Compiled Micro-Economics Notes

Nixor O Levels
MICRO- ECONOMICS NOTES
By: Miss Madiha Charania
MICRO ECONOMICS
The nature of the economic problem
The basic economic problem arises as humans have unlimited wants and
resources* available to fulfill such wants are limited or finite. This is known as the
problem of scarcity.
Due to scarcity, people are forced to make choices. Thus, individuals or
governments have to rank their choices and decide the allocation of resources for
production of goods that have top priority, as it is impossible to satisfy all wants.
*Resources available in the world are of two types:
Non-
Renewable
renewable
Renewable resources are commodities such as solar energy, oxygen, fish stocks or
forestry that is inexhaustible or replaceable over time.
Non-renewable resources are those which are available in fixed quantities and are
limited in supply. Examples include metal ores, oil and coal.
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When a choice is made, it results in an opportunity cost. It is the next best
alternative that is forgone. For instance, an individual may have to choose between
studying for economics test or watch Netflix. If he decides to study for the test,
watching Netflix becomes an opportunity cost.
The economic problem of scarcity is faced by the agents such as consumers,
workers, producers and the government. Hence, each of them have to make a
choice, which results in an opportunity cost.
Consumers
• An individual might be faced with a situation where he can either
buy airpods or apple watch with his current savings
Workers
• A worker might face an opportunity cost in terms of his career
choice. For instance, I can choose to be a teacher or an accountant
with my current credentials
Producers
• A producer have to decide what to make. In a given agricultural
field, a farmer might have to decide to grow wheat or tomatoes.

Factors of Production
Resources are commonly known as factors of production. It includes all the inputs
used in the production of a good or service. There are four factors of production:
land, labor, capital and enterprise
Land:
It is quite a broad category as a factor of production in that it refers to all natural
resources. These resources are gifts that are given by nature. It can range from land
used for agriculture or commercial real estate, as well as the natural resources
derived from land. These resources can be renewable, such as forests, or non-
renewable such as oil or natural gas
The income earned from land or other such natural resources is called rent.
Labor:
Labor includes any human input. This includes both the mental and physical effort,
involved in producing goods and services. On the mental side of this factor of
production are laborers like artists producing art, or programmers creating
software. On the more physical side of labor might be food service workers,
construction workers, or factory workers.
The income earned by labor resources is called wages.
Capital:
These are man-made goods used in the production of other goods. Their use in
commercial production is what separates them from more widely used consumer
goods. It include hammers, forklifts, computers, and delivery vans.
The income earned by owners of capital resources is called interest.
Enterprise:
It is the willingness and ability to bear uncertain risks and to make decisions in a
business. Entrepreneurs are the people who organize the other factors of
production. They crucially bear the risk of losing their money in case of business
failure.
The income an entrepreneur receives is referred to as profit.

FOP and Mobility
Geographically Mobile Occupationally Mobile
(It refers to the level of flexibility and freedom It refers to the ability of workers to switch career
laborers have to move in order to find gainful fields in order to find gainful employment or meet
employment in their field) labor needs.
A land is perfectly immobile in the The occupational mobility of land

traditional sense as it is not possible is high. It can be used for a
Land
to move a piece of land from its number of purposes.
location
For instance, a school premise
However, in its wider sense, it can can be used as a hospital too
be moved to a certain extent
Labor’s geographically mobility In case of an unskilled worker,

depends on factors such as: the occupational mobility of labor
remains high
Labor 1. Visa Restrictions
2. Family Ties For skilled workers, it is difficult
3. Lack of information to switch occupations as
appropriate skills and
qualifications may be required.
The geo mobility of heavy The occupational mobility

machineries remains low or depends on the type of capital
immobile. In case of a coal mine good.
and a dock, it is in fixed position
Capital A delivery van for books can be
The geo mobility of screw drivers used by a pharmaceutical
and other smaller capital goods company to distribute medicines.
remain high However, a coal mine
occupational mobility cannot be
changed as it has been made for
specific purpose
An entrepreneur is geographically An entrepreneur is occupationally

mobile as someone who has been mobile because if he has the
successful in starting up and ability to bear risks and organize
Enterprise running a business in one country is fop for one business, he should be
likely to be successful in another able to do this for another
country also. business as well.

FOP (Quantity and Quality)
Quantity Quality
The amount of physical land does The quality of land can be

not change much with time. It can improved by the use of fertilizers,
Land
however be impacted by natural less pollutants and proper
disasters drainage system.
Natural resources, especially non-
renewable resources are reduced by
use.
The quantity of labor can be The quality of labor can be

increased by improved as a result of better
education, better training, more
Labor 1. increase in the size of population experience and better healthcare.
2. increase in retirement age
3. reduction in the school leaving
age
4. people switching from part-time
work to full-time
The quantity of capital can be The quality of capital goods can

increased by buying more physical be improved by producing
capital goods from abroad. The technologically advanced capital
country can also invest money in goods. If the capital good is
Capital producing more capital goods technologically advanced, it will
result in more productivity.
The quantity of enterprise will The quality of enterprise can be

increase if there are more improved if entrepreneurs
entrepreneurs, reduction in both, received better education,
Enterprise corporate taxes and government training, healthcare and gain more
regulations. experience.

Few Definitions in Economics
Goods
Economics
Free Goods
Goods
Consumer
goods and Capital goods Public Goods Merit Goods
services
Free Goods: A product that does not require any resources to make it and so does
not have an opportunity cost
Economic Goods are those goods that require resources to produce it and therefore
has an opportunity cost. It can be further classified into consumer goods &
services, capital goods, public goods and merit goods.
Consumer goods satisfy human

wants. They can be durable i.e.
long lasting such as cars,
televisions, furniture and
computer. Non-durable consumer
goods perish or gets used up
quickly, for instance food, drinks,
petrol & washing powder
Consumer Services include when
someone performs services for
people to satisfy their wants or
needs. For e.g. banker, doctor,
insurance, cleaner, teacher or
policemen

Capital goods are man-made
resources which help to produce
other goods and services. The
buying of capital goods is known
as an investment. For e.g. screw
drivers, drills, ploughs and lorries
Public goods are provided by the

government to the general public
because people need them, but will
not pay for them.
A government provides these
goods & services as no private
firm would wish to produce them
because nobody would pay for
their use.
For e.g. defense, law & order,
street light and light houses.
Merit goods are provided by the

government because she thinks
that the public deserves the goods
such as education and health care.
These goods provide benefits not
only to the recipient, but produces
welfare for the society.

Production Possibility Curve
Definition of PPC
Production Possibility Curve

also known as production
possibility frontier shows the
maximum combination of
two goods, given that
resources in the economy are
fully and efficiently
employed and assuming a
constant state of technology
Points under, on and beyond a PPC
The PPC helps us to examine various economic models. In the above figure:
Point A, B & C represents full employment of the resources. Each point lying on
the PPC is efficient and indicates no wastage of resources
Point F is beyond the curve and represents that with the current resources
available, the output combination at F is unattainable. This indicates the concept of
scarcity.
Point D & E represents unemployment of resources or underutilization of resources
as the production level is below full capacity, which represents inefficiency.
Movement along a PPC
The concept of opportunity cost & choice can also be shown via the Production
Possibility Curve. Since the PPC is downward sloping, it shows that in order to
produce more of one good, resources have to be diverted away from the production
of the other good.
The concept of choice can be illustrated by the diagram as the economy has to
decide either to produce at Point A (200 Wheat & 300 Cotton) or Point B (160
Wheat & 400 cotton).
If the economy decides to move from Point A to B, it is giving up 40 output of

wheat to produce 100 additional output of cotton. In this example, opportunity cost
or the next best alternative foregone, then is the 40 output of wheat
The economy has moved to Point B, it has made a choice and can no longer
produce at Point A

Shifts in the PPC
An outward shift of the PPC An inward shift of the PPC represents

represents economic growth. For an a fall in the economy’s production
outward shift to occur, there has to be potential. For an inward shift to occur,
an increase in the quantity or quality there has to be a decrease in the
of resources. For instance: quantity or quality of resources. For
instance:
1. Advances in technology
1. Natural disasters
2. Improved education
2. Fall in the labor force
3. Increase in the labor force
3. Exhaustion of non-renewable
4. Discovery of new resources
resources
5. Training of labor
4. Lack of investment in capital and
labor
Few More Definitions in Economics

Micro Economics: The study of the behavior and decisions of household and
firms, and the performance of individual market
Macro Economics: The study of the whole economy, for e.g. unemployment,
inflation, economic growth and balance of payments.

Money
Money is an economic unit that functions as a generally recognized medium of exchange for
transactional purposes in an economy and used in the settlement of debts.
Forms of Money
1. Barter System: In the barter system, two individuals, each possessing some
goods the other want, would enter into an agreement to trade. For example, a
person who has cows would enter into an agreement with someone possessing
apples, if both parties want the other good.
There were some drawbacks with the barter system such as
I. Double Coincidence of Wants: This means that both parties should want
each other’s good. For instance, a person selling his cow would be in need of
oranges, but is unable to find someone who would trade-in oranges for cows.
II. Measurement of Value: It becomes hard to determine the value of one good
for another. For instance, how much apples should be traded in to be worth a
full cow.
III. Durability: Some goods, for instance food and fruits, used as money may
perish and lose value overtime. Also, this discourages the savings of money.

2. Paper money: Most modern monetary systems are based on fiat money for e.g.
paper money is a form of fiat money. This means that the current value of
monetary currency is not necessarily derived from the materials used to produce
the note or coin – it does not have an instrinsic value. Instead, value is derived
from the willingness to agree because the government announces it as a legal
tender – it has an extrinsic value.
Charactersitcis of Money
1. Portablitiy: Money must be easy to carry around, convenient & easy to use
2. Divisible: It can be broken down into smaller denominations
3. Durable: The physical character of the good should be durable enough to retain
its usefulness in future exchanges and be reused multiple times.
4. Generally Acceptable: It must be widely and readily accepted as a medium of
exchange
5. Limited Supply: For money to have and hold value, it must be limited in supply
6. Uniformity: Uniformity of money calls for a standardization of money so that it
looks the same. This would make it hard to counterfeit money, so that it can’t be
easily faked or copied.

Functions of Money
1. Medium of Exchange:
The most important function of

money is used to buy goods and
services. To be able to fulfill this
function, it has to have general
acceptability and value.
In the barter system, where there was
no paper currency, double
coincidence of wants is required i.e.
each party to the transaction wants
what the other has to trade. This is
costly and difficult, and also
discourages trade.
2. Unit of Account:
Money also acts as a unit of account,

that is, a measure of value. Every
type of good or service will have an
easily recognized market price in
terms of money.
Knowing the value or price of a
good, in terms of money, enables
both the supplier and the purchaser of
the good to make decisions about
how much of the good to supply and
how much of the good to purchase.

3. Store of Value
Money is used as a store of

purchasing power. It is the most
liquid asset among all assets (stocks,
lands, jewelry, etc.). Liquid assets
facilitate transactions of all kinds of
goods and services.
Moreover, when people save money,
they get the assurance that the money
saved will have value when they wish
to spend it in the future. However,
this statement holds only if there is
no severe inflation (or deflation) in
the country which can deteriorate the
value of money.
4. Standard of Deferred Payments
With the introduction of money,

borrowing and lending have become
easier. With the expansion of trade
and commerce based on credit,
money has become a standard of
deferred payments. Deferred
payments are those which are
postponed for the future. Money
enables current transactions to be
discharged in future. Lending and
borrowing virtually come to halt in a
moneyless economy.

Commercial Banks
A financial institution that offers services to households and firms such as accepts
deposit, lends money and acts as an agent of payment. These banks work with the
aim of profit and are usually in the private sector.
Functions of the Commercial Bank

1. Accepting deposits
Money is deposited by individuals and organizations in commercial banks by

opening accounts, these deposits are considered by the bank as liabilities that must
be paid back. There are different types of account based upon the needs of the
depositor.
 Current Account/Checking Account: It is used by the account holder for
everyday transactions. Interest is usually not paid on money held in any such
account. Customers use current account mainly to receive and make
payments

 Saving/Deposit Account: It is a safe place to store your savings. Interest is
paid on any money held in a deposit account and customers use deposit
accounts as a way of saving
2. Making loans
Banks lend out money in two main ways:

 Overdraft: This enables a customer to spend more than what is in his or her
account, up to an agreed limit. Interest is charged on the amount borrowed.
It helps to cover the short-term gaps between expenses and income
 Loan: This is usually for a particular purpose and for a period. Interest is
charged on the full amount of the loan. A customer may be asked to provide
some form of security, known as collateral, when taking a loan. This is to
ensure that if the loan is not repaid, the asset given as collateral can be sold
and the money recovered
# The bank merely acts as a financial intermediary which means that they accept
deposits from those with more money and lend to those with an immediate desire
to spend more money
## Commercial banks make most of their profit by charging a higher interest rate
to borrowers than they pay to people who save their money with them

3. Acting as agents of payment (MCQs)
It facilitates financial transactions and enables their customers to receive and make
payments.
4. Other functions of the commercial bank

 Clearing cheques
 Custody of valuables
 Foreign exchange
 Credit and debit cards
 Lockers
 Advice on investments
Aim of commercial bank

The key aim of a commercial bank is to make a profit. The main way it does this is
by giving loans. Another aim which can conflict with the main aim is of liquidity.
Banks must ensure that they can meet their customers’ requests to withdraw money
from their accounts.
Hence, they have to balance profitability and liquidity – having some assets
earning high interest but being illiquid, and having others earning low or no
interest but being liquid.

Central Bank
A national bank that provides financial and banking services for its country's
government and commercial banking system, as well as implementing the
government's monetary policy and issuing currency.
Examples of Central Banks include
1. State Bank of Pakistan

2. US Federal Reserve Bank (USD)
3. European Central Bank (EUR)
4. Bank of England (GBP)
5. Bank of Japan (JPY)
6. Swiss National Bank (CHF)
7. Bank of Canada (CAD)
Functions of the Central Bank
1. It issues notes
The Central Bank is the only institution that has the right and authority to issue
bank notes. The central bank prints notes and supplies them to the market.
2. Acts as a banker and agent to the government
I. Banker
As a banker to government, the central bank performs the same functions for the
government as a commercial bank performs for its customers:
a. It maintains government accounts
b. It receives deposits from government

c. It collects cheques and drafts deposited in the government account
d. It provides foreign exchange resources to the government for repaying
external debt or purchasing foreign goods or making other payments.
II. Agent
As an agent to the government, the central bank collects taxes and other payments
on behalf of the government
3. Manages National Debt
As tax revenue may not be enough, the central bank on behalf of the government
issues government bonds, savings schemes to borrow money from the general
public in return for a rate of return. The government on advice from the central
bank uses that finance in various projects or paying its own expenses.
4. The bankers' bank ("Lender of Last Resort")
a. All commercial banks need to keep cash minimums known as the reserve ratio
with the central bank which it keeps secure. The commercial bank cannot lend this
money, but rather keeps it with the central bank in order to meet an unexpected and
large demand for withdrawals.
b. If commercial banks are not able to meet their financial requirements like paying
back to depositors, it can take out the reserve ratio kept with the central bank. In
case the reserve ratio is inadequate, the central bank also lends out money to the
commercial banks to maintain their liquidity. This maintains consumers’
confidence in the banking system as they are assured that their deposits are safe.
5. Controls economy through monetary policy
Monetary Policy involves setting the ‘Interest Rate’ of lending and borrowing
a. To increase economic activity, the Central Bank can lower the policy
interest rates to foster credit expansion in the economy. The commercial banks set
their interest rates based on these policy rates. As a result, commercial bank will
set lower interest rate which will encourage consumers and businesses to borrow
money.
b. To decrease economic activity, the Central Bank raises the policy interest
rates to curb credit expansion in the economy. The commercial banks set their
interest rates based on these policy rates. As a result, commercial bank will set
higher interest rates which will reduce consumer and producer borrowing.

Money & Banking past paper questions
Define commercial bank (2 marks) S18 q22
A financial institution that offers services to households and firms such as accepts
deposit, lends money and enables online banking transactions. These banks work
with the aim of profit and are usually in the private sector.
Define standard of deferred payments (2 marks) S17 q21
It is one of the functions of money which enables people to borrow money and pay
it back later. It encourages the provision of credit and acts as an incentive to trade.
Hence buyers can consume goods and services immediately, but the payment can
be spread over a period.
Explain two ways in which a central bank differs from a commercial bank (4
marks) S16 QP22
A central bank provides financial and banking services to the governments and
commercial banks whereas a commercial bank is the bank of households and firms.
The central bank is the only institution that has the right and authority to print
notes and supplies them to the market, whereas commercial bank does not possess
this authority. In addition, a central bank implements the monetary policy
measures such as the change in interest rate and money supply and a commercial
bank responds to the monetary policy measures enforced by the Central Bank.
Explain why an item has to be generally acceptable and divisible for it to carry out
the functions of money (4) S14 QP 21
Money has to be generally acceptable to divisible to carry out its function of
medium of exchange, store of value, means of deferred payment and unit of
account. To perform these functions, it needs to have acceptability as people have
to be willing to accept the item as payment universally. In addition, divisibility
allows people to make payments of differing amounts and to be able to give
change. It must be possible to divide money into different values such as a dollar is
divided into 100 cents.

Analyze how a central bank might reduce household borrowing (6) W16 QP22
A central bank provides financial and banking services to the governments and
commercial banks. It can reduce household borrowing by increasing the rate of
interest, reducing the money supply and increasing the minimum reserve ratio.
The central bank controls the monetary policy of the economy. If it increases the
policy interest rate, the commercial bank will set their interest rate at high too, this
discourages household from borrowing money as a higher amount will have to be
repaid. Instead, the household will be inclined to save money at a higher rate of
interest. In addition, if the government reduces the money supply, it reduces
household spending, and thus reduces their demand for loans. Lastly, the central
bank can increase the minimum reserve ratio that a commercial bank has to keep
with them. If a higher reserve has to be kept, this reduces the amount available to
lend out to the general public.
To conclude, the central bank enforces such tight restrictions on commercial bank
to discourage household borrowing.
Discuss whether a central bank should lend to commercial banks which get into
financial difficulties (8 marks) W17QP 23
Commercial Bank aims to make profit by providing a range of services to
households and firms such as accepts deposits, lends money and facilitate online
banking services. These banks are usually owned by the private sector and aims for
profit maximization. Central banks are financial institutes providing services to
government and commercial banks and performs services such as manages
currency, money supply and interest rate.
One of the functions of the central bank is to act as a lender to commercial banks
during financial crises. Occasionally due to excessive lending, the commercial
banks fall short of cash and borrows from the central bank. In this case, the central
bank should lend to commercial bank otherwise it may collapse and shut down.
This may be harmful to the customers as bank holders will lose money on account
of bank’s shut down.
Further, it will damage the reputation of commercial banks in general and people
will no longer trust these banks with their money and withdraw deposits. As a
result, it will not be able to perform any of its functions. As commercial banks will
have lessor deposits, this will reduce their lending power and investments in the
economy will reduce to a great extent as borrowing becomes harder. This will
dampen economic growth. For these reasons, central bank must lend to commercial
bank in times of financial difficulties.
Central bank should not lend to commercial bank that faces financial difficulties
because it involves significant risk and the central bank may lose out on its money
in case the commercial bank cannot repay its loan. In addition, it involves an
opportunity cost as central bank could use funds to lend to new, expanding banks.
To conclude, the advantages of lending to bank outweigh the disadvantages;
therefore, the central bank should lend to commercial bank which faces financial
difficulties. This will increase investment and promote economic growth.

Demand
Demand is defined as consumers’ willingness and ability to consume a product or
service at a given time, period or place.
Quantity demanded: The amount

or quantity of a good or service
that is demanded by an individual
at each price is called quantity
demanded of that good.
Law of Demand
The law of demand states that there is an inverse relationship between quantity
demanded and price of a good or service when other factors are constant, i.e.
ceteris paribus.
Increase in price will decrease the Decrease in price will increase the
quantity demanded quantity demanded

Demand Schedule and Demand Curve
A demand schedule is a table that lists the quantity demanded of a good at different
price points
The demand curve shows the quantity demanded at each price. It has a negative
slope indicating the inverse relationship between price and quantity demanded.
Changes in Quantity Demanded
The movement along the demand

curve happens when price of a
good changes.
In the given diagram, the price
increases, which results in a
decrease in quantity demanded.
This is known as a contraction in
demand
If the price of a product decreases,
it will result in an increase in
quantity demanded. This is known
as extension in demand

Shifts in the Demand Curve
Shifts in the demand curve happens due to non-price factors
A fall in demand will shift the A rise in demand will shift the
demand curve inwards or to the demand curve outwards or to the
left and shows that consumers right and shows that consumers
demand less than they did before demand more than they did before
at every possible price. at every possible price.

Reasons for shifts in the demand curve
1. Income. A change in income can cause a shift in the demand curve.
If the income increases, it is most If the income increases, it will lead

likely that demand for normal to a fall in the demand for inferior
good increases and shifts to the good and the demand shifts to the
right. left.
Examples of a normal goods are Examples of inferior good are bus
branded chocolates, perfumes and service, thrift store clothes and
destination weddings value meals at fast food restaurants
2. Changes in direct taxes

When direct taxes are reduced, this increases the disposable incomes of consumers
and should cause an increase in market demand for goods.
Alternatively, an increase in direct taxes reduces the disposable income and causes
a leftward shift in the demand curve.

2. Price of related goods:
Substitutes:
Two goods can be regarded as

substitutes if consumers regard
them as alternatives such as coffee
or tea, Pepsi or Coke, Mc. Donald
or Burger King
If price of Mc Donalds increases, the quantity demanded for Mc Donalds fall. As a

result the demand for Burger King will increase.

Complements:
Complements are goods that are

in joint demand, i.e., when there is
demand for one good, the other is
likely to be demanded. For e.g. tea
and milk, tooth brush and paste,
cars and tires, iPhone and iPhone
charger, DVD and DVD players
If price of DVD increases, the quantity demanded for DVD falls. As a result the
demand for DVD players will decrease.
3. Changes in fashion/taste: The more desirable people find a good, the more they
will demand. Tastes are affected by advertising, fashion or by observing other
consumers.
4. Advertising campaigns: A successful advertising campaign will increase

demand for a product. It may bring the product to the notice of some new
consumers and persuade the existing customers to buy more quantities.

5. Expectations of future price changes: If people think that prices are going to fall
in the future, they are likely to buy more at a future date, when the price falls. For
instance, hi-tech products are highly priced initially, but the price falls later as the
product becomes more common in the market
6. Changes in population: If the population increases, the demand for products will
increase or vice versa.
7. Other factors: Changes in weather conditions, special events such as Olympics

and ban on de-merit goods may affect demand.
Market Demand Curve
Market demand is the total demand for a product at different prices. It is found by
adding up each individual’s demand at different prices. This totaling up of the
demand of all of the potential buyers is sometimes referred to as aggregation.

Supply
Supply is the willingness and ability to sell a product at a particular time, place or
period.
Quantity supplied: The amount or

quantity of a good or service that is
supplied by an individual at each
price is called quantity supplied of
that good.
Law of Supply
The law of supply states that there is a positive or direct relationship between
quantity supplied and price of a good or service when other factors are constant,
i.e. ceteris paribus.
Increase in price will increase the Decrease in price will decrease the
quantity supplied quantity supplied

Supply Schedule and Supply Curve
A supply schedule is a table that lists the quantity supplied of a good at different
price points
The supply curve shows the quantity supplied at each price. It has a positive slope
indicating the direct relationship between price and quantity supplied.
Changes in Quantity Supplied
The movement along the supply

curve happens when price of a
good changes.
In the given diagram, the price
increases, which results in an
increase in quantity supplied. This
is known as an extension in supply
If the price of a product decreases,
it will result in a decrease in
quantity supplied. This is known as
a contraction in supply.

Shifts in the Supply Curve
Shifts in the supply curve happens due to non-price factors
A fall in supply will shift the A rise in supply will shift the
supply curve inwards or to the left supply curve outwards or to the
and shows that producers supply right and shows that producers
less than they did before at every supply more than they did before
possible price. at every possible price.

Reasons for shifts in the supply curve
1. Changes in the cost of production:
If firms are aiming to maximize profits, an important influence on their supply

decision will be the costs of production incurred by them.
If the cost of those input increases, firms will generally be expected to supply less
output at any given price. The supply curve will shift to the left.
2. Improvements in technology:
This will raise the productivity of capital, reduce costs of production, and result in
an increase in supply. It has become cheaper to produce a range of products due to
the availability of more efficient capital goods and methods of production.
3. Government Policy:
Indirect taxes affect the cost of Subsidies affect the cost of

producing an extra unit of a good. producing an extra unit of a good.
An indirect tax is a payment to the A subsidy is a payment to firms by
government by firms per unit of the producer per unit of output
output produced. An indirect tax produced. Subsidy will decrease
will increase production costs and production costs and lead to an
lead to a decrease in supply and a increase in supply and a shift in the
shift in the supply curve. supply curve.

4. Exogenous factors:
Weather conditions can affect the supply of agricultural products. A good harvest
will increase the supply of crops. However, unfavorable weather conditions such as
floods, drought will shift the supply to the left. Natural disasters, outbreak of a
pandemic and wars also affect the supply negatively.
5. Price of related goods
Joint Supply: It is where an Competitive Supply: It is where a

increase or decrease in the supply change in the price of a
of one good leads to an increase or competitive supply will have an
decrease in the supply of a by- effect.
product.
For instance, a farmer with a
For instance, if the price of mutton fixed amount of land uses it to
increases, the quantity supplied of produce lemons and oranges.
mutton will increase.
If the price of oranges increases
At the same time, the supply of then this farmer will have the
wool will increase and the supply incentive to increase the quantity
curve will shift to the right supplied of oranges so the supply
of lemons will decrease and shift
the supply to the left

Market Supply Curve
Market Supply is the total supply for a product at different prices. It is found by
adding up each individual’s supply at different prices. This totaling up of the
supply of all of the potential producers is sometimes referred to as aggregation.
Market Equilibrium
The market equilibrium occurs when demand and supply are equal, so that there
are no shortages or surplus of the product.
The diagram shows the

market equilibrium, with
equilibrium price at P1
and equilibrium quantity
at Q1

Market Disequilibrium
When demand and supply does not equal, it results in a market disequilibrium.
There is a disequilibrium
at P2, where supply is
greater than demand
which results in excess
supply or surplus. In this
scenario, the price falls
until the market
equilibrium (supply =
demand) is achieved.
There is a
disequilibrium at P2,
where demand is
greater than supply
which results in excess
demand or shortage. In
this scenario, the price
rises until the market
equilibrium (demand =
supply) is achieved.

Changes in Market Equilibrium
When at market equilibrium, there is a shift in the demand and/or supply curve, a
new market equilibrium arises.
The effect of changes in demand
When the demand shifts to the When the demand shifts to the left
right in the market, a new in the market, a new equilibrium
equilibrium arises with an increase arises with a decrease in both -
in both - price and quantity price and quantity

The effect of changes in supply
When the supply shifts to the right When the supply shifts to the left
in the market, a new equilibrium in the market, a new equilibrium
arises with a decrease in price and arises with an increase in price and
increase in quantity decrease in quantity
The effect of changes in demand and supply

Scenario: A decrease in the population & an increase in the cost of labor
In this scenario, the demand

will decrease as a result of a fall
in the population.
The supply also shifts to the left
on account of an increase in the
cost of production
After accounting for both
changes, D1 and S1 intersects
at a new equilibrium E1 with
price P and quantity Q1
The price remains uncertain as
it depends upon the magnitude
of demand & supply, whereas
the equilibrium quantity falls

Price Elasticity of Demand
The price elasticity of demand measures the responsiveness of a change in quantity
demanded due to a change in price.
(New quantity – old quantity) *100

Old quantity
(New price – old price) * 100

Old price
Example: When the price of a good increases from $15 to $20, the quantity
demand falls from $100 to $75. Find out the PED?
(75-100)/100*100 -25
(20-15)/15*100 33.33 -0.75 0.75
The price elasticity of demand will always be negative due to the inverse
relationship between price and quantity demanded. Hence, the negative sign needs
to be ignored as it is a mathematical occurrence and the correct answer is 0.75
Ranges of Price Elasticity of Demand
PED = 0 PED < 1 PED = 1 PED > 1 PED = ∞
Perfectly Inelastic Relatively Inelastic Unitary Elastic Relatively Elastic Perfectly Elastic

1. Perfectly Price Inelastic Demand (PED = 0):
If PED = 0, it is perfectly inelastic. It is

represented by a straight vertical line. It
means that a change in price results in
no change in quantity demanded.
For e.g. an increase in price of 50%
results in 0% change in quantity
demanded; therefore, the PED is 0
Perfectly inelastic demand is a
theoretical concept and cannot be
applied in a practical situation.
2. Relatively Price Inelastic Demand (PED < 1)
If PED is less than 1, it is relatively

inelastic. It means that a change in
price results in less proportionate or
smaller change in quantity demanded.
For e.g. a decrease in price of 10%
results in 5% increase in quantity
demanded; therefore PED is 0.5
3. Unitary Price Elastic Demand (PED = 1)
If PED = 1, it is unitary elastic. It

means that a change in price results
in a proportionate change in quantity
demanded.
For example, an increase in the price
by 50% results in the quantity
demanded to fall by 50%; therefore,
the PED is 1

4. Relatively Price Elastic Demand (PED > 1)
If PED is greater than 1, it is relatively

elastic. It means that a change in price
results in greater proportionate or
larger change in quantity demanded.
results in 75% fall in quantity
demanded; therefore PED is 1.5
5. Perfectly Price Elastic Demand (PED = ∞)
If PED is ∞, it is perfectly elastic. It is

represented by a straight horizontal
line and shows that the market
demand is infinite at a specified price.
For e.g. it can be interpreted from the
graph that at price P consumers are
ready to buy as much quantity of the
product as they want.
Though, perfectly elastic demand is a
applied in the real situation.

Determinants of PED
1. Availability of substitutes:
If a product has many close

substitute, it is likely to have an
elastic demand. In this case, if the
producer decides to increase the
price of the product, the quantity
demanded will fall at a greater
proportion as people will switch
over to the substitutes. For
instance, if the prices of Coca Cola
were to increase sharply, many
consumers would turn to other
kinds of cold drinks, and as a
result, the quantity demanded of
Coca Cola will decline very much.
2. The proportion of income spent on the good
If a higher proportion of income is spent on a good, it will have an elastic demand.

An increased price will force consumers to reduce purchases to a greater extent as it
accounts for a higher proportion of income.
On the other hand, the demand for common salt, soap, matches and such other goods
tends to be highly inelastic because the households spend only a fraction of their
income on each of them.
When the price of such a commodity rises, it will not make much difference in
consumers’ budget and therefore they will continue to buy almost the same quantity
of that commodity and, therefore, the demand for them will be inelastic.
.
3. Time Period Involved
The element of time also

influences the elasticity of demand
for a commodity. Demand tends to
be more elastic if the time involved
is long. This is because consumers
can substitute goods in the long
run. In the short run, substitution
of one commodity by another is
not so easy. The longer the period
of time, the greater is the ease with
which both consumers and
businessmen can substitute one
commodity for another.
4. Nature of Product
If the nature of the product is accounted as a necessity such as basic food,

drinking water and electricity, the demand for it becomes relatively inelastic
and people buy it regardless of an increase in price.
Some goods are habit-forming or addictive in nature such as cigarettes and
alcohol and therefore the demand tends to be inelastic for such goods.
Luxuries are usually relatively elastic as consumers can easily substitute or give
up consumption when price rises.

PED and Total Revenue
It is important to answer the question of the impact of elasticity on the total
revenue. Total revenue refers to the amount of money that a seller makes on the
number of products sold.
A seller is interested in earning higher total revenue as it will lead to a greater

profit. Many private sector firms have the primary objective of profit maximization
Hence, it is important to know the impact of price – (increase or decrease) on the

quantity sold in order to figure out how to generate higher total revenue. Thus, the
concept of elasticity becomes significant to determine the responsiveness of a
change in quantity demand due to the change in price.
Graphical representation of total revenue

Total Revenue and the range of PEDs
1. Perfectly Inelastic Demand (PED = 0)
For perfectly inelastic goods,

revenue is a function of price. The
higher the price, the higher will be
the revenue as quantity demanded
does not change.
An increase in 10% in price will
result in a 10% increase in the total
revenue
TR = P * Q
2. Relatively Price Inelastic Demand (PED < 1)
For relatively inelastic goods, the

higher the price, total revenue will
increase as quantity demanded
falls by a smaller proportionate
Similarly, if prices falls, the

quantity demanded increases by a
smaller proportionate, which
results in a fall in the total revenue

3. Unitary Price Elastic Demand (PED = 1)
For unitary elastic goods, the

increase or decrease in price will
leave the total revenue unchanged
as quantity demanded falls by an
equal proportionate
4. Relatively Price Elastic Demand (PED > 1)
For elastic goods, lowering price

will result in an increase in the
total revenue.
When price decreases, the quantity
demanded increases at a higher
proportion leading to an increase in
the total revenue
Similarly, if prices rises, the
quantity demanded decreases by a
larger proportionate, which results
in a fall in the total revenue
5. Perfectly Price Elastic Demand (PED = ∞)
For perfectly elastic goods, revenue

is a function of quantity. The
higher the quantity sold, the higher
will be the revenue, as price does
not change.
TR = P * Q

Significance of PED
 It allows a firm or business to predict the change in total revenue with a
projected change in price.
 Firms can charge different prices in different markets, a practice known

as price discrimination. For example, airlines have segmented airplane
seats into different classes – economy, business and first in order to
charge the less price-sensitive customer a higher price for premium seats.
 It allows a firm to decide how much tax to pass on to a consumer. If a

product is inelastic, then the firm can force the customer to pay the tax.
This is a common tactic used by cigarette manufacturers who pass on
most of the indirect tax directly to the consumer.
 A firm can make the PED of its good relatively inelastic by establishing
brand loyalty for its products via marketing techniques such as
advertisements and promotions.

Price Elasticity of Supply
The price elasticity of supply measures the responsiveness of a change in quantity
supplied due to a change in price.
Example: When the price of a good increases from $50 to $70, the quantity
supplied increases from $150 to $200. Find out the PES?
(200-150)/150*100 33.33
(70-50)/50* 100 40.00 0.83
The price elasticity of supply will always be positive due to the direct relationship
between price and quantity supplied.
Ranges of Price Elasticity of Supply
PES = 0 PES < 1 PES = 1 PES > 1 PES = ∞
Perfectly Inelastic Relatively Inelastic Unitary Elastic Relatively Elastic Perfectly Elastic

1. Perfectly Price Inelastic Supply (PES = 0):
If PES = 0, it is perfectly inelastic. It is

represented by a straight vertical line. It
no change in quantity supplied.
results in 0% change in quantity
supplied; therefore, the PES is 0
2. Relatively Price Inelastic Supply (PES < 1)
If PES is less than 1, it is relatively

inelastic. It means that a change in
price results in less proportionate or
smaller change in quantity supplied.
For e.g. an increase in price of 33.33%
results in 6.67% increase in quantity
supplied; therefore PES is 0.2
The linear inelastic supply curve hits
cuts the quantity axis if extended
3. Unitary Price Elastic Supply (PES = 1)
If PES = 1, it is unitary elastic. It

a proportionate change in quantity
supplied.
For example, an increase in the price
by 50% results in the quantity supplied
to increase by 50%; therefore, the PES
is 1
The linear elastic supply curve always
passes through origin

4. Relatively Price Elastic Supply (PES > 1)
If PES is greater than 1, it is relatively

elastic. It means that a change in price
results in greater proportionate or
larger change in quantity supplied.
For e.g. an increase in price of 32.5%
results in 66.6% increase in quantity
supplied; therefore, PES is 2.05
The linear elastic supply curve cuts
the price axis.
5. Perfectly Price Elastic Supply (PES = ∞)
If PES is ∞, it is perfectly elastic. It is

represented by a straight horizontal
line and shows that the market supply
is infinite at a specified price.
For e.g. it can be interpreted from the
graph that at price P producers are
ready to produce as much quantity of
the product.
Though, perfectly elastic supply is a
applied in the real situation.

Determinants of PES
1. Time Period:
Time is the most significant factor
which affects the elasticity of
supply.
If the price of a commodity rises
and the producers have enough
time to make adjustment in the
level of output, the elasticity of
supply will be more elastic.
If the time period is short and the
supply cannot be expanded after a
price increase, the supply is
relatively inelastic.
2. Capacity:
When there is excess capacity and
the producer can increase output
easily to take advantage of the
rising prices, the supply is more
elastic.
In case the production is already
up to the maximum from the
existing resources, the rising prices
will not affect supply in the short
period. The supply will be more
inelastic.
3. The mobility of factors of production:
If the factors of production can be easily moved from one use to another, it will affect
elasticity of supply. The higher the mobility of factors, the greater is the elasticity of
supply of the good and vice versa.

4. Agricultural or industrial products:
In agriculture, time is required to increase output in response to rise in prices of goods. The
supply of agricultural goods is fairly inelastic. The production process can take a full year and
it might not be possible to react proportionately to a sudden rise in price. In addition, it is
perishable, which means such products cannot be stored for future uses, which again makes it
relatively inelastic to an increase in price.
As regards to the supply of manufactured consumer goods, it is comparatively easy to

increase production in a short period and is relatively elastic. Also, most of the industrial
goods are non-perishable, which means that it can be stored. In case of an increase in price,
such goods can be released from the stock, so that their supply increases at a greater
percentage than the change in price

Economic System
Economic System
Planned/Command
Mixed Economy Market Economy
Economy
The way scarce resources get distributed within an economy determines the type of
economic system. There are widely three main economic system – Planned, Mixed
and Market economy. To allocate resources efficiently under these economic
system, three economic questions have to answered, i.e.
1. What to produce?
2. How to produce?
3. For whom to produce?
Planned/Command Economy
Features of Planned Economy

In a planned economy, all resources are
allocated and controlled by the
government.
The government follows a centralized
decision making and answers the question
of what to produce, how to produce and
for whom to produce.
There is no intervention by the market
The government aims to achieve social
welfare maximization

Advantages of Command Economy
 Equal distribution of goods and wealth: The government will allocate factors of
production to produce goods and services that facilitates necessities rather than
producing luxuries. In addition, the distribution of income in the economy is
more equitable.
 External Costs will be considered. In a planned economy, the government

considers the external consequences of production and consumption. It can use
environmental-friendly ways of production to alleviate negative externalities
such pollution, deforestation and overfishing
 Public goods and merit goods are under-produced and under-consumed in a

market economy due to lack of profitability in providing such goods. The
government will ensure adequate supply of such goods to benefit the society
 Fewer Unemployment: The government will use more labor intensive method
of production which keeps unemployment rate as low as possible.
Disadvantages of Command Economy
 Inefficiency: Due to the absence of price mechanism, the government decides
on how to allocate and use resources which can sometimes result in
inefficiency. For instance, shortages can occur if consumers decide to buy
more and surpluses occur if they decide to buy less. The government does not
aim for profit maximization; therefore, it does not have the incentive to
improve the current state of technology.
 Bureaucratic cost and time lags: The larger and more complex the economy,
the greater the task of collecting and analyzing the information for planning
and the more complex the plan. Complicated plans are likely to be costly and
involve cumbersome bureaucracy.
 Limited choices available: The government does not aim to maximize on profit
which means that products available will be lacking variety. This means that
all members of the community will use the same product without any
differentiation among ordinary and premium.

 In a planned economy, the government employs more labor to provide
employment to its people. Low unemployment is one of the primary objective
of the government. The employees feel a sense of security in the job and
consequently become complacent and lazy.
Market Economy
Features of Market Economy

In a market economy, all resources are
owned and controlled by private
individuals and corporations.
All economic decision such as what to
produce, how to produce and for whom to
produce are taken in the market through
market forces, with the interaction of
demand and supply.
There is no govt. intervention
The market economy aims to achieve
profit maximization
Advantages of Market Economy:

 Self-correction: The market economy operates via the price mechanism which
means that shortages and surplus (disequilibrium) in the market can be self-
corrected into equilibrium position where demand = supply. Unlike the
planned economy, there is no need to employ costly and complex
bureaucracies to coordinate economic decisions.
 Competition: The market system encourages competition between firms which

keeps the prices low and encourages the firm to be efficient by cutting down
on the cost of production.
 Innovation and Improved Products: Advanced technological methods of

production are favored to increase efficiency and productivity. There is also a
strong incentive to produce high quality and wide-ranging products to entice
the customers to purchase their products.
 Consumer Sovereignty: The market system is responsive to consumer’s needs.

It only produces those goods which are demanded by the people. This
addresses the problem of scarcity as resources are efficiently allocated in line
with consumer wishes.
Disadvantages of Market Economy

 De-merit goods: Under the market economy, demerit goods are
overproduced such as drugs, weapons and cigarettes because the producers
are not concerned about the negative effects of the society.
 Merit goods: Under the market economy, merit goods are under produced
such as health and education. These goods result in positive externalities in
the economy and it should be available on a larger scale; however, the
producer is not concerned with the benefits to the society. He produces it to
the extent where it maximizes his personal profit.
 Inequality: The resources under the market economy are unequally

distributed. For example, goods and services will only be available to those
consumers who have the ability to pay for them. This also results in the
opportunity cost as resources will be employed in producing luxuries for the
rich instead of necessities for the poor.
 Monopoly: In certain cases of market economy, a few giant firm may

dominate the industry which results in monopolistic behavior. Lack of
competition may result in higher prices and poor quality.
 Public Goods: In case of public goods, private firms do not produce them
because it becomes impossible to charge everyone for their use. If the
market provides the good, it will create free-rider problem as it is not
possible to exclude non-payers from using these services. For e.g. defense,
law & order, street light and light houses.

 Unemployment: In the market economy, a firm employs only those
resources that maximizes on its profits. Hence, many labors are removed
from employment in order to cut down on the cost of production.
Market Failure
Market failure arises when inefficient allocation of resources takes place. *Market
failure is noted above as disadvantages of market economy and will be discussed in
some greater depth. So let’s begin…
The common types of market failure includes:

1. Not factoring externality for merit and de-merit products: When considering a
product, we need to look at:
Social Cost = Private Cost + External Cost Social Benefit = Private Benefit + External Benefit
Social Cost: It is the total cost to the Social Benefit: It is the total benefit to the
society of an economic activity. society of an economic activity.
Private Cost: The cost borne by directly Private Benefit: The benefits received by
consuming or producing a product directly consuming or producing a product
External Cost: These are costs imposed on External Benefits: These are benefits enjoyed by
third parties who are not involved in the third parties who are not involved in the
consumption and production activities of consumption and production activities of others
others directly. directly.

Merit Goods: In case of a merit good, social benefits are greater than the private
benefits due to positive externality. The failure to acknowledge positive
externalities may result in the product being under-produced, under-consumed and
overcharged. For example: healthcare and education
De-merit Goods: In case of a demerit good, social costs are greater than the private
costs due to negative externality. The failure to acknowledge negative externalities
may result in the product being over-produced, over-consumed and undercharged.
For example: cigarettes and drugs.
2. Lack of provision of Public Goods:
Due to non-excludability and non-rivalry of public goods, some consumers take a
free ride on the product. If provided by the market, producers do not gain profit as
many consumers do not pay for the good while utilizing the service. Therefore, the
government must make provision of public goods. Examples of public goods are
street lights, roads, and light-house and so on.
These goods have two features i.e. non-excludable and non-rival:
Non-excludability: It means that no one can be excluded from gaining benefits of
the goods or services. Once a public good, for example streetlight is produced, it is
available to everyone whether they pay or not.
Non-rival: It is a feature that explains consumption by one person will not reduce
the benefit or availability of others. It can be consumed by as many people as
possible.
3. Monopolization: Monopolization of market can result in market failure as well.
This occurs when a single firm or a few giant firms dominate the entire market.
The demand for monopoly’s product is highly inelastic due to lack of substitute,
which gives power to the monopoly to exploit consumers by charging a higher
price and providing substandard quality products. In this case, the monopoly does
not allow the market to clear or reach equilibrium, instead it identifies and operates
at the price and output where profit is at its maximum.

Mixed Economy
Mixed Economy is an economic

system which has a combination of
both, planned and market economy.
Some firms operate in the private
sector while other firms are in the
public sector, where resources are
owned by the government.
In this manner, the advantages of both
a market and planned economy can be
achieved under the mixed economy.
The government can intervene in the
market to correct market failures which
occurs in the market economy.
Ways of Government Intervention

1. Maximum Price:
A government may limit firms’ ability to set their own prices by imposing price
controls. It may set a maximum ceiling on price in order to enable the poor to
afford basic necessities.
The diagram shows that the

maximum price is set below the
equilibrium price P1.
At the lower price ceiling set by the
govt. there will be a shortage of the
product (Q3-Q1)
In order to avoid the occurrence of
the black market, govt. can reduce
the problem by rationing, queuing or
lottery.

2. Minimum Price:
To encourage production of a product, the government may set a minimum price.
This is a price floor, as it represents the lowest price producers are allowed to
charge.
The diagram shows that the minimum

price is set above the equilibrium price
P1.
At the higher price floor set by the
govt. there will be a surplus of the
product (Q3-Q1)
In order to keep the prices at min
price, the surplus will be bought by the
government or some other official.
3. Subsidies:
A subsidy is a form of government intervention, it usually involves a payment by
the government to suppliers that reduce their costs of production and encourages
them to increase output of a good or service

4. Indirect Taxation:
Indirect taxes are those imposed by a government on goods and services. It is
levied on de-merit goods such as cigarettes to reduce its consumption.
The indirect tax increases the cost of production, which shifts the supply curve. As a result, the
price of the good increases and quantity decreases.
5. Direct Provision of Goods:

It can provide public goods, such as street lighting, sea and flood defenses and
national parks that would otherwise be unprofitable for private sector firms to
provide.
6. Law & Regulation:
 Regulations can be implemented to protect the natural environment and
people’s health and safety. Firms may have to pay large fines if their
business practices break these laws.
 Laws shall be made to curb the production of harmful goods such as drugs
 Monopolies can be regulated to keep their prices down or be broken up into
smaller firms to increase competition and choice.

7. Nationalization:
This involves moving the ownership and control of an industry from the private
sector to the government. The main motive behind nationalization is to provide
social welfare to the community.
8. Privatization:
Privatization occurs when a government-owned business, operation, or property
becomes owned by a private, non-government party. The reason behind
privatization is to avoid inefficiency that occurs in the state-owned enterprises such
as poor quality products, wastage of resources and lack of variety.
Effectiveness of Government Intervention
Evaluation of Govt. Intervention

1. The effectiveness of indirect tax imposed
on de-merit goods depend upon the price
elasticity of demand for the product. In case
of cigarettes, for example, the PED is
relatively inelastic which allows producers to
pass a higher incidence of taxes onto the
consumer.
2. Regulations that are imposed on the
corporation can be demanding and onerous,
which increases the cost of production for the
firm, and increase their price and reduce the
quantity produced
3. Public sector provision may be inefficient
which results in poor quality as organizations
are not motivated to make profits
4. Government spending may be politically
motivated instead of correcting market
failures and improving economic welfare.

Households
Household
Consumption Saving Borrowing
Consumption
People spend money in order to buy goods and services and to maintain a given
standard of living.
Influences on spending:
Disposable Income (income after tax):

People will divide their disposable income
between spending and saving
The main influence on the amount by a person
or household is disposable income. As income
rises, people usually spend more in total, but
less as a percentage of their income.
In general, people will choose to spend their
disposable incomes on consuming those
goods and services that provide them with the
most satisfaction or utility. That is, a person
with a given disposable income, and faced
with a set of prices and places to buy different
goods and services, will consume those goods
and services that will maximize his or her
total utility.

Wealth:
A stock of assets including money held in
bank accounts, shares, companies,
government bonds, cars and property.
Consumer confidence:
Confidence is an important influence on
consumption. If people feel more
optimistic about their future career
prospects and income, they are likely to
spend more. In contrast, if they become
pessimistic about economic prospects, they
will tend to spend less.
Rate of interest:
Expenditure may fall if the rate of interest
rises. This is because, it will make
borrowing more expensive, encourage
saving and people will consume less.
Expenditure may rise if the rate of interest
falls. This is because, it will make
borrowing cheaper, discourage saving and
people will consume more.

Patterns of Expenditure:
1. Different income groups tend to have different patterns of spending
 Poor tend to spend a higher proportion of their income and total expenditure
on food and clothing
 Rich spend more, both in total and as a proportion on luxury items,
consumer durables, entertainment and services. For example, the rich spend
more on cars, jewelry, theatre trips and foreign holidays.
2. Our individual spending patterns depend on our preferences, economic
circumstances and characteristics:
 Households without children are likely to spend a higher proportion on
recreation and eating out than households with children
 People in their late teens and twenties often spend a higher proportion on
clothing and entertainment
 Some households may value cultural activities more than others, whilst
others may be keener to spend more on medical
Savings
Savings refers to the amount left over after an individual's consumer spending is
subtracted from the amount of disposable income earned in a given period of time.
Saving involves delaying consumption until some later time when they withdraw
and spend their savings plus any interest.
Saving ratio measures the proportion of the total disposable income saved in an
economy.
Reasons for savings:
1. Target savers: This means that they save to gain a sum of money for a particular
purpose for e.g.to buy a house
2. People save for precautionary purpose such as retirement, children’s education
and inheritance when they die, unexpected emergencies and problems.
3. Some people also save to increase their current income. The more people save,
the more interest they tend to receive in total, but also per unit saved.

Influences on saving:
1. Income: As with consumption, the main influence on saving is disposable
income. As disposable income rises, the total amount saved, and the proportion
saved increases.
2. Wealth: The wealthier the people are, the easier they will find it to save
3. The rate of interest: A rise in the rate of interest will encourage people to save
more money instead of borrowing money for consumption or investment
4. Tax treatment on savings: Tax concessions on the income earned from savings
will encourage people to save. In several countries, there are some tax-free savings
schemes where no tax is charged.
5. Social attitudes: The attitude to saving varies between countries. In some it is
held in high esteem, while in other people prefer to spend most of their income
when they receive it.
6. Age-factor: Young people and old-aged people tend to save lessor than middle-
aged people. Old people may withdraw money or spend savings they have
accumulated over time to meet their living expense. This is known as dissaving.
Borrowing
Borrowing involves receiving money from another party with the intention to
repay it within an agreed period of time at later date. The money returned is
usually accompanied with interest payments.
Consumers may borrow money to:
1. Increase their expenditure on goods and services, usually for a good or service
they want
2. Borrow simply to pay everyday bills such as electricity and phone charges
3. Most people who buy a house may borrow some of the money to finance their
purchase. The loan they take out is known as mortgage
4. People may also borrow to finance their own education or the education of their
children to cover their healthcare costs
#Personal debt is the total stock of money borrowed and yet to be repaid by a
person or household

Influences on borrowing
1. The availability of loans and overdrafts: The easier it is to borrow, the more
likely people are to borrow
2. The rate of interest: A rise in the rate of interest will increase the cost of
borrowing which is likely to reduce borrowing
3. Confidence: The more confident people are about the future, the more they will
anticipate earning in the future. They may adjust their spending patterns now,
financing some of their extra expenses by borrowing with an expectation that their
higher income will enable them to repay their loans
4. Social attitudes: Some countries and some groups within countries are more
concerned about the risks of getting into debt by borrowing than others
Problems with borrowing:
 It becomes troublesome to repay borrowing if a person’s income falls or
they have become unemployed or their business has been forced to shut
down
 In such a scenario, people unable to repay their personal debts will be
declared bankrupt or insolvent by a law court.
 Their personal belongings can be taken into possession by the bank or they
may be forced to sell their assets to repay the money they owe

Household –Spending, Saving, Borrowing (past paper questions)
Explain two reasons why household borrowing may increase (4) S16QP21
Household borrowing increases when the interest rate is low as lower the interest
rate, the easier it will be to repay loans. Therefore, people tend to borrow more
when interest rate is low. Another reason that causes household borrowing to
increase is greater availability of credit. If credit is available widely and on
customer-friendly terms, then people are inclined to borrow more.
Explain the differences between saving and borrowing (4) W16 QP23
Saving involves people delaying consumption until some later date when they will
withdraw and spend their savings plus the interest earned. On the other hand,
borrowing is to increase current expenditure on goods and services such as loan to
buy property known as mortgage. In addition, when we save money, we do not
have to pay interest, but instead we receive interest which can be consumed later.
While in borrowing, we must pay back the original amount with an agreed rate of
interest.
Analyze how the spending, saving and borrowing patterns of young workers may
differ from older workers (6 marks) S16 QP22
Spending refers to money spent on consumption of goods and services to satisfy
needs and wants. Saving means to store money for future consumption. Borrowing
is taking out money with the intention to repay it back with a set rate of interest.
It has been noticed that the spending, saving and borrowing patterns may differ
between different age groups. A young person has increased spending as he wishes
to buy luxurious or high-technology items. In addition, the disposable earning of a
young worker may be low; therefore, the proportion of spending remains high. For
instance, a young person might spend 80% of his disposable income. Further, the
savings of a young person is limited because they do not have sufficient income
and spend a higher proportion of their disposable income on consumption. Also,
younger workers do not have a lot of financial responsibilities on their shoulders
and thus save less. Further, young people borrow more money in order to satisfy
their wants for e.g. to buy a house or a car.
On the other hand, the spending pattern for the older worker remains high as well,
but majority of their income is spent on medical expenses, utilities, making
mortgage payments. The older workers may save more money as they are

preparing for their retirement or for their children’s education. The older workers
do not occasionally borrow money; however, their borrowing may increase in case
of an unforeseen financial circumstance.
To conclude, the spending, saving and borrowing differs among young and old
workers.
Discuss whether highly paid teachers are likely to spend more and borrow more
than less well-paid teachers. (8 marks) W14 QP23
Spending is the consuming of goods and services to maintain a standard of living. Whereas
borrowing is taking out a specific amount of money with the intention to repay it within an
agreed period of time. The money returned is usually accompanied by interest payments.
Highly-paid teachers spend more money because they have more disposable income. If income
after tax is high, it means that highly-paid teachers have more money available to spend. These
teachers can afford to spend more money in total, and a higher proportionate of their income on
luxurious products or services, for instance, foreign holidays in the summer break. Another
factor that contributes to higher spending is their confidence to earn a steadier stream of income
in the future. The highly-paid teachers are experienced and qualified, thus they are optimistic
about their future income and prospects for promotion remains high.
In addition, these teachers borrow more as the bank is willing to give loans to highly-paid
teachers. On account of their strong credibility, the bank assesses them to be less risky and gives
out loan on favorable terms.
On the other hand, highly paid teachers would spend less as a percentage because at higher
disposable income, the individual earns sufficient money to be able to spend and save. Senior
teachers are usually highly-paid as they have served in the field for a longer period of time. It is
common for these elderly teachers to spend less money because they are less susceptible to
changes in fashion and technology. Rather, these older teachers save money for retirement or
other purposes.
The borrowing for highly-paid teachers is usually lower because they can afford to satisfy their
needs and wants with their disposable income and do not have to raise funds from an external
party. In case of senior teachers, they must have accumulated savings over their tenure, which
can serve as a cushion in unforeseen circumstances. This eliminates the need to borrow.
In my opinion, majority of highly paid teachers spend and borrow more because they possess the
ability to do so, whereas some might prefer to save and spend less at higher income level.

Market Structure
Market
Structure
Perfect
Monopolistic Oligopoly Monopoly
Competition
Features of Perfect Competition
Agricultural market comes close to

perfect competition
1. In a perfectly competitive market, there is a large number of buyers and

sellers. None of the firm or consumer will have any influence over the
market price; hence they are price taker.
2. The products sold in a perfectly competitive market are identical or

homogenous. It cannot be differentiated
3. There is free entry into and exit from the market. This means that there must
not be anything which makes it difficult for the firms to enter or leave the
industry.
4. Perfect Information: Buyers and sellers must possess complete knowledge

about the prices at which goods are being bought and sold. This will help in
having uniformity in prices.

Perfect Competition is an extreme and limiting concept used by economists only as
a comparator for all other market structures. Not surprisingly, most markets are in
reality, not “perfect”.
Features of Monopoly
K-Electric is the only private

power company in Karachi to
transmit electricity
1. In a monopoly, there is a single seller that owns 100% of the market share. It
is a price maker and decides the price to be charged for the product
2. The product offered by a monopoly is a unique and differentiated product

which allows a higher price to be charged
3. There are high barriers to entry and exit making it difficult for other firms to
enter the market
4. There is imperfect information as the seller who is the single producer can
exploit the buyer and surge up prices to make abnormal level of profit
Why do monopolies continue?
Monopolies are often criticized as absence of competition may lead to inefficiency.
As a result, production cost may be higher than they would otherwise be in a
competitive firm
A monopoly may restrict the supply to push up prices and may produce a lower
quality product.
It may also fail to respond to changes in consumer tastes and develop new
products.

Despite these shortcomings, the monopoly exists due to high barriers to entry and
exit. There are two types of barriers of entry:
Natural Artificial
Natural Barriers to Entry: Large scale production is more efficient and smaller
firms may be unable to compete with larger firms on costs and revenues
1. If a single firm is able to produce the entire supply of a product at a lower
average cost, i.e. economies of scale than a number of smaller competing
firms then it has a natural monopoly.
2. The supply of a product may involve the input of such a vast amount of
capital equipment. New, smaller and competing firms will find it difficult to
raise enough finance to buy or hire their own equipment.
3. A business may have a monopoly because it was the first to enter the market
for a product and has built up an established and loyal customer base.
Artificial Barriers to Entry: Some powerful firms may introduce pricing, output
and marketing strategies purposefully to restrict new competitions from eroding
their market power and profits
1. Existing firms in the same market with a dominant share can threaten their
suppliers that if they supply any new firms, the firms will stop buying from
the current supplier and contract others.
2. Predatory pricing occurs when a large firm cuts it prices, even if it means
losing money in the short run, in order to force new and smaller competing
firms out of business. Once the new competitor has been removed, the
dominant firm can raise its price again

3. In exclusive dealing, retailers are prevented from stocking the products of
competing firms. This method of restricting competition is particularly
effective if the product supplied by the dominant firm is very popular with
consumers
4. Full line forcing means a large multi-national firm will only supply a retailer
if it stocks and sells the firm’s full range of products or these shops would
risk losing an attractive and well-recognized brand
5. The development of new production methods and products can be expensive

but can be encouraged by granting innovative producers patents or
copyright to protect them from other firms copying their idea and thereby
reducing their potential sales and profits
Why & how does the government intervene to correct monopolies behavior?
1. Some monopolies may be nationalized and taken into public sector
ownership. If the government owns them, their prices and services can be
controlled directly
2. Consumer protection laws are designed to protect consumers from

exploitation and harmful business activities. For example, in my countries, it
is an offence to sell goods or services which does not meet the quality
standard. It is also illegal to mislead consumers about prices and product
features.

Occupations and Earnings
Factors that affect an individual’s choice of occupation
Workers consider monetary and non-monetary factor rewards when choosing their
occupation:
Choice of
Occupation
Non-
Monetary
monetary
factors
factors
Monetary factors:
1. Wages are paid with respect to time or work done. Such payments are usually
made to unskilled workers whose work can be measured
a. Time Rate: A rate of pay per hour worked, so the more hours an employee
works the more he or she will earn.
b. Piece rate: It is paid to employee of a firm per unit of output produced, so the
more output produced by an employee the more he or she will earn
2. Salary/Fixed Annual rate: The job will be divided into 12 equal monthly
payments regardless of the number of hours worked by the job holder each week
over and above an agreed amount of time.
3. Commissions: Commissions are proportion of sales paid to labor. These
payments are usually made above workers salary. Commissions can motivate
workers to make greater sales
4. Bonuses: Bonus is a one-time extra payment made to labor. Usually bonuses are
paid out of the annual profit of the firm
5. Increments: Increments are increase in wage rate or salary of the worker. These
increments can be fixed or performance-related

6. Overtime pay: Additional hours worked by labor above their shifts are called
overtime. For e.g. a worker who is employed for 8 hours a day works for additional
two hours then he will be paid overtime for the additional two hours.
7. Profit sharing: Firms may share part of their profit with labor. Such offers are
usually made to workers that are essential of the firm and can create a lot of sales
and profits.
Non-monetary factors:
Non-financial factors or benefits associated with job
1. Location: Labor prefers to work in firms located in convenience and safe
locations. High transport cost discourages worker
2. Nature of job: Workers are discouraged from dangerous and dirty jobs and
prefer to avoid jobs at unsociable hours. Respectable and safe jobs attract more
workers
3. Job Security: Jobs that are permanent attract more workers. For e.g. workers
may choose a relatively low paying public sector job over a high paying private
service because it is more secure
4. Growth Prospects: Workers consider margin for growth when taking up work.
Labor may choose a relatively low paying job because it may have higher chances
of growth
5. Status of firms: Larger firms with the higher status attract more labor. Such
firms are more reliable and can create a better prospect for labor
6. Fringe benefits: Off the job benefits provided by the job. For e.g. company car,
paid vacations, and health insurance. Labor considers the overall package and may
settle for low wage with fringe benefits
7. Trade Union: Stronger union attracts more worker as unions can negotiate
appropriate wages, job security, working conditions and avoid exploitation.
#Conclusion:
All the wage & non-wage factors that affect the attractiveness of a job or
occupation are called its net advantages. A person will compare and select a job or
occupation by comparing their advantages and disadvantages. Choosing between
different occupations will therefore involve trade-offs. For example, the

opportunity cost of choosing a job with high wages may be a loss of leisure time
because of the need to work longer hours.
Take a snap chat break!!
Demand for labor:
The demand for labor is derived demand which means that the demand for this
FOP occurs when there is demand of the final output.
The labor demand by employers is downward sloping showing an inverse
relationship between wage and quantity demanded of labor
As the wage rate rises, quantity demand for labor contracts. Similarly, when the wage
rate falls, the quantity demand for labor increases.

Factors affecting labor demand (Shifts in the demand curve):
Demand for product:
Labor demand is the derived demand. If consumer demand rises, firms may expand
output in response. To do so, they will increase their demand for labor to produce
additional output
Productivity of labor:
Labor demand is higher when labor is more productive than other factors of
production. Firm employs more workers when labor can produce more and better
output than alternative factor of production e.g. capital
Relative cost of FOP:
Firms demand resources by comparing the cost of employing each factor. It is
demanded more when it is cheaper than alternative source of production

Supply for labor
Labor supply is upward sloping showing that quantity supplied of labor increases
when wage is higher. The movement along the supply curve reflects the effect of a
change in wage rate on the quantity supplied of labor.
Positive relationship:
As WR increases, Qs of L will
increase
As WR will decrease Qs of L will
decrease
Backward Bending Labor Supply Curve

However, at higher wages labor may choose to work less. Labor chooses between
working hours and leisure hours. Additional hours of work reduce the number of
leisure hours.
At high wage rate, labor can work

for fewer hours and maintain high
total income. This can allow him to
enjoy more leisure hours for rest or
to spend time with his family etc.

Factors affecting labor supply (Shifts in the supply curve):
Shifts in the supply curve are caused by factors other than the wage rate
Population:
Larger population creates a larger labor force. For example, China and India have
higher supply of labor in most market due to higher population. It also depends
upon the nature and structure of population e.g. population with a low average age
has more school going students which causes the labor supply to be lower
Information:
Labor supply is based on the information available to labor. Easy and cheap access
to information allows workers to quickly respond to wage changes which can keep
labor supply higher
Training required:
Jobs that require a long and expensive training period have lower labor supply as
fewer workers choose to undertake such training for e.g. surgeons have lower
supply due to the long education and training required
Nature of job:
Workers prefer safe and respectable jobs causing labor supply for such jobs to be
higher. Jobs that are dangerous or dirty attract fewer workers keeping labor supply
lower. Similarly, lower labor supply is received for job with odd hours or night
jobs

Mobility:
Higher geographical and occupational mobility increase supply of labor in each
market
Wage Determination
Wage determination occurs when

QD of labor intersects with QS of
labor at point W. This is the
equilibrium wage rate at which the
market clears, or labor demand is
matched by labor supply. At this
wage, we find out how much labor
will be employed by firms.
Changes in the equilibrium wage rate and equilibrium quantity of labor

The equilibrium wage rate changes when there is a shift in the demand and/or
supply curve. This change results in a new wage rate equilibrium and quantity
of labor.
Scenario 1: An increase in the labor supply due to an increase in population

Scenario 2: An increase in the labor demand due to an increase in the productivity
of labor
Scenario 3: An increase in the demand for baristas/coffee servers due to an

increase in takeaway coffee – Derived Demand

Scenario 4: Shift in the demand and supply curve – both
An increase in the demand for labor due to cost of capital being expensive and a
decrease in the supply of labor due to harsh job conditions.
Factors affecting occupational wage differentials:

Why do doctors earn more than farmers?
1. Training, skills and experience: Workers with higher skills and experience can
add more value to production and have lower chances of making mistakes.

2. Nature of job: Jobs that create hazards (dangerous and dirty) may have higher
wages to compensate for the hazards of the job. Also, fewer worker may opt for
such jobs keeping labor supply lower and wages higher
3. Information: Wage differences can occur due to imperfect information. Workers
that have lack of information may agree to work for lower wages while workers
with information are able to negotiate better
4. Fringe Benefits: Some jobs may offer lower wages than others because they
offer more perks instead, such as company cars, free life insurance, or cheap travel.
5. Labor mobility: If workers are occupationally mobile, they can move easily to
jobs that offer them the most pay, and if they are geographically mobile, they will
also move from places with high unemployment to areas with vacancies more job
Why do earnings differ between people doing the same job?
1. Regional difference in labor demand and supply conditions:
There may be shortages of workers with types of skills in some parts of the
country. Firms in such areas needing these workers may offer higher wages to
attract from rival firms or from elsewhere in the country
2. Length of service:
Many firms have pay scales that offer pay increases linked to the number of years a
worker stays with the firm. This extra pay is both a bonus for loyalty and also a
payment for having more experience and skill
3. Non-monetary rewards differ:
Some firms may offer their workers more fringe and other benefits than rival firms
such as longer holidays, free medical care and enhanced pension contributions,
instead of higher rates of pay
4. Discrimination:
Workers doing the same job may be treated differently by different employers
simply because of their sex, age, race or religion.

Why do governments intervene in labor markets?
1. To protect the rights of employees and employers:
Employment laws and workplace health and safety regulations have been
introduced in many countries not only to give employers and workers certain
rights, but also to make them responsible for observing the rights and
responsibilities of each other.
2. To outlaw and regulate restrictive practices that may be used by powerful trade
unions and major employers
Laws have been introduced in several countries to control the power of employers
and trade unions over wages and working condition.
3. To raise the wages of the lowest-paid workers:
Many countries have minimum wage legislation designed to protect vulnerable and
low-paid workers from exploitation by powerful employers. Apart from raising the
pay of low-paid workers, it is argued that favorable minimum wages will make
them work harder and achieve levels of productivity

4. To reduce unemployment:
Government may often provide unemployed workers with help re-training in the
new skills required for employment in new growing industries and occupations. A
government may also provide financial assistance to firms to encourage them to
locate in areas of high unemployment
5. To outlaw unfair discrimination

It is unlawful in many countries to discriminate against people because of their sex,
education, race, or disability, and also their age in some countries. For e.g. the
Equal Pay Act in the UK makes it unlawful for employers to discriminate between
men and women in terms of their pay and conditions where they are doing the
same or similar work of equal value
Specialization
Advantages of specialization Disadvantages of specialization
It allows individuals to make the best Individuals must rely on others to
use of their skills and abilities produce the goods and services they
want but cannot produce themselves
Employees can improve further on Doing the same task for many years
their skills by repeatedly carrying out can become boring and stressful
same or similar tasks
Skills and occupations can become
Skilled employees will often earn more outdated and unwanted if consumer
than unskilled employees as they are demand or technology change. This
more productive and there is greater means people with unwanted skills
demand for their labor from firms may lose their jobs and be unable to
find new ones until they retrain

Trade Union
Trade Unions or labor unions are organization formed by labor to represent their
rights and protect their interest. An individual worker does not have the ability to
negotiate his rights but as part of a large union, workers can achieve better wages
and working conditions and can be protected from exploitation.
Union elects one of its members to be union leader to negotiate for them
Functions of a trade union
1. Negotiating workers’ wages: Unions are responsible for negotiating wage rises
for its members. In case of inflation, where the real income of the employees may
fall, union members negotiate for higher wages to compensate for inflation and
improve living standards.
2. Ensuring adequate condition: Unions are responsible for ensuring that workers
have safe and secure working conditions depending upon the nature of the job.
This can include provision of safety equipment, hygiene and cleanliness of the
workplace.
3. Safeguarding jobs: Unions protect workers against unfair dismissal and generate
job security.
4. Secondary aims: Developing the skills of trade union members, by providing
training and education courses. It also provides social and recreational amenities
for their members.

Tools of Trade Unions
Collective bargaining: It involves representatives of workers negotiating with
employers’ association.
The employees can make the following wage claims:
 Workers deserve to be paid more because they have been working harder
and have increased productivity
 Industry whose profits have risen can afford to pay higher wages to its
workers
 A union may argue that the worker it represents should receive a pay rise to
keep their pay in line with similar workers. For e.g. a union representing
nurses may press for wage rise if doctors are awarded high pay.
Industrial Disputes
Collective bargaining between trade unions and employers can sometimes fail to
reach an agreement. For example, if a union demands for more holidays, better
pensions and sick pays, and resistance to new working practices, it will tend to
raise costs and could mean that a firm becomes uncompetitive.
Industrial Actions
When workers disrupt production to put pressure on employers to agree to their
demands.
Official action: It has the backing of their trade union, and other unions may also
act in support
Unofficial action means that workers taking the industrial action do not have the
support of their union

Overtime ban: Workers refuse to work more than their
normal hours
Work to rule: Workers deliberately slows down production

by compiling rigidly with every rule and regulation
Go-slow: Workers carry out tasks deliberately slowly to

reduce production
Stike: Workers refuse to work and may also protest,or picket,

outside their workplace to stop deliveries and prevent non-
unionized workers from entering
Picketing: Union representatives protest outside the factory

gate to gain support of labor force, consumer, government
and other institutions. A picket line is drawn to encourage
workers to join the union. This increases the strength of
union’s actions and can influence employers

How to resolve industrial dispute
Arbitration:
It involves employers and unions agreeing to let an independent referee, often a
senior government official or lawyer, help them reach agreement.
This normally means both sides in the dispute accepting a compromise –
something that is satisfactory to both parties but rather less than they had initially
wanted.
Alternatively, both sides agree to accept the judgement of an independent arbitrator
who will determine what a fair wage increase or change in working conditions
should be based on evidence and recommendations presented by the union’s and
employer’s representative.
Strengths of Unions
1. Labor representations: Unions are stronger when they represent a larger
proportion (majority) of labor. Any action by such unions have a stronger effect on
production process
2. Importance of labor: Unions are stronger in labor intensive firms. When output
mostly depends upon effort of labor, unions become stronger
3. Nature of Output: Unions provide products such as public services and
consumers need and for which, there are few close substitutes, such as electricity,
public transport, health care and education
4. Unemployment rate: High rate of unemployment creates job insecurity. During
recessions and times of high unemployment, unions are more concerned about
avoiding redundancies and lose power to raise wages
5. Wages: Unions find it easier to negotiate rise in wages when wages are a small
part of the total cost. If current wages are already high, unions will find it difficult
to negotiate higher wages.

Positives & Negatives of Trade Unions
Positive Impacts Negative Impacts
 Act as a channel of  Unions can cause wages to rise
communication between which increases cost of
employers and employees. production. Firm can lose its
Through negotiation and competitive advantage or
collective bargaining, they help profitability due to higher cost. It
to solve disputes and settle pay also results in price rises for
claims effectively consumers
 Offer legal support and advice to  Firm plans redundancy to

employees generate growth and efficiency
by introducing advance
 Negotiate on behalf of their machinery. Unions resist such
members with employers for changes as they can result in loss
better pay and working of jobs. Too much union power
conditions and can therefore help in a country can slow down its
to raise living standards development.
 Skilled and trained workers may  Job security can make workers
be attracted towards the firm due lazy and inefficient. Labor
to strong unions. These workers becomes less productive as they
will feel more secure working in consider their jobs to be secure
an organization where a strong and lose incentive to work
union can represent them. Such
workers increase the overall
productivity of the firms which
results in higher
output

Growth of Firms
The size of the firm can be measured in a number of ways
1. Number of employees:
This is a straightforward measure. Firms with less than 50 employees are often
classified as small.
2. Organization:
Larger firms are often divided up into different departments specializing functions
such as purchasing, sales and marketing, finance and production.
The size of an organization can therefore be judged by how it is organized
internally.
3. Capital employed:
It is money invested in those productive assets in a firm that help it generate
revenue. They are assets used to produce and sell goods and services.
The more capital employed in a firm, the more it can produce and therefore the
greater its size or scale of production.
4. Market share:
Market share represents the percentage of an industry, or a market's total sales that
is earned by a particular company over a specified time period.
Market share is calculated by taking the company's sales over the period and
dividing it by the total sales of the industry over the same period.
This metric is used to give a general idea of the size of a company in relation to its
market and its competitors.

Types of Growth
Growth can be carried out in two ways: Internal Growth & External Growth
Internal Growth
Internal growth is when the firm

expands by increasing its existing
operations such as:
 Opening new branches
 Product development and
value addition
 Diversification
 Tapping into new markets
 Increasing existing
production capacity
External Growth
The increase in the size of a firm resulting from it merging or taking over another
firm
Difference between a merger and take-over?
Merger: In a merger (also known as Take-over: It is when one firm

amalgamation), two or more firms completely buys the assets of another
combine their assets to form a new firm. A firm that buys another firm is
larger business called predator firm whereas the firm
that was bought is called a prey firm.

Types of external integration
Horizontal Vertical
Conglomerate
Integration Integration
Horizontal Integration
It is when the merger of two firms at the same stage of production, producing the
same product, for example, the merger of two car producers or two TV companies
Advantages of horizontal integration:
 Greater economies of scale
 Increased market share
 Save on managerial cost
Disadvantages of horizontal integration:
 Diseconomies of scale
 Different management styles
Vertical Integration
A vertical integration occurs when a firm merge with another firm involved with
the production of the same product, but at a different stage of production. It can
take the form of vertical backward or vertical forward.

Vertical Backward Integration:
It is when a firm merges with a firm that is the source of its supply of raw
materials, components or the product it sells.
Advantages of Vertical Backward Integration:
 To ensure adequate supply of good quality raw materials at a reasonable
price
 To restrict the access of the rival firms to the supplies
Vertical Forward Integration:

It is when a firm merges with, or takes over, a market outlet. For instance, an oil
company may buy a chain of petrol stations.
Advantages of Vertical Forward Integration:
 To ensure sufficient outlets, and the products are stored and displayed well
in high quality outlets
 A firm may also hope that such a merger may help in the development and
marketing of new products
Conglomerate Integration:
A conglomerate integration involves the merger of two firms making different
products. For example, an electricity company may merge with a travel company
and an insurance company may merge with a chocolate producer.
Advantages of Conglomerate
 The main motive behind a merger is diversification
 Firm can spread risks over several products (risk-bearing economies)

Benefits of the growth of firms
Economies of scale: Large scale production allows firm to enjoy economies of
scale as fall in average cost can result in lower prices for consumer. Firms can
enjoy higher profitability due to lower cost
Research and Development: Larger firms have greater ability to carry out research
and development. This can result in better quality output and greater diversification
which can benefit consumers and producers.
Greater status and reliability: Larger firms have greater credibility due to greater
value of assets. As firms grow in their status in goods, it can result in the
following:
 Brand loyalty from consumers
 Raw material can be purchased on credit
 Easier to raise finance etc.
Skilled labor is attracted: Growing firms generate vacancies which attracts labor
and skilled labors prefer to work in larger organizations.
Hazards of growth of firms

Diseconomies of scale: Larger organization can become difficult to control which
can create inefficiencies resulting in higher average costs.
Loss of personal contact: Owners lose direct contact with consumers as firm
grows. Lack of direct feedback can result in loss of quality.
Greater risk: Greater amount of capital is invested which increases the risk for
enterprise.
Monopolization: Larger firms can monopolize the market which can result in the
following
 Higher prices are charged from consumers
 Lack of competition can lead to stagnancy and inefficiency
 New firms are restricted from entering
Environmental Hazards: Large scale production can lead to greater environmental
hazards in terms of air and water pollution etc.

Why do some firms remain small?
1. Many smaller businesses act as a supplier / sub-contractor to larger enterprises

especially in the construction industry and in sectors such as software coding / web
design.
2. Smaller businesses can avoid internal diseconomies of scale (which lead to
rising long run average cost)
3. Many smaller businesses run as lifestyle enterprises where owners are looking to
satisfice not maximize profits
4. Small businesses are often innovative, flexible and nimble in responding to
changes in market demand
5. Some goods and services require a personal contact of consumers with
producers such as hairdresser etc. Such businesses providing such services may not
expand.
6. The owner might not have the necessary capital to expand his business
7. The market for some goods may be small and hence there would be no need to
expand. For example, the market for a French newspaper in Pakistan is very small
8. Some goods and services such as jewelry etc. have limited demand; therefore,
they do not have the advantage in expansion

Economies of Scale
Economies of Scale are the advantages, in the form of lower long-run average
costs (LRAC) of producing on a larger scale.
There are two type of Economies of Scale
Internal External
Economies of Economies of
Scale Scale
Internal Economies of Scale:

These are the advantages gained by individual firm by increasing its size, that is
having larger or more plants. As a result, the total output increase while the
average cost falls and the firm is said to enjoy internal economies of scale.
Types of Internal Economies:

1. Purchasing Economies: Firm purchase raw materials in bulk quantities which
allows it to negotiate higher discounts. Similarly, the cost of transporting and
storing this raw material is spread over greater number of units causing average
cost to fall.

2. Financial Economies: Banks and other financial institutes are always willing to
give loans to large firms as there is less chance of non-payment. Easier and cheaper
finance is available to larger firms which can be used to increase output
3. Technical Economies: The larger the output of a firm, the more viable it
becomes to use large, technologically advanced machinery. Such machinery is
likely to be efficient, producing output at a lower average cost than small firms.
4. Risk bearing economies: Larger firms usually produce a range of products. This
enables them to spread the risks of trading. If the profitability of one of the
products it produces falls, it can shift its resources to the production of more
profitable products.
5. Managerial Economies: Specialist managers can be employed to run every

department where they can specialize in one department rather than doing
diversified tasks. These managers can streamline the process and generate
efficiency.
External Economies of Scale:

These are the economies which occur due to the growth of industry in which the
firm is operating. A firm is said to experience external economies when its average
cost falls as the size of the industry rises.
1. Regional Specialization of Labor: Labor of a particular region becoming
specialized at a specific occupation gives the producers the advantage of skilled
labor and hence more efficiency.
Workers train themselves to match the requirements of growing industries which
saves training cost and increases efficiency.
2. Specialized services: Specialized banking, marketing and insurance services will
have grown up in the area to deal with the particular requirement of the industry.

3. Subsidiary firms (ancillary firms): These firms provide subsidiary goods such as
maintenance, training and marketing services and develop and supply specialized
machinery, computers.
It may locate nearby large firms in particular industries to provide them with
specialized equipment and services they require.
4. Transportation and infrastructure: Government sets up and improves the
infrastructure around growing industries. A good transportation system reduces
cost and time.
Diseconomies of Scale
Diseconomies of Scale results when a firm expand their size and scale of
production process too much and too quickly. As a result, productivitiy may fall
and average costs will rise.
There are two types of diseconomies of scale:
Internal External
Diseconomies Diseconomies
of Scale of Scale

Internal Diseconomies of Scale
Growing beyond a certain output can cause a firm’s average cost to rise. This is
because a firm may encounter a number of problems including:
1. Difficulties controlling the firm: It can be hard for those managing a large firm
to supervise everything that is happening in the business. Management becomes
more complex.
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 condtions.
2. Communication problems: It can be difficult to ensure that everyone in a large
firm has full knowledge about their duties and available opportunities, such as
training etc. Also, they may not get the opportunity to effectively communicate
their views and ideas to the management items.
3. 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:

With more and larger firms in an area, there will be an increase in transport with
more vehicles bringing in workers and raw materials, and taking out workers and
finished products.
This may cause congestion, increased journey times, higher transport costs for
firms and possibly reduced workers’ productivity.
The growth of an industry may also result in increased competition for resources,
pushing up the price of key sites, capital equipment and labor.

Firms and Production
Demand for factors of production
The type of factors of production employed is influenced by the
 Type of product produced
 Productivity of the factors
 Cost of the FOP
Altering factors of production
If a firm wants to change the quantity of resources employed by it, it will find it
easier to do this with some factors than others.
In the short run, there is likely to be

at least one fixed factor of
production. This means that the
quantity cannot be altered quickly
i.e. a firm can not extend its
building. It can however increase
quantity of its product by altering the
quantity of labor by changing the
amount of overtime available
Combining the factors of production
When deciding the combination of resources, firms seek to achieve the highest
possible productivity.
The table below shows that the most appropriate number of workers to be
employed (in terms of productivity) with 4 machines is 5 workers since this is
where the output per worker is highest i.e. 20.

No. of Total Average Output per
No. of machines workers output worker
4 1 10 10
4 2 24 12
4 3 45 15
4 4 72 18
4 5 100 20
4 6 108 18
4 7 112 16
A firm will want to combine its resources in the most efficient way to maximize its
overall productivity for the minimum of cost. It will therefore compare the costs
and productivity of labor with capital and will tend to employ more of the most
productive factor.
It follows that if wage rate rises or the productivity of capital rises, a firm will tend
to replace labor with more capital. This is known as factor substitution.
Factors influencing the demand for capital goods
A rise in the price of capital goods will cause a contraction in demand

for capital goods or vice versa
A rise in the price of a factor substitute such as labor will make

production more expensive and producers will switch to capital
If profit levels are high, firms will have both the ability and the
incentive to buy capital goods.
A cut in coporation tax would also mean that firms would have more
profit available to plough back into the business and buy capital goods
A cut in interest rates would encourage firms to borrow more to buy

more equipment
Government subsidies: funds that are provided by the govt to the

producer to buy capital goods

Labor-intensive production
A labor-intensive organization will employ more labor than capital machinery and
equipment.
Reasons for labor intensive:
 A large supply of labor in the country, making labor relatively cheap
 Some firms may be too small to take advantage of capital equipment
 Firm may focus on customized product rather than mass production
Advantages of labor intensive:
 Workers are flexible in terms of their work
 Size of labor can be adjusted by small amounts
 Labor can provide feedback on how to improve production methods and the
quality of methods
Capital-intensive production
A capital-intensive firm is one that has invested heavily in capital equipment and
machinery and less workers.
Reasons for capital-intensive:
 Advances in technology tend to make capital goods more affordable and
productive
 Capital goods produce products of uniform standard at a lower average cost
(technical economies)
Advantages of capital-intensive:
 Unaffected by human error
 They do not engage in industrial action
 They do not take time off and are not affected by tiredness
Production and Productivity
Production is a measure of the value of output of goods and services in a specific
industry such as car manufacturing
Productivity is a measure of an economic performance that indicates how
efficiently inputs are converted into output. For e.g. output per person employed or
output per hour is a measure of labor productivity.

Calculating costs and revenues
Total Cost: It is the total amount that has to be spent on the factors of production
used to produce a product.
Total Cost = Fixed Costs + Variable Costs
Fixed Cost: It remains constant for all levels of output and is incurred, even when
no output is produced. For e.g. mortgage payments or rents for premises, interest
charges on bank loans, insurance premium.
Variable Costs: It is sometimes called direct cost, are the costs of the variable
factors. They vary directly as output changes.
Higher level of output leads to higher cost of production. Variable cost is zero
when production is stopped. For e.g. cost of raw materials varies with the amount
of output produced.

Calculate: Total Fixed Cost, Variable Cost and Total Cost when FC is 5,000 and
VC is 5/ unit.
Total Total
Fixed Variable Total
Output Cost Cost Cost
0 5000 0 5000
1 5000 5 5005
2 5000 10 5010
3 5000 15 5015
4 5000 20 5020
5 5000 25 5025
FC shows fixed cost which

remains constant
VC shows variable cost which

rises as more units are
produced
TC shows the sum of FC and

VC
Firms are usually more concerned with average costs rather than total cost as
average cost compares total cost with output produced.
Average Costs (AC): It is the total cost divided by output

Average Costs = Average Fixed Cost + Average Variable Cost
Average Fixed Costs (AFC): It is total fixed cost divided by output
Average Variable Costs (AVC): It is the total variable cost divided by output
Find the Average Fixed Cost: Find the Average Variable Cost:
Total Variable Average

Total Fixed Average Fixed
Output Cost Cost
Output Cost Variable Cost
0 10 - 1 40 40
1 10 10 2 70 35
2 10 5
3 90 30
3 10 3.33
4 10 2.5 4 120 30
5 10 2 5 175 35
AFC: Total fixed cost remains

unchanged, but AFC falls with the
level of output
AVC: As output increases, AVC

tends to fall and then rise
ATC: It is usually a U-shaped curve

showing economies &
diseconomies of scale

Calculate TFC, TVC, AC, AFC, AVC
Output TC TFC TVC AC AFC AVC
0 60 60 0- - -
1 110 60 50 110 60 50
2 150 60 90 75 30 45
3 180 60 120 60 20 40
4 200 60 140 50 15 35
5 230 60 170 46 12 34
6 300 60 240 50 10 40
Revenue: The money received by firms from selling their products is referred to as
revenue. Total revenue is the total amount of money received by firms through the
sale of their products.
Total Revenue = price per unit * quantity sold
Calculate Total Revenue
Qty Price Total Revenue
0 10 0
1 10 10
2 10 20
3 10 30
4 10 40
5 10 50
6 10 60
Average Revenue (AR): Average revenue (AR) is the estimated amount earned
per unit of sales. It also represents the average price the firm has obtained for all
units sold.
Average Revenue = Total Revenue/Quantity
Profit, loss or break-even
Profit or Loss: It is calculated as the difference between total revenue and total cost
at each level of output.
If Total Revenue > Total Cost = Profit
If Total Revenue < Total Cost = Loss

If Total Revenue = Total Cost, or where Total Revenue – Total Cost = 0, this
situation is known as break-even.
Break-Even:
Break-Even is that level of output,

which if sold, will generate a total
revenue that will exactly equal total
cost. At the break-even level of
output, a firm will neither make a
profit or a loss.
Break-even can also be calculated with the formula:
Calculate Break-Even Level

Break-Even = 200/ (10-8)
of Output
Fixed Cost 200 = 200/2
Selling Price per unit 10
=100 units
Variable Cost per unit 8

Objectives of firms
Firms may pursue a range of objectives including:
Profit Maximization: It is the objective that is pursued by most private sector firms.
Total profit is the positive difference between total revenue and total cost. Profit is
maximized when the positive gap between revenue and cost is greatest.
Ways of Increasing Profit:
The two fundamental ways of increasing profit are to:
1. Reduce costs of production
o Reducing any wastages and inefficiency
o Increasing the productivity of FOP
o Increasing the size of the firm via a merger or takeover, so that it can
benefit with economies of scale
2. Raise revenue (P*Q)

o Increasing price
o Improvement of their products
o Diversify and be more responsive to changes in consumer demand by
improving the market research
o Firms can do successful advertising campaign
Survival: When firms start, their initial objective may be just to survive in what
may be a very competitive market. A firm may be content to just cover its costs
until it can become better known.

During difficult times when demand is falling, even large firms may have survival
as their key objective. They will try to stay in the market in the hope that
conditions will improve.
Growth: Some firms may pursue the objective of growth. Increasing the size of the
firm may bring several advantages such as
 Internal economies of scale
 Raise finance more easily
 Managers, directors and CEO’s pay and status may be more closely linked to
the size of the firm
If growth is achieved by merging with other firms, competition will be reduced and
the firm will gain a larger market share.
Social Welfare: Public-owned enterprises usually aims for improving social
welfare. They may, for instance, charge a relatively low price for their product to
ensure they are affordable to even the poor.
In recent years, some private sector firms have sought to clean their production
process and ensure that they source their raw materials from firms that do not
employ child labor.
Profit satisficing: In this situation, the firm makes satisfactory level of profit, as
opposed to profit maximization, where the aim is to increase profits. This involves
making enough dividends to keep shareholders happy while pursuing other
objectives.

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Nixor O Levels

MICRO- ECONOMICS NOTES

By: Miss Madiha Charania

*Resources available in the world are of two types:

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A land is perfectly immobile in the The occupational mobility of land

Labor’s geographically mobility In case of an unskilled worker,

The geo mobility of heavy The occupational mobility

An entrepreneur is geographically An entrepreneur is occupationally

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The amount of physical land does The quality of land can be

The quantity of labor can be The quality of labor can be

The quantity of capital can be The quality of capital goods can

The quantity of enterprise will The quality of enterprise can be

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Consumer goods satisfy human

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Public goods are provided by the

Merit goods are provided by the

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Production Possibility Curve

Points under, on and beyond a PPC

If the economy decides to move from Point A to B, it is giving up 40 output of

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An outward shift of the PPC An inward shift of the PPC represents

Few More Definitions in Economics

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The most important function of

Money also acts as a unit of account,

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Money is used as a store of

4. Standard of Deferred Payments

With the introduction of money,

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Functions of the Commercial Bank

Money is deposited by individuals and organizations in commercial banks by

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Banks lend out money in two main ways:

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4. Other functions of the commercial bank

Aim of commercial bank

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1. State Bank of Pakistan

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Quantity demanded: The amount

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The movement along the demand

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If the income increases, it is most If the income increases, it will lead

2. Changes in direct taxes