Chapter 16

Money and Banking

Money is anything which is universally acceptable as a medium of
exchange that is generally acceptable as a means of payment.

Forms of Money

 Cash: Bank notes & coins are a physical form of money

 Bank Deposits: these are money reserves placed in commercial banks
accounts. Examples are Cheques, Bank Drafts, Debit Cards, Credit Cards
 Central Bank Reserves: These are money held by central banks and used by
commercial bank to make payments to themselves.

Functions of Money

Medium of Exchange – When money is used to intermediate the exchange of

goods and services, it is performing a function as a medium of exchange. It
thereby avoids the inefficiencies of a barter system. Exchange is easier and less
time consuming in a money economy than in a barter economy.

Measure of Value / Unit of Account – Different commodities can be

expressed in terms of money uniformly. This simplifies the comparison of the
value of two products or services.

Store of Value – To act as a store of value, a money must be able to be reliably

saved, stored, and retrieved – and be predictably usable as a medium of
exchange when it is retrieved. The value of the money must also remain stable
over time.

Standard for deferred payments – Future transactions can be carried on in

terms of money. The loans, which are taken at present, can be repaid in money
in the future.

Money can be used to pay over time for commodities. Goods and services can
be paid for in instalments over a period of time e.g. hire purchase.
Features of money

 Durability: Money must be durable, which means it should be usable for a

long time and must be of good quality. It should not be something that gets
damaged easily or spoiled in a short period of time. Since money is durable,
it can be used as a store of wealth/value.
 Scarcity: Since anything to have economic value, it must be scarce. Money is
scarce and that’s why it has value. People can accept something as money
only if it has value.
 Portability: Money must be something that people can easily carry with
them from one place to another. Today paper currency is used instead of
gold and silver because paper currency is more portable.
 Acceptability: Money must be something that everyone can accept for a
unit of account and medium of exchange.
 Divisibility: Money must be something that can measure all the goods and
services accurately. For this purpose, money must be something that we can
divide into small denominations.
 Stability: Money must be something which has a relatively stable value over
time. It should not lose its value over time. Its function as a store of value
can be fulfilled only if its value is stable.

Central Bank

A central bank is a public institution that manages a state’s currency, money

supply, and interest rates. Central banks also usually oversee the commercial
banking system of their respective countries.

Function of Central bank

1- Issuing Currency
The Central Bank in every country, now, has the monopoly note issue. The
issue of notes is governed by certain regulation which is enforced by the
government.

2-Banker to the state

A Central Bank acts as a banker to the government. It holds cash balances of
the government free of interest.

3-Bankers’ bank.
The central bank acts as a banker to the commercial banks.
4-Bankers’ clearing house
The Central Bank acts as a clearing house for the settlement of mutual
obligations of different commercial banks.

5-Lender of the last resort

The Central Bank helps the member banks in times of crisis.

6-Financial agent
The Central Banks act as financial agents for the government. It is an agent for
the government in purchasing and selling of gold and foreign exchange.

7-Effective monetary policy

The aim of the government is to create employment in the country, resist
undue inflation and achieve a favorable balance of payment.

Commercial Banks

A commercial bank is a retail bank that provides services to its customers such
as accepting deposits and giving bank loans, its main aim is to make a profit.

Primary Functions

1. Accepting Deposits: commercial banks accept deposits from their

customers. These deposits could be sights deposits which are always
available on demand or time deposits which comes with a fixed period of
time.
2. Giving Loans: They provide loans to their customers which could be in form
of overdraft or mortgage for acquiring properties.
3. Credit Creation: This process ensures that banks increase money supply in
an economy by making money available to borrowers.

Secondary Functions

1. Offering financial advice to clients and government

2. Providing money transfer avenues
3. Providing internet banking activities
4. Providing safety deposit boxed for valuables
5. Collecting and clearing cheques on behalf of their clients
 Chapter 17
Households

TYPES OF PERSONAL INCOME

1. Gross personal income: This is the total personal income from all sources of
an individual.

2. Disposable personal income: This is the amount which remains after

income tax and national insurance contributions have been deducted from
gross personal income.
Disposable personal income = Gross personal income – Income Tax & NI
contribution.

3. Real disposable personal income: This refers to the quantity of goods &
services which disposable income can buy. It is the purchasing power of
money income.

CONSUMPTION/SPENDING

• Consumption involves the using up of goods and services to satisfy wants

• People earn money to buy goods and services they want and need but do
not produce themselves in their work
• The income a person has left after income-related taxes and social security
contributions have been deducted is called disposable income
• The person may dispose of this income as they please
• The more disposable income a person has, the more their potential
consumer expenditure on goods and services is

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 FACTORS INFLUENCING CONSUMER SPENDING

1. Disposable Income - (more real income more spending). As income rises,

people usually spend more in total, but less as a percentage of their
income.
2. Wealth – (more wealth held more spending)
▪ Wealth generates income, eg dividends on shares which can be
spent.
▪ Wealth can be sold to generate money.
▪ Wealth also can be used as a security for loans.
▪ Wealth also creates confidence in the people. If the value of a house
rises, people feel richer and will spend more on products.

3. Rate of interest (low rate of interest more spending)

▪ When the rate of interest falls, people will spend more as borrowing
becomes cheaper and saving will be discouraged.
▪ With a rise in the rate of interest, people will save more of their disposable
incomes in order to earn higher interest income.

4. Rate of income tax – As Income tax rises, disposable income falls, leading
to lower consumption.
5. Distribution of income - A more even distribution of income and transfer of
income the rich to the poor is likely to increase spending.
6. Confidence- If people feel optimistic about their future career prospects
and income, they are likely to spend more.

SAVING

• Saving involves a person delaying consumption until some later time when
they withdraw and spend their savings plus any interest earned

• The more disposable income a person has, the more they will be able to
save

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 • The savings ratio measures the proportion of the total disposable income
saved in an economy = S/Y

FACTORS INFLUENCING SAVING

1. Disposable Income- if the amount of disposable income people have is

high, the more likely that they will save. Thus, rich people save more than
poor people

2. Wealth- wealthy people find it easier to save

3. Tax treatment of saving- Tax concessions on the income earned from

saving will encourage people to save.

4. Interest Rate: A rise in the interest rate promotes saving

people also save so that their savings may increase overtime with the
interest added. Interest is the return on saving; the longer you save an
amount and the higher the amount, the higher the interest received.

5. Age Structure- The young and the old save less than the middle aged
people.

6. Social attitude- The attitude to savings varies between countries.

7. Range and quality of financial institutions: the more ways people can
save, the more they may be tempted to.

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BORROWING

• A consumer may borrow money to increase their expenditure on goods and

services

• They can then make repayments overtime from future earnings

• The total stock of accumulated borrowing by a person is called their

personal debt.

FACTORS AFFECTING BORROWING

1. Interest Rates: interest is also the cost of borrowing. When a person takes
a loan, he must repay the entire amount with an extra amount interest,
which is fixed by the bank. When the interest rates rise, people will be
more reluctant to borrow and vice versa

2. Consumer Confidence: how confident people feel about financial situation

in the future may affect borrowing, too. For example, if they think that
prices will rise (inflation) in the future, they might borrow now, so that they
can make big purchases

3. Availability of loans and overdrafts: the easier it is to borrow money, the

greater the demand for loans.

4. Social Attitude- The attitude towards borrowing varies from country to

country. Some people consider borrowing risky.

Expenditure patterns between income groups

 The richer people spend, save and borrow more amounts than the poor.
 The poor spend more proportion of their disposable income, especially on
necessities, than the rich.

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  The poor save less proportion of their disposable income in comparison
with the rich.

Relationship between saving and Disposable income

Relationship between consumption and disposable income

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 Chapter 18
Workers
What are wages?
Wages are the reward to the factor of production – Labour. Wages are also
regarded as the Price of labour. Wages are payments made to labour. Price of
labour is determined by the market forces i.e. demand and supply.

Why earnings of Occupations change over time?

 Changes in demand and supply of labour

 Changes in stages og production
 Changes in bargaining power
 Changes in Government policy
 Changes in Public opinion
 Changes in earnings of individuals overtime

Demand for labour

Demand for labour rises with a fall in wage rate and decreases with a rise in
Wages. Demand curve of labour slopes downward.

Factors affecting the demand for labour

Increase in demand for the product- The demand for labour is always derived
from the demand for the good or service it produces. Thus if the demand for a
particular goods or service increase it will lead to a rise in demand for labour
used to produce those commodities. Hence, Demand for labour is a derived
demand.

Wage rates - A fall in wages will cause an extension in the demand for labour
while a rise in wages paid to works will cause a contraction in demand.
Productivity - Higher labour productivity will cause the demand for labour to
increase.

Rise in price of capital- When labour is easily substitutable with capital

demand for labour will fall.
Supply of labour
Supply of labour increases with the rise in wage rate. The supply curve of
labour normally slopes upward to the right.

Factors affecting the supply of labour

Wage and non-wage benefits- The supply of labour will increase with the
increase in wages or non-wage benefits. This is because more workers will be
attracted by a higher wage rate and better fringe benefits.

Size of the Labour force- An increase in population will lead to an increase in

supply of labour of the labour force

Working age- Lowering the working age of will increase the supply of labour.
An increase in the retirement age will increase the supply of labour.

Educational requirement- Jobs which need special training or educational

qualifications will see less supply of labour as compared to jobs which don’t
need high level of educational qualification.

Why wages differ?

Reasons for differences in remuneration:

 Skills/training: Jobs requiring higher level of skills and training usually

fetch higher remuneration
 Education/qualifications: Again jobs requiring higher level of
education/qualification are paid higher remunerations.
 Experience: People with vast experience will get higher remuneration as
compared to a person with lesser experience.
 Level of responsibility: Jobs with greater responsibilities are usually paid
more.
 Geographical area: Jobs located in urban areas are usually carrying
higher remunerations because of higher living costs in cities. People
working in treacherous geographical areas may get extra remuneration
in the form of additional allowances.
 Trade union membership: Trade Union members might end up
negotiating better remunerations then non-trade union members.
 Demand factors: Firms producing goods and services which are high in
demand usually pay better remunerations to their workers.
  Supply factors: Industries where there is a shortage of workers will
usually pay higher remuneration to attract workers.

What is Specialisation?
Through years, production has developed into a complicated process and thus
broken down into a series of highly specialised task. Each task is then
performed by a worker. This is known as Division of Labour.

Advantages of Division of Labour

 Practise makes perfect: Worker specialises in a particular task and gives

in the best, thus producing goods faster and less wastage of material.
 Use of machinery: Specialised machinery can be used which is further
increase the productivity.
 Increased Output: with improvement in efficiency and use of machinery
output is increased.
 Saves time: There is no time wasted in switching of jobs and thus the
momentum of production can be maintained which leads to less
wastage of time.

Disadvantages of Division of Labour

 Boredom: Performing the same task over and over again may lead to
boredom for the workers.
 Lack of variety: Though the number of goods produced increases but
they are identical or standardized.
 Low motivation for worker: Repeatedly performing the same task may
lead to low motivation level for the worker. The worker might not have
the sense of fulfilling a complete task as he is performing only a part of
the job.
 Lack of mobility: Due to specialisation workers might find it difficult to
switch between occupations.

Factors affecting individual's choice of job

An individual might be influenced by many factors while choosing a job. These
factors are divided into wage factors and non-wage factors and limiting factors.
Wage Factors

 Wages: A payment which an employer contracts to pay a worker. It can

be paid per unit of time (Time rate) or per unit of output (piece rate).
 Overtime pay: It is paid to workers who work in excess of the standard
working week. It is usually paid at a higher rate.
 Bonuses: It is an extra payment received when a worker produces above
the standard output or contributes to increasing profits of the business.
 Commission: It is often paid to sales staff as an incentive to increase
sales of the business. It is a proportion of the sales revenue that they
make.

Non-wage factors
Here are some of the non-wage factors which might influence an individual's
choice.

 length/number of holidays
 Job satisfaction
 working conditions/environment
 hours of work
 promotion/career prospects
 location/ travelling distance
 size of company
 Pensions
 Fringe benefits
 Job security
 Size of the firm

Limiting factors

 Skills
 Qualifications
 Experience
 Place where worker lives

How to wage rate is determined?

The wage rate in a particular industry is determined by the market forces i.e.
demand and supply.
A rise in the demand for labour will lead to a rise in the equilibrium wage
rate.

A fall in the supply of labour will result in a rise in the equilibrium wage rate.
Why would a person’s wage rate change overtime?

As a beginner, the individual would have a low wage rate since he/she is new
to the job and has no experience. Overtime, as his/her experience increases
and skills develop, he/she will earn a higher wage rate. If he/she gets
promoted and has more responsibilities, his/her wage rate will further
increase. When he/she nears retirement age, the wage rate is likely to
decrease as their productivity and skills are likely to weaken.
 Chapter 19
Trade Unions

Trade Unions are associations of workers formed to represent their interests. They aim on
improving wage rates, working conditions and other job-related aspects.

Types of Trade unions

• Craft unions. These represent workers with particular skills, for example plumbers and
weavers. These workers may be employed in a number of industries.
• General unions. These unions include workers with a range of skills and from a range of
industries.
• Industrial unions. These seek to represent all the workers in a particular industry, for
example, those in the rail industry.
• White collar unions. These unions represent particular professions, including pilots and
teachers.

Functions of a trade union:

 Negotiate on behalf of their members improvements in non-wage benefits with employers.

 Defending employees’ rights.
 Improving working conditions, such as better working hours and better safety measures.
 Improving pay and other benefits.
 Supporting workers who have been unfairly dismissed or discriminated against.
 Developing the skills of members, by providing training and education.
 Providing recreational activities for the members.
 Taking industrial actions (strikes, overtime ban etc.) when employers don’t satisfy their needs.

Collective bargaining
 It is a process which involves representatives of workers negotiating with employers’
associations.
 An individual worker may not have the skill, time or willingness to negotiate with her
or his employer and has limited bargaining power to press for a wage rise or an
improvement in working conditions. The employer may be able to replace the worker.
Trade unions enable workers to press their claims through collective bargaining.

When can trade unions argue for higher wages and better working conditions?

 High level of skill

 Increased cost of living
 High number of members
 Consistent demand of the firm’s product
 Workers in other firms are getting a higher pay.
 High level of economic activity- increase in income and output
 Favourable government legislation

Factors that affect strength of Trade unions

• A high level of economic activity.

• A high number of members. The more members a union has, the more funds it is likely
to have to finance its activities
• A high level of skill. Unions representing skilled workers are in a relatively strong
position, as it can be difficult to replace their workers with other skilled workers and
expensive to train unskilled workers.
• A consistent demand for the product produced by the workers. Unions that
represent workers making goods and services that are essential to consumers are in a
strong position to bargain.
• Favourable government legislation. A union will be in a stronger position if laws allows
Trade unions to take action.

Industrial disputes
When workers disrupt production to put pressure on employers to agree to their demands.

 Overtime ban: workers refuse to work more than their normal hours.
 Go-slow: workers deliberately slow down production, so the firm’s sales and profits go
down.
 Work to rule: workers undertake tasks required by their contracts only.
 Strike: workers refuse to work to put pressure on the employer to agree to their
demands.

Advantages to workers:

 Workers benefit from collective bargaining power by being able to establish better terms of
labour.
 Workers feel a sense of unity and feel represented, increasing morale.
 Lesser chance of being discriminated and exploited.

Disadvantages to workers:

 Workers might get lesser wages or none if they go on strike – as the output and profits of the
firm falls and they refuse to pay.

Advantages to firms:

 Time is saved in negotiating with a union when compared to negotiating with individual
workers.
 When making changes in work schedules and practices, a trade union’s cooperation can
help organise workers efficiently.
 Mutual respect and good relationships between unions and firms are good for business
morale and increases productivity.

Disadvantages to firms:

 Decision making may be long as there will be need of lengthy discussions with trade unions in
major business decisions.
 Trade unions may make demands that the firm may not be able to meet – they will have to
choose between profitability and workers’ interests.
 Higher wages bargained by trade unions will reduce the firm’s profitability.
 Businesses will have high costs and low output if unions organise agitations. Their revenue and
profits will go down and they will enter a loss.

Advantages to the economy:

 Ensures that the labour force in the economy is not exploited and that their interests are
being represented.

Disadvantages to the economy:

 Can negatively impact total output of the economy.

 Firms may decide to substitute labour for capital if they can’t meet trade unions’ expensive
demands, and so unemployment may rise.
 Higher wages resulting from trade union activity can make the nation’s exports expensive and
thus less competitive in the international market.

Realistic Approach

In modern times, the powers of trade unions have drastically weakened. Globalisation,
liberalisation and privatisation of economies are making markets more competitive. Firms
have more incentive to reduce costs of production to a minimum in order to remain
competitive and profitable. Therefore, it is much harder for unions to force employers to
increase wages. Most unions operating nowadays are more focused on bettering working
conditions and non-monetary benefits.
 Chapter 20
Firms

Classification of Firms
 the sectors they operate (stages of production)
 ownership
 the relative sizes.

based on stages of production

 Primary: all economic activity involving extraction of raw natural materials. This includes
agriculture, mining, fishing etc.
 Secondary: all economic activity dealing with producing finished goods. This includes
construction, manufacturing, utilities etc.
 Tertiary: all economic activity offering intangible goods and services to consumers. This
includes retail, leisure, transport, IT services, banking, communications etc. This sector is
now the fastest-growing sector as consumer demand for services have increased in
developed and developing nations.
 Quaternary: This is a subsection of the services sector, and includes those services which
are involved with the collection, processing and transmission of information, essentially
information technology.

On the basis of ownership

 Public: this includes all firms owned and run by the government. Usually, the defence, arms
and nuclear industries of an economy are completely public. Public firms don’t have a profit
motive, but aim to provide essential services to the economy.
 Private: this includes all firms owned and run by private individuals. Private firms aim at
making profits.

On basis of size of firms

 The age of the firms

 Availability of financial capital
 Type of business organisation
 Internal economies and diseconomies of scale
 Size of the market

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 Small Firms
 A small firm is an independently owned and operated enterprise that is limited in
size and in revenue depending on the industry.
 They require relatively less capital, less workforce and less or no machinery.
 These businesses are ideally suited to operate on a small scale to serve a local
community and to provide profits to the owners.

Advantages of small businesses:

 Independence: owner(s) are free to run the business as he/she pleases.

 Control: the owner(s) has full control over the business, unlike in a large business where
multiple managers, departments and branches will exist.
 Flexibility: small businesses can adapt to quick changes as the owner is more involved in the
decision-making.
 Better communication: since there are fewer employees, information can be intimated
easily and quickly.
 Innovation: small businesses can tend to be innovative because they have less to lose and
are willing to take risks.

Disadvantages of small businesses:

 Higher costs: small firms cannot exploit economies of scale – their average costs will be
higher than larger rivals.
 Lack of finance: struggles to raise finance as choice of sources of acquiring finance is limited.
 Difficult to attract experienced employees: a small business may be unable to afford the
wage and training required for skilled workers.
 Vulnerability: when economic conditions change, it is harder for small businesses to survive
as they lack resources.

Reasons why small firms exist:

 Size of the market: when there is only a small market for a product, a firm will see no point
in growing to a larger size. The market maybe small because:
 the market is local – for example, the local hairdresser.
 the final product maybe an expensive luxury item which only require small-scale
production (e.g. custom-made paintings)
 personalised/custom services can only be given by small firms, unlike large firms that
mostly give standardised services (e.g. wedding cake makers).
 Access to capital is limited, so owners can’t grow the firm.
 Owners preference: a lot of entrepreneurs don’t want to take risks by growing the firm and
they are quite satisfied with running a small business.
 co-operation between small firms: co-operation between small firms can lead them to set
up jointly owned enterprises which allow them to enjoy many of the benefits that large
firms have.

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 Governments support: governments provide financial help and advice to small firms as

small firms provide employment opportunities, develop skills of entrepreneurs and have the
potential to grow into large firms.

Growth of Firms

When a firm grows, its scale of production increases. Firms can grow in two ways:

 internally
 externally.

Internal Growth/Organic Growth

This involves expanding the scale of production of the firm’s existing operations. This can
be done by purchasing more machinery/equipment, opening more branches, selling new
products, expanding business premises, employing more workers etc.

External Growth

This involves two or more firms joining together to form a larger business.
This is called integration. This can be done it two ways: mergers or takeovers.
Takeover
 A takeover or acquisition happens when a company buys enough shares of another
firm that they can take full control.
 The firm taken over loses its identity and becomes a part of what is known as the
holding company. A well-known example would be Facebook’s acquisition of
WhatsApp in 2014.
Merger

A merger occurs when the owners of two or more companies agree to join together to form
a firm.

Horizontal Integration:

Integration of firms engaged in the production of the same type of good at the same level
of production. Example: a cloth manufacturing company merges with another cloth
manufacturing company.

Advantages:

 Exploit internal economies of scale: including bulk-buying, technical economies,

financial economies.

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 Save costs: when merging, a lot of the duplicate assets including employees can be laid
off and unnecessary equipment can be sold leading to more efficiency- rationalisation
 Potential to secure ‘revenue synergies’ by creating and selling a wider range of
products.
 Reduces competition: by merging with key rivals, the two firms together can increase
market share as a direct competitor is eliminated.

Disadvantages:

 Risk of diseconomies of scale: a larger business will bring with a lot of managerial and
operational issues leading to higher costs.
 Reduced flexibility: the addition of more employees and processes means the need for
more transparency and therefore more accountability and red tape, which can slow
down the rate of innovating and producing new products and processes.

Vertical Integration:

Integration of firms engaged in the production of the same type of good but at different
levels of production. Example: a cloth manufacturing company (secondary sector) merges
with a cotton growing firm (primary sector).
 Forward vertical integration: when a firm integrates with a firm that is at a later stage of
production than theirs. Example: a dairy farm integrates with a cheese manufacturing
company.
 Backward vertical integration: when a firm integrates with a firm that is at an earlier
stage of production than theirs. Example: a chocolate retailer integrates with a
chocolate manufacturing company.

Advantages:

 It can give a firm assured supplies or outlets for their products.

 The firm can prevent supplying materials or selling products to competitors.
 The profit margins of the supplier or outlet can now be absorbed by the merged firm.
 The firms can increase their market share and become more competitive in the market.

Disadvantages:

 Risk of diseconomies of scale: a larger business will bring with a lot of managerial and
operational issues leading to higher costs
 Reduced flexibility: the addition of more employees and processes means the need for
more transparency and therefore more accountability and red tape, which can slow
down the rate of innovating and producing new products and processes
 It’s a difficult process: The managers may not be familiar with the operations of the
supplier or outlet. This will require staff of either firm to be educated and trained. Some
might even lose their jobs

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 Lateral/Conglomerate integration:

This occurs when firms producing different type of products integrate. They could be at the
same or different stages of production. Example: a housing company integrates with a dairy
farm. Thus, the firm can produce a wide range of products. The main motive is
diversification.

Advantages:

 Diversify risks: conglomerate integration allows businesses to have activities in more

than one market. This allows the firms to spread their risks. In case one market is in
decline, it still has another source of profit.
 Creates new markets: merging with a firm in a different industry will open up the firm to
a new customer base, helping it to market its core products to this new market.
 Transfer of ideas: there could be a transfer of ideas and resources between the two
businesses even though they are in different industries. This transfer of ideas could help
improve the quality and demand for the two products.

Disadvantages:

 Inexperience can lead to mismanagement: if the firms are in entirely different industries
and have no experience in the other’s industry, cooperating and managing the two
industries may be difficult and could turn disastrous.
 Lose focus: merging with and focusing on an entirely new industry could cause the firm to
lose focus of its core product.
 Culture clash: as with all kinds of mergers, there could be a culture clash between the two
firms’ employees on practices, standards and ‘how things are done’.

Economies of scale

Economies of scale are the advantages in the form of lower long run average costs, of

producing on a large scale.

Internal economies of scale

Lower long run average costs resulting from a firm increasing its scale of production.

 Purchasing economies: large firms can be buy raw materials and components in bulk
because of their large scale of production. Supplier will usually offer price discounts for bulk
purchases, which will cut purchasing costs for the firm.
 Selling economies: large firms can afford their own vehicles to distribute their products,
which is much cheaper than hiring other firms to distribute them. Also, the costs of
advertising are spread over a much large output in large firms when compared to small
firms.

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 Financial economies: banks are more willing to lend money to large firms since they are
more financially secure (than small firms) to repay loans. They are also likely to get lower
rates of interest.
 Technical economies: large firms are more financially able to invest in good technology,
skilled workers, machinery etc. which are very efficient and cut costs for the firm.
 Risk-bearing economies: large firms with a high output can sell into different markets (even
overseas). They are able to produce a variety of products (diversification in production).
This means that their risks are spread over a wider range of products or markets.
 Managerial economies of scale: Large firms can afford to employ specialist staff in key posts
as they can spread their pay over a high number of units. Employing specialist buyers,
accountants, human resource managers and designers can increase the firm’s efficiency,
reduce costs of production, and raise demand and revenue.
• Labour economies: Large firms can engage in division of labour among their other staff.
For example, car workers specialise in a particular aspect of the production process.
Research and development economies. A large firm can have a research and development
department, that can reduce average costs by developing more efficient methods of
production and raise total revenue by developing new products.

External economies of scale

External economies of scale occur when firms benefit from lower long run average costs
resulting from the entire industry growing in size.

 Access to skilled workers: large firms can recruit workers trained by other firms. For
example: when a new training institution for pilots and airline staff opens, all airline firms
can enjoy economies of scale of having access to skilled workers, who are more efficient and
productive, and cuts costs.
 Ancillary firms: they are firms that supply and provide materials/services to larger firms.
When ancillary firms such as a marketing firm locates close to a company, the company can
cut costs by using their services more cheaply than other firms.
 Joint marketing benefits: when firms in the same industry locate close to each other, they
may share an enhanced reputation and customer base.

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 Shared infrastructure: development in the infrastructure of an industry or the economy can
benefit large firms. Examples: more roads and bridges by the govt. can cut transport costs
for firms, a new power station can provide cheaper electricity for firms.
 Good reputation
 Improved infrastructure: The growth of an industry may encourage a government and private
sector firms to provide better road links and electricity supplies, build new airports and develop dock
facilities.
 Specialist markets. Some large industries have specialist selling places and arrangements such as
corn exchanges and insurance markets
 Specialist services Universities and colleges may run courses for workers in large
industries and banks, and transport firms may provide services specially designed to
meet the particular needs of firms in the industry.

Internal Diseconomies of scale

Diseconomies of scale occur when a firms grows too large and average costs start to rise.

 Difficulties controlling the firm. It can be hard for those managing a large firm to
supervise everything that is happening in the business. A number of layers of management
may be needed and there may be a need for more meetings. This can increase administrative
costs and make the firm slower in responding to changes in market conditions.
 Communication problems.
Employees may not get the opportunity to effectively communicate their views and ideas to
the management team leading to demotivation.
 Poor industrial relations. Large firms may be at a greater risk from a lack of
motivation of workers, strikes and other industrial action. This is because workers
may have less sense of belonging, longer time may be required to solve problems and
more conflicts may arise due to the presence of diverse opinions.

External Diseconomies of Scale

These occur when an industry grows too large in size, resulting in increased average costs.
 Increased traffic congestion- With an increase in number of firms, transport of raw
materials, finished products and workers increases leading to increased traffic
congestion resulting in higher journey times and increased transport costs.
 Increased competition for resources- More number of firms may cause an increased
demand for resources pushing up the prices of key sites, capital equipment and
labour resulting in increased average costs.

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In the short run:

 A firm that doubles all its inputs (resources) and is able to more than double its
output as a result, experiences increasing returns to scale.
 A firm that doubles all its inputs and fails to double its output as a result, experiences
a decreasing or diminishing returns to scale.

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 Chapter 21
Firms and production

Factors determining demand for factors of production

 The demand for the product: if more goods and services are demanded by consumers,
more factors of production will be demanded by firms to produce and satisfy the demand.
That is, the demand for factors of production is derived demand, as it is determined by the
demand for the goods and services (just like demand for labour).
 Type of product: standardised or unique
 The availability of factors: firms will also demand factors that are easily available and
accessible to them. If the firm is located in a region where there is a large pool of skilled
labour, it will demand more labour as opposed to capital.
 The price of factors: If labour is more expensive than capital, firms will demand more capital
(and vice versa), as they want to reduce costs and maximize profits.
 The productivity of factors: If labour is more productive than capital, then more labour is
demanded, and vice versa.

Labour-intensive production

Labour-intensive production is where more labour is employed than capital.

It is usually adopted in small-scale industries, especially those that produce personalised,
handmade products. Examples: hotels and restaurants.

Advantages:

 Flexibility: labour, unlike most machinery can be used flexibly to meet changing levels of
consumer demand, e.g., part-time workers.
 Personal services: labour can provide a personal touch to customer needs and wants.
 Personalised services: labour can provide customised products for different customers.
Machinery is not flexible enough to provide tailored products for individual customers.
 Gives feedback: labour can give feedback that provide ideas for continuous improvements
in the firm.
 Essential: labour is essential in case of machine breakdowns. After all, machines are only as
good as the labour that builds, maintains and operates them.

Disadvantages:

 Relatively expensive: in the long-term, when compared to machinery, labour has higher per
unit costs due to lower levels of productivity.

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 Inefficient and inconsistent: compared to machinery, labour is relatively less efficient and
tends to be inconsistent with their productivity, with various personal, psychological and
physical matters influencing their quantity and quality of work.
 Labour relation problems: firms will have to put up with labour demands and grievances.
They could stage an overtime ban or strike if their demands are not met.

Capital-intensive production

is where more capital is employed than labour. It is a production which requires a relatively
high level of capital investment compared to the labour cost. Most capital-intensive
production is automated (example: car-manufacturing).

Advantages:

 Less likely to make errors: Machines, since they’re mechanically or digitally programmed to
do tasks, won’t make the mistakes that labourers will.
 More efficient: machinery will be more efficient and can operate 24/7 as no breaks or
holidays required.
 Consistent: consistent quality output is produced.
 Technical economies of scale: increased efficiency can reduce average costs

Disadvantages:

 Expensive: the initial costs of investment is high, as well as possible training costs.
 Lack of flexibility: machines need not be as flexible as labourers are to meet changes in
demand.
 Machinery lacks initiative: machines don’t have the intuitive or creative power that human
labour can provide the business, and improve production.

Production and Productivity

 Production is the transformation of raw materials (input) to finished or semi-finished

goods and services (output).

 Production is the adding value to inputs to create outputs.

Productivity

 Productivity measures the amount of output that can be produced from a given
amount of input over a period of time.
 Productivity = Total output produced per period / Total input used per period

Productivity increases when:

 more output or revenue is produced from the same amount of inputs

 the same output or revenue is produced using fewer resources.

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 (Labour productivity is the measure of output that can be produced by each worker in a
business).

Factors that influence productivity:

 Division of labour: division of labour is when tasks are divided among labourers. Each
labourer specializes in a particular task, and thus this will increase productivity.
 Skills and experience of labour force: a skilled and experienced workforce will be more
productive.
 Workers’ motivation: the more motivated the workforce is, the more productive they will
be. Better pay, working conditions, reasonable working hours etc. can improve productivity.
 Technology: more technology introduced into the production process will
increase productivity.
 Quality of factors of production: replacing old machinery with new ones, preferably with
latest technologies, can increase efficiency and productivity. In the case of labour, training
the workforce will increase productivity.
 Investment: introducing new production processes which will reduce wastage, increase
speed, improve quality and raise output will raise productivity. This is known as lean
production.

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 Chapter 22
Firms, costs, revenue and Objectives

Total Cost (TC) – is the total amount that has to be spent on the factors of production used
to produce a product. The higher the output, more will be the total cost of production.

Fixed costs (FC) are costs that are constant in the short run and have to be paid even when
there is no output. Examples: rent, interest on bank loans, telephone bills.

Average Fixed Cost (AFC) = Total Fixed Cost (TFC) / Total Output
Average fixed cost (AFC) is total fixed cost divided by output. As total fixed cost is constant,
a higher output will reduce average fixed cost. It falls as output increases.

Variable costs (VC) are costs that change with output in the short run and are paid
according to the output produced. The more the production, the more the variable costs
are. Examples: wages, electricity bill, cost of raw materials.
 As output increases, total variable cost rises slowly at first and then rises more
rapidly. This is because productivity often rises at first and then declines.
Average Variable Cost (AVC) = Total Variable Costs (TVC) / Total Output

Total Costs (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC)

 This is a simple graph showing the relation between TC, FC and VC. The gap between
the TC and TVC indicates the TFC

Average cost or Average total Cost (ATC) is the cost per unit of output.
Average Total Cost (ATC) = Total Cost (TC) / Total Output or
 Average Cost (AC) = Average Variable Cost (AVC) + Average Fixed Cost (AFC)

(Remember ‘average’ means ‘per unit’ and so will involve dividing the particular cost by the
total output produced. In the graphs above you will notice that the average variable costs
and average total costs first fall and then start rising. This is because of economies of scale
and diseconomies of scale respectively. As the firm increases its output, the average costs
decline but as it starts growing beyond a limit, the average costs rise).

Revenue

Revenue is the total income a firm earns from the sale of its goods and services. The more
the sales, the more the revenue.

Total Revenue (TR) = No. of units sold (Sales) * Price per unit (P)
Average Revenue = Total Revenue (TR) / No. of units sold (Sales) = Price per unit (P)

Total Revenue – Total Cost = Profit

: The average and total revenue curves of a perfectly competitive firm

Objectives of Firms

 Survival
new or small firms usually have survival as a primary objective. Firms in a highly
competitive market will also be more concerned with survival rather than any other
objective. During a recession and falling demand, firms will have survival as their key
objective.

 Profit maximisation
Private sector firms usually have profit maximisation as a primary objective. This is
because profits are required for further investment into the business as well as for
the payment of return to the shareholders/owners of the business. Usually, firms aim
to maximise their profits by either minimising costs, or maximising revenue, or both.

 Growth
Once a business has passed its survival stage it will aim for growth and expansion. This is
usually measured by value of sales or output. Aiming for business growth can be very
beneficial. A larger business can ensure greater job security and salaries for employees.
The business can also benefit from higher market share and economies of scale.

 Market share
Market share can be defined as the sales in proportion to total market sales achieved by
a business. Increased market share can bring about many benefits to the business such
as increased customer loyalty, setting up of brand image, etc.

 Social welfare
State owned enterprises may be given the aim of social welfare by the government.They
may charge low prices to ensure they are affordable to all. They will base their decisions on
social costs and benefits.

 Profit satisficing
This involves making enough dividends to keep shareholders happy while pursuing other
objectives. A firm may be prepared to sacrifice some profit, at least in the short run, in
order to improve staff facilities or to get their raw materials from more sustainable
sources.

Why do business objectives change?

A business’ objectives do not remain the same forever. As market situations change and as
the business itself develops, its objectives will change to reflect its current market and
economic position. For example, a firm facing serious economic recession could change its
objective from profit maximization to short term survival.
 Chapter 23

Market Structure
Market structure refers to those characteristics of a market that influence the behaviour of
buyers and sellers and the outcome they achieve in terms of product, quality and price.
These characteristics include:

 number and size of firms in the market

 the degree and intensity of price and non-price competition
 the nature of barriers to entry.

Firms can compete with each other in the following ways:

1. Price competition which involves cutting prices below that of rival products in other to
boost sales and market share. If demand is price inelastic, cutting price may not boost
sales and it will reduce the profit margin between price and average cost.
2. Non-price competition: This involves competing on all other products features other
than price. It can involve new product development, product placements in trade fairs,
promotional campaigns, after sales care etc. Non-price competition is important because
consumers do not just compare product prices, they are also out for the best value for
money.

Competitive markets

A market with a large number of firms. That compete with each other.

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Features

 Each firm has a relatively small market share, which means the change in output of
one firm has no effect on price. Firms are price takers.
 Consumers can switch between products of rival firms.
 There is free entry and exit from the market, i.e. there are no barriers to the market
 In the short run, they earn super normal profit.
 In the long run, they earn normal profits.

Monopoly Markets

A market with a single supplier. It can set any price it wishes since it has all the market
power. Consumers do not have any alternative and must pay the price set by the seller.

Pure monopoly- 100% market share

Dominant monopoly- 40% market share

Monopoly (some governments)- 25% market share

Features of monopoly

 The firm is the industry. It has 100% market share.

 The firm is a price maker. Its output is the industry’s output and changes in its supply will
affect the market price.
 There are high barriers to entry and exit, making it difficult for new firms to enter the
market.
 The firms will make supernormal profits in the short and long run due to barriers to
entry.

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Advantages of Monopoly

 Monopolies avoid wasteful duplication of capital equipment and hence avoids

wastage of resources.
 As monopoly produces on a large scale, its unit cost and price may be lower than a
firm in a competitive market. It enjoys economies of scale as it is the only supplier of
product or service in the market. The benefits can be passed on to the consumers in
the form of lower prices.
 Due to high profits, monopolies can invest in research and development and may
introduce new products.
 Source of revenue for the government- the government gets revenue in form of
taxation from monopoly firms.

Disadvantages of monopoly

 Less incentive to innovate than firms in competitive firms. The lack of competition means
that monopolist become complacent rather than focusing on newer innovations for their
survival.
 No incentive to reduce costs due to absence of competition resulting in productive
inefficiency.
 A monopoly may restrict the supply to push up prices and may produce poor quality
products knowing that consumers cannot switch to rival products.
 It may also fail to respond to changes in consumer tastes and not develop new products
making it allocatively inefficient.

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