to take a house near his work place.

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 LESSON 17 THE INCOME AND EXPENDITURE OF GOVERNMENT

1. Define Real Spending and transfer payments.

Ans. There are two very different kinds of public expenditure, real spending and transfer payments.
Real spending takes place when goods and services are bought by the central government and
local authorities. The payments for the services of civil servants, teachers, policemen and nurses
represent real spending. This type of spending also includes such things as the purchase of the
food and medicines used in the hospitals and the textbooks and equipment used in schools.

Transfer payments consist of transfers of money in the form of grants from the government to
households and firms. Unemployment benefit, child benefit and investment grants are examples of
transfer payments. About half of total public expenditure consists of transfer payments.

2. Differentiate between private and public expenditure/sector.

Private Expenditure Public Expenditure

1. Private expenditure is an expenditure Public expenditure is an expenditure

made by private individuals. made by the government.

2. It involves expenditure on private It involves expenditure on public

consumption (T.V., fridge etc.). benefit facilities such as education,
health care etc.

3. Private expenditure is financed through Public expenditure is financed

a persons income and wealth. mainly through taxation.

3. Why a country has to rely on public expenditure and not leave everything on private
players?

Ans. Public expenditure is the government spending on various goods and services. Government spends
on supply of basic necessities as it cannot rely on private players for the following reasons:

- Public Goods: There are some things which people would like to have and which many people
regard as necessities, but which would not be supplied by a market economy. These things
are known as public goods. E.g. defense, law and order, street lighting, etc. The reason why
such goods and services would not be supplied in a market economy is the fact that the
consumption of such goods and services cannot be restricted to those who are prepared to
pay for them.

- Merit Goods: These are the goods which provide great benefits both to individuals and to
society as a whole. E.g. education and health services. It is widely believed that people ought
to have more of these services than most of them would buy, or could buy, if they were sold at
market prices. The supply of these services should not be left entirely to the private sector for
the following reasons:
o Many people would not be able to afford adequate health services and a reasonable
education.
o Those who could not afford these services would find their opportunities for living a healthy
life and making the most of their abilities greatly restricted.
o Even when people could afford to pay, some of them might not act in their own best
interest. They might not fully appreciate the long-term benefits of spending on health and
education.
o Quite apart from the benefits to the individual, the whole population will benefit from living
in a healthy and well-educated society.

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 - Helping those in need: A major reason for the great increase in public spending is to create
a welfare state. This is a state in which:
o Everyone is guaranteed some minimum level of income
o People are protected from unnecessary hardship when they suffer misfortunes such as
sickness and unemployment and
o Certain social services such as education health help for the aged are made available to
all regardless of their income.

Social security payments of various kinds now account for more than a quarter of total public
expenditure.

4. Why might public expenditure fall if an economy relies more on the market system?

Ans. There are some things which people would like to have and which many people regard as necessities,
but which would not be supplied by a market economy. These things are known as public goods.
These are defense, law and order, street lighting, lighthouses, and barriers to prevent flooding. The
reason why such goods and services would not be supplied in a market economy is the fact that
the consumption of such goods and services cannot be restricted to those who are prepared to pay
for them. But in market economy government earns nearly 84% of the income from taxation i.e.,
national insurance contributions and local rates. So the expenditure is less than the income in
market system.

55
 5. Why does the government impose tax?

Ans. The government imposes tax to:

1. Raise revenue for necessary government expenditure.
2. To lessen inequality of wealth & income and to maximize economic welfare: Redistribution
takes place as a result of:
a. Progressive method of taxation of income, and capital transfer and capital gains taxes
which affect mostly the wealthy & middle income groups.
b. Transfer payments & subsidies: The revenue collected from above is allocated so as to
give most benefit to the less well off.
3. To improve the balance of payments:
a. Tariffs (import taxes) help to increase the price of imports & reduce demand for them.
b. Bounties or subsidies on exports reduce their price abroad & helps increase overseas
demand for them.
4. To manage the economy: The main aim of government is to achieve some socio economic
objective such as price stability, full employment, etc by such means as:
a. Deficit budget financing or surplus budget financing ?( unbalanced budgets)
b. Use of the customs & excise regulators.
c. Tax allowances, loans & grants to specially selected firms or industries to:
i. Stimulate growth.
ii. Reduce regional localized unemployment.
5. To influence certain consumer spending: To achieve certain moral social or health objectives,
the consumption of:
a. Certain goods & services (demerit goods) may be discouraged by taxes on tobacco, alcohol,
gambling.
b. Certain merit goods might be encouraged by legislation for e.g. vaccination, education,
etc.

6. Explain the difference between direct and indirect tax with examples. What do you mean
by proportional, progressive and regressive taxes?

Ans. Direct tax is a tax which is paid by an individual to the government directly. It is a tax on a
persons income. It is not easy to pass away the burden of tax to any other person. Some examples
of direct taxes are income tax, corporation tax, rates, etc.

Indirect tax is a tax which is levied on goods and services. They are called indirect because they
are normally collected from businesses. The burden of payment is shifted to consumers in form of
higher prices e.g. VAT, custom duties, excise duty, license fees, stamp duty, etc.
Proportional tax means that the taxes are imposed at a uniform rate. For e.g. All taxpayers have
to pay 10% of their income.

Progressive tax means lower income groups a smaller percentage of their earnings in tax than
higher income groups.

Regressive tax means the burden falls mainly on the poor since a greater percentage of their
income is spent on taxed basic goods & services than that of wealthier groups e.g. cigarette and
alcoholic drink.

7. Explain how public expenditure / public sector can be paid for.

Ans. The government gets its finance through:

1. Public sector borrowing.
2. Interest payment on loans of money made by the public sector.
3. Rent from public owned land and building.
4. Gross operating surpluses (Profits) from agencies and publicly owned industries selling goods
and services.
5. Proceeds from the sale of government owned industries and assets.

56
 6. Money paid into the national lottery distribution fund by the organization running the national
lottery.
7. Taxes on income, wealth and expenditure. Most of the governments revenue is raised from
taxation. Taxes are compulsory payments backed by law.

8. What might happen in an economy if the government increases income tax rates?

Ans. Taxes are used to control the amount of spending in an economy. This is when excess demand is
causing prices to rise. An increase in income tax will generally:
- Reduce peoples ability to spend.
- Be a disincentive to work and enterprise.
- Efficient firms may tend to suffer since higher profits are subject to a high rate of tax.
- Might discourage investment in national firms.
- Might result in fewer saving, which ultimately has adverse economic effects, e.g. reduced
investment.
- Often costly to administer, since
o It may require complicated forms-fillings.
o Complexity of the system e.g. allowances, claims for expenses etc. means many
accountants are needed to interpret tax law.
o Can result in high levels of tax avoidance or evasion, making necessary more tax officers
to be employed.

9. How might a reduction in tax helps to achieve macro economic aims?

Ans. Government has different aims such as reducing unemployment, raising standard of living of people,
maintaining a fair position of the balance of payments, economic growth and development. A
reduction in taxation may help in reducing income inequalities to a great extent. If the amount
of tax that a person gives to the government than his disposal income increases, this increase in
disposal income will in turn raise the standard of living of the people. Also if standard of living
increases the demand for goods & services will also increase. To meet this demand the output of
goods and services will have to be increased which will generate employment opportunities for
the unemployed. This will make the economy progress towards growth and development. As
the national income and GDP, GNP of an economy increases.

10. What is a budget-deficit and surplus?

Ans. Budget is a statement which gives details of the central governments income and expenditure for
a financial year. It is a statement that contains details of the planned spending of the various
government departments. It also gives the details of the proposed changes in the system and
rates of taxation for the next year. It is more than a simple balance sheet showing how the
government spends its income and how it intends to obtain that income.

If the government wishes to reduce unemployment by increasing the demand for goods and services,
it will spend more than its income from taxation which is called as Budget Deficit. This means it
can put more purchasing power into the economy than it take out in taxation.

On the other hand if government wishes to reduce the total demand for goods and services because
of fear of inflation, it will aim for a Budget Surplus. It will spend less than its income from taxation.
This will reduce the amount of purchasing power in the economy.

11. What policies might a government use to encourage private businesses (industrial
development)?

Ans. Government offers several forms of assistance to industries to move or expand:

- Capital Grants: These are intended to help towards the cost of purchasing land, buildings,
machinery and equipment. Additional grants are available in development areas.

57
 - Training grants: Firms setting up in or expanding in assisted areas can obtain grants to cover
part of the cost of training local labour.

- New Factories: The government has built new factories in the assisted areas. These are
made available to firms for rent or sale on very favourable terms.

- Preferential Treatment: Firms in assisted areas are sometimes given preference when
government contracts are being awarded.

- Enterprise zones: Firms setting up in enterprise zones are offered tax allowances on industrial
buildings, exemptions from local rates and a relaxation of certain planning controls.

- New Towns: As a means of restricting the growth of the large conurbations, a number of new
towns have been built. These have sited so as to draw people and industry away from the
more densely populated region.
The government is an important source of finance for privately owned firms:

- Technology: The government offers grants as a means of encouraging firms to introduce new
methods of production, to make use of the latest technology and to introduce new products.

- Regional Aid: The financial assistance available to firms in assisted areas and enterprise
zones.

- Employment subsidies: The government has a variety of subsidized schemes to provide

people with temporary jobs, to encourage employers to take on more new workers and to offer
training to young people.

- Small Firms: Grant, subsidies and tax incentives are made available to help people to set up
in business for themselves and to encourage people to invest in small firms.

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 LESSON 18 INTERNATIONAL TRADE

1. Why is free trade often considered advantageous to a country. OR Discuss immediate and
long term changes that might occur in developing countries if trading restrictions were
reduced.

Ans. Free trade is often considered advantageous to a country due to following reasons:
- Countries can import goods which they cannot produce for themselves: This is the oldest form
of international trade, and it is still important. Trading with other countries enables people to
enjoy a much wider range of goods than they can produce for themselves.
- More specialization means larger outputs and lower costs: The major part of world trade takes
place between countries which could produce for themselves many of the goods they import.
International trade makes it possible for them to specialize in producing those goods in which
they have some kind of advantage over other countries. So countries specialize, and exchange
their goods for those produced by other countries. Specialization increases total world output.
Goods are produced on a larger scale and at lower cost. International trade enables countries
to have more goods than they could obtain by trying to be self sufficient.

Disadvantages of Free Trade:

1. Dangers of over-specialisation: A country may build up a large industry by specializing and

developing a large export market. But its export market might lose due to following reasons:-
o Another country may become more efficient in that industry.
o Technical progress may develop a highly competitive substitute. For e.g. the introduction
of synthetic rubber affected countries which specialized in the production of natural rubber
for export.
2. Immobilities: When a country loses an important export market, it will find itself in difficulties.
Factories and machinery are designed to produce one good cannot be easily transferred to
another industry. Workers who have been trained to work in that industry become redundant.

2. Discuss how the use of protective measure such as tariff might be better than allowing free
trade.

Ans. There are some problems of free trade between countries like

1. Dangers of over-specialisation: A country may build up a large industry by specializing and

developing a large export market. But its export market might lose due to following reasons:-
o Another country may become more efficient in that industry.
o Technical progress may develop a highly competitive substitute. For e.g. the introduction
of synthetic rubber affected countries which specialized in the production of natural rubber
for export.

2. Immobilities: When a country loses an important export market, it will find itself in difficulties.
Factories and machinery are designed to produce one good cannot be easily transferred to
another industry. Workers who have been trained to work in that industry.
So most countries put some restrictions on foreign trade, mainly to protect their own industries
by using various methods of restricting imports like tariffs (taxes on imports), setting up quotas,
limiting foreign currency, and by subsiding home producers.

Every country places restrictions international trade for different reasons:

1. Balance of payments problems: If a country is spending more on imports than it is
earning from exports, it is getting into debt with the rest of the world. If it finds difficulty in
increasing its exports, it may be forced to remedy the situation by placing limits on its
imports.
2. To protect an infant industry: To enable an industry to grow and achieve large scale
production, a government may protect it from foreign competition by restricting imports.

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 3. Unfair competition from low wage countries: Imports from low wage countries
represent unfair competition for home industries which are paying much higher wages than
producers in countries where wages are relatively low. If exports from such countries are
restricted, the effect would be to increase unemployment in those countries and drive
wages even lower.
4. Strategic arguments: It may be necessary to protect some industries by tariffs and
quotas to prevent firms in them from being driven out of business by foreign competition.
5. To prevent dumping: A country may restrict its imports when it believes they are being
dumped, i.e. sold below cost by a country which is trying to get rid of a surplus.

3. What forms do trade restrictions often take? OR What is the difference between tariff and
quota?

Ans. Most countries put some restrictions on foreign trade to mainly protect their own industries using
the following methods:
1. Tariffs: These are taxes placed on imports. They protect home producers by increasing the
prices of foreign goods in the domestic market. They also increase revenue for the government.
2. Quotas: These are the important barrier to trade, because they place an upper limit on the
quantity of foreign goods entering a country. For e.g. limiting the imports of a certain products
by numbers 100 or 200.
3. Exchange control: Imports can only be purchased with foreign currency. The government
can limit imports, by restricting the amount of foreign currency available to firms wishing to
import goods.
4. Subsidies: By subsidizing home producers, a government can reduce the prices of goods
made by domestic firms. This helps to protect home producers from foreign competition.

4. What are the barriers to trade?

Ans. Barriers to trade are:

1. Tariffs, quotas and exchange controls restrict the supply of goods available to home consumers,
and prices will be higher then they would be under free trade.
2. When a country restricts its imports, it is restricting other countries exports. Countries which
decided to restrict their imports would find their own exports being restricted.
3. Protecting a home industry from foreign competition may cause it to become less efficient.

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 LESSON 19 BALANCE OF PAYMENT AND EXCHANGE RATE

1. What is Balance of Payment (deficit and surplus) and what does it measure?

Ans. The payment for goods and services which cross international boundaries are quite different from
payments made within a country. For example if a British firm wishes to buy goods from the USA,
it must first obtain dollars; if it wishes to buy Italian goods and services, it will have to acquire lire.
That is imports cause us to spend foreign currency. The balance of payments is an account of a
countrys payments to and receipts from the rest of the world. Although it shows the value of the
transactions in that countrys own currency, it must be remembered that the transactions which
actually took place were foreign currency transactions. It basically measures a countrys payments
to and receipts from the rest of the world.

Deficit refers to a situation where the total outflow of currency in the economy is higher as compared
to the inflow of the currency.

Surplus refers to a situation where the total inflow of currency in the economy is higher as compared
to the outflow of the currency.

2. Describe the structure of the balance of payments of a country.

Ans. The balance of payments consists of the following accounts.

1. Current account: This account provides information regarding the difference between the
visible trade (Visible Exports - Visible imports) and invisible trade (Invisible exports - Invisible
imports)
2. Capital account: It is made up of variety of investments (property, portfolio investment, External
assets & liabilities) both long term & short term carried out by governments, firms & households
and capital inflows and outflows from the economy.
3. Balancing item: It represents the sum of all errors & omissions. If it is positive it means that
there have been unrecorded net Exports & if it is negative then there have been unrecorded net
imports.
4. Balance of official financing: It represents the sum of current balance, capital movements
& balancing items. It is also shows the total currency flow. Negative balance means net outflow
of foreign currency. Positive balance means net inflow.
5. Official financing: Shows how monetary authorities have dealt with the net currency flow. In
case of negative balance authority draw upon the official foreign currency reserves, borrow
from IMF &/or from foreign central banks. In case of positive balance authority may increase
the official foreign currency reserves, repay borrowings from IMF or make repayments or loans
to foreign central banks

3. Discuss what might lead to an improvement in the balance of payments of a country.

Ans. Improvement in BOP refers to surplus i.e. inflow of currency is more than the outflow of currency.
BOP can be improved by adopting the following measures.

1. Reducing imports: One of the main reason for deficit is large scale imports from other countries.
If necessary steps are adopted to reduce imports then the BOP can be maintained at a fair
position. Imports can be reduced by encouraging domestic industries to produce these goods,
imposing tariffs and quotas on imports, keeping a control on foreign exchange in the hands of
the importers.
2. Encouraging exports: Government should encourage export industries by providing them
with subsidies and grants as more exports will bring in the foreign exchange and will result in
inflow of money. If the value of exports are more than the value of imports it will improve BOP
drastically.
3. Capital Investments: Government should increase the capital investment both within the
economy and outside the economy as it will again lead to a positive balance in the countrys
BOP.
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 If exports are more than the imports and a decent level of capital investments are undertaken
by the government, citizens & firms of the nation then it will improve the balance of payment s
to great extent.

4. Where would the minerals, precious stones etc be recorded in balance of payments. If
exports of above products decreased, yet the export value rose, how?

Ans. Minerals, precious stones etc will be recorded under current account, visible trade. Even if the
exports of minerals, precious stone etc decreases, it will be a decrease in a quantitative aspect of
it that is the number of units going out of the country may be less but the value that these products
yield is far more higher than its quantitative value.

5. Define and distinguish between visible and invisible export.

Ans. A country has to keep a record of its trade with other countries this is called the balance of
payments account. The current account is divided into two parts i.e., the visible account and the
invisible account. Visible trade refers to the trade in physical goods i.e., those things which we
can see being loaded and unloaded at docks and airports. The value of service which cannot be
seen or touched are called invisibles. If investment overseas at some future date leads to earnings
or income to someone the income counts as an invisible export. The difference between the
values of exports and imports of physical goods is known as the balance of trade, or the visible
balance.

6. What is exchange rate and why does it fluctuate? Value of exports might be affected by
changes in a countrys exchange rates. Discuss the effect of appreciation (strength) and
depreciation (weakness) of currency on an economy.

Ans. When the exchange value of a currency falls, it is said to depreciate. When the exchange value of
a currency rises, it is said to appreciate. Thus a fall in the value of the rupee from 40 to 42 would
be described as a depreciation of rupee. An increase in its value would be described as an
appreciation.

Changes in the value of currency are very important because they affect a countrys export and
imports. When the currency of a country depreciates, the overseas prices of its exports fall and the
home prices of its imports increase. When the currency of a country appreciates, the overseas
prices of its exports rise and the home prices of its imports fall.
The value of a currency depreciates when the demand for imported goods increases, the value
of a currency falls in terms of other currency and when investment overseas increases.
The value of currency appreciates when other countries demand our goods and services or
other countries invest in our countries or citizens of other companies buy shares of our companies
or when other countries make loans to our residents.
If a countrys exports are of a greater value than its imports due to foreign inflation then
demand for foreign currencies will rise, this will increase the price of our currency and our
exports will become expensive. This will reduce our exports and increase our imports.
Hence we can say that as the currency of a country appreciates people from other countries
demand more of it, which gives a boost to export industries.

7. Discuss whether it matters if a country has visible trade deficit? What measures can
government take to influence its countrys balance of payment?

Ans. Yes, it will matter if a country has a visible trade deficit because it may lead to disequilibrium in its
balance of payments if it persists for a longer period of time. A visible trade deficit may occur due
to excess of visible imports over visible exports and adverse change in terms of trade. The following
are the measures which the government can take to influence its countrys balance of payments
account.

a. Short term remedies which include:

Drawings on gold and foreign currency reserves.
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 - Loans from abroad.
- Increase in interest rates, thereby attracting funds from abroad.
- Increase in trade barriers or use of temporary import surcharge.
- Sale of foreign assets.

b. Medium term remedies which include:

- Deflationary measures which may be taken via fiscal, monetary or incomes policies to
reduce domestic prices or at least to stabilise them, e.g. higher taxes or interest rates,
greater hire purchase restrictions, restriction of bank credit.
- Devaluation: This involves altering the rate of exchange so that the domestic currency
does not buy so much foreign currency, making exports cheaper and imports dearer.
Devaluation only succeeds if the demand for both imports and exports are elastic, resulting
in increased exports and reduced imports. However it would fail under the following
conditions:
1. If competitive devaluation was applied by other countries.
2. If there was an inelastic demand by other countries for the bulk of our exports.
3. If British export goods were in inelastic supply.
4. If the amount of goods imported did not increase much due to an inelastic demand for
them.
- Floating exchange rate: Theoretically an automatic means of eliminating deficits is provided
when countries are on a floating exchange rate system.
1. If a countrys exports are of a greater value than its imports due to foreign inflation then
demand for foreign currencies will rise, this will increase the price of their currency and
their exports will become expensive.
2. This will reduce their exports and increase cheap imports. Thus over a period the deficit
should be self-righting.

c. Long term remedies: This involves creating or improving the conditions that make real growth
in productivity and economic growth possible, such as, for example:
- Changes in attitudes to work and improved industrial relations.
- Improved political, economic and social environment.

8. If exports from India became more expensive, how might that affect production and
employment both in India and in countries importing Indian goods?

Ans. If exports form India become expensive then it will lead to losses in the export industry. This may
raise the unemployment levels and decrease income and standard of living in the Indian economy.
Fewer amounts of goods and services will be produced as it will not be in much demand as it will
be expensive for other countries to buy goods and services from India.

On the other hand, importing countries will reduce their imports from India and may switch over to
home production of these goods and services. This will increase productivity and employment
levels in their economy. As more number of industries will have to be opened to meet the increased
demand for those goods and services that were imported from India.

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 LESSON 20 THE GOVERNMENT AND THE NATIONAL ECONOMY

1. What is National Income- GDP, GNP, NNP? What are the methods of measuring National
Income?

Ans. Gross Domestic Product (GDP): It refers to the total value of all goods and services produced
within an economy during a given period of time. It includes export and excludes imports.
Gross National Product (GNP): It refers to the total value of all goods and services produced by
the residence of a country using the resources at home and abroad.
Net National Product (NNP): This is the Gross National Product- Depreciation or capital
consumption i.e. the amount necessary to replace worn out or obsolete factors of production.

The methods of measuring National Income are:

1. The output method: This method attempts to measure the value of the outputs of all the
different industries. One serious problem is that of double counting. This problem is overcome
by counting only the value added by each firm.
2. The income method: The money value of the goods and services produced will be equal to
their costs of production plus profits. But all these costs of production represent incomes to
the owners of the factors of production. They are payments for the services of labour, capital
and land, and take the form of wages, interest and rent. Profits too are income payments to
entrepreneurs and shareholders. Only the incomes earned in producing goods and services
are counted in the national income. Transfer payments such as pensions and social security
benefits do not represent payments for factor services, and are not included in the national
income.
3. The expenditure method: Only that spending which creates income can be counted in the
national income. However, expenditure on exports must be included, because these payments
create income. Another problem is that the market prices of many goods and services include
taxes such as VAT, and some of them include subsidies. Taxes on goods and services must
be deducted from total spending if we are to get a figure which represents the costs of production
plus profits. Subsidies should be added on to market prices in order to obtain the costs of
production including profits.

2. What are the reasons for measuring national income?

Ans. The reasons for measuring national income are:

1. To provide the government with essential information: When the government is making
plans for the economy, it must have reasonably accurate and up-to-date information on which
to base its decisions.
2. To indicate changes in the standard of living: Changes in the standard of living are usually
estimated by looking at the change in real income per head the real value of total output
divided by the total population. This figure tells us, on average, how the amount of goods and
services available to each person has changed.
3. To compare the standards of living in different countries: Figures for national income per
head are used as a means of comparing living standards in different countries.

3. Explain the main aims of the government economic policy? How can it be achieved?

Ans. Economic policy refers to the economic objectives of the government and the ways in which it tries
to achieve those objectives. The aims of economic policy are:

A High and stable level of employment: The objective is to create a situation where people
who are willing to work are able to find jobs within a reasonable period of time.

A relatively stable price level: This means that inflation should be brought under control and
kept under control. Inflation can have several harmful effects on the economy.

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 A satisfactory balance of payments position: A country which is persistently spending more
on foreign goods and services than it is earning from its exports will be getting deeper and
deeper into debts with the rest of the world. So the aim of economic policy is to prevent this
from happening.

- A rising standard of living: People have come to expect that, as the years go by, they will be
able to enjoy such things as higher real wages, better housing, more modern hospitals,
improvements in the education system, more leisure facilities and so on.

- A more equal distribution of income and wealth: Economic policy should aim to reduce
inequalities of income and wealth.

4. How do the different aims of government conflict with each other?

Ans. The Government has the following aims such as

Reducing unemployment by setting up new industries, giving grants & subsidies, training
young people:
By adopting such measures to reduce unemployment the government creates employment which
provides people with income due to which they demand goods and services. If demand exceeds
supply then it will create an imbalance in the economy causing the prices to rise. This will lead to
inflation.

Reducing inflation by adopting monetary policies such as increasing the rate of interest
and fiscal policies such as reducing government spending and increasing taxes. The
ultimate aim is to reduce the money supply in the market:
By adopting measures to control inflation government will either increase taxes which will affect
the real disposable income of the people i.e. they will not be in a position to purchase many goods
and services. This will adversely affect their living standards. Also if government reduces its
spending lot of developmental work will close down leading to large scale unemployment.

Making balance of payments favorable by increasing exports and reducing imports by

adopting measures such as providing subsidies to export oriented units and levying taxes
on imported items and achieving economic growth by ensuring that people are literate,
and are enjoying a good standard of living:
By trying to make balance of payment favorable government may create an inflationary situation in
the market as a large number of people will be given employment opportunities which will accelerate
consumer spending. Also by trying to reduce imports the availability of quality products will go
down which will again adversely affect the living standards.
Thus in this whole bargain the main aim of achieving economic growth and development will be
lost.

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 LESSON 21 INFLATION

1. Define inflation and explain how it is calculated.

Ans. Inflation is a sustained rise in the general price level. In order to measure the rate of inflation, it is
necessary to measure the rate at which prices are changing. This is done by means of an index of
prices. An index number deals with percentage changes. An index of prices is an average of the
percentage changes in the prices of a number of different goods and services.

The main measure of inflation is the Retail Price Index (RPI). This shows changes in the price of
consumer goods and services purchased in the learn economy. There are three main stages in
calculating RPI.

1. Government officials first seek to find out what people spend their money by carrying out a
family expenditure survey.
2. From this weights are given to different items of expenditure. If it is found for instance that
10% of peoples expenditure goes on food. This will be given a weighting of 10/100 or 1/10.
Then how the prices of a variety of items have changed is checked.
3. The final stage is to multiply the price changes by the weights in order to find the inflation rate.
The RPI aims to give a representative picture of what is happening to prices the economy.
However this may not be a totally accurate picture. To assess whether the prices are rising,
the prices of same goods and services should be compared. In practice though goods and
services change often improving in quality so for example if the price of a vacuum rises by 6%
this may reflect a higher change to cover the improvements in the model rather than the same
cleaner becoming more expensive. Also government officials do not monitor prices in charity
shops and other outlets, so the RPI may overstate the price rises which people face.

2. What are the causes for inflation?

Ans. The following are the causes for inflation:

1. Demand pull inflation: Prices will rise when the total demand for goods and services
persistently exceeds the total supply of goods and services at current prices. In these
circumstances it will be very difficult to increase supply to meet an increase in demand. Hence
prices are increased to reduce demand this causes demand-pull inflation.

2. Cost push inflation: Cost represents the payments made for the services of the factors of
production. If the prices of raw materials increase, then costs of the production will rise. Costs
and prices may also be pushed upwards by increases in indirect taxes such as VAT and by
increases in import prices due to higher tariffs or to a fall in the exchange rate. The main cause
of rising prices is an increase in labour costs. Wages are the largest single element in total
costs. When wages rise faster than productivity labour costs will increase and so will prices.

3. Inflation and the money supply: An increase in the money supply does cause total spending
to increase, because the rate at which money changes hands is fairly constant. Inflation takes
place when the government allows the money supply to increase at a faster rate than the
supply of goods and services. In other words, inflation is due to excess demand which is
caused by allowing the money supply to grow too quickly.

3. How fall in unemployment leads to inflation?

Ans. If unemployment is reduced it will increase the income of individuals thereby increasing savings
and spending. If spending increases, the demand for goods will increase which will encourage
producers to produce more and so these producers may increase the price of goods to meet
requirement of consumers resulting in inflation.

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4. What are the effects of inflation?

Ans. The following are the effects of inflation:

1. It tends to accelerate: When inflation has been experienced for some time, people will begin
to anticipate future price increases. Workers will base their wage claims on past price increases
and on expected future price increase. These actions will tend to speed up the rate of inflation.
2. It affects the distribution of income: Some workers get automatic wage increases because
their earnings are linked to the index of Retail Prices. Some groups for example those receiving
private pensions or those who obtain an income from fixed interest securities, will not be able
to avoid a fall in real income.
3. Borrowers gain at the expense of lenders: Suppose someone borrows $1000 for one year
and during the course of that year, prices increase by 10%. When the $1000 is repaid, it will
buy less than the $1000 which was borrowed. It is true that the borrower will have to pay
interest on the loan, but if the rate of interest is less than 10% the purchasing power of the
money repaid will still be less than that of the money borrowed.
4. It affects the balance of payments: If the prices of goods produced in the UK are rising
faster than prices in competing countries, there will be harmful effects on the balance of
payments. The UKs exports will become relatively more expensive in overseas markets, and
hence more difficult to sell. Imports into the UK will become relatively cheaper when compared
with UK products. The balance of payments will tend to move into deficit.

5. What are the policies to deal with inflation?

Ans. The following are the policies to deal with inflation:

1. Reducing Demand: When inflation is being caused by excess demand, the government will
take one of these following measures:

- Fiscal Policy: Increasing taxes and reducing government spending.

- Monetary policy: Putting restrictions on bank lending and raising the rate of interest. These
measures will slow down the growth of the money supply.
- Hire purchase restrictions: Raising the minimum deposit and reducing the time allowed for
repayment.

2. Increasing Supply: One way of overcoming the problem of excess demand would be to
increase the supply of goods and services. This could be difficult in the short run, but the
government could help to increase the efficiency of industry in several ways:
- By improving the training and retraining of labour to make workers more mobile.
- By providing grants to encourage investment in more up-to-date equipment.
- By promoting horizontal integration where it would lead to economies of scale.
- By carrying out improvements in the road and rail network.

3. Income policies: An income policy is an attempt to deal with inflation by slowing down the
rate at which costs of production are rising. These costs are incomes to the factors of production
i.e. wages, interest rent and profits. If the government can hold down the rate of increase of
these incomes, it will be successful in restricting the rate at which costs are rising. If incomes
do not increase or if they increase much more slowly than in the past there is much less
danger of excess demand causing prices to rise. Since cost push inflation appears to be
mainly due to wages rising faster than productivity, incomes policies tend to concentrate on
wages.

4. Price Controls: Governments have the power to control prices, and this would seem an obvious
way of controlling inflation. If prices are held down below the equilibrium level, shortages arise
and these could lead to some form of rationing. Another problem is that if prices are held down
while costs are still rising, many firms could find themselves making losses and be forced to
close down.

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 LESSON 22 UNEMPLOYMENT

1. What are the different types of unemployment and how they are caused?

Ans. The different types of unemployment are:

1. Frictional unemployment: Many people will take some time to search for another job. They
may be looking for something which pays more or is more interesting then their previous job.
The time they spend between jobs is described as frictional unemployment. It is a type of
short term unemployment.

2. Structural unemployment: This is a more serious type of unemployment which is caused by

changes in the structure of industry. It develops when a major industry is suffering a permanent
decline in the demand for its product. It is particularly serious when the industry is concentrated
in a particular region. There are

3. Technological unemployment: Unemployment can also be caused by technical progress.

In many cases the result has been that for fewer workers are required to produce a given
output, this is described as technological unemployment.

4. General Unemployment: This is the most serious type of unemployment caused by a lack of
demand. General unemployment exists when total spending in the economy is much too low to
purchase all the goods and services which could be produced if the labour force were fully
employed. Full employment might be defined as a situation where the number of job vacancies
is equal to the number of people out of work. There are a number of reasons why demand for
labour may be too low:
1. If there is a slump many workers in the industry will lose their jobs.
2. The government may be deliberately reducing the demand for goods and services in order
to reduce the rate of inflation.
3. Lack of demand for goods and services is due to the fact that industries are slower to
change their methods and their products than industries in some other countries.
4. Some economists believe that the high rate of unemployment exists because labour has
been passing itself out of a job.

5. Seasonal unemployment: In some industries there is a seasonal pattern in the demand for
labour. The demand for workers on building sites tends to fall in the winter while farmers
demands for labour tend to be higher during the harvest period than at other times.

2. What are the disadvantages of unemployment in an economy?

Ans. The following are the disadvantages of unemployment:

1. Unemployment represents a waste of resources.
2. Unemployment has serious social effects. People who lose their jobs suffer a fall in their
standard of living and so do their dependants.
3. There is a loss of skill: Workers who are unemployed for long periods of time may find it
difficult to retain their skills.
4. If the level of unemployment could be reduced this money might be sent on pensions, schools,
hospitals, road and so on, taxation might be reduced.

3. Why might a government wish to increase employment opportunities?

Ans. Government wishes to increase employment opportunities for the following reasons.
Utilisation of resources: If people are unemployed then the resources will be lying idle which will
be of no good for the economy. However if the people re employed then more of the resources will
be utilised.

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 Reduce public expenditure: If people are unemployed the government has to divert its resources
towards payment of unemployment benefits which could have been utilised for benefit of the
economy. Also poor people are more inclined towards anti social activities. Raising the level of
unemployment will reduce these activities.

National income: More number of working people will contribute to the national income of the
country. An increase in employment will increase output in.

4. What are the policies to deal with the unemployment situation?

Ans. The policies to deal with unemployment include:

- For Frictional unemployment: Frictional unemployment cannot be eliminated. It might

however, be reduced by improving the information services. Information and advice on job
vacancies are available at the Job Centers which are to be found in almost all towns. This type
of unemployment might also be reduced if young people started working.

- For Structural unemployment: While reducing structural unemployment a major problem is

the occupational immobility of labour. One way in which the government might help this situation
is by slowing down the rate at which an industry is declining. It could do this by granting
subsidies to the firms in that industry which could help them to improve their training facilities
or by persuading firms to move into areas where industries are declining.

- For General unemployment:

1. Increasing the demand for goods and services: The government has the ability to increase
total spending on goods and services in order to create more jobs. It can also increase the
money supply and lower the rate of interest to encourage more borrowing and spending.
However increasing total spending in the economy can lead to either -
More goods and services being purchased at the same prices or
The same amount of goods and services being purchased at higher prices.
But only in the first case will increased spending lead to more jobs being created.
However if the employment is very high the government could also take the following
special employment measures to reduce unemployment:

1. The Youth Training Scheme (YTS)

This scheme offers two years training for 16 year old school leavers and one years
training for 17 year old school leavers. Trainees are paid a weekly allowance by the
government. The aim is to provide trainees with some recognised qualification at the end
of the course.
2. The Community Programme
This scheme provides a years employment for the long term unemployed on projects of
benefit to the local community. This helps those who find it difficult to obtain a job because
of their lack of recent work experience.
3. The New Workers Scheme
The idea of this scheme is to encourage employers to provide more full-time permanent
jobs for young people.
4. The Job Release Scheme
This is intended to encourage older workers to take early retirement so that their employer
replaces them with an unemployed person.
5. The Enterprise Allowance Scheme
The purpose of this scheme is to encourage unemployed people who want to start their
own businesses. This scheme has encouraged many people who have lost their jobs to
use their redundancy payments to set themselves up in business.
6. The Jobshare Scheme
The scheme offers grants to employers who create new part-time jobs by either:
- Dividing an existing full time job into two part time jobs
- Combining the overtime hours of existing full-time jobs or
- Creating two new part time jobs.
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 LESSON 23 POPULATION

1. What are the causes of population growth?

Ans. The population of a country can increase in two ways:-

1. When the birth rate is higher than the death rate: - The natural rate of increase of population =
Birth rate Death rate. The increase in world population has not been due to an increase in
birth rates the main cause has been a fall in death rates. Medical science has reduced the
incidence of diseases cholera, which had been largely responsible for very high death rates.
Improvements in sanitation, water supplies, transport, food production and education have
also played an important part in lowering death rates.
2. When the number of immigrants exceeds the number of emigrants. : - Migration means the
movement of people. This can be internal that is movement of people within a country, or
external that is movement of people between countries. External migration can effect the total
size of the population. If more people are immigrating (coming in) than emigrating (going out)
then the population size will rise.

2. Discuss the main features of population of UK/Developed country? Compare the structure
of population of developed and developing country?

Ans. In developed country the growth of population is increasing due to decrease in death rate whereas
in developing country the birth rate increases without decrease in death rate. The age distribution
in developed country is 1/3rd of population under 15 years whereas in developing country this is 1/
5th. In developed countries the dependency rates is less as compared to developing country
where the number of dependents on the working group is more. Since females live longer than
males in developed country the ratio of males and females is becoming almost same whereas in
developing country the ratio of male is more than females. In developed country most of the
population is migrated to towns and cities whereas in developing country each state, city and
village is populated. In developed countries the working population is high as compared to developing
country.

3. Sometimes a government might try to limit the population growth of a country. Why?

Ans. If the population increases a country can face various problems like
High population will lead to fewer employment opportunities regulating to increase in poverty
and low standard of living.
It would be difficult for the government to provide basic necessities to all with high population
which may lead to increase in crime rate of the country.
Government develops a country with a contribution. From the population in form of tax. But,
since the country may go through low economic standard this contribution. Also will be low
which will again held govt. from developing.

4. What are the recent trends in the occupational distribution of people in a developed
country? Compare it with the occupational distribution 0f population in a less developed
country?

Ans. The recent trends in the occupational distribution of people is as given below :-
- In a developing country majority of the population depends on primary sector occupations
such as farming, fishing, mining, etc. the main reason for such dependence is lack of educational
& training facilities. Inclination of population towards tertiary sector is less as the population is
poor ad cannot afford the services provided by the tertiary sector. Secondary sector is the
second most important sector of a developing economy as people are engaged in the production
activities but here dependence is more on labour intensive techniques rather than capital
intensive due to lack of technical knowledge.
- In a developed country majority of the population is engaged in tertiary sector oriented
occupations such as banking, insurance, advertisement, etc. this is because people are

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 educated and they are economically in a better position which enables them to enjoy the
services provided by the tertiary sector. It does not mean that the other two sectors are not
given importance but most of the work under these sectors is mechanized and very few people
are required to work there. This reduces the demand for labour and due to automation of work
the output produced is much higher as compared to a less developed country.

5. In most developed countries there will be a large increase in the proportion of older
people in the next 10 years. Discuss how this might cause problem for the government and
affect the pattern of employment? Also discuss the ways the government might do to try to
deal with this situation?

Ans. If there are older people in the population it becomes an expensive deal for the government because
of the following reasons:
The government will have to spend more on the health and medical facilities so as to keep the
population healthy as older people are more prone to illnesses.
Since older people are dependent on the working population it may burden the people working
which may lead to increase in the stress levels and which may in turn lead to an increase in
anti social activities. Again the expenditure of the government increases as it may have to
spend more on maintaining the law and order.
Since there are more older people in the population it directly means that there will be a
reduction in the expenditure on the education and child care benefits. A major part of the
governments revenue will be used up on health care facilities. This may cause serious effects
on the economy in the long run.
Even the transportation facilities will have to be changed so as to make it comfortable for the
elderly people.
The tax burden on the working population will increase as the government needs revenue to
take care of these expenses which may reduce the real disposable income and thus the living
standard of the people.
The retirement age may have to be increased so as to keep the people working for a longer
time or voluntary retirement schemes have to be launched so that young people can secure
the job easily.

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 LESSON 24 ECONOMIC GROWTH

1. Define economic growth and how it is measured?

Ans. Economic growth refers to an increase in a countrys annual output of goods and services. The
measurement of output which is used to measure economic growth is normally the Gross National
Product (GNP). However, the Gross Domestic Product (GDP) is also used for this purpose. The
rate of economic growth is often used as a measurement of changes in the standard of living.

2. Explain a link between a rise in investment and a rise in economic growth. How can it be
achieved?

Ans. Rise in investment and rise in economic growth are directly related. If the investment increases, it
will lead to purchase of real assets/output thereby increasing the production capacity of a firm. If
there is rise in real output/goods then the gross national product will increase which is measured by
the output of a country. This can be achieved in 2 ways:
- A country may have many people out of work and much capital and land idle. If these resources
are put to work, Gross National Product will increase.
- Even when all resources are fully employed, however economic growth is still possible. Increases
in the supplies of labour and capital, and increases in the efficiency with which economic
resources are being used will lead to increase in total output.

3. What are the various benefits and costs of economic growth?

Ans. Economic growth refers to an increase in a countrys annual output of goods and services. The
benefits of economic growth are -

- Improvements in living standards: The main reason for desiring economic growth is to raise
the living standards of the population. More than half of the worlds population now live in great
poverty. For most of these people, the economic problem is getting enough to eat. Economic
growth- more output per person- offers the only real hope of raising their living standards above
a bare subsistence level. The benefits of economic growth need not be in the form of more
goods and services- they can take form of more leisure.

- Better Social Services: When real income per head is increasing, the government will be able
to raise more revenue without increasing the rates of taxation. People will be paying more
taxation but sill be better off. This means that the government will be able to spend more on
education, health and other social services without anyone being worse off.

- National Prestige: In the modern world, a government is often judged to be successful or

unsuccessful according to the countrys rate of economic growth. League tables show the
rates of economic growth in different countries.

Whereas the disadvantages or Costs of economic growth are:

- Social Costs: Economic growth can impose some heavy social costs on the community like
large industrial installations can create problems with pollution and noise. Also the concentration
of industry leads to growth of urban areas with congestion and overcrowded cities.

- Opportunity Cost: Economic growth requires more investment which means that fewer
resources can be used to produce consumer goods. The opportunity cost of increasing the
rate of economic growth is a reduced output of consumer goods while more capital goods are
being produced.

- Non replaceable resources: Our present standard of living depends very much on the use
of resources which cannot be replaced which is again a heavy cost of economic growth.

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4. What are the causes of economic growth?

Ans. The causes of economic growth are:

Capital: Increasing the stock of capital is described as net investment- it is one of the most
important causes of economic growth.

Labour: An increase in the number of workers makes it possible to increase a countrys

output. In these countries, increases in output per head depend upon improvements in the
quality of labour, that is on raising its productivity.

Land: In agricultural countries, land is obviously a most important resource. In industrialized

countries, the supply of land is a less important source of economic growth.

Mobility: In a changing world, a countrys rate of economic growth depends very much on its
willingness and ability to shift its economic resources from declining and low- growth industries
to industries which have better prospects of growth.

Technical knowledge: A most important cause of economic growth is the increase in technical
knowledge. This takes many forms, such as inventions, improvements in the design and
performance of machinery, the development of new materials, and changes in the organization
and methods of production.

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 LESSON 25 ECONOMIC DEVELOPMENT

1. How is a developed country different from a developing country?

1. In developed countries the rational income is high as compared to developing countries because
there is less unemployment, proper utilisation of resources etc.
2. The standard of living is high in a developed country as people are economically in a better
position to enjoy the services provided by the different sectors as majority of the population is
employed whereas this is not the same in a developing economy.
3. The birth rate in a developing country is comparatively higher than a developed country. This is
because in developing countries people lack knowledge about limiting the size of their family.
4. The death rate in developing countries is high due to lack of medical and health care facilities
whereas it is low in developed countries as they have access to better medical facilities.
5. Unemployment is high in developing countries because there is over dependence on primary
and secondary sector which proves to be inefficient as far as employment opportunities are
compared. However in developed countries there is more reliance on secondary and territory
sector as they are known for generating employment opportunities.
6. Poverty is high in developing countries due to high rate of unemployment and population
whereas it is low in developed countries.
7. Utilisation of natural resources is better in developed countries because people are well educated
and are well versed with the technical know how which is the ultimate requirement for optimum
utilisation of resources. However this is not the case in developing countries even though they
have abundant natural resources as people are illiterate unskilled as they lack technical
knowledge.
8. BOP of a developing country is mostly unfavorable as most of the time their imports are
heavier than their exports. Whereas the same in a developed country is favourable as these
countries are in a better position as far as their BOT is concernment.
9. Depending ratio is high in developing countries as people have big families to support whereas
it is low in developed countries as the family size is small.

2. What are the various indicators of standard of living?

Ans. A developing country is one in which the average standard of living is very low as compared to
living standards in developed countries. There are various indicators of standard of living:

- GNP: The gap in living standards between rich and poor countries can be reduced if GNP per
head is under developed grows faster than developed countries.
- Life expectancy is an average life of a person- If the life expectancy rate is high than the
standard of living is high because a person will live longer only if he has access to better health
care facilities.
- Infant mortality rate is the number of deaths of infants in one year per thousand live births in
that year which is a good guide standard of living. In the year where infant mortality rate is low
we can say that a country has a good standard of living.
- Good health and education facilities is also a good indicator for standard of living.
- Proper housing and infrastructure indicates that the standard of living of the population is high.
- If the doctor population ratio is high we can say that the standard of living is high.
- If the school enrollment ratio is high then the standard of living will be high.

3. If a country had good natural resources, would the standard of living of its population
necessarily be high?

Ans. No, it is not necessary that if a country has good natural resources its standard of living will be high
because of the following reasons:
- Standard of living of people in a country depends greatly on the rate of economic development
that is higher the economic development better the standard of living.

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 - Economic development is dependant upon many factors such as availability of natural resources,
capital formation, technical progress or development agricultural and industrial production etc.
- Availability of natural resources is one factor which greatly depends on the geographical location
of a particular country e.g. oil from gulf areas.
- Mere availability of natural resources will do no good to the economic development of the
country until and unless they are utilized in a proper way.
- This can only be possible if the country has good workforce or educated workforce, technological
knowledge and proper planning.
- However, in a developing country there are very often many problems with regards to education
or technology or planning.
- This results in either over exploitation or under exploitation of natural resources. If the natural
resources are over exploited it creates a danger of exhaustion of natural resources at a faster
pace and under-utilisation on the other hand leads to its wastage thus for example over-utilisation
of petrol has created the danger of its exhaustion.
- Thus just the availability of natural resources will not contribute towards the standard of living
unless they are utilized in the right manner.

4. What policies might a government adopt in order to improve the standard of living in its
country?

Ans. Government must adopt certain policies in order to improve standard of living in its country which
are stated below:
- The major difference of rich and poor should be removed by designing the policy in such away
that rich are taxed and poor are given subsidy.
- Government has to help the poor by providing subsidies in basic necessities like food, clothing
so that it improves the standard of living of poor.
- If business are given facilities to produce more and to export more revenue will be generated to
improve standard of living.
- Employment opportunities will be created by setting up industries, encouraging entrepreneurs
to open up their own firms and to provide employment to themselves and others.
- Government should implement policies so as to provide education to all children.
- Government should make health care facilities, proper and easily accessible to the general
public.
- Public sector borrowing: Government should implement policies in such a way that all its
expenses prove out to be beneficial to the general public. The government should utilize its
treasury for infrastructural development purposes.

5. What are the cures for under developed countries?

Ans. Cures for underdevelopment are:

1. Self help that is to improve standards of living, under developed countries must invest in new
roads, transport networks, system of communication and machinery.
2. Foreign Aid i.e. any help provided by foreign countries like
- Food Aid - Food grains provided by developed countries.
- Financial Aid - Finance that a developed country may get through other developed countries
or World Bank.
- Technological Aid - Technologic help from developed countries.
3. Borrowing:
Instead of relying on foreign aid, many developing countries have borrowed money in order to
improve their economies.
4. Trade:
If developing countries have to improve its standard of livings it must produce more manufactured
goods and sell them to the richer developed countries.
5. Population Control:
More people in poor countries means less resources per person. Better education about family
planning would help to reduce this population growth and improve living standards.

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 BIBILIOGRAPHY

1. G. F. STANLAKE, STARTING ECONOMICS

2. SUSAN GRANT, ECONOMICS

3. www.cie.org.uk

4. www.dineshbakshi.com

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