ECONOMICS

NOTES
AND
WORKED
EXAMPLES
PERSON
IGCSE
2024
MICRO

Microeconomic Fundamentals, Basic economic problem, opportunity cost, Division of Labour, Profits and
economies and diseconomies of scale
The Basic Economic Problem
Product Possibility Curves (PPC) / Frontiers (PPF)
Economic Assumptions
Production
Productivity
Costs, Revenues and Profits
Economies & Diseconomies of Scale

Business Economics
Competition
Size of Firms
Monopoly
Oligopoly
The mixed Economy

Supply and Demand (Elasticities included PED, PES and YED)

Demand
Supply
Market Equilibrium
Price Elasticity of Demand (PED)
Income Elasticity of Demand (YED)
Price Elasticity of Supply (PES)

Labour Markets
Demand of Labour
The supply of labour:
TRADE UNIONS
Minimum Wage

Market Failure
Externalities
Policies to solve externalities
Public Goods

MACRO

Macroeconomic Fundamentals
Circular flow of income
Aggregate Demand
Aggregate Supply

Macroeconomic Objectives
Economic growth
Inflation
Unemployment
Protecting the Enviroment
Balance of Payments
Redistribution of Income
The world trade organisation
Micro
Microeconomic Fundamentals, Basic
economic problem, opportunity cost,
Division of Labour, Profits and
economies and diseconomies of scale
 The Basic Economic Problem

The Basic Economic Problem is there are unlimited wants but there is scarcity of resources

Wants and needs:

 An important distinction must be made between wants and needs. In order to survive people
only really need food, shelter and clothing. At the present level of world resources would be
sufficient to provide these for everyone.
 However, people desire or want many things no matter how much they have at any point in
time. Since human material wants are unlimited or infinite, scarcity exists in all societies.

Choices:

 Because the basic economic problem exists, societies are faced with scarcity and need to
confront three interrelated questions:
1. What to produce: Since resources are limited, societies must decide what goods and
services to produce and in what quantities. This involves making choices about which
products or services are most needed or desired by the population.
2. How to produce: Once the decision on what to produce is made, societies must
determine the most efficient and effective methods of production. This involves deciding
on the combination of resources to use, such as labour, capital, and technology, to
produce the desired goods and services.
3. For whom to produce: After determining what and how to produce, societies need to
allocate the produced goods and services to different individuals and groups. This raises
questions about the distribution of resources and the equitable allocation of goods and
services among the population
Factors of Production:
 To satisfy the unlimited wants we need to use the resources available to us. These are split
into four broad categories that are known as the factors of production:

 Capital - Capital goods are used to produce other consumer goods and services in the future
o Fixed capital includes machinery, equipment, new technology, factories and other
buildings
o Working capital means stocks of finished and semi-finished goods (or components)
that will be either consumed in the near future or will be made into consumer goods
o New items of capital machinery, buildings or technology are used to boost the
productivity of labour. For example, improved technology in farming has vastly
increased productivity and allowed millions of people to move from working on the
land into more valuable jobs in other industries.

 Entrepreneurship - An entrepreneur is an individual who supplies products to a market to

make a profit
o Entrepreneurs will usually invest their own financial capital in a business and take on
the risks. Their main reward is the profit made from running the business
 Land includes all natural physical resources – e.g. fertile farmland, the benefits from a
temperate climate or the harnessing of wind power and solar power and other forms of
renewable energy.
o Some nations are richly endowed with natural resources and then specialise in their
extraction and production – for example – the high productivity of the vast expanse
of farmland in the United States and the oil sands in Alberta, Canada. Other
countries such as Japan are heavily reliant on importing these resources.
 Labour is the human input into production e.g. the supply of workers available and their
productivity
o An increase in the size and the quality of the labour force is vital if a country wants to
achieve growth. In recent years the issue of the migration of labour has become
important. Can migrant workers help to solve labour shortages? What are the long-
term effects on the countries who suffer a drain or loss mitigation. through
migration?
Renewable & Non-Renewable Resources:
 A number of land resources can be classed as renewable resources. They are resourcing
whose stock can be maintained over a period of time. These include, solar energy, wind
power, timber, and water.
 Non-renewable resources are those whose stock level decreases over time as it is consumed.
These include fossil fuels such as coal, oil, and gas, as well as commodities such as
aluminium, copper, and steel.

Production & Consumption

 Resources are combined in the process of production to create goods and services.
 The process through which individuals use up goods and services to satisfy wants is known
as consumption.
 Goods which satisfy wants over a longer period are called durable goods, e.g., appliances.
 Another key concept you will come across frequently in Economics is called ‘opportunity
cost,’ which is defined as ‘the next best alternative given up (when making a decision).’ This
arises because a sacrifice must be made when making a choice.
Product Possibility Curves (PPC) / Frontiers (PPF)
 A PPC (Production Possibility Curve) shows the combinations of two goods an economy can
efficiently produce with its resources and technology. It illustrates trade-offs, indicating the
opportunity cost of producing one good over another. Points on the curve are efficient,
inside suggests underutilization, and outside is unattainable.
 IT assumes that:
o That current technology is used
o That all resources are used efficiently both labour and physical resources
 In reality, an economy may not produce on the PPC due to factors such as not everybody will
be working due to unemployment and also the factors of underutilization of resources,
technological limitations, and poor infrastructure.
 The economic concept shown on a PPE is opportunity cost. Opportunity cost is the value of
the next best alternative that must be forgone when a decision is made to allocate resources
to a particular option.
 In the context of a PPC, it is reflected in the trade-off between producing different goods. As
an economy moves along the curve, shifting resources from one good to another, the
opportunity cost increases, illustrating the sacrifices made in terms of forgone production of
the alternative good.
 An example of a PPE:

 The curve will be affected by any of these:

o Changes in Technology: Advancements in technology can shift the PPC outward,
allowing for increased production of both goods.
o Changes in Resources: Alterations in the quantity or quality of resources, such as
labour or raw materials, can impact the position and shape of the PPC.
o Changes in Efficiency: Improvements in efficiency and productivity can result in a
more efficient use of resources, moving the economy toward the PPC or even
beyond it.
o Changes in Population: Population growth or decline can affect the availability of
labour, impacting the economy's ability to produce goods and services.
o Natural Disasters or Wars: External shocks, such as natural disasters or conflicts, can
disrupt production and shift the PPC inward.
Economic Assumptions
 Economics is a social science that studies how individuals make decisions about the
allocation of scarce resources. It often uses economic models to help predict the behaviour
of variables (such as inflation, unemployment, consumer spending and wages) and to explain
the cause of certain events. In using these models, economists are required to make some
assumptions about the behaviour of individuals.
 When making economic assumptions, economists assume that consumers will always choose
a course of action that gives them the greatest satisfaction. This will help them maximise
their benefit and is seen as the rational choice.
 When business owners make decisions, economists assume that they will always choose a
course of action that has the best financial results because they are always looking to
maximise profit and therefore this will be the rational choice.
 However, sometimes people don’t choose rational choices such as smoking this is because of
 Computational weakness - consumers are not always good at calculating the benefit of a
decision/of a good they are consuming
 Habitual behaviour – consumers have habits that are difficult to give up
 Herding – consumers sometimes copy others’ behaviour
 Information gaps – sometimes consumers lack the information required to make a fully
informed decision

Why businesses don’t always maximize profits

 Social or Environmental Goals: Some businesses prioritize social or environmental objectives

over profit maximization. They may aim to contribute positively to society or reduce their
ecological footprint, even if it means sacrificing some financial gains.
 Long-Term Sustainability: Businesses may prioritize long-term sustainability over short-term
profits. This can involve investing in research and development, employee training, or
environmentally sustainable practices, even if it initially reduces profitability.
 Risk Aversion: Inherent risk accompanies expansion. Some companies, particularly smaller
ones or those in volatile industries, may be risk-averse and prefer to maintain their current
size and stability.
 Operational Challenges: Expanding operations often involves dealing with logistical
complexities, increased workforce management, and the need for new infrastructure. If a
company is not prepared to address these operational challenges, it may choose to delay or
avoid expansion.
Production
 As stated, before there are 4 factors of production:
o Land - Farmland, Oil, Fish Stocks, and Timber
o Capital - Machines, Tools, Vehicles and Computers
o Labour - Teachers, Musicians, Cotton Weavers and Farmhands
o Enterprise - Farmers, Bill Gates, Jeff Bezos and Alan Sugar

Production and Productivity

 Production – a process which involves converting resources into goods and services
 Productivity – the amount of output that can be produced with a given quantity of resources
 In production some jobs are ladled as labour intensive, and some are capital intensive this is
what these 2 definitions mean:
 Labour-Intensive:
o Definition: A production process is considered labour-intensive when a significant
proportion of the work is done by human effort or manual labour.
o Example: Handicrafts, where skilled artisans create products using hand tools and
traditional methods, are labour-intensive. In agriculture, tasks like planting and
harvesting by hand are also examples of labour-intensive activities.
 Capital-Intensive:
o Definition: A production process is considered capital-intensive when it heavily relies
on machinery, technology, and other forms of capital, minimizing the need for
extensive human labour.
o Example: Automated manufacturing plants, where machines and robots perform
tasks, such as assembling, welding, or packaging, are capital-intensive. Additionally,
large-scale agricultural operations using advanced machinery for planting and
harvesting demonstrate capital-intensive practices.
Economic Sectors
1. The Primary sector refers to that part of the economy that extracts and uses natural
resources (this includes agriculture, fishing, and the extraction of raw materials). e.g.,
farming, mining, forestry.
2. The Secondary sector refers to that part of the economy which processes and manufactures
goods. e.g., manufacturing, construction, processing industries.
3. The Tertiary sector refers to that part of the economy which provides services. e.g.,
healthcare, education, retail, hospitality.
 Countries are separated into Developing and Developed here are differences:
 Developing Country
o A country which has a significant decrease in the importance of primary sector
industries, de-industrialisation and a large (and growing) tertiary sector
 Developed Country
o A country which has a decrease in importance of the primary sector but increasing
importance of the secondary and tertiary sectors.
o Counties can go through Industrialisation and de-industrialisation
 Industrialisation
o The expansion of the Secondary sector (manufacturing) within a predominantly
Primary industry (agriculture) economy
 De-Industrialisation
o The contraction of the Secondary sector (manufacturing) within an economy where
the Tertiary sector (services) is growing.

Economic Development
Why do the primary and secondary sectors tend to decline as a country develops?

 An economy consists of a Primary Sector of which produces raw materials and extracts them
from the earth (farming, livestock breeding, exploitation of mineral resources), a Secondary
Sector of manufacturing and processing of raw materials, and a Tertiary Sector of service
industries.
 As a country develops it moves through the different sectors of the economy. Over time, the
percentage of GDP increases in the Secondary and then Tertiary sectors, as does the
percentage of the labour force employed.
 Growth of the Primary Sector
• Agriculture has always been a very significant element of every country’s
economy more because it paves the path towards development rather than
because it contributes significantly to the economy’s GDP.
• Most pre-industrial economies had standards of living not much above the level
that was required to survive. The majority of the population were focused on
producing enough food in order to survive. For example, in medieval Europe,
80% of the labour force was employed in subsistence agriculture.
• In the eighteenth and nineteenth centuries, Great Britain experienced a massive
increase in agricultural productivity known as the British Agricultural Revolution,
which enabled an unprecedented population growth, freeing a significant
percentage of the workforce from farming, and helping to drive the Industrial
Revolution.
 Industrialisation (growth of secondary sector)
• The industrialisation process is historically based on the expansion of the
secondary sector in an economy dominated by primary activities.
• Due to the limited amount of arable land and the increased efficiency of
mechanized farming, the increased population could not all be dedicated to
agriculture.
• New agricultural techniques allowed a single peasant to feed more workers than
previously. As result a significant percentage of the labour force previously
occupied in the agricultural sector was freed and demand for goods rose. An
increase in the efficiency of the primary sector led to an increase in demand for
machines, also feeding the growth in the secondary sector.
• As the economy develops, the need for a strong agricultural sector becomes less
and less important because:
 The country no longer needs to raise money to fund its industrialisation
drive.
 It can use the income to import the goods it needs and can’t produce
domestically.
• Also, as economies develop, agriculture stops being the way for people in rural
areas to achieve a better standard of living because they can specialise in the
jobs, they are most efficient at.
 Deindustrialisation (decline in secondary sector)
• Deindustrialisation can be defined as a sustained decline in the manufacturing
(secondary) sector of the economy.
 This occurs because:
• As technology improves, firms are able to increase output per worker/machine,
lowering the cost of production. The increased use of machines also lowers the
demand for workers.
• Also, as economies grow, they are able to outsource manufacturing processes to
other countries.
• In can also be argued that as incomes rise, demand for service industries also
increases
Productivity
Improving productivity of the different factors of production

 Land:
o Fertilisers – chemicals given to plants to improve their health and appearance and
raise crop yields (number of crops produced)
o Crop Rotation - Implementing a crop rotation system can help maintain soil fertility
and prevent the depletion of nutrients. This can lead to higher yields over time.
o Crop Selection - Choosing crops that are well-suited to the local climate and soil
conditions can improve productivity. Some crops may be more resilient or better
adapted to specific environments.
 Labour
o Improved working practices – a new layout or improving the flow of production can
increase productivity as workers have to move around less
o Employee Incentives - Providing performance-based incentives or bonuses can
motivate employees to work more efficiently and contribute to higher productivity
levels.
o Training Programs - Investing in training programs for workers can enhance their
skills and efficiency, leading to increased productivity. This can include technical
skills, soft skills, or management training.
 Capital
1. Primary Sector
o Advanced Farming Machinery - The use of modern farming equipment, such as
tractors, combine harvesters, and precision agriculture technology, can significantly
enhance productivity in agriculture
2. Secondary Sector
o Automated Assembly Lines - Implementing robotic systems and automated
assembly lines in manufacturing plants can speed up production processes and
reduce reliance on manual labour, thereby increasing overall efficiency.
3. Tertiary Sector
o Online Banking Platforms - Investing in sophisticated online banking systems and
financial technology (fintech) can streamline banking operations, reduce the need
for physical infrastructure, and improve overall service efficiency.
Division of Labour
 Specialisation can be defined as production of a limited range of goods by individuals, firms,
regions or countries
 Division of Labour is an example of specialisation. Division of labour is the breaking down of
the production process into smaller parts, with each worker specialising in a smaller, specific
task.
 Division of labour brings many benefits however, there are some downsides to both workers and
businesses.

Using Division of Labour

Advantages for Workers:

1. Specialization: Workers can become highly skilled and efficient in a specific task through
repetition, leading to increased expertise and proficiency.
2. Time Efficiency: Division of labour can reduce the time required to produce a good or
service, allowing workers to focus on a specific aspect of the production process.
3. Job Opportunities: As production becomes more efficient, firms may expand, creating more
job opportunities for workers, particularly in industries that benefit from economies of scale.
4. Training Opportunities: Workers may receive training in a specialized task, which can
enhance their employability and contribute to career development.

Advantages for Firms:

1. Increased Productivity: Specialization can lead to increased overall productivity as workers

become more skilled and efficient in their specific tasks.
2. Cost Reduction: Efficiency gains often result in cost reductions, as less time and resources
are needed to produce each unit. This can contribute to lower production costs for firms.
3. Quality Improvement: With a focus on specific tasks, there is potential for higher quality
output, as workers become experts in their assigned roles.
4. Economies of Scale: As production efficiency improves, firms can take advantage of
economies of scale, leading to lower average costs per unit as output increases.

Disadvantages for Workers:

1. Monotony and Boredom: Performing the same task repeatedly can lead to monotony and
boredom, potentially affecting job satisfaction and motivation.
2. Limited Skill Development: Workers may have limited exposure to various tasks, hindering
the development of a broad skill set.
3. Job Insecurity: Specialized tasks may be more susceptible to automation, potentially leading
to job insecurity for workers with highly specific skills.
4. Health Issues: Repetitive tasks can lead to physical strain and health issues, such as
musculoskeletal problems, for workers engaged in assembly line work.
Disadvantages for Firms:

1. Dependency on Specialized Skills: Firms may become overly dependent on specialized skills,
making it challenging to adapt if there are changes in the market or technology.
2. Training Costs: Initial training costs for specialized tasks can be high, and firms may face
challenges if they need to retrain workers for different roles.
3. Coordination Challenges: Coordinating the activities of specialized workers can be complex,
and firms may face challenges in managing workflow and communication.
4. Resistance to Change: Employees may resist changes in their roles or tasks, potentially
leading to difficulties in implementing new production methods or technologies.
 Costs, Revenues and Profits

 Costs = Money going out of an organisation

 Revenue = Money going out of an organisation
 Sales revenue
o Money coming into a business. The value of all the goods you have sold
o Sales Revenue = Price * Quantity
 Fixed and variable costs
o Fixed Costs = Costs that do not vary with the level of output – such as rent
o Variable Costs = Costs that rise as output levels are increased – such as materials
 Working out total variable cost is easy, TVC = number of units * variable cost per
unit
 Total cost = Fixed costs + Total variable costs
 Average cost = total cost / total made
 Profit = total revenue – total costs
 Profit margin = selling price – average cost per unit / selling price) * 100
 Economies & Diseconomies of Scale
 The diagram below shows the LRAC (long run average cost) curve falling as output increases.
This is due to the “economies of scale” gained by spreading the fixed costs over more units.
 Economists believe that average cost per unit can only by so much and then the average cost
per unit will start to increase – this is referred to as “diseconomies of scale”. See below:
 The Long Run Average Cost Curve is U-shaped due to economies and diseconomies of scale:

As output increases:

 Total costs will decrease

 But the average cost of making each product will increase
 This is called diseconomies of scale
 This happens because as a business expands it
 OPTIMAL OUTPUT or MINIMUM EFFICIENCY SCALE (Point MES on the diagram) is where
average costs are at their lowest point.
INTERNAL Economies of Scale:

To start with we will look at the INTERNAL reasons why average costs fall. Internal economies of
scale are the cost benefits to a SINGLE FIRM as a result of increasing output (average costs fall).

This can be remembered by using the following Mnemonic:

Really Fun Mums Try Making Pies!

It seems like there might be a misunderstanding or error in the letters provided, as they don't
directly correspond to traditional types of internal economies of scale. However, I can provide you
with common types of internal economies of scale using relevant initials:

 R - Risk-bearing Economies of Scale Larger: firms may be better equipped to handle risks
due to their diversification and financial resources.
 F - Financial Economies of Scale: Larger firms can often negotiate better terms with suppliers
and lenders, leading to cost savings.
 M - Marketing Economies of Scale: Larger firms can spread their marketing and advertising
costs over a larger output, reducing the cost per unit.
 T - Technological Economies of Scale: Bigger firms may invest in more advanced
technologies, leading to increased efficiency and cost savings.
 M - Managerial Economies of Scale: As firms grow, they can benefit from more specialized
and efficient management structures.
 P - Purchasing Economies of Scale: Larger firms can buy inputs in bulk, securing discounts
and reducing average costs.

Diseconomies of Scale

Here are the 4 main type of diseconomies of scale:

1. Bureaucracy – If a business becomes too big it means too many resources are being taken up
by administration such as writing forms and also leads to slower decision making
2. Communication problems – if a company has hundreds of thousands of workers in different
countries and cultures it leads communication problems
3. Lack of control – a very large business may be difficult to control, there are hundreds of
thousands of employees leading to lack of control or extra resources being dedicated to
supervisors
4. Distance between top management and workers at the bottom of the organisation – relations
may worsen because of the many layers between managers and lower-level employees
meaning they become more demotivated
External economies of Scale

EXTERNAL ECONOMIES OF SCALE are the benefits to the INDUSTRY as a result of all firms in the
industry expanding and locating. These include:

1. Skilled labour

 Some industries tend to concentrate in the same area (Silicon Valley in California is home to
many software companies). If one firm trains its workers and some of these workers leave,
they will be skilled for their new employer. There will also be an increase in supply of skilled
workers in the area to meet the needs of that industry, making it easier to recruit workers
and decreasing the firm’s training costs.

2. Infrastructure

 If a particular industry dominates a region, then roads, rail, ports and communication
systems (infrastructure) will be built to meet the needs of the industry. This will improve the
efficiency of the firms in the area. Improved efficiency leads to lower average costs.

3. Access to suppliers

 Industries that cluster together in an area will find that suppliers in that industry will likely
set up nearby. For example, specialist marketing, banking, cleaning, distribution,
maintenance and components suppliers will tend to establish themselves nearby. All firms in
the industry are likely to benefit from their services. This will help to decrease average costs
for the firms.

4. Similar businesses in the area

 When firms in the same industry are located close to each other they are likely to co-operate
so that they can all benefit from each other. For example, they might join together to share
the cost of Research & Development and training facilities, as high-tech businesses do in
Silicon Valley, California, USA. They may also contribute ideas to a monthly magazine which
shares the latest ideas within the industry. This will decrease their overall costs and therefore
decrease their unit cost.
Why might EXTERNAL ECONOMIES OF SCALE not be important to a firm?

 Firms that are clustered together would mean that lots of competition is located in one
region. This is only good if you are able to compete through price or non-price competition.
If a firm is not competitive then they may be forced to close down.
 Locating close to other businesses may not be the best decisions for firms, especially when
the cost of land may be high. With firms competing, to group together, this may push up the
price of land and other factors of production, such as labour costs.
 Not all firms need to have access to external training facilities or trained labour. They may be
using relatively unskilled labour or are able to train their staff internally at relatively low cost.
 When assessing the success of a business, there are many other factors that influence
business decisions apart from the benefits of external economies of scale. Examples include
availability of land and access to raw materials.
 The importance of external economies of scale does depend on the type of industry the firm
is in. When firms are highly competitive, it may be that new developments are business
secrets rather than ideas that are shared.
 The importance of external economies of scale does depend on the size of the benefit to the
firm. If firms require workers to have on the job training that is specific to their own needs,
then the fact that skilled labour exists in the area may not be that important to the firm.
 Business
Economics
Competition

How do firms compete?

Firms in competitive Markets will compete on the ‘four Ps’:

Price:

Businesses in competitive markets will look to sell their products at a price lower than their
competitors in order to attract customers to their product

Product:

Businesses in competitive markets will look to innovate in order to differentiate their product from
competitors, often by focusing on quality

Promotion:

Businesses in competitive markets may use promotional tactics such as sponsorships, advertisement
and branding to encourage customers to buy their products.

Placement:

Businesses in competitive markets may focus on ensuring their products are in the right location and
on sale at the best times to gain competitive advantages.
Impacts of Competition:
Stake Advantages
holder
Firms 1. Market Expansion: Competition
can drive firms to explore new
markets and expand their
customer base.
2. Diversification: Firms may
diversify their product offerings
to meet diverse consumer
preferences.
3. Improved Reputation:
Competing on quality and
customer satisfaction can
enhance a firm's reputation.
Consumer 1. Increased Choices: Competition
provides consumers with a wider
range of product choices.
2. Customer Empowerment: Firms
may prioritize customer
satisfaction to retain loyalty.
3. Technological Advances:
Competing firms invest in
technology, benefiting consumers
with innovative products
Economy 1. Resource Allocation Efficiency:
Competition ensures that
resources are allocated based on
demand and efficiency
2. Global Competitiveness: A
competitive market can enhance
a country's global
competitiveness.
3. Encourages Entrepreneurship:
Competition fosters a culture of
entrepreneurship and innovation.
Disadvantages
1. Exit of Weaker Firms: Intense
competition may lead to the exit
of weaker firms from the market.
2. Short-term Focus: Some firms
may focus on short-term gains
rather than long-term
sustainability.
3. Risk of Price Wars: Aggressive
competition may trigger
damaging price wars.
1. Information Overload: Too many
choices may lead to confusion
for consumers.
2. Quality Variability: Some firms
may compromise on quality to
offer lower prices.
3. Monopoly Threat: Intense
competition may drive some
firms to monopolize the market.
1. Externalities and Negative
Effects: Some industries may
generate negative externalities
that harm the environment or
society.
2. . Income Mobility: Intense
competition may contribute to
income mobility, but it could also
exacerbate income disparity
3. Regulatory Challenges:
Regulating competitive markets
to prevent abuses can pose
challenges for governments
 Size of Firms
Small
Number of Employees 0 - 49
Turnover (Sales revenue) <10
(m Euros)
Capital Employed (m Euros) <10
Advantages
Large Firms 1. Economies of Scale: Large
firms benefit from lower
average costs as they can
produce goods and services
in bulk, leading to cost
savings.
2. Research and Development:
Large firms can invest more in
research and development,
leading to innovation and the
creation of new products.
3. Access to Capital: They
typically have better access to
financial resources, making it
easier for them to invest in
expansion and new projects.
Small Firms 1. Flexibility: Small firms can
adapt quickly to changes
in the market, making
them more responsive to
customer needs.
2. Personalized Service:
Small firms can provide
more personalized and
customized services,
building strong customer
relationships.
3. Innovation: They can
innovate more easily due
to fewer bureaucratic
hurdles, fostering
creativity and niche
market development.
Medium Large
50 - 249 250+
10 - 50 >50
10 - 43 >43
Disadvantages
1. Bureaucracy: The size of
large firms can lead to
bureaucratic inefficiencies
and slow decision-making
processes.
2. High Fixed Costs: They
often have high fixed
costs, which can be
challenging to cover
during economic
downturns.
3. Risk of Monopoly Power:
Large firms may abuse
their market power,
leading to monopolistic
behaviour that harms
consumers.
1. Limited Resources: Small
firms may lack the financial
resources to invest in large-
scale projects or research
and development.
2. Limited Market Share: Small
firms may struggle to gain a
significant market share and
face intense competition.
3. Vulnerability to Economic
Fluctuations: They are often
more vulnerable to economic
downturns due to limited
financial reserves.
4. Limited Bargaining Power: In
negotiations with suppliers
or buyers, small firms may
have less bargaining power.
Reasons why firms grow:

 To gain more internal economies of scale. The different economies of scale increase
efficiencies in larger businesses, average costs fall, helping to increase profit margins and
total profits (i.e. increasing profitability).

 Firms can grow by taking over other firms with a range of benefits:

o Gaining expertise from other firms which can lead to further competitive
advantages.

o Reducing competition in the market which can allow the larger firm to increase
prices and therefore obtain higher profits.

o Entering new markets; by taking control of a business in another country, larger

businesses can access more customers.

 Increase total revenue and/or market share, helping to increase profitability.

 Reduce the risk by operating in a variety of markets, or by having a wider product

portfolio.

 Entrepreneurial Spirit – business minded people often like to increase the size of their
firm as there is a prestige involved in running a larger business.

Reasons why some firms stay small:

 To sell into a niche (small) market i.e. a specialist product

o Small firms might be more in touch with their customers’ needs. They can give their
customers a more personal service. e.g. more friendly or give more specialist advice.

 Some markets aren’t big enough for large firms to be profitable. e.g. local laundrette.

 Some businesses may not be able to access the loans necessary to grow from banks –
therefore unable to increase output due to lack of finance.

 The entrepreneur running a small business may not be inclined to expan their business,
aiming instead at providing a high-quality service, keeping a personal feel to the
business, keeping risks low or a range of other objectives.

In some situations, small firms can keep their average costs low, by grouping together with other
small firms to buy in bulk (economies of scale).
 Monopoly

A monopoly can be defined as a situation where there is one dominant seller in the market.

 The monopoly will sell a unique product, with no close substitutes.

 Monopolies will only exist when there are high barriers to entry into the market.
 A monopoly therefore acts as a price maker because it can restrict market supply to force
price up, in order to maximise profits. The profits that monopolies make are also referred to
as abnormal profits because they are higher than if the market was competitive.

Monopoly Power

 It is important not to get confused between a monopoly and monopoly power.

 A firm can have a large market share and have some control in the market, without being a
monopoly (the sole supplier). Many governments have set thresholds, above which a firm is
considered to have monopoly power.
 In the UK 25% is the monopoly power threshold.
 Abuse of monopoly power is illegal, so competition authorities keep a close eye on firms
with monopoly power to ensure they don’t exploit customers.

DISADVANTAGES of Monopoly

1. Prices may be higher and output lower because:

 Monopolies face less competition, reducing the incentive to lower prices or increase output.
Without competitive pressure, they may choose profit maximization over consumer welfare.

2. Choice may be restricted

 Limited competition often results in fewer product choices for consumers. A monopoly may
offer a narrow range of goods or services without the variety available in competitive
markets.

3. Level of customer service may be lower because

 Monopolies may not feel the same urgency to provide excellent customer service, as
customers have limited alternatives. The absence of competition reduces the need to attract
and retain customers through superior service.

4. Product quality may be poorer because

 With no direct competition, a monopoly may not have the same motivation to continually
improve product quality. In a competitive market, firms must strive for excellence to gain an
edge, but a monopoly may lack this pressure.

5. Production costs may be lower because

 Monopolies can achieve economies of scale, reducing average production costs. However,
this may not necessarily translate into lower prices for consumers, as the lack of competition
diminishes the pressure to pass cost savings on to customers.
ADVANTAGES of Monopoly

1. Lower average costs of production due to internal economies of scale.

 Monopolies can benefit from efficiency gains and lower average costs as they scale up
production.

2. Therefore, prices may be lower

 While monopolies can have lower production costs, the extent to which they pass these cost
savings on to consumers depends on the level of competition they face.

3. Possibly more innovation through a higher level of spending on research & development since
the business knows it can sell what is produced

 Monopolies may invest more in innovation, as they are assured of a market for their
products. However, the actual level of innovation can vary.
Sources of monopoly power
 Monopolists can protect their position by using BARRIERS to ENTRY to prevent new firms
from entering the market.
 They can either be NATURAL barriers to entry or ARTIFICIAL barriers to entry.

Examples of NATURAL barriers to entry:

• Cost barriers resulting from:

o Economies of scale (lowering the average cost of production)

o High Set up Costs – in order to supply a product, it may require a large investment in
specialist and expensive capital equipment, which new competing firms will find
difficult to raise finance for or hire.

e.g. an electricity company would require a power station!

• Legal Barriers

e.g. patents and copyrights, government licences

o It can be expensive to develop new production methods and products, so granting

patents and copyrights encourages firms to invest in developing new methods
without the fear that competing firms will copy their ideas and lower their profits.

• Marketing barriers

e.g. advertising, product differentiation and brand image

While some monopolies occur naturally, others may achieve and retain their powerful market
position by creating their artificial barriers to competition.

Examples of ARTIFICIAL barriers to entry:

• Forwards/Backwards Vertical Integration

o Monopoly firms ‘tie up’ the supply chain and make life difficult for potential entrants,
such as a manufacturer having its own retail outlets, such as a brewer owning its
own pubs.

• Predatory pricing

o Occurs when a large firm cuts its prices, even if this means losing money in the short,
in order to force new and smaller competing firms out of business.

Once the smaller firm has been removed, the larger firms can raise its prices again.

• Exclusive Dealing

If a monopolist produces a well-known and popular good or service, it may threaten firms selling its
products, that if they stock alternatives, the monopolist will stop supplying them.

• Cartels

• If a group of firms has an agreement to work together in order to achieve market power (e.g.
to limit output and increase prices), it is known as a CARTEL. The most well-known cartel is
OPEC
Oligopoly
Features of Oligopolies:

 Few firms: one of the main features is that a FEW firms DOMINATE the market. A few can be
3-6 – there is no exact number.
 Large market share: as a few firms dominate they will have a large share of the market.
 Barriers to entry: The few firms that dominate are likely to benefit from BARRIERS TO ENTRY.
These might include: financial barriers such a large set up costs and legal barriers.
 Non-price competition: To try to avoid PRICE WARS, oligopolies will use NON-PRICE
COMPETITION as a way of competing with other large firms in the industry. Examples of
non-price competition include:
 DIFFERENTIATION – firms in an oligopoly market usually try to differentiate their products
from those of their rivals by location, features, service, quality, style etc.
 Price-competition: In many oligopoly markets prices stay the same for quite a while (price
stability). The market leader often sets the price and others follow. This is usually to avoid
PRICE WARS. This leads us to the idea that oligopoly firms are said to be INTERDEPENDENT.
If one firm decides to reduce their price, this has an impact on other firms in the industry. As
a result, firms take into account the likely reactions of their competitors before they make
decisions.
 Economies of scale: The large firms in an oligopoly will benefit from economies of scale
because they are large scale producers. As an oligopolies output increases their AVERGE
COSTS decrease. This helps them to increase PROFITS. Smaller firms cannot exploit
economies of scale and therefore will compete using non-price methods.
 Collusion: The risks of competition in an oligopolistic market are so high, that in some cases,
firms try to avoid it all together by colluding.
 One example of collusion is where firms divide up a market (e.g. geographically) and agree
not to compete against each other, therefore restricting consumer choice so they are able to
increase profits.
 Another form of collusion is PRICE FIXING. This is where firms secretly agree to pretend to
compete but prices are actually fixed at an agreed price so that the oligopolist’s can make a
profit.
 Another example of collusion is when firms may agree to restrict output. By restricting
output, supply is reduced and prices increase.
 Collusion occurs in the oil industry through oil cartels and petrol stations.
 Collusion is illegal in the EU and United States and in many other parts of the world. In the
UK the Office of Fair Trading will ensure that firms in the UK to not undertake anti-
competitive practices.

EVALUATION:
 Collusion is illegal in most countries, so if it is discovered firms will be fined and legal
action will be taken. This makes it less likely to happen.

 Depends on the level of collusion and the effects it has on consumers.

 Some collusion may actually benefit consumers. If business profits increase because of
collusion then firms may invest more and develop better innovative products.

 In some industries collusion is legal, e.g. pharmaceutical firms, as it helps to avoid

doubling up on R&D costs (external EOS – co-operation). In this case consumers will
eventually benefit from better quality products.

 Depends on the extent to which firms compete in an oligopoly market. The degree to
which they compete against each other will also depend on the industry. For example:
low cost airlines will compete using price whereas chocolate manufacturers may compete
more using non-price competition.
Aspect Advantages Disadvantages

- Large firms in oligopoly can achieve - Smaller firms may struggle to compete
significant economies of scale due to their on cost, potentially leading to reduced
Economies of size and production volume. This can lead to market access for new or smaller
Scale lower average costs and increased efficiency. businesses.

- Lack of competition can sometimes stifle

- Oligopolistic firms may have the financial innovation, as firms may be less
resources to invest in research and motivated to create new products or
Innovation development, fostering innovation. improve existing ones.

- Oligopolies may avoid aggressive price - Intense competition can lead to price
competition to maintain stability and prevent wars, harming profitability for all firms
Price Wars financial losses. involved.

- Oligopolistic firms may invest in quality - In some cases, a lack of competition may
improvements to differentiate their products reduce the incentive for firms to prioritize
Quality and attract customers. product quality.

- Limited competition may result in

- High entry barriers, such as significant reduced choices for consumers, and
Deterrence startup costs or brand loyalty, can deter new existing firms may not feel the pressure to
of Entry firms from entering the market. improve their products or services.

- Oligopolistic firms may collude to fix prices - Collusion can lead to anti-competitive
or limit production, leading to increased practices, reduced consumer welfare, and
Collusion stability and potentially higher profits. may be illegal in many jurisdictions.

- Oligopolies may engage in non-price

competition through advertising, branding, - Excessive promotion spending may lead
and promotions to differentiate their to increased costs and potentially result in
Promotion products. higher prices for consumers.
 The mixed Economy
Private and Public Sector

PRIVATE SECTOR ORGANISATIONS:

PRIVATE SECTOR is the provision of goods and services by organizations owned by private individuals
or shareholders.

Three types of private sector organizations are:

 Sole traders: owned and controlled by a single individual. In a sole proprietorship, the owner
has complete control over the business and is personally responsible for its debts and
liabilities.
 Partnerships: owned and controlled by two or more individuals who share the
responsibilities, profits, and losses of the business. Partnerships can be general, where
partners share equally in the management and liability, or limited, where there are both
general and limited partners with different levels of responsibility.
 Companies: where shareholders own the business. In a company, ownership is divided into
shares, and individuals can become shareholders by purchasing these shares. Shareholders
elect a board of directors to oversee the management of the company, which provides a
level of separation between ownership and control. Companies can be either private or
public, with public companies having shares traded on a stock exchange.

Aims of private sector businesses:

Most owners attempt to make a profit, however, aims need to be considered.

 Survival: the aim of many new businesses is just to survive. Customers need to be
established; staffing established etc. In times of recession, survival is the aim for many
businesses due to falling demand for their products.
 Profit maximisation: Most private sector firms aim to maximise profit. Some companies
distribute their profit by dividends to shareholders. Some firms just want to make enough
profit to keep the owners satisfied (satisfice).
 Growth: growth can achieve economies of scale and secure jobs for employees.
 Social responsibility: to be good corporate citizens
Public SECTOR ORGANISATIONS:

PUBLIC SECTOR: Public sector organizations are government-owned and operated entities that
provide goods and services.

 Government departments e.g. Department of Education: These are administrative units of

the government responsible for specific policy areas, such as education, health, or defense.
 Public Corporations or state-owned corporations: e.g. British Broadcasting Corporation
(BBC): These are commercial entities owned by the government, often created to provide
essential services, and they operate in various sectors such as broadcasting, transportation,
or energy.
 Local authority services such as Croydon Council: They provide essential services at the local
level, including libraries, housing, swimming pools, and other community services.

The aim of public service corporations is to:

1. Improve the quality of service.

2. Minimize inefficiencies.
3. Take into account the needs of a wide range of stakeholders and allow for social costs and
benefits (externalities – to be taught later).
4. Some publicly owned businesses are profit-motivated, e.g., Emirates.
Privatisation
Since the 1980s, some governments around the world have transferred public sector resources to
the private sector.

This process is called PRIVATISATION.

 The sale of nationalised industries: i.e. government owned businesses, that were often
public-sector monopolies were sold off to the private sector.

The following industries have been privatised in the UK over the last 40 years:

 British Rail

 British Gas

 British Telecom

 Jaguar

 Rolls Royce

 Royal Mail

 Contracting Out: This is when the government gives the private sector a chance to bid to win
contracts to provide services previously supplied by the public sector. Examples: cleaning
hospitals, rubbish collection or school canteens.

 Sale of land and property: For example: the sale of state (government) houses to tenants at
very competitive prices.

REGULATORS:

If the government sells a nationalised industry (public sector owned) and it becomes a private
monopoly, then it is possible that they can exploit consumers through their dominance. For this
reason, when a natural monopoly is privatised, the government appoints a REGULATOR to oversee
its activities. For example: Ofcom for British Telecom, Ofgem for British Gas and the electricity
industry, Ofwat for the water industry.

These bodies (or regulators) have different powers, but they are all given the responsibility to protect
the public/consumer interests. Privatised organisations need regulating as they may:

 Monopolise the industry and increase prices

 Reduce non-profit making services so consumers suffer e.g. cut non-profitable mail delivery
services.

EVALUATION POINT:

Just because a state-owned enterprise (government owned resource/asset) is privatised, this does
not automatically mean that COMPETITION results from this process. It could be that the now
privately-owned business still dominates the market, such as Royal Mail and THAMES WATER.

Does privatisation benefit consumers?

Advantages
1. Increased Efficiency: Privatisation can lead
to improved efficiency and cost-
effectiveness in the provision of goods and
services. Private firms often strive to be
more efficient to maximize profits,
potentially leading to lower costs and
better value for consumers.
2. Innovation: Private firms may be more
innovative in their approach, introducing
new technologies and methods that can
enhance the quality of products and
services for consumers.
3. Customer Focus: Private companies are
driven by profit motives and often
prioritize customer satisfaction to maintain
and expand their customer base. This focus
on consumers' needs can result in better
services and products.
4. Choice: In a competitive market,
privatisation can increase the number of
providers, offering consumers a wider
range of choices. This can lead to more
variety in products and services, catering to
diverse consumer preferences.
Disadvantages
1. Monopoly Power: Privatisation can
sometimes result in the creation of private
monopolies. In such cases, consumers may
face limited choices, and the monopoly may
exploit its market dominance to set higher
prices and provide lower-quality services.
2. Inequality: Privatisation may exacerbate
income inequality, as access to certain
essential services could become limited to
those who can afford them. This could leave
certain segments of the population at a
disadvantage.
3. Natural Monopolies: Some industries, such
as utilities, are considered natural
monopolies where it is more efficient to
have a single provider. Privatisation in such
cases may not lead to increased competition
and could harm consumers.
4. Short-Term Profit Focus: Private companies
may prioritize short-term profit over long-
term sustainability and consumer welfare.
This could lead to cost-cutting measures that
compromise the quality of services or
products.

EVALUATION:
Whether consumers benefit from privatisation will depends on whether competition in the market is
created. If a firm becomes a private monopoly, then consumers may not necessarily get better quality,
choice and lower prices.
If no competition is created, and a monopoly situation exists, many governments make use of REGULATORS
or a COMPETITION and MARKETS AUTHORITY. This organisation monitors and controls business activity to
ensure that firms do not act against the public interest and consumers are not exploited e.g. unfair price
rises.
Are workers better off or worse off because of privatisation
Advantages Disadvantages
1. Increased Efficiency and Productivity: 1. Job Losses: Privatisation often involves
Privatisation may lead to increased restructuring and cost-cutting
efficiency and productivity in the measures, which can lead to job losses
workplace, resulting in higher wages as companies seek to maximize profits.
and better working conditions for This can leave workers unemployed or
employees. in less secure positions.
2. Performance-Based Incentives: Private 2. Reduced Job Benefits: In the pursuit of
companies often link employee cost savings, privatised companies may
compensation to performance, cut back on employee benefits, such as
providing workers with greater healthcare, pensions, and other perks,
incentives to contribute to the success potentially leaving workers with less
of the company. This can result in favorable overall employment
improved job satisfaction and financial packages.
rewards for workers. 3. Wage Suppression: While increased
3. Job Security: A more competitive and efficiency may benefit companies, it
efficient private sector could contribute doesn't necessarily translate to higher
to economic growth, potentially wages for workers. In some cases,
creating more job opportunities and privatisation may lead to wage
enhancing job security for workers. suppression, as companies focus on
4. Training and Skill Development: controlling labor costs to improve
Privatised companies may invest in profitability.
employee training and skill 4. Loss of Collective Bargaining Power:
development to stay competitive. This Privatisation may weaken the collective
can benefit workers by enhancing their bargaining power of workers, as private
skillsets and making them more companies may be less inclined to
marketable in the long run. negotiate with labor unions. This could
result in less favorable terms and
conditions for workers.
EVALUATION:
The effect of privatisation on workers will depends on the need to cut costs and the amount of
existing idle labour in the firm.
If a firm is capital intensive, then if may be that few workers are made redundant. For those who
are made redundant, many governments provide unemployment benefits and training schemes to
help them while they are unemployed.
In the short term, privatisation may create unemployment, but as the firm become more efficient
and competitive, they may grow. Thus, in the long term, as the firm expands, they may need to
employ more workers.
 Does privatisation benefits businesses
Advantages Disadvantages
1. Increased Efficiency: Privatisation often 1. Monopoly Formation: Privatisation
leads to increased efficiency as private may lead to the formation of private
companies are motivated by profit. monopolies, especially in industries
They tend to be more responsive to with high barriers to entry. This can
market demands and are driven to reduce competition, resulting in higher
minimize costs, which can enhance prices and reduced choices for
overall business efficiency. consumers.
2. Innovation and Investment: Private 2. Job Insecurity: While increased
firms may bring innovation and efficiency can benefit businesses, it may
investment into industries that were also lead to job losses through
previously state-owned. The profit automation and restructuring. This can
motive can drive companies to invest in create job insecurity among employees
research and development, leading to and contribute to social and economic
technological advancements and challenges.
improved business practices. 3. Short-Term Focus: Private companies
3. Market Competition: Privatisation may prioritize short-term profits over
introduces competition, encouraging long-term sustainability. This focus on
businesses to become more immediate financial gains may lead to
competitive and responsive to neglect of essential investments, such
consumer needs. This competitive as infrastructure and employee
environment can stimulate innovation, training, which are crucial for long-term
improve services, and drive down success.
prices, benefitting both businesses and 4. Negative Externalities: Privatised firms
consumers. may neglect environmental and social
4. Entrepreneurial Spirit: Private responsibilities in the pursuit of profit.
ownership fosters an entrepreneurial This can lead to negative externalities,
spirit, encouraging risk-taking and such as environmental degradation or
initiative. This can lead to the creation exploitation of workers, which may
of new businesses, increased harm the reputation of businesses in
competition, and a dynamic business the long run.
environment.
EVALUATION:
If the funds generated have been used wisely, then all stakeholders should be better off. These
funds could be used to provide public and merit goods that help to improve living standards.
Governments can regulate to restrict foreign ownership, if they see the need. This has occurred in
Australia with the government not allowing overseas firms to own key infrastructure.
Arguments FOR Privatisation benefiting an
ECONOMY (Government) Arguments AGAINST

- Creates revenue for the government, enabling - Lengthy and costly privatization process, with
investments in education and infrastructure extensive advertising expenses, leading to forward
essential for economic growth and job creation. spending of revenue and less for other areas.

- Increased efficiency due to competition, as firms

strive to reduce waste and lower prices, enhancing - If the privatised enterprise is sold to a foreign
international competitiveness and generating buyer, profits may be repatriated overseas,
more tax revenue. providing limited benefit to the local economy.

- Potential increase in competition, boosting - Possibility of a monopoly situation leading to

demand and contributing to economic growth, consumer exploitation, service cuts, worker
ultimately improving the standard of living for redundancies, and increased prices, contrary to
consumers. the public interest.

- Increased competition may force firms to cut

- Lower prices of services to consumers as a result costs, make workers redundant, and increase
of increased efficiency, contributing to a decreased unemployment rates, reducing consumer spending
cost of living and improved standard of living. and the standard of living.

EVALUATION:

The impact of privatisation on an economy depends on various factors, including the creation of
competition, the efficiency of the process, and the regulatory framework in place. While privatisation
can generate revenue, improve efficiency, and foster economic growth, concerns about potential
negative effects such as job losses, exploitation, and repatriation of profits must be addressed through
careful planning and effective government intervention. Policymakers should strive to strike a balance
that maximizes the benefits of privatisation while mitigating its drawbacks for the overall well-being of
the economy and its citizens.

Types of Economies
An economic system refers to the system employed by a country to solve the problem of scarcity i.e.
ration its scarce resources in order that it can satisfy as many of its unlimited wants and needs as is
possible.

All economic systems face the problem of scarcity i.e. unlimited wants and needs but limited
resources with which to meet them and therefore each must work out how to best solve it. They
must all answer the same key or basic economic questions namely:

 What to produce? This question looks at what should be produced and in what quantities.

 How to produce? What is the best way to combine available resources to satisfy wants and
needs? Should production be labour intensive or capital intensive?

 For whom to produce? Who should receive the production? Should production be available
to only those who can pay for it or should it be made available to all?

There are two extreme types of economic systems namely the market system and the planned
system.

Market or Capitalist System Planned or Command System

Features:

Features: - Centralized decision-making by government

authorities.
- Decentralized decision-making by private
individuals and firms. - Central planning dictates production and resource
allocation.
- Prices determined by market forces (supply
and demand). - State ownership and control of key industries and
resources.
- Private ownership of resources, means of
production, and businesses.

What to produce: What to produce:

- Efficiency and cost-effectiveness determined - Production methods planned and directed by

by market competition. central authorities.

- Technological advancements driven by profit - Limited incentives for innovation as central planning
motives and competition. may not prioritize it.

For whom to produce? For whom to produce?

Goods and services distributed based on Distribution based on societal needs and priorities, as
purchasing power determined by central planning

How to produce: How to produce:

Efficiency and cost-effectiveness determined Production methods planned and directed by central
 Market or Capitalist System Planned or Command System

by market competition. authorities.

Technological advancements driven by profit Limited incentives for innovation as central planning
motives and competition may not prioritize it.

Free Market Economy

Advantages Disadvantages
Free Market Economy

- Income inequality may widen as some earn

- Efficient allocation of resources due to market forces. more than others.

- Lack of government intervention may lead to

- Competition fosters innovation and drives efficiency. market failures.

- Consumer choice is maximized with a wide range of - Social and environmental concerns may be
products and services. neglected for profit.

- Flexibility allows for quick adjustments to changing - Potential for monopolies and abuse of market
market conditions. power.

- Certain essential services may be inaccessible to

- Encourages entrepreneurship and economic growth. low-income individuals.

- Prices determined by supply and demand reflect true - Economic instability due to boom and bust
market value. cycles.

Planned Economy

Advantages Disadvantages

- Central planning allows for the equitable - Lack of individual freedom and limited consumer
distribution of resources. choice.

- Reduced income inequality as decisions are - Inefficiency due to the absence of market-driven
made based on societal needs. competition.

- Focus on societal goals and priorities, such as - Slow to adapt to changing consumer preferences and
healthcare and education. technological advancements.

- Stability in terms of employment and economic

planning. - Bureaucratic inefficiencies in central decision-making.

- Prevention of monopolies and exploitation of

consumers. - Limited entrepreneurial spirit and innovation.

- Reduced economic volatility and avoidance of - Difficulty in accurately gauging supply and demand,
boom and bust cycles. leading to surpluses or shortages.

- Greater emphasis on collective welfare and social - Lack of motivation for workers due to fixed incomes
equality. and limited career advancement
 Supply and Demand (Elasticities
included PED, PES and YED)

Demand
THE LAW OF DEMAND - states that if the price of a good or service rises, the quantity
demanded will fall. Likewise, if the price of a good falls, then the quantity demanded will
increase.
 Market Demand Schedule and Demand Curves:
 A demand schedule is a table that will identify the quantity demanded for a product for a range
of prices. For simplicity, say that there are only two consumers that make up the market for
Strawberries – consumer A & B.
 Below is the Demand Schedule for two consumers buying Strawberries. What’s the Market
Demand for Strawberries at each price?

Demand curves
 MOVEMENT ALONG A DEMAND CURVE:
 The demand curve shows the relationship between price and quantity demanded. When the
price of a punnet of strawberries changes, we can see the effect of the price change on quantity
demanded by moving up and down the demand curve.

Demand curve example

 If I were to go from Q3 to Q2 this would be known as a contraction of demand as the

price has increased
 If I were to go from Q1 to Q3 this would be known as an extension in demand as demand
increases due to decreased price
What causes a shift in Demand
Factor Explanation
Population (Demographics) The age, gender, and size of the population can influence demand
for various goods and services. For example, an aging population
may increase demand for healthcare services.
Advertising businesses try to influence consumers through advertising. if goods
are advertised more, the demand curve will shift outwards.
Credit availability The availability of credit affects consumer spending and investment.
When credit is readily available, people are more likely to make
large purchases, stimulating economic activity.
Income Higher income levels generally lead to increased spending on goods
and services. It also affects the types of goods and services people
choose to consume.
Fashion, tastes and Trends Higher income levels generally lead to increased spending on goods
and services. It also affects the types of goods and services people
choose to consume.
Income Tax The level of income tax can influence disposable income, affecting
consumer spending and saving patterns. Changes in income tax
rates can impact overall economic activity.
Price of complements The price of complementary goods (goods that are used together)
can influence demand. For example, a decrease in the price of
smartphones may increase the demand for mobile apps.
Price of substitutes The price of substitute goods (goods that can replace each other)
can impact demand. If the price of one substitute rises, consumers
may switch to the other, affecting demand in the market.
 Supply
SUPPLY:

 SUPPLY is the quantity of goods and services that a supplier is willing to offer to the market
at a given price in a given period of time.
 LAW OF SUPPLY states that as price increases, quantity supplied will increase, ceteris paribus.
Likewise, if the price of a good falls, the quantity supplied will decrease.
 MOVEMENT ALONG A SUPPLY CURVE: A change in price is the only thing that will cause a
movement up (an extension) or down (a contraction) the supply curve.
 Unlike a demand curve a supply curve has a positive gradient as the more money you offer to
pay for a good more people will produce it leading it increased quantity

Supply curve
What causes a Shift in Supply
Factor Explanation
Productivity The efficiency of the production process, measured by the amount of output
produced per unit of input. Higher productivity often leads to increased economic
growth.
Indirect Taxes imposed on goods and services, such as value-added tax (VAT). They affect
taxes consumer prices and can influence consumer behaviour and government revenue.
New The entry of new firms into a market, which can impact competition, prices, and
entrants market structure. New entrants may bring innovation and increased supply.
Changes in Technological advancements that can lead to increased efficiency, reduced costs,
Technology and improved production methods. Technology changes can drive economic
growth.
Subsidies Financial assistance provided by the government to businesses or individuals,
typically to support specific industries or activities. Subsidies can affect prices and
production levels.
Weather / Natural events like weather conditions, climate changes, or natural disasters that
natural can impact agricultural production and other industries, affecting supply and
factors prices.
Costs of The amount that a firm is able to supply of a good or service is influenced by their
production costs (wages, rent, etc.) If price is fixed and costs rise, sellers will reduce the
amount they supply as they aren’t able to make as much profit.
 Market Equilibrium
 Understanding how demand and supply interact is essential to understanding how prices are
determined in economies. The forces of demand and supply determine prices in a market. This
is the PRICE MECHANISM, which allocates resources between alternative uses in a market
economy.
 The balancing of the forces of demand and supply can be demonstrated both through the
demand/supply schedule and by plotting the demand curve and supply curves together on the
same graph.
 Buyers and sellers come together in a market. A price, sometimes called the market price, is
struck and goods/services are exchanged. There is only one price where demand equals supply.
This is also known as the EQUILIBRIUM PRICE.
 This can be shown on a graph with both supply and demand

Where the demand and supply curve meets is where market equilibrium is
Excess demand
 In the above schedule, if the price is £2, quantity demanded will be 12 units, but only 2 units will
be supplied. Demand is greater than supply, OR there is a shortage of goods. In this situation, we
say there is EXCESS DEMAND, i.e., excess demand of 10 units. For example, excess demand can
happen when a government sets a maximum price that firms can charge consumers in a market
that is below the equilibrium price.
 In a real-world situation of excess demand, what could happen to resolve this situation of excess
demand?
o Consumers will be willing to pay higher prices.
o As a result, suppliers will be willing to supply more because prices have increased.
o Quantity demanded will start to decrease.
o This movement continues until there is a return to equilibrium.

Excess Supply
 In the above schedule, if the price was $8, demand will be 3 units, and 8 will be supplied. Supply
is greater than demand, and there is, therefore, excess supply of 5 units OR a SURPLUS. Excess
supply can happen when a government sets a minimum price in a market that is above the
equilibrium price.
 Stocks of unsold goods build up on a shopkeeper's shelves. What would they do?
o Sellers are likely to lower prices.
o Consumers react by increasing their quantity demanded.
o Sellers respond by reducing quantity supplied.
 This continues until equilibrium is reached. The automatic forces of demand and supply take
over, which leads to a return to the equilibrium price and quantity.
 Price Elasticity of Demand (PED)

 Price Elasticity of Demand (PED) measures the responsiveness or sensitivity of quantity

demanded for a product due to a change in price of THAT product.
 This is shown through this equation

% change∈quantity demanded
PED=
% change∈ price
 To find the percentage change we use this equation

−New Value−Old Value

%Δ= × 100
Old Value
Demand for a product – price elastic or price inelastic

 Price elastic: consumers are very sensitive to price changes.

 Price inelastic: consumers are not very sensitive to price changes.

Be Price Elastic when
 Price ELASTIC when the %
change in Qd is greater
than % change in price.
 PED > 1
 Demand is very responsive
to changes in price.
Have unitary elasticity when
 Price UNITARY ELASTICITY
when the % change in Qd is
equal to % change in price.
 PED = 1
 Demand is equal to change
in price
Be Price Inelastic when
 Price INELASTIC when the
% change in Qd is less
than % change in price.
 PED < 1
 Demand is not very
responsive to changes in
price.

Examples: Example: Example:

 If the price of a luxury car
increases by 10%, and the
quantity demanded
decreases by 15%, the PED
would be -1.5, indicating
price elasticity.
 If the price of a staple food
item increases by 10%, and
the quantity demanded
decreases by 10%, the PED
would be -1, indicating
unitary elasticity.
 If the price of a life-saving
medicine increases by
10%, and the quantity
demanded decreases by
5%, the PED would be -
0.5, indicating price
inelasticity.
Value Demand is
0 Perfectly inelastic (No response to price changes)

0 to -1 Inelastic (Quantity demanded is not very responsive to price changes)

-1 Unitary elastic (Percentage change in quantity demanded is equal to the percentage

change in price)

Less than Elastic (Quantity demanded is very responsive to price changes)

-1
∞ Perfectly elastic (Any change in price results in an infinite change in quantity
demanded)"

PED and Total Revenue

Total REvenue=Price per unit ×Quantity demanded

 A change in price is likely to cause a change in TR (Total Revenue).

 The change in TR will depend upon the price elasticity of demand for the product.

Price Elasticity and its effect on TOTAL REVENUE / INCOME:

Elasticity Effect on demand Value Effect of a price Effect of a price

of say a 1% change decrease on increase on
in price REVENUE REVENUE

Elastic Demand changes Less than -1 Increases Decreases

by more than 1%

Inelastic Demand changes 0 to -1 Decreases Increases

by less than 1%

Perfectly elastic Demand = 0 Equal to infinity Decreases Falls to 0

(∞)

Unitary Changes by 1% Equal to -1 Doesn’t change Doesn’t change

Perfectly No change Equal to 0 Decreases Increases

inelastic
Factor influencing PED
 PED can also be influenced, here is a table stating all the factors think of SPLAT as a
nonmonic

Factor Explanation
Substitutes / The availability of close substitutes for a product in the market. If there are
Substitutabilit many substitutes, consumers are more likely to switch if the price changes,
y leading to more elastic demand.
Proportion of The proportion of a consumer's income spent on a particular good. If a product
Income: represents a significant portion of a consumer's income, the demand for that
product tends to be more elastic.
**L - Luxury or Whether the product is considered a luxury or a necessity. Luxury goods often
Necessity have more elastic demand as consumers can easily cut back on such items when
prices rise. Necessities, on the other hand, tend to have inelastic demand.
Addictiveness The degree to which a good or service is considered addictive or habit-forming.
Goods with addictive qualities often have inelastic demand as consumers are
less responsive to price changes.
Time The time consumers have to adjust to a price change. Demand may be more
elastic in the long run as consumers can find alternatives or adjust their habits,
while it may be more inelastic in the short run
Income Elasticity of Demand (YED)

BE CAREFUL!!!
In Economics:
“I” stands for Investment
“IR” stands for Interest Rate
“Y” stands for Income

o PED measures the responsiveness of quantity demanded due to a change in price. ,

o YED measures the responsiveness of quantity demanded for a good due to a change in
income.

% change∈quantity demanded
The formula for PED is: PED=
% change∈ price
% change∈quantity demanded
The formula for YED is YED=
% change∈ Income
 With PED, we look at to what extent a change in price can cause a change in quantity
demanded (Qd). However, with YED, we look at how a change in income can cause a
change in quantity demanded (Qd). YED helps us understand whether a good is a normal
good, an inferior good, or a luxury good based on consumers' responses to changes in
their income levels.

Using YED, we can CASIFY GOODS into Inferior goods

o If a good’s YED value is negative (< 0), the good is an inferior good. This means that when
incomes rise, quantity demanded falls.
 If the value is between 0 and -1, we can say that it is an inferior good for which
demand is income inelastic.
 If the value is less than -1, we can say that it is an inferior good for which demand is
income elastic.
o If a good’s YED value is positive (> 0), the good is a normal good. This means that when
incomes rise, quantity demanded rises.
 The two main types of normal goods are normal necessity and normal luxury.
o If a good’s YED value is between 0 and 1, the good is a normal necessity. This means that
when incomes rise, quantity demanded also rises, but by a less than proportionate amount.
We can say demand for these goods is income inelastic.
o If YED > 1, the good is a normal luxury good. This means that when incomes rise, quantity
demanded also rises, but by a more than proportionate amount. We can say that demand for
these goods is income elastic.
Price Elasticity of Supply (PES)

Price Elasticity of Supply (PES) measures the responsiveness or sensitivity of quantity supplied due
to a change in price. In can be shown in the following equation:

% change ∈quantity supplied

PES=
% change ∈ price

 PES measures how quickly, easily, and cheaply firms can increase their quantities, usually
in order to meet extra demand.
Elastic and Inelastic Supply:
 A good is said to have price elastic supply if the PES is greater than 1.
 e.g., PES = 1.5 indicates elastic supply.
 A good is said to have price inelastic supply if the PES is less than 1.
 e.g., PES = 0.8 indicates inelastic supply.

Value Supply is Diagram

O Supply is perfectly inelastic.

O to 1 Supply is relatively inelastic.

1 Supply is unitary elastic.

>1 Supply is relatively elastic.

 ∞ Supply is perfectly elastic.

THE VALUE OF PES IS ALWAYS POSITIVE, FOR PED IT IS ALWAYS NEGATIVE AND
FOR YED IT CAN BE EITHER

Factors effecting PES

Factor Explanation
Availability of  The availability of resources influences how easily and quickly producers
resources can respond to changes in price. If resources are abundant, supply is
more likely to be elastic.
 Example: Agricultural goods with readily available land and inputs.
Infrastructure  The quality of infrastructure, such as transportation and communication
networks, affects the ease with which goods can be produced and
supplied. Better infrastructure can lead to more elastic supply.
 Example: Improved roads facilitating faster transportation of goods.
Time Required  The time it takes to produce goods impacts supply elasticity. Goods with
for longer production cycles are likely to have inelastic supply, while those
Production: with shorter cycles may have more elastic supply.
 Example: Handcrafted items with a lengthy production process.
Ease of  Goods that are easily stored can be supplied more flexibly in response to
Storage changes in price. Perishable goods may have less elastic supply.
 Example: Non-perishable goods like canned food or durable goods.
Risk and  High levels of risk and uncertainty in production may lead to less elastic
Uncertainty supply, as producers may be hesitant to increase production without
certainty in market conditions.
 Example: Agricultural goods vulnerable to unpredictable weather
conditions
Substitutabilit  The ease with which inputs can be substituted in the production process
y of Inputs influences supply elasticity. If there are easily substitutable inputs,
supply is more likely to be elastic.
 Example: Manufacturers using multiple suppliers for raw materials.
Labour
Markets
Demand of Labour
What is the market for Labour?
 Labour is one of the four Factors of Production. The labour market consists of all those
people willing and able to supply themselves for work and all those people and businesses
willing and able to employ them. The price of labour is called wages. Within each labour
market the wage paid of workers will be determined by the forces of demand (by firms) and
supply (by workers).
 Demand curve for labour

What determines the Demand for Labour?

 The WAGE RATE influences the demand for labour. Below are some other factors that
influence the demand for labour:

1. The demand for labour is a DERIVED DEMAND:

Businesses demand labour because of the good or service it produces. As more goods and services
are demanded, more labour is demanded to produce them, and vice versa. Hence, the demand for
labour is derived from the demand for the goods and services produced by labour i.e. demand for
labour is a derived demand.

2. The quantity of labour demanded DEPENDS ON THE ABILITY TO SUBSTITUTE LABOUR for capital
goods (for example using technology/machinery instead of people):

As technology improves, the demand for certain types of labour falls, while the demand for other
types of labour rises, e.g. the introduction of computers has reduced the demand for typists, but has
increased the demand for computer science engineers.
The substitution of capital for labour can be seen in many modern industries but labour is still seen
as a relatively cheap factor of production in developing economies such as India and China, where
less machinery is used in the production of many goods and services.

The ability to substitute labour for machinery is determined by COST and AVAILABILTITY of
substitutes.

3. The quantity of labour demanded DEPENDS ON THE PRODUCTIVITY OF LABOUR:

If labour is more productive it can produce more goods and services. Therefore productive labour is
more valuable to a firm. An increase in the productivity of labour will cause a firm to increase its
demand for labour because production becomes more profitable, provided the extra output can be
sold.

4. Other employment costs:

The demand for labour may also be linked to other costs linked to employing workers. For example:
health insurance, sick pay, training costs, bonuses, holiday pay and providing childcare facilities.

Summary

 An increase in the demand for a product (derived demand)

 A decrease in the use substitutes (eg technology / machinery)

 An increase in productivity of labour

will cause an outwards shift in the demand curve for labour.

 An increase in wage rates and other employment costs

 A decrease in the demand for a product (derived demand)

 An increase in the use of substitutes (eg technology/machinery)

 A decrease in productivity of labour

will cause an inwards shift in the demand curve for labour.

Note: A MOVEMENT ALONG a demand curve happens when there is:

  an increase in the wage level (price of labour) causing a contraction in the quantity
demanded of labour.

 A decrease in the wage level which will cause a movement down the demand curve for
labour (extension/expansion).

The supply of labour:

 Increased role of women in the workforce: In the last 50 years there has been a change in the
attitudes towards women working – this is now much more acceptable. This has increased
the amount of labour supplied.

 Changes in retirement age: Due to people living longer the retirement age has increased.
This means that people work for longer and this increases the supply of labour.

 Net increases in migration: A net increase in migration into a country will mean that more
people of working age will be available to work. In developed countries immigration has
increased the amount of labour. This is what occurred in the UK after the Second World
War. In Australia immigration from war torn Europe was used to increase the supply of
labour. Those from the UK were referred to as £10 poms. In less developed countries
emigration has decreased the amount of labour available. This is often referred to as “brain
drain”.

 Changes in school leaving age: School leaving age tends to increase over time. This means
that the supply of this labour is delayed (as it stays in education for longer) and therefore this
decreases the supply of labour.

 Age distribution: Some countries (especially developed countries) have an ‘ageing

population’ which means that more people are retiring than entering employment. This
decreases the supply of labour. This is a real problem in Japan and China.

 Providing more subsidised child care: will allow more woman to enter the workforce, thus
increasing the supply of labour

 Reducing income tax: may provide an incentive for more workers to enter the workforce as
they have the ability to earn more income.

 Reduce unemployment benefits/job seekers allowance: may encourage workers to actively

look for work as benefits fall in value.

 Provide more training and education: will allow unskilled workers to become more skilled
and qualified enabling them to join the workforce and become more employable. This
reduces structural unemployment.

 Population size: in most countries’ populations are growing. As the population grows more
people are available to work, thus increasing the supply of labour.

 Wage rates: increasing wage rates, e.g. increasing minimum wage rates, may encourage
those on unemployment benefits to look for work, thus increasing the supply of labour.
Wage differences between different occupations:

Not everyone receives the same pay for their work. Why is this?

 Supply of labour:

Jobs that require high levels of skill will only be acquired by those who have the aptitude, talent,
commitment and funding to be trained for these jobs. This does not suit everyone, so the supply of
labour is limited because of the skill required by workers and therefore less people can do the job. As
the supply of workers is low, this causes the wage rate to increase.

The supply of unskilled labour is relatively large because anyone can undertake an unskilled job. This
results in the supply of unskilled workers being much higher and therefore causing the wage rate to
be lower.

• Dirty/dangerous jobs and jobs with unsociable hours:

Jobs that are unpleasant, dangerous to perform and/or require workers to work shifts or long hours,
usually command higher wages. Give examples of such jobs include: night nurses, deep sea divers
and bomb disposal. As a result, the supply of labour is reduced and this causes wages to rise.

• Trade union membership:

Workers that are part of a trade union tend to have higher wages. This will be explained later in the
course.

• Growth of the industry:

Industries that are growing often experience skill shortages and therefore wages rise. Industries that
are declining have skill surpluses and therefore wages fall.
 • Public v Private sector:

It is common for the private sector to pay higher wages than the public sector however this is not
always the case. In many developing countries wages are often higher if working for the government

Labour Mobility
Importance of the quantity and quality of labour to business:

When setting up a business both the QUANTITY (supply of labour) and QUALITY (skill of labour) are
important issues to consider.

Poor quality work produced with poor quality labour has far reaching consequences in terms of a
firm’s long-term reputation and brand image.

A shortage of skilled labour will also add to a firm’s cost of production as they will need to train and
educate their workers if skilled labour is not available.

Impact of education and training on human capital and quality of labour:

 the quality of human capital can be improved with training and education (T&E)

 the quality of labour is an important consideration when recruiting (employing) workers

 the responsibility of T&E lies mainly with the government and firms

 improved quality of labour helps to increase PRODUCTIVITY

 T&E is also required when there are changes in the work place e.g. new technology, new
health & safety procedures or new working practices.

 T&E improves job security and provides opportunities for promotion

 T&E can be motivational for workers and enables them to increase their wages.
 TRADE UNIONS
 Trade Unions are organisations of workers that seek through collective bargaining with
employers to protect and improve the real incomes of their members, provide job security,
protect workers against unfair dismissal and provide a range of other work-related services
including support for people claiming compensation for injuries sustained in a job.

Trade Union membership

 Large decline in union membership over the last twenty-five years.
 Unions may seek to exercise collective bargaining power with employers for higher wages
compared to non-union members.
 Control over total labor supply is crucial for effective collective bargaining.
 In the past, control was often achieved through closed shop agreements, where all workers
were required to be members of a specific union.
 Closed shop agreements are now rare in most sectors.
 Instead, unions often engage in bilateral negotiations with employers to secure wage
increases above the inflation rate.
 Goals include raising real wages and improving working hours and conditions.
Trade unions 3 main purposes
 Collective Bargaining: Collective Bargaining involves negotiations between worker
representatives (trade union officials) and employer representatives (management) to reach
agreements on various employment terms, including wages, working hours, and conditions.
The effectiveness of collective bargaining is often influenced by the size of the union's
membership, as larger unions typically have more negotiating power. This negotiation
process is crucial for securing favorable terms for union members.

 Industrial Action: Trade unions have various forms of industrial action at their disposal,
including striking (temporary cessation of work), working to rule (strict adherence to
contractual terms), and go slow (deliberate reduction in work speed). When considering
striking, trade unions weigh the advantages and disadvantages.

 Advantages of Striking:

 Increased negotiating leverage.

 Demonstrates unity and commitment among union members.

 Disadvantages of Striking:

 Loss of wages for workers during the strike period.

 Potential damage to relationships between workers and management.

 Negative impact on the overall productivity of the firm.

 Collective Power Utilization: Trade unions leverage their collective power not only during
negotiations but also to address broader issues affecting their members. This includes:

 Improving Fringe Benefits:

 Negotiating for enhanced fringe benefits like health care, education

allowances, and housing allowances.

 Legal Representation:

 Providing legal representation for union members in court cases related to

employment issues.

 Advocacy for Legislation:

 Pressuring governments to enact legislation that favors employees' interests.

Note: Over the years, the power of trade unions in the UK has diminished due to government
interventions. Legislation changes, such as the banning of secondary picketing, making closed shops
illegal, and implementing secret ballots before strikes, have limited the influence of trade unions in
the country.
Impacts of Trade Union Power
1. Increased Wages: Trade Unions can negotiate (through Collective Bargaining) an increase in
wages. As a result, the firm cannot employ workers below the wage rate, W1. A new supply
of labour curve, S1, emerges with a perfectly elastic horizontal section. Firms must pay all
workers the higher wage, W1, employed up to Q2. If additional workers are needed beyond
Q2, wages will rise further.

2. Lower Profits for Firms: Assuming a firm's demand for labour is fixed (perfectly inelastic), a
forced increase in wages by the Trade Union (TU) will compel the firm to pay higher wages.
This results in an increase in the firm's cost of production (shown by the shaded area),
affecting the firm's profits.

3. Higher Prices for Consumers: To maintain profit margins, firms may increase prices,
impacting consumers' purchasing power.

4. Increase in Unemployment: Alternatively, firms may decide to make workers redundant,

causing an increase in unemployment. This can be illustrated in the diagram below.

HOWEVER,... (Evaluation Point) Job losses may be avoided if:

1. Labor productivity increases due to higher wages – workers may be motivated to work more
productively.

2. Employers pass on the wage increases to customers in the form of price rises.

3. Employees decide to accept lower profits.

EVALUATION: Whether an increase in wages will lead to unemployment depends on:

 Whether the wage level was at equilibrium or not. An increase in wages to a point nearer
equilibrium may not increase unemployment if the company was paying below equilibrium
wages.
 How much the wage has been increased above equilibrium. A small increase above
equilibrium is unlikely to cause unemployment, while a large increase may lead to some
unemployment.
 If employers pass on the extra labor cost by increasing the price of their product (depends on
the price elasticity of demand, PED).

Unemployment could also be reduced if:

 Labor productivity increases due to higher wages.

 Employers pass on wage increases to customers in the form of price rises.
 Employees decide to accept lower profits.
 Minimum Wage
What is the minimum wage and how much is it?
The minimum wage for workers aged 23 and over will rise from £9.50 to £10.42 an hour in April.

 The increase to the National Living Wage will boost the pay of about two million people.
 Chancellor Jeremy Hunt announced the 9.7% increase as part of his Autumn Statement, to
help workers cope with rising prices.
 There are lower rates of pay for younger workers.

How much is the minimum wage?

 The minimum wage - known officially as the National Living Wage - varies depending on the
age of the employee.

From 1 April 2023, the increases will be:

 National Living Wage for over-23s: £9.50 to £10.42 an hour

 National Minimum Wage for those aged 21-22: £9.18 to £10.18

 National Minimum Wage for 18 to 20-year-olds: £6.83 to £7.49

 National Minimum Wage for under-18s: £4.81 to £5.28

 The Apprentice rate: £4.81 to £5.28

The apprentice rate applies to people aged under 19, or people over 19 in the first year of their
apprenticeship.

Do employers have to pay the minimum wage?

 The UK national minimum wage sets out the lowest amount a worker can be paid per hour
by law.
 The retail, care and hospitality sectors account for a large number of minimum-wage jobs,
although they are found in many other parts of the economy too.

 Any employer not paying the minimum wage can be fined by the UK tax authority, HMRC.
 If you think you should be getting the minimum wage and aren't, you can complain via the
HMRC website. You can also get advice from the Acas website or by calling its helpline on
0300 123 1100.
Who sets the minimum wage?

1. The rates are decided each year by government and based on the recommendations of an
independent advisory group, the Low Pay Commission.

2. It bases its recommendations on the state of the economy, and considers how many people
are in work, what's happening to everyone's earnings and how much they are having to pay
for essentials such as food and housing.

Who isn't entitled to the minimum wage?

 People who don't qualify include the self-employed, company directors, volunteers,
members of the armed forces, prisoners and people living and working in a religious
community.
 People with disabilities or those in long-term unemployment who take part in a government
work programme are paid fixed amounts at different stages of the programme, which are
less than the minimum wage.
 Work done by prisoners is paid at a minimum of £4 a week, while students on work
placements of less than a year as a required part of their studies are not entitled to be paid
anything.

When was the minimum wage introduced?

 The law to introduce the minimum wage was passed in 1998 by the Labour government and
it came into force the following year.
 It started at £3.60 for those 22 and older, and £3.00 for 18-21 year olds.
 Before the minimum wage was introduced, the lowest-paid people consistently saw the
slowest growth in their wages.
 The introduction of the minimum wage reversed this trend, according to the Low Pay
Commission.

Did the minimum wage cost jobs?

 Before the minimum wage was introduced, there was concern that it would cost jobs,
because employers would compensate for their higher wage bill by hiring fewer people.
 But this didn't turn out to be the case. There's no evidence of an overall loss of jobs linked to
the minimum wage, and only weak evidence of negative impacts on some groups of workers.
Why would the government want a National Minimum Wage?
1. Social Equity:

 Income Equality: Implementing a National Minimum Wage helps address income inequality
by ensuring that all workers receive a basic level of pay. This promotes social justice and
reduces the wage gap between different segments of the workforce.

 Poverty Alleviation: A minimum wage serves as a tool for poverty reduction by setting a
floor on wages, ensuring that even the lowest-paid workers earn enough to cover basic living
expenses. This contributes to an overall improvement in the standard of living for low-
income individuals and families.

2. Economic Stability:

 Reduced Income Disparities: A National Minimum Wage can contribute to economic stability
by reducing disparities in income distribution. When the lowest-paid workers receive a
higher income, they are more likely to participate in consumer spending, positively impacting
aggregate demand and supporting economic growth.

 Reduced Reliance on Social Assistance: A minimum wage helps reduce the reliance of low-
wage workers on social assistance programs. By ensuring that wages cover essential needs,
the government can potentially lower the demand for welfare programs, easing the financial
burden on public resources.

3. Labor Productivity and Motivation:

 Enhanced Productivity: A minimum wage policy can motivate workers to be more

productive, as they are compensated fairly for their efforts. When employees receive a
decent wage, they may be more motivated to contribute positively to the workplace,
ultimately improving overall labor productivity.

 Reduced Employee Turnover: Offering a reasonable minimum wage can decrease employee
turnover rates. When workers are satisfied with their compensation, they are more likely to
stay in their jobs, reducing recruitment and training costs for businesses. This stability in the
workforce benefits both employers and the economy.

4. Social Cohesion:

 Social Stability: Establishing a National Minimum Wage fosters social cohesion by addressing
issues related to income disparities. It helps prevent social unrest and discontent that may
arise from widespread poverty and inequality, contributing to a more stable and harmonious
society.

5. Public Health and Education:

 Improved Health and Education: A minimum wage that ensures a basic standard of living
can positively impact public health and education. Workers with higher incomes may have
better access to healthcare and education for themselves and their families, leading to
improved overall well-being and human capital development.
Impact of Minimum Wage
Impact on Individuals:
 Positive Effects:
o Increased Income: Individuals benefit from a minimum wage as it ensures that even
the lowest-paid workers receive a basic standard of pay, contributing to improved
living standards.
o Poverty Reduction: The minimum wage serves as a tool for poverty alleviation,
providing financial stability for low-income individuals and families.
 Negative Effects:
o Possible Job Loss: Some individuals, particularly those with low skills or in labor-
intensive industries, might face unemployment as firms adjust to higher labor costs.
Impact on Unemployment:
 Positive Effects:
o Potentially Lower Unemployment: A minimum wage can stimulate consumer
spending, leading to increased demand for goods and services, potentially boosting
employment.
 Negative Effects:
o Job Loss: Firms, especially small businesses with tight profit margins, may cut jobs to
cope with increased labor costs, resulting in higher unemployment rates, particularly
among low-skilled workers.
Impact on Firms:
 Positive Effects:
 Enhanced Productivity: A reasonable minimum wage can motivate workers to be
more productive, benefiting firms through improved efficiency.
 Reduced Turnover: Firms may experience reduced employee turnover, leading to
cost savings on recruitment and training.
 Negative Effects:
 Increased Costs: Firms may face higher operational costs due to increased wages,
potentially impacting profitability, especially for small businesses.
 Potential Job Cuts: Some firms, particularly those with thin profit margins, may
respond to increased labor costs by reducing the workforce, affecting employment
levels.
Impact on Inflation:
 Positive Effects:
 Increased Consumer Spending: Higher wages for low-income individuals can lead to
increased consumer spending, stimulating demand and contributing positively to
economic growth.

  Negative Effects:
 Cost-Push Inflation: Firms facing higher labor costs may increase prices to maintain
profit margins, contributing to cost-push inflation.
 Potential Business Closure: Some small businesses may struggle with increased
costs, leading to closures, impacting competition and potentially contributing to
inflation.
Advantages of a minimum wage:
 Benefits disadvantaged workers – e.g. low-income families, women and ethnic minorities –
helping to reduce inequality and increase fairness.
 reduces poverty by raising the living standard of the lowest paid workers.
 prevents exploitation of workers who have poor bargaining strength in the labour market i.e.
no access to trade unions.
 a minimum wage raises the income of the poorest workers who spend all their income on
goods and services. This increases demand in the economy and therefore decreases
unemployment.
 increasing the MWR will increase incomes and therefore provide more income tax to the
government which they can use to provide public & merit goods (note: this is not the
purpose of the MWR).
 increasing the MWR will encourage more voluntary unemployed workers to go and find a job
as they are able to earn more income compared to the unemployment benefit, thus helping
to reduce unemployment (note: this is a consequence and not the main purpose of the
MWR).
 Employers may be more willing to train workers to improve labour productivity to justify
higher wages.

Disadvantages of a minimum wage:

 a minimum wage can cause unemployment because it increases the cost of employing
workers and therefore the demand for these type of workers decreases.
 a minimum wage will raise business costs and may therefore cause them to increase their
prices. This reduces a firm’s international competitiveness as their products become more
highly priced. As a result, an economy may see a fall in exports and a drop in the balance of
payments.
 a minimum wage may cause capital (i.e. machinery) to be substituted for labour (firms
become more capital intensive). This may make these firms more efficient and therefore the
economy more efficient.

EVALUATION of NMW:
The minimum wage diagram shows that IF a minimum wage causes wages to rise above the
equilibrium wage level then it will result in causing unemployment.
HOWEVER:
1. The minimum wages increases the wages of those who are on the lowest wage level and therefore
it is likely that these workers will spend all their extra income on goods and services. This will
increase demand for goods and services and therefore increases demand for labour (it has been
shown that an increase in the minimum wage does not cause unemployment because of this
reason).

2. The impact of the MWR depends upon how many people are paid this rate. As a larger
percentage of the population are unskilled, then it is likely that there will be a substantial number of
people receiving the minimum wage rate. So, while the MWR may cause some unemployment,
perhaps a larger percentage of workers will benefit from higher standards of living.

3. If the original wages rate was below the equilibrium level then the imposition of a MWR will have
little effect on business costs and pricing. Any increase in wages will only bring wage rates to the
equilibrium level and therefore there is no negative impact on employment.

4. The effect of a minimum wage rate will depend upon the size of the increase in wage rates. If the
MWR increases wages substantially and causes wages to be above equilibrium, then yes, the MWR
will have a bigger impact on employment levels. The impact of the MWR all depends on how far
above equilibrium the minimum wage rate is set.

5. The increase in wage rates may also provide ammunition to higher income earners to negotiate
their own wage increase. Thus, having a much wider impact on the economy and perhaps leading to
inflation.

6. While a MWR will create unemployment, if an economy is in a boom period it may be relatively
easy for unemployed workers to find a new job. However, if the economy is in a recession it will be
harder for workers to find new employment as unemployment is already high during this period of
time.
Market
Failure
Externalities
 Many goods generate externalities when they are produced or consumed, in addition to
having private costs and private benefits.
 “An externality is a spillover effect on third parties not involved in the initial transaction.”
 “Externalities can be positive or negative.”
 Spillover effects include passive smoking to other passers-by as a result of consumers
purchasing cigarettes from producers and engaging in smoking (a private activity in itself).
 Passive smoking happens to those who are not involved in the original purchase of the
cigarettes by another private individual. These people who are not involved in the original
purchase are referred to as third parties.
 An explanation below:

The purchase of the cigarettes by a consumer

from producers (i.e., tobacco merchants) is
the original transaction.

The consumer here incurs private benefit

from consuming these cigarettes (temporary
relaxation from satisfying nicotine craving)

The producer also incurs private benefit in

the form of profit from selling the cigarettes

The consumer here also incurs private costs

to themselves ONLY – these include the cost
of the cigarettes (e.g., £13 per packet) and
the long-term cost to their personal health

HOWEVER:

 The consumption of cigarettes does not only cause private costs and benefits to the original
consumer and producer!
 Cigarette consumption generates negative externalities in the form of passive smoking to
passers-by.
 The passers-by (other members of society) were not involved whatsoever in the initial
purchase or sale of the cigarettes.
 However, they are negatively impacted by a negative spillover effect anyway; they have to
breathe in the second-hand smoke from the original consumer.
 Hence, cigarettes cause negative externalities to the rest of society!
 This means that from society’s perspect, cigarettes are OVER-CONSUMED. The cost to
society is GREATER than the cost to the private individuals involved in the original purchase
and consumption of the cigarettes.
 For this we are 2 equation which can help with this
1. Social Cost (Negative Externalities):

 Social Cost = Private Cost + External Cost

2. Social Benefit (Positive Externalities):

 Social Benefit = Private Benefit + External Benefit

THE KEY IDEA IS THAT FREE MARKETS ONLY CARE ABOUT PRIVATE COSTS AND PRIVATE BENEFITS

Summarised below:

If social costs are GREATER Then are EXTERNAL COSTS or Society wants LESS
than private costs… NEGATIVE EXTERNALITIES consumption /
production!

If social benefits are GREATER There are EXTERNAL BENEFITS or Society wants MORE
than private benefits… POSITIVE EXTERNALITIES consumption /
production!

What does it all mean?

BECAUSE FREE MARKET PARTICIPANTS IGNORE EXTERNAL EFFECTS WHEN DECIDING

PRODUCTION / CONSUMPTION, THEY LEAD TO A MISALLOCATION OF RESOURCES FROM SOCIETY’S
PERSPECTIVE

This is known as MARKET FAILURE.

Governments may INTERVENE in order to correct market failures, through policies such as
taxation, subsidies, regulation, fines and pollution permits.
Policies to solve externalities.
Policy Examples:

 Subsidy:
 Example: Government providing financial support to farmers for agricultural
production.
 Advantage: Encourages desired economic activities, such as agriculture, by reducing
production costs for producers.
 Disadvantage: Can lead to inefficiencies and overproduction if not carefully targeted,
resulting in potential waste of resources.
 Tax:
 Example: Imposing a carbon tax on industries emitting greenhouse gases.
 Advantage: Discourages activities with negative externalities by increasing their cost,
promoting environmental conservation.
 Disadvantage: May be regressive, impacting lower-income groups
disproportionately, and could lead to potential tax evasion.
 Fines:
 Example: Issuing fines for companies violating environmental regulations.
 Advantage: Acts as a deterrent, discouraging undesirable behavior and encouraging
compliance with regulations.
 Disadvantage: The effectiveness depends on the severity of fines and enforcement
mechanisms; some companies may view fines as a cost of doing business.
 Regulation:
 Example: Imposing emission standards on vehicles to reduce air pollution.
 Advantage: Provides a clear framework for businesses, ensuring a level playing field
and addressing market failures.
 Disadvantage: Can lead to administrative burdens and compliance costs for
businesses, potentially stifling innovation and economic growth.

Public Goods
Private goods
Private goods display the characteristics of rivalry and excludability in consumption:

• Excludable – when one person buys a good, they have ownership of that good and can stop
others from benefitting from the good

• Rivalrous - when one person consumes a good that reduces the availability and prevents
others from consuming the good.

Examples of Private Goods:

1. 1, clothing
2. Cards
3. Food
4. electronics

Public goods

However, there are also public goods which display two key characteristics:

 NON-EXCLUDABILITY - once provided, no person can be prevented from using and

benefiting from the good.

 NON-RIVALRY – consumption of the good by one person does not lead to a reduction in
the availability for others. (Once a public good has been provided, the cost of supplying it
to an extra consumer is ZERO.)

Definition: Public goods are those items which can be jointly consumed by many consumers
simultaneously without any loss in quantity or quality of provision.

Examples of Public Goods:

• Public Parks
• Streets
• Air quality national defence.

Why are Public Goods Under-Provided?

 Public goods are under-provided as a result of the free rider problem

  Once a public good has been provided for one individual, it is automatically provided for all.
The market fails because it is not possible for firms to withhold the good from those
consumers who refuse to pay for it.
 The rational consumer would wait for someone else to provide the good and reap the
rewards by consuming it for free. However, if everyone waits for the public good to be
supplied, it may never be provided.
 This leads to market failure as resources are not being allocated to the provision of a good
that would improve social welfare

Government provision of public goods

 In a mixed economy the government tends to provide the public goods in order to correct
market failure. It raises funds from general taxation to pay for their provision. Without
government intervention, public goods are not likely to be provided.
 Even with government provision, there may be some under-provision due to the valuation
problem. As there is no price for the good, due to free riders not paying for its use, the
government will find it hard to accurately determine the value of a public good. As such,
governments may still underprovide the good if they underestimate the value it brings
society.
Macro
Macroeconomic
Fundamentals
 Circular flow of income

Injections / money into the economy:

 Government spending = G
 Investment by firms = I
 Exports = X

National
National Expenditure
Income
National
Output

Factors
of
production

National expenditure = national output = national income

E = O = Y

Leakages / Withdrawals:

 Taxes = T
 Savings = S
 Imports = M

Effects on the Circular flow of Income

Increase investments.

 Negative economic growth – a reduction in spending from companies leads to a decrease in

injections to an economy leading to a decrease in economic growth or negative economic
growth
 Lower Income for Households: Due to less investments firms cut back on hiring and may lay
off workers leading to a reduction in national income due to less jobs and rent being paid by
business
 Lower national expenditure – a decrease in investment leads to less income meaning the
demand for goods and services decreases there for people buy less decreasing national
expenditure
 Decreased national output – a decreases in expenditure / a decrease in demand for goods
and services means that business scale back to reach market equilibrium therefore, the
output overall falls

Increase in exports:

 Positive economic growth – a increase in exports means more money in the circular flow of
income leading to an increase of overall money in the economy leading to positive economic
growth due to increase production and spending
 Higher income for households – more expansion of firms to reach the demand from
overseas means firms pay more to workers, employ more and also expand and rent
equipment meaning that households take home more money from wages, profits and rent
 High national expenditure – increased household income means that people may spend
more on goods and services or buy more luxury goods meaning that the overall money being
spent increases
 Increased national Output – due to increase of demand overseas and people spending more
domestically means that businesses produce more to reach the new market equilibrium
therefore increases national output

Increased government spending

 Positive economic growth – a increase in government spending means more money in the
circular flow of income leading to an increase of overall money in the economy leading to
positive economic growth due to increase production and spending
 Higher income for households – due to people on benefits or older people receiving more
money means that these households will have a higher income.
 Higher national expenditure – due to people getting money that they didn’t before means
that people can afford more goods and services necessary or luxury and therefore
expenditure increase
 Increase national Output – due to people sending more that couldn’t previously means that
businesses produce more to reach the new market equilibrium therefore increases national
output
Implementation / increase in government tax

 Decrease economic growth – due to increased taxes it means that money leaves the
economy which leads to a decrease in spending and therefore the output
 Decreased income for households – due to a greater proportion of income being taken up in
taxes it leads to a decrease amount of money being taken home be each person
 Decrease national expenditure – due to a decrease in the average income it means that the
overall spending in the economy decrease hence the total expenditure decreases
 Decrease national Output – due to overall less spending companies produces less leading to
overall less national output

Increase in Bank interest rates

 Decrease economic growth – due to increased interest rate it means people save more
leading to less overall spending and investment leading to a decrease in economic growth
 decrease income for households – less investment leads to less profits, rent and wages
leading to a decrease in income brought home
 decrease in national expenditure – more saving from households and less investment means
that the overall demand for goods and services decrease leading to a decrease in national
expenditure
 decreased national Output – due to more saving and less investment it means the demand
of goods and services decrease therefore, the output decreases due to this slump in demand

fall in currency value

 increase in economic growth – due to increased exports in means that more money has
entered the economy leading to an increase in economic growth
 increase household income – people’s business has more revenues, and profits leading to an
increase in wages and take-home pay leading to an increase of household income
 increase in national expenditure – more goods and services being bought means that the
overall national expenditure has increase therefore an increase has occurred
 increase national Output – business expanding their occupations to reach new demand
means that the output increases due to new expansion and creation of goods and services

Stock:

 effect on the economy as a whole – does it lead to an increase in expenditure, income or

output, if so, increase in economic growth same opposingly
 effect on households/ income: due to the equation the effects on “……” will be positive due
to increase expenditure / income / output
 effect on national expenditure – how does “x” effect overall spending in the economy or
how does spending effect the other if an increase in expenditure everything else increases
 effect on National Output – an increase in any of the others will lead to increased demand
hence output increase and same opposingly if demand increases the others increase

Exam Tip
REMBER THAT WITH THE CIRCULAR FLOW OF INCOME THAT EVERYTHING IS CORELATED. THE
EQUATION SHOWN (E = Y = O) SHOWS SHOW AN INCREASE WILL LEAD TO AN INCREASE OF
 ANOTHER. IF THERE IS A CHANGE IN BOTH THINK OF THE OVERALL EFFECT IT MAY NEUTRAL OR
ONE CHANGE MAY BE BIGGER SO FIT YOUR ANSWER TO THAT.

Aggregate Demand

 aggregate demand is the total level of real spending on goods and services produced in the
economy over a period of time
 aggregate demand is useful for measuring things such as the change in overall spending due
to currency change and inflation
 This is the equation for aggregate demand

AD=C+ I +G+(X−M )
 Were
o C - consumers’ expenditure – this is how much consumers spend on goods and
services including durable and non-durable goods
o I – investment (gross domestic Fixed Capital Formation) – spending on companies
on capital goods and working capital (stocks of finished goods and work in process)
o G – government spending (General Government Final Consumption) – on publicly
provided goods and services including public and merit goods. Transfer payments in
the form of social security benefits are not included as they are not a payment to a
factor of production for output produced. A substantial increase in government
spending would be classified as an expansionary fiscal policy
o X – Exports of goods and services – exports sold overseas are inflow of demand into
the circular flow of income as seen above and add to the overall demand within the
economy
o M – imports of goods and services – imports are withdrawn (leakage) from the
circular flow of income and spending in the economy. Due to the money and the
demand being in another country’s economy it means that money and demand is
leaking from another economy. Therefore, this is subtracted from the aggregate
demand equation.

Aggregate Demand Curve

 The aggregate Demanded curve is slopping
  This shows that a rise in the price level cause a contraction AD – proper will buy less UK
goods and services
 Below is an example of an aggregate demand curve

This is the general graph for AD

Effects on the AD curve

 Increase in consumer expenditure (C) – an increase in consumer expenditure leads to a

direct increase in AD, this means that the demand has increased for good and services
shifting the curve outwards
 Increase in investment (I) – an increase in investment leads to a direct increase in AD due to
directly contributing to the output and spending on good and service thus shifts the curve
outwards due to increased demand
 Increase in government spending (G) – Due to the government spending its money on goods
and services this means that the total real level of spending increase thus increasing demand
and shifting it outwards
 Increase in exports (X) – an increase in exports means that people from foreign countries are
spending more money in this economy meaning the real spending on goods and services
increase shifting the curve outwards
 Increase in Imports (M) – an increase in imports means that money and demand is in
another economy therefore decreasing the overall real spending of goods and services in this
economy thus making the graph shift inwards
Examples
Demand for imports increases

An increase in imports it means that a greater value is subtracted from exports shifting the curve
inwards

Increase in consumer and business confidence due to a government budget announcement

Consumer and business confidence means increased investment and consumer expenditure hence
the graph shifts outwards

Increase in the value of the pound

Due to exports being more expensive for other countries it means that the demand decreases, and
the curve shifts inwards (we cover this in this fiscal budget later on)

Exam Tip
REMEMBER LIKE THE CIRCULAR FLOW OF INCOME THINK WHAT “X” EFFECT HAS ON ONE OF THE
COMPONENTS OF AD. DOES THIS LEAD TO AN INWARD SHIFT OR OUTWARD SHIFT AND
THEREFORE THAT IS Its OVERALL EFFECT ON THE REAL SPENDING IN THIS ECONOMY

Aggregate Supply
 Aggregate supply is – the total value of Output in the Economy
  Also known as the output of all firms in the economy added, together known also as National
Output
 The total value of all output in an economy must be equal to the total value of all
expenditure in an economy.
o Therefore, AD = AS
 AS therefore can be increased using these 3 methods:
o Increase in Quality of resources available
o Increase in the Quality or productivity of resources
o Decrease in the Costs of production

Shifts in Aggregate Supply:

Increase in aggregate supply:

Outwards shift due to an increase of one of the factors above

Decrease in Aggregate supply

 A decrease in a factor above a lead to a decrease in aggregate supply

Exam tip
WHEN ASKED A QUESTION JUST REMEMBER WHETHER IT IS A FACTOR OF SUPPLY BEING EFFECT
USING ONE ON THE 3 FACTS YOU CAN DETERMINE WHETHER IT LEADS TO An INCREASE OR
DECREASE IN AGGREGATE SUPPLY
Macroeconomic
Objectives
  Here are the 6 main macro-economic objectives:
o High and stable Economic growth
o Low inflation
o Low unemployment, full employment
o A balance of payments, surplus on fiscal budget
o Protect the enviroment
o Reduce income inequality

Economic growth

 Economic growth is the percentage increase in real GDP in an economy over a period of
time. Economic growth is often measured using GDP and expressed as a percentage change
in real GDP
 Economies usually grow over a period of time, meaning the total amount of goods and
services produce increase. This means national income will rise.
 National income is the value of all income in the economy added together and includes
income from wages, profits, dividends, interest and other income earned from abroad
 Economic growth can be measured in 2 ways
o Gross Domestic Product (nominal GDP)
 The value of output of goods and services produced in an economy over a
period
o Real GDP
 The value of goods and services produced by a country in a period of time,
having been adjusted for inflation

Increase in GDP:

 An increase in GDP is a sign that a country is experiencing an increase in output, income &
Spending
 People have more goods & services, implying they have a better standard of living
(economic welfare)

Important:

 Falling economic growth does not mean the level of GDP is falling. China is currently
growing at around 6% per annum. If the growth rate fell to 4% per annum, its GDP would still
be rising by 2% each year. So, if the percentage change of economic growth is positive, then
the economy is growing (and if the percentage change is negative then the economy is
shrinking
 A falling rate of growth simply means that GDP is not rising as fast as before. So, it’s
important to distinguish between level of GDP and rate of growth of GDP.
Exam tip
 If the percentage change in real GDP is greater than 0 then the economy is GROWING
 If the percentage change in real GDP is less than 0 then the economy is SHRINKING
 Negative real GDP for TWO CONSECUTIVE QUARTERS (i.e. 6 months) will mean the economy
is in a RECESSION
 If real GDP declines (negative) for eight consecutive quarters (i.e. two years!) then an
economy is in a DEPRESSION

 If a country has a growth rate of 6% but it falls by 2% their growth rate is still 4%.
 So, if the percentage change of economic growth is positive, then the economy is growing
(and if the percentage change is negative then the economy is shrinking)
 A falling rate of growth simply means that GDP is not rising as fast as before. So, it’s
important to distinguish between level of GDP and rate of growth
Common Exam Question
Access the benefits of using GDP as a measure of Economic growth

Benefits of Using GDP as a Measure of Economic Growth:

1. Simple and Quantifiable:

 GDP is a straightforward and easily quantifiable measure. It provides a single

numerical value that represents the total value of goods and services produced in an
economy over a specific period. This simplicity makes it accessible for policymakers,
analysts, and the general public.

2. International Comparisons:

 GDP allows for easy comparisons of economic performance between different

countries. This is particularly useful for policymakers and investors in making
informed decisions about resource allocation, trade, and investment. It serves as a
common metric for assessing the relative economic health of nations.

3. Indicator of Standard of Living:

 GDP per capita, which is GDP divided by the population, can be used as an indicator
of the average standard of living in a country. While it doesn't provide a complete
picture of well-being, it gives a general sense of the economic conditions
experienced by the population and can be a useful starting point for assessing living
standards.

Drawbacks of Using GDP as a Measure of Economic Growth:

1. Excludes Non-Market Activities:

 GDP primarily focuses on market transactions and may exclude non-market activities
such as household work, volunteerism, and the informal sector. This limitation
results in an incomplete representation of economic activities and can lead to an
inaccurate assessment of the actual well-being of a society.

2. Ignores Income Distribution:

 GDP does not provide information about how income is distributed among the
population. A country with a high GDP may still have significant income inequality.
This oversight can be crucial, as high GDP figures may not necessarily translate into
improved living standards for the entire population.

3. Neglects Environmental Impact:

 GDP does not account for the environmental costs associated with economic growth,
such as pollution and resource depletion. As a result, a focus solely on GDP growth
may lead to unsustainable practices that harm the environment in the long run.
Sustainable development considerations are not adequately captured by GDP.
Other limitations of using GDP as a measure of economic growth

1. INFLATION

Inflation is the sustained rise in the average price level of goods and services Ina n economy in a
given period of time. Inflation can make it appear that GDP has risen when actually it might not have.
We must be careful when measuring GDP to distinguish between real and nominal GDP.

• Nominal GDP is GDP which has not been adjusted for inflation.
• Real GDP is GDP which has been adjusted for inflation and measures if there has been an
increase in the level of output (amount of goods and services produced by an economy).

For example:

In 2017 country A’s entire output is 10 products which it sells at a price of $100 each.

What is country A’s nominal GDP?

In 2018 country A’s entire output is 10 products which it sells at a price of $105 each.

What is country A’s nominal GDP?

This is called nominal GDP as it has not been adjusted for inflation; therefore, it appears that
there is an increase in the amount of goods and services produced when actually there are still
only 10 products produced.

If we were to calculate the real GDP for Country A in 2018, we would need to keep the prices the
same as 2017 and therefore the calculation would be:

This means that price increases can mean that using nominal GDP as a measure of economic
growth can be misleading.
2. Population Changes
o If an economy is experiencing an increase in population, then it is necessary
to consider this growth pattern when analysing GDP results.
o This problem can be overcome by calculating GDP per capita
 GDP per capita = GDP / Population
o Real GDP per capita is often used as a measure of standards of living. This measures
how many goods and services the average person has access to.

3. Statical errors
o As mentioned in the article above, the collection of GDP data is a huge task involving
‘thousands of UK companies’ and documents. It is inevitable that mistakes and
omissions will occur.

4. Home Produced Goods

o GDP does not take into account the negative externalities created as a result of
production and the effect on the environment. (This will be covered more later
when looking at the impact of economic growth….)
The economic Cycle

Boom: During a boom phase, the economy is in a period of rapid growth and expansion.

 Confidence: High confidence prevails among businesses and consumers, driven by positive
economic conditions.
 Income: Income levels are high, with increased wages and business profits.
 Demand: Demand for goods and services is robust as consumers and businesses increase
spending.
 Unemployment: Unemployment rates are low as businesses expand and create more jobs.
 Inflation: Inflation is high during a boom, driven by increased demand and economic activity.
 Profits: Businesses experience high profits as sales and revenues surge.
 Investment: Investment is high as businesses seek to capitalize on favourable economic
conditions.
Downtown: During the downtown phase of an economic cycle, several key indicators are affected.

 Confidence: Low confidence prevails among businesses and consumers due to economic
challenges.
 Income: Typically, income levels decrease as businesses may cut back on wages or
workers face unemployment.
 Demand: Demand for goods and services tends to decrease as consumers cut back on
spending.
 Unemployment: Unemployment rates are generally high as businesses may lay off
workers to cope with economic challenges.
 Inflation: Inflation tends to be low during a downtown phase, as weak demand puts
downward pressure on prices.
 Profits: Profits for businesses are often lower or negative due to decreased demand and
increased costs.
 Investment: Investment tends to be low as businesses are hesitant to expand during
economic uncertainty.

Depression: A depression is an extended and severe downturn in economic activity.

 Confidence: Extremely low confidence prevails, with a bleak outlook on the economy.
 Income: Income levels continue to decline, with widespread job losses and reduced
wages.
 Demand: Demand remains very low as consumers and businesses cut back on spending.
 Unemployment: Unemployment rates are very high, and long-term unemployment
becomes a significant issue.
 Inflation: Inflation remains low or may even turn negative due to weak demand and
excess capacity.
 Profits: Many businesses face substantial losses, and bankruptcies may become more
common.
 Investment: Investment remains depressed as businesses struggle to survive and lack
confidence in future prospects.

Recovery: During the recovery phase, the economy starts to rebound from the downturn.

 Confidence: Confidence begins to improve as economic conditions show signs of

stabilization.
 Income: Income levels may start to recover as businesses rehire workers and wages
begin to increase.
 Demand: Demand gradually picks up as consumer and business confidence improves.
 Unemployment: Unemployment rates begin to decline, although the recovery in the
labour market may be gradual.
 Inflation: Inflation may start to rise as demand increases, putting upward pressure on
prices.
 Profits: Businesses see improving profits as economic activity picks up.
  Investment: Investment levels start to rise as businesses regain confidence in the
economic outlook and seek opportunities for expansion.

Effects of the economic cycle:

1. Employment:

For:

 Economic growth often leads to an increase in job opportunities across various sectors,
including manufacturing, services, and technology.

 As businesses expand to meet rising demand, they require more workers, contributing to
lower unemployment rates.

Against:

 However, economic growth may not always result in an equitable distribution of

employment, potentially leading to job market distortions and income inequality.

 In some cases, economic growth driven by automation and technological advancements can
lead to job displacement, particularly for low-skilled workers.

2. Standards of Living:

For:

 Economic growth can enhance standards of living by increasing income levels and providing
resources for improved public services, healthcare, and education.

 With a growing economy, individuals and households generally have access to a wider range
of goods and services, contributing to an improved quality of life.

Against:

 Despite overall economic growth, benefits may not be evenly distributed, leading to
disparities in standards of living across different socioeconomic groups.

 In some cases, rapid economic growth may be accompanied by environmental degradation

and resource depletion, negatively impacting living standards.

3. Poverty:

For:

 Economic growth has the potential to lift people out of poverty by creating job opportunities
and increasing incomes.

 Governments can use increased tax revenue from a growing economy to fund poverty
alleviation programs and social welfare initiatives.

Against:

 In certain situations, economic growth may exacerbate poverty if the benefits primarily
accrue to a small segment of the population, leaving others behind.
  Unregulated growth can lead to social inequality, hindering poverty reduction efforts.

4. Inflation:

For:

 Moderate inflation is often associated with a growing economy and increasing demand
for goods and services.
 Central banks can use monetary policy tools to manage inflation and stabilize prices,
ensuring a conducive environment for economic growth.

Against:

 Rapid economic growth can lead to demand-pull inflation, where excessive demand
outpaces the economy's ability to supply goods and services.
 High inflation rates erode the purchasing power of consumers, particularly those on fixed
incomes, leading to reduced standards of living.

5. Productive Potential:

For:

 Economic growth positively impacts productive potential by fostering technological

advancements, innovation, and improvements in efficiency.

 A growing economy encourages investment in capital goods and infrastructure, enhancing

the overall productive capacity of an economy.

Against:

 Rapid economic growth may strain resources, leading to overutilization and diminishing
returns on capital.

 In some cases, the pursuit of short-term economic gains may compromise long-term
productive potential due to unsustainable practices.

6. Environment:

For:

 Economic growth can enable investment in green technologies and sustainable practices,
fostering a transition to a more environmentally friendly economy.

 Governments and businesses, driven by the awareness of environmental concerns, may

implement policies that balance economic growth with ecological preservation.

Against:

 Uncontrolled economic growth may result in increased pollution, deforestation, and

depletion of natural resources, negatively impacting the environment.
  The pursuit of profit in a growth-focused economy might lead to a disregard for
environmental sustainability, causing long-term harm to ecosystems and biodiversity.

Inflation
 Inflation is the sustained rise in the average price level of goods and services in an economy
over a period of time.
 Deflation is a sustained fall in the average price level of goods and services in an economy in
a given period of time. (Negative inflation)
 Disinflation is a term used to describe a situation in which the general level of prices in an
economy is still increasing, but at a decreasing rate.

The consumer price index (CPI)

 The Consumer Prices Index (CPI) measures the average change in prices of consumer goods
and services purchased.
 The process
o Every month the government collects prices on the same basket of 600-700 goods
and services purchased by 7000 typical families.
o The items in the basket are regularly updated to show changes in trends and
consumer spending patterns.
o The prices of the 600-700 G&S are collated together and converted to an INDEX
NUMBER.
o This allows comparison of prices to previous years.
o CPI represents the rate of inflation in index form.
o A BASE YEAR is selected in which the price of the 600-700 items is given the value of
100. If the price of the 600-700 items increases by 3.6% over the next year, then the
index will read 103.6 for that year, therefore making it easier to judge the change in
prices from the previous year.
Types of inflation
Demand Pull inflation

 Aggregate demand exceeds aggregate supply

 Firms raise their price in order to increase their profit margins
 Deman-pull inflation is caused by an increase in one or more of the components in AD
AD=C+ I +G+(X−M )

This graph shows the effects of demand- pull inflation

Cost Push inflation

 When a cost of production increase and firms put up prices to maintain profits
 This increase may be because of
o Commodity price fluctuation increase price of raw material
o Government increases in national minimum wage
o A rise in the exchange rate
o Trade unions demanding higher wages
 Graph showing the effects of cost-pull inflation

The impacts of inflation

Consumers:

 Prices – inflations increase the general costs of goods and services leading to decrease
purchasing power
 Menu Costs and Shoe Leather Costs: Frequent changes in prices (menu costs) and the
associated transaction costs (shoe leather costs) can indirectly affect consumers by making
shopping more complicated and potentially leading to price confusion.

Workers:

 Unemployment:
o High unemployment rates can make it challenging for workers to find jobs, leading to
increased competition in the labour market.
o Job insecurity during economic downturns can cause stress and anxiety among
workers.
 Wages
o directly affect workers' income levels. Higher wages lead to increased disposable
income, improving the standard of living for workers.

Firms:

 Investment:
o Firms are directly affected by their own investment decisions, which can be
influenced by factors such as interest rates, government policies, and overall
economic stability.
 Exports:
o Firms engaged in international trade are directly affected by changes in export levels.
o Exchange rate fluctuations can impact the competitiveness of a firm's products in
foreign markets

Economy:
  Consumer Confidence:
o Consumer confidence influences spending patterns. High confidence levels are
associated with increased consumption, while low confidence can lead to decreased
spending.
 Consumer Confidence:
o Consumer confidence influences spending patterns. High confidence levels are
associated with increased consumption, while low confidence can lead to decreased
spending.

How to reduce inflation:

1. Monetary Policy Adjustments:

 One effective strategy to reduce inflation is through the implementation of a tight

monetary policy. This involves central banks raising interest rates to make borrowing
more expensive, thus reducing consumer spending and business investments. By
controlling the money supply, central banks can influence inflationary pressures and
stabilize the economy.

2. Fiscal Measures:

 Governments can adopt fiscal policies aimed at reducing inflation. For instance, they
can implement contractionary fiscal policies, such as reducing government spending
and increasing taxes. These measures can help curb excessive demand in the
economy, contributing to a slowdown in inflationary pressures. Effective fiscal
management is crucial in achieving a balance between economic growth and price
stability.

3. Supply-Side Reforms:

 Addressing the root causes of inflation requires structural reforms to enhance the
efficiency and productivity of the economy. Governments can implement supply-side
policies, including deregulation, tax reforms, and investments in infrastructure and
technology. Improving the overall productivity of the economy can help meet
demand without causing excessive inflation, fostering sustainable economic growth.
Unemployment

Unemployment can be expressed as:

 the number of people from the working population (labour force) who are willing
and able to work but who cannot find a job.
 a rate of unemployment, which is the percentage of people from the working
population (labour force) who are willing and able to work but who cannot find a job.
Formula:

Unemployment
×100
Labour Force

Different measures of Unemployment:

The Labour Force Survey:

 The data to calculate unemployment is collected from a survey called the LABOUR
FORCE SURVEY (LFS). This is a huge, continuous survey organised by the
International Labour Organisation (ILO), with results reported on a three-monthly
basis. Over 100,000 people in 40,000 households are surveyed every month. If they
are not working and actively seeking work, they are categorised as unemployed.
 The survey is extensive (large sample size), making it an accurate measure of
unemployment (advantage), but it is costly to carry out the survey because of its size
and administration costs involved (disadvantage).

Problems with the ILO survey:

 The way that unemployment is measured varies widely between countries and so
international comparisons are difficult. For example, in the UK people registered as
 unemployed or claiming unemployment benefits are classified as unemployed, while
in other countries this is not the case.
 In addition, even though it is an extensive survey, unemployment levels may still be
underestimated.

The claimant Count:

 Apart from using the Labour Force Survey to measure unemployment, the UK also
uses a second method called the CLAIMANT COUNT. This is reported on a monthly
basis.
 The claimant count is calculated using the number of UK workers claiming the Job
Seekers Allowance.
 The UK claimant count is always below the ILO’s level of unemployment because
many unemployed workers in the UK cannot claim the Job Seekers Allowance, for
example: youth under the age of 18 years or people over 65. This makes it a
narrower measure of unemployment. On average, the labour force survey measure
has exceeded the claimant count by about 400,000 in recent years. The Claimant
Count:
 Apart from using the Labour Force Survey to measure unemployment, the UK also
uses a second method called the CLAIMANT COUNT. This is reported on a monthly
basis.
 The claimant count is calculated using the number of UK workers claiming the Job
Seekers Allowance.
 The UK claimant count is always below the ILO’s level of unemployment because
many unemployed workers in the UK cannot claim the Job Seekers Allowance, for
example: youth under the age of 18 years or people over 65. This makes it a
narrower measure of unemployment. On average, the labour force survey measure
has exceeded the claimant count by about 400,000 in recent years.
 Because it is a survey - albeit a large one and one that provides a rich source of data
on the employment status of thousands of households across the UK - there will
always be a sampling error in the data. The Labour Force Survey uses the
internationally agreed definition of unemployment and therefore best allows cross-
country comparisons of unemployment levels.
 No measure of unemployment is completely accurate since there are some people
out of work but looking for a job who are not picked up by the official statistics. An
example of this is discouraged workers who may have been out of employment for a
lengthy time and who have lost the will and the motivation to keep applying for jobs.
All economies suffer from hidden unemployment and also from under-employment,
where people are in some form of work, but they are either over-qualified for this
job or are working fewer hours than they would otherwise wish to.
Types of unemployment
Cyclical (Demand-Deficient) Unemployment:

When does this occur and why?

 Cyclical unemployment occurs during economic downturns or recessions when aggregate

demand (AD) for goods and services in an economy decreases. This decline in demand leads
to reduced production, causing firms to lay off workers. The key factor is the contraction of
economic activity during the trough phase of the business cycle.

Real Example of this Happening in an Economy of Your Choice:

 An example of cyclical unemployment occurred during the global financial crisis of 2008. As
financial markets collapsed, consumer and business confidence plummeted, leading to
reduced spending and investment. Many industries, particularly in the United States and
Europe, faced declining demand, resulting in widespread job losses.

Explain why this type of unemployment is sometimes known as a ‘lagging indicator’:

 Cyclical unemployment is considered a lagging indicator because it tends to follow the

overall economic cycle. When an economy enters a recession, firms may initially reduce
working hours or implement other cost-cutting measures before resorting to layoffs. As a
result, the full impact of cyclical unemployment becomes apparent only after the economic
downturn has persisted for some time.

Possible Solution:

 Implementing countercyclical policies can help mitigate cyclical unemployment. Central

banks may use monetary policy tools, such as lowering interest rates, to stimulate economic
activity. Governments can also pursue expansionary fiscal policies, increasing public
spending or cutting taxes to boost aggregate demand. These measures aim to counteract
the negative effects of a recession and reduce cyclical unemployment. However, the
 effectiveness of these solutions may vary depending on the specific circumstances of each
economy.

Seasonal Unemployment
When does this occur and why?

 Occurrence: Seasonal unemployment occurs during specific times of the year when
demand for certain goods or services experiences a predictable pattern.

 Why: It is typically linked to industries with a strong seasonal component, such as

agriculture, tourism, or retail, where demand fluctuates based on the time of the
year.

Example:

 In agriculture, seasonal unemployment may occur during the winter months when
there is less demand for farm labour compared to the planting and harvesting
seasons.

Possible Solution:

 Governments and businesses could focus on diversifying economic activities in

regions prone to seasonal unemployment. This might involve training workers in
alternative skills or promoting industries with more stable employment throughout
the year.

Frictional Unemployment
When does this occur and why?

 Occurrence: Frictional unemployment happens when individuals are temporarily

between jobs as they search for new employment opportunities or transition from
one job to another.
  Why: It is a natural part of the labour market as people move between jobs,
industries, or locations, and the process of finding a suitable job takes some time.

Example:

 A recent graduate who is actively searching for a job in their field may experience
frictional unemployment during the period between completing their education and
securing their first professional position.

Possible Solution:

 Improving information channels and job-matching services can help reduce the
duration of frictional unemployment. Government-sponsored career counselling and
online job platforms can facilitate smoother transitions between jobs for individuals
in the labour market.

Structural Unemployment
Definition: Structural unemployment refers to the long-term, persistent unemployment
caused by fundamental shifts in the economy, leading to a mismatch between the skills of
the labour force and the requirements of the job market.

3 Main Types:

1. Sectorial:

 When does this occur and why? Sectorial unemployment occurs when there
is a decline in demand for a particular industry or sector, often due to changes
in consumer preferences or international competition.

 Example: The decline in the demand for traditional manufacturing jobs in

developed countries as production shifts to more cost-effective locations.

2. Technological:

 When does this occur and why? Technological unemployment arises when
advancements in technology replace certain job functions, making some skills
obsolete.

 Example: The automation of routine tasks in manufacturing, leading to job

losses for workers performing repetitive functions.

3. Regional:

 When does this occur and why? Regional unemployment occurs when
economic activities decline in a specific geographic area, often due to the
closure of industries or a shift in economic focus.
  Example: The closure of coal mines in a particular region due to a shift
towards cleaner energy sources.

Geographical Immobility of Labor: Geographical immobility of labour refers to the inability

or reluctance of workers to move to regions with better employment opportunities. In the
context of regional unemployment, workers may be unable to relocate due to personal or
financial constraints.

Occupational Immobility of Labor: Occupational immobility of labour refers to difficulties in

workers switching between different types of jobs. In the case of sectorial and technological
unemployment, workers may lack the skills required for emerging industries, contributing to
their unemployment.

Possible Solutions to Reduce Structural Unemployment:

1. Education and Training Programs: Implementing programs to retrain and upskill

workers to meet the demands of emerging industries.

2. Labor Market Flexibility: Enhancing flexibility in labour markets to facilitate easier

transitions between jobs and industries.

3. Regional Development Policies: Implementing policies that promote economic

development in regions facing structural unemployment, attracting new industries
and creating job opportunities.
Voluntary Unemployment:
Voluntary unemployment occurs when individuals choose not to work despite the
availability of job opportunities. This can be attributed to various reasons, such as personal
preferences, pursuing further education, or taking time off for family responsibilities. In
some cases, individuals may decide to delay their entry into the workforce to seek better job
prospects or engage in activities like entrepreneurship.

Example:

An individual may voluntarily choose unemployment after completing formal education to

pursue additional training or skill development. They might opt for this period of voluntary
unemployment to enhance their qualifications and increase their competitiveness in the job
market.

Possible Solution:
To address voluntary unemployment, policymakers can focus on initiatives that encourage
skill development and training programs. This could involve collaborations between
educational institutions and industries to ensure that individuals acquire relevant skills
demanded by the job market. Additionally, promoting entrepreneurship and providing
support for start-ups could offer alternative avenues for individuals who voluntarily choose
unemployment as they explore business opportunities.

It's important to note that this example is tailored to a voluntary unemployment scenario. If
the question is related to a different context within the field of economics or a different
aspect of voluntary actions, please provide more details for a more accurate response.

Impact of Unemployment

The worker / individual:

Protecting the Enviroment
Protection of the enviroment – why?

 Some businesses activities damage the enviroment. For example, chemical processing lants
may discharge dangerous emissions into the atmosphere and oil companies ay spill crude oil
into oceans
 However, consumers are becoming increasingly aware of this and are changing their
consumption. Two-thirds of consumers now avoid specific brands due to environmental
concerns.
 One major concern is that the planet may be under threat. This threat comes from climate
change and global warming.

Different types of pollution:

 Visual pollution - Where a business activity results in something physical that looks very
unattractive - Litter, overflowing skips, giant office blocks, pylons, wind farms.
 Noise pollution - Where a business activity results in disturbance to everyday life for people
and/or wildlife through excessive noise. - Jet engines, music from nightclubs, machinery on
construction sites, traffic.
 Air pollution - Where a business activity results in the presence in or introduction into the air
of a substance which has harmful or poisonous effects. - CO2, Sulphur Dioxide, CO,
hydrocarbons, ammonia
 Water pollution - Where a business activity results in the contamination of oceans, rivers,
lakes, groundwater or other bodies of water by harmful substances - Oil, plastics, industrial
waste, sewerage.
Government Intervention to Protect the Environment

Taxation

Subsidies

Regulation

Fines
Balance of Payments
 The current account records a country’s trade in:
o Goods
o Services
 The export and import off these items are broken down into the following:
o Balance of Trade (Visibles): i.e. value of exports MINUS value of imports of physical
goods, e.g. machinery, food (visibles).
o Balance of Invisibles: i.e. value of exports MINUS value of imports of services, e.g.
banking, tourism, and communications.
The size of the Bop current account balance is mainly determined by the VALUE OF UK EXPORTS &
IMPORTS
Impact of a Current account deficit (need to continue)
 A fall in exports
Redistribution of Income

Introduction to Relative and Absolute Poverty

Absolute poverty - is where people do not have enough resources to meet all of their basic human
needs.

Relative poverty - is poverty when relative to existing living standards of the average individual. It
can also be when a person earns less than 50% or 60% of the median income of that economy.

Economists measure inequality using the Gini Coefficient. The lower the value, the more equal a
country is.
Absolute Poverty:
 As you can see from the Kosovo and Jersey example, it is critical to understand the difference
between absolute and relative poverty. In 1995, the United Nations clarified its definition of
absolute poverty:
 This is where people’s basic needs are not met, e.g. food, shelter, safe drinking water,
sanitation facilities, education and basic health care.
The world trade organisation
 The WTO was established in 1995 and has 164 members and emplys over 600 people
including: laywers, econmists, statisticans and communications experts.

Trade negotiations

 The TWO aims to reduce or eliminate trade barriers through negotiation.

 It does this by encouraging counties to draw up trading agreement covering matters such as
anti-dumping , subsidies and product standards

Fx value changes