CB2 Business Economics Combined Materials Pack for exams in 2023 The Actuarial Education Company on behalf of the Institute and Faculty of ActuariesCB2.—PC—23 Combined Materials Pack : 2023 Examinations ActEd Study Material. Subject CB2 Contents Study Guide for the 2023 exams Course Notes In addition to the material contained in this pack, you will be given access to. the X assignments via The Hub at bpp.com/account. If you think that any pages are missing from this pack, please contact ActEd’s admin team by email at Acted@bpp.com. How to use the Combined Materials Pack Guidance on how and when to use the Combined Materials Pack is set out in the Study Guide for the 2023 exams. Important: Copyright Agreement This study material is copyright and is sold for the exclusive use of the purchaser. You may not hire out, lend, give out, sell, store or transmit electronically or photocopy any part of it. ‘You must take care of your material to ensure that it is not used or copied by anybody else. By opening this pack you agree to these condi 313-1-3202-3043-782: study Guide Introduction Paget Subject CB2 2023 Study Guide This Study Guide has been created to help you navigate your way through Subject CB2. It contains all the information you will need before starting to study Subject CB2 for the 2023 exams and you may also find it useful to refer to throughout your studies. The guide is split into two parts: . Part 1 contains specific information about Subject CB2 . Part 2 contains general information about the Core Business (CB) subjects. Please read this Study Guide carefully before reading the Course Notes, even if you have studied for some actuarial exams before. While you may have already read (the majority of) the Part 2 material in previous subjects, the information in Part 1 is unique to this course. Contents Part1 Section 1 Section 2 Section 3 Section 4 Section § Part2. Section 1 Section 2 Section 3 Section 4 Section § Subject €B2 - background and contents Subject €B2 - Syllabus and Core Reading Subject C82 — summary of ActEd products Subject €B2 - skills and assessment Subject €B2 - frequently asked questions General information and support Core study material ‘ActEd study support Study skills and assessment Queries and feedback Page 2 Page 4 Page 14 Page 15 Page 16 Page 18 Page 20 Page 22 Page 29 Page 35at Page? a2: Study Guide Subject CB2 — background and contents History The Business subjects (Subjects CB1, CB2 and CB3) were introduced in the Institute and Faculty of Actuaries’ 2019 Curriculum. ActEd is not involved in the delivery of Subject CB3. Prior to 2023, Subjects CB1 and CB2 were examined using a mixture of multiple-choice and ‘free form’ answer questions. Subject CB2 is Business Economics. Predecessors The topics in the Business subjects (Subjects CB1 and CB2) cover content previously in Subjects 12 and C17: . Subject CB1 replaces Subject CT2. . Subject CB2 replaces Subject CT7. Exemptions In order to be eligible for a pass in Subject CB2, you will need: . to have passed or been granted an exemption from Subject CT7 during the transfer process . to have met the Institute and Faulty of Actuaries’ requirements based on the current curriculum. See the Institute and Faulty of Actuaries’ website for further deta actuaries.org.uk/studying/exam-exemptions Links to other subjects . Subjects CB1 and CB3 — Business Finance and Business Management are the ather Business subjects. . Subject CM2 ~ Financial Engineering and Loss Reserving, which covers the principles of actuarial modelling, the behaviour of financial markets, and the pricing of financial products. . Subject CP1 — Actuarial Practice, which builds on basic economic relationships to explore ‘the impact of the economic environment on the investment markets, Subject SPS - Investment and Finance Principles, which covers the key principles of evaluating, selecting and risk managing a portfolio of investments. * Other Specialist Principles subjects and all the Specialist Advanced subjects require the use of economic judgement.82: study Guide Contents Pagea There are three parts to the Subject CB2 course. The parts cover related topics and are broken down into modules. At the end of each part there is an assignment testing the material from that part. The following table shows how the parts and modules relate to each other. The final column shows how the modules relate to the days of the regular tutorials. This table should help you plan your progress across the study session. Part | Module | Title nee X Assignment Se 1 _ | Economic concepts and systems 16 2 | Main strands of economic thinking 15 3. [Supply and demand (1) 21 1 [4 _ | Supplyand demand (2) 28 5 [Background to demand 36 x1 ‘p 6 [Background to supply 39 7 Perfect competition and monopoly 28 8 —|Monopolistic competition and oligopoly | 27 9 [Pricing strategies 25 10 | Market failure and government 40 intervention 11 _| The macroeconomic environment 26 2 | 12 _ [Macroeconomic objectives 25 x2 2 13 _ International trade and payments 24 14 _ |The financial system and the money supply| 40 15 _ |The money market and monetary policy| 18 16 _| Classical and Keynesian theory 55 17 _[Monetarist and new classical schools, and | Keynesian responses ig _ | Relationship between the goods and x money markets 3 19 _ | Supply-side policy 7 8 a 20 _|Demand-side policy 21 21 [exchange rate policy 26 22 _|Global harmonisation and monetary union | 15 23 _ [Summary of debates on theory and policy | 231.2 Pages a2: Study Guide Subject CB2 — Syllabus and Core Reading syllabus The Syllabus for Subject CB2 is given here. To the right of each objective are the module numbers in which the objective is covered in the ActEd course. Aim The aim of the Business Economics subject is to introduce students to the core econornic principles and how these can be used in a business environment to help decision making and behaviour. It provides the fundamental concepts of microeconomics that explain how economic agents make decisions and how these decisions interact. It explores the principles underlying macroeconomics that explain how the economic system works, where it fails and how decisions taken by economic agents affect the economic system. Competences On successful completion of thi subject, a student will be able to: show a systematic knowledge and critical awareness of economic theory in the areas of syllabus covered by the subject apply a range of techniques to solve problems in the areas of syllabus covered by the subject 3. appreciate recent developments and methodologies in economics 4. understand the relevance of economic theory to the business environment and the links between economic theary and its application in business 5. apply basic microeconomic and macroeconomic theory to business problems. Syllabus topics 1, Economic models and recent historical applications (5%) 2. Microeconomics (40%) * behaviour of consumers * behaviour of firms * behaviour of markets 3. Macroeconomics (55%) * relationships between governments, markets and firms * government policies * international trade ‘These weightings are indicative of the approximate balance of the assessment of this subject between the main syllabus topics.82: study Guide Pages The weightings also have a correspondence with the amount of learning material underlying each syllabus topic. However, this will also reflect aspects such as: . the relative complexity of each topic, and hence the amount of explanation and support required for it the need to provide thorough foundation understanding on which to build the other objectives * the extent of prior knowledge which is expected the degree to which each topic area is more knowledge or application based. Detailed syllabus objectives 1, Economic models and recent historical applications (5%) 1.1 Discuss the relevance of economics to the world of business. (Module 1) 1.1.1 Describe what is meant by opportunity cost and scarcity and their relevance to 14.2 11.3 ‘12 13 134 13.2 133 13.4 135 economic choice. Discuss the core economic concepts involved in choices made by businesses relevant to selection of outputs, inputs, technology, location and competition. Contrast microeconomics and macroeconomics. ‘Assess the main strands of economic thinking: (Modules 2, 10, 16, 17 and 23) . classical . Marxian socialism . neo-classical, Keynesian, neo-Keynesian and post-Keynesian . monetarist . Austrian, ‘Analyse the recent macroeconomic history. (Modules 14, 15, 20, 22 and 23) Describe the progress of the world economy since the Great Depression, with a particular focus on: . a history of banking crises and irrational behaviour . consequences of banking crises. Discuss the banking crisis of 2008, the Great Recession and recovery. Describe the effectiveness of monetary policy in the 2008 financial crisis and the governments’ actions to combat recession. Discuss the aftershocks in Europe following the 2008 financial crisis Assess the wlus-austerity debate and regulatory action after the 2008 crPages a2: Study Guide Microeconomics - the behaviour of consumers, firms and markets (4056) 2.1 Discuss the workings of competitive markets. (Modules 3 and 4) 2.1.1 Discuss how the markets operate: 2.16 247 218 219 22 221 292 223 23 23.1 2.4 24.1 2.4.2 . Explain the role of the price mechanism in a free market. . Discuss the behaviour of firms and consumers in such markets. Describe the factors that influence the market demand and supply. Describe and discuss how market equilibrium quantity and price are achieved. Discuss how markets react to changes in demand and supply. Define and calculate price and income elasticities of demand and price elasticity of suppl . Calculate elasticities of demand using both original and average quantities. Discuss the factors that affect elasticity. Explain the effect of elasticity on the workings of markets in the short and long run. Discuss how firms deal with risk and uncertainty about future market movements. Describe price expectations and speculation and how price bubbles develop. Discuss consumer demand and behaviour. (Module 5) Describe the concept of utility and representation of consumer preferences as indifference curves. Discuss rational choice and how optimal consumption choice is determined by using indifference curves and budget lines. Discuss the concepts of rational choice, perfect informat behaviour in behavioural economics. Discuss the importance of advertising for a firm. (Module 4) Explain the effects of advertising on sales and demand. Discuss the production function, costs of production, revenue and profit in order to understand a firm’s price and output decisions. (Module 6) Explain how the production function reflects the relationship between inputs and. outputs in the short and long run. Define average and marginal physical product.82: study Guide 2.43 244 24.5 2.4.6 247 2.4.8 2.49 25 25.4 252 253 25.4 255 2.6 2.6.1 2.6.2 2.63 2.6.4 Page7 Describe the meaning and measurement of costs and explain how these vary with output in the short and long run, Define total, average and marginal costs. Describe what is meant by ‘economies of scale’ and explain the reasons for such economies and how a business can achieve efficiency in selecting the level of its inputs. Describe revenue and profit and explain how both are influenced by market conditions. Define and calculate average and marginal revenue. Describe how profit is measured and explain how the firm arrives at its profit-maximising output. Explain what is meant by the ‘shut-down’ point in the short and long run. Discuss profit maximisation under perfect competition and monopoly. (Module 7) Explain what determines the market power of a firm. Describe the main features of a market characterised by perfect competition. Explain how output and price are determined in such markets in the short and long run. Describe how monopolies emerge, how a monopolist selects its profit-maximising price and output and how much profit a monopolist makes. Describe the barriers to entry in an industry and a contestable market and explain how these affect a monopolist’s profit. Discuss profit maximisation under imperfect competition. (Module 8) Describe the behaviour of firms under monopolistic competition and explain why in this type of market only normal profits are made in the long run. Describe the main features of an oligopoly and explain how firms behave in an oligopoly. Discuss what determines competition and collusion of firms in an oligopoly and how the strategic decisions of such firms can be explained by game theory. Discuss whether firms in an oligopoly act in consumers’ interest.Pages a2: Study Guide 2.7 Assess various pricing strategies that firms in the financial services sector can adopt. (Module 9) 2.7.1 Describe how prices are determined in practice and factors that affect the ability ofa firm to determine its prices. Describe average-cost pricing and price discrimination. 2.7.3 Discuss the pricing strategy for multiple products and explain how pricing varies with the stage in the life of a product. Macroeconomics ~ relationships between governments, markets and firms, government policies and international trade (5596) 3.1 Discuss the reasons for government intervention in the market. (Module 10) 3.1.1 Explain and discuss the extent to which businesses meet the interests of consumers and society in general. 3.1.2 Explain in what sense perfect markets are ‘socially efficient’ and why most markets fail ta achieve social efficiency. 3.1.3 Explain why externalities can lead to inefficient markets. 3.1.4 Describe the ways in which governments intervene in markets in order to influence business behaviour and explain the drawbacks of such intervention. Explain and discuss whether taxation or regulation could be more useful in correcting markets’ shortcomings. 3.1.6 Explain why government intervention might not improve market outcomes in practice even if the existence of ‘market failures’ suggest they can in theory. Understand policy instruments that can be used to promote environmental sustainability. 3.2 Discuss the relationship between the government and the individual firm. (Modules 10 and 19) Describe the main targets of ‘competition policy’ and explain the extent to which itis effective. 3.2.2 Explain why a free market fails to achieve the optimal amount of research and development. 3.2.3 Describe the various forms of intervention that the government can undertake in order to encourage technological advance and innovation.82: study Guide 33 331 332 34 341 34.2 343 34.4 as 35.1 35.2 353 35.4 35.5 35.6 357 35.8 35.9 3.5.10 Pages Discuss globalisation and multinational business. (Module 22) Describe what is meant by globalisation and its impact on business. Explain what is driving the process of globalisation and whether the world benefits from globalisation of business. Discuss the importance of international trade. (Module 13) Describe the growth of international trade and its benefits to countries and firms. Explain the advantages of specialisation. Discuss the arguments for trade restriction and protection of domestic industries. Explain the role of the World Trade Organisation (WTO) in international trade. Discuss the macroeconomic environment of the business. (Modules 11, 12 and 16) Describe the main macroeconomic variables that governments seek to control. Describe the effect on business output if a stimulus is given to the economy. Contrast actual and potential growth. Describe the factors that determine economic growth and explain the reasons for differences in different nations’ growth rates. Describe why economies experience periods of boom followed by periods of recession and explain factors that influence the length and magnitude of the phases of a business cycle. Describe the causes and costs of unemployment and how unemployment relates tothe level of business activity. Discuss the determination of the price level in the economy by the interaction between aggregate supply (AS) and aggregate demand (AD) in a simple AS-AD model. Describe the causes and costs of inflation and how inflation relates to the level of, business activity. Explain what is meant by GDP and describe how it is measured. Discuss the representation of the economy asa simple model of the circular flow of income.Page 10 3.6 3.6.1 3.63 3.6.6 3.67 37 37.4 37.2 373 37.4 375 37.6 a2: Study Guide Discuss what is meant by the balance of payments and how exchange rates are determined. (Modules 13, 21 and 22) Describe what is meant by ‘the balance of payments’ and how trade and financial movements affect it. Explain how exchange rates are determined and how changes in exchange rates, affect business. Explain the relationship between the balance of payments and the exchange rates. Discuss the advantages and disadvantages of fixed and floating exchange rates. Explain how governments and/or central banks seek to influence the exchange rates. Describe the implications of such actions for other macroeconomic poll for business. Describe the purpose and examine the effectiveness of monetary union and singte currencies, with reference to the European Economic and Monetary Union, the Exchange Rate Mechanism and the creation of a single currency. Discuss the role of money and interest rate: the economy. (Modules 14, 15 and 18) Describe the function of money. Describe what determines the amount of money in the economy, what causes it to grow and the role of banks in this process. Discuss the concept of the money multiplier in the real world. Describe how interest rates are determined. Explain the relationship between money and interest rates. Explain why central banks play a crucial role in the functioning of economies. Describe how a change in the money supply and/or interest rates affects the level of business a82: study Guide 38 381 38.2 383 3.8.4 385 38.6 387 39 39.1 39.2 3.9.3 3.9.4 39.5 3.9.6 39.7 39.8 Paget Discuss the role, structure and stability of the financial system. (Module 14) Describe the functions of the financial sector. Distinguish between the functions of investment funds, banks and insurance companies / pension funds. Describe the different ways banks and insurance companies can be exposed to credit risk and liquidity risks through: . bank loans . corporate bonds . securitisations (which can be owned by the non-bank sector) . syndicated loans . credit derivatives. Discuss why the banking sector is more likely to be exposed to systemic risk than the non-bank financial sector. Describe how financial innovation could lead to some functions of the banking sector being performed by non-banks. Describe the basic principles on which Islamic finance is based. Describe the features of one Islamic finance product and compare its features to the principles of Islamic finance. Discuss what determines the level of business activity and how it affects unemployment and inflation. (Modules 12, 16, 17 and 18) Discuss how the equilibrium level of income is determined within a simple aggregate demand-expenditure model. Describe the concept of the multiplier and calculate its value. Describe the effect of a rise in money supply on output and prices. Describe the relationship between unemployment and inflation and whether the relationship is stable. Discuss how business and consumer expectations affect the relationship between unemployment and inflation and explain how such expectations are formed. Describe how a policy of targeting inflation affects the relationship between unemployment and inflation. Describe what determines the course of a business cycle and its turning points. Discuss whether the business cycle is caused by changes in aggregate demand, or changes in aggregate supply (or both).Page 2 3.10 3.10.1 3.10.2 3.103 3.10.4 3.10.5 3.10.6 3.11 3414 3.112 3.113 3114 a2: Study Guide ‘Assess how macroeconomic policies impact on businesses. (Modules 15 and 20) Describe the types of macroeconomic policy that are likely to impact on business and explain the way in which this impact takes effect. Describe the impact of fiscal policy on the economy and business, and explain the factors that determine its effectiveness in smoothing out economic fluctuations. Describe the fiscal rules adopted by the government and discuss if following these rules is a good idea. Explain how monetary policy works in the UK and the Eurozone and describe the roles of the Bank of England and the European Central Bank. Explain how targeting inflation influences interest rates and hence the economic activity. Discuss the merits of following a simple inflation target as a rule for determining interest rates, and suggest an alternative rule. ‘Assess how supply-side policies impact on businesses. (Module 19) Describe the effect of supply-side policies on business and the economy. Describe the types of supply-side policies that can be pursued and discuss their effectiveness. Explain the impact on business of a policy of tax cuts. Describe the major types of policy open to governments to encourage increased competition.2.3 Page 22 ce: Study Guide ActEd study support This section gives a description of the products offered by Actéd. ‘Successful students tend to undertake three main study activities: 1, Learning ~ initial study and understanding of subject material 2. Revision - learning subject material and preparing to tackle exam-style questions 3. Rehearsal — answering exam-style questions, culminating in answering questions at exam speed. Different approaches suit different people. For example, you may like to revise material gradually ‘over the months running up to the exams or you may do your revision in a shorter period just before the exams. Also, these three activities will almost certainly overlap. We offera flexible range of products to suit you and let you control your own learning and exam preparation. The following table shows the products that we produce. Not all products are available for all subjects. LEARNING LEARNING & REVISION Course Notes | x assignments Combined Materials Pack (cmp) X Assignment Marking, Tutorials oO Classroom 1e The products and services are described in more detail below.82: study Guide Pages Core Reading Accreditation ‘The Core Reading consists of references to material from: Sloman, J., Garratt, D., Guest, J., 2022, Economics, 11th ed., Pearson ISBN: 978-1-292-40533-9 (print) ISBN: 978-1-292-40539-1 (PDF) ISBN: 978-1-292-40540-7 (ePub) In addition, there are a number of extra sections of Core Reading, which are included within the relevant modules in the ActEd Course Notes. Further reading The exam will be based on the relevant Syllabus and Core Reading (including the textbook) and the ActEd course material will be the main source of tuition for students. There is also further information available on the website linked to the textbook as well as relevant external websites (indicated at the end of some chapters of the textbook). This material is a useful source of additional material but it is not directly examinable.13 Page 4 a2: Study Guide Subject CB2 — summary of ActEd products ‘The following products are available for Subject CB2: . Course Notes . X Assignments — three assignments: - _X1-X3: 100-mark tests (you are allowed 3% hours to complete these) © SeriesX Marking * Online Classroom + Flashcards . Revision Notes — six AS booklets . ASET (2014-17 papers)* — an archive of four years of exam papers, ie eight sittings, covering the period April 2014 to September 2017 . ASET (2019-21 papers) - three years of exam papers, ie six sittings, covering the period April 2019 to September 2021 . ‘Mock Exam - one 100-mark test . Additional Mock Pack (AMP) ~ two additional 100-mark tests . ‘Mock Exam Marking . Marking Vouchers. Products are generally available in both paper and eBook format. Visit ActEd.co.uk for full details about available eBooks, software requirements and restrictions. * This product is no longer updated each year to reflect changes to the Syllabus and Core Reading. Some of the questions may be used elsewhere in ActEd’s product range. The following tutorials are typically available for Subject CB2: © Regular Tutorials (three days) * Block Tutorials (three days). Tutorials are typically available both face-to-face and live online. Full details are set out in our Tuition Bulletin, which is available on our website at ActEd.co.uk.1.4 82: study Guide Pages Subject CB2 — skills and assessment Technical skills Subjects CB1 and CB2 are less mathematical than the other Core Principles subjects, instead involving in-depth understanding of economics. Exam skills Exam question skill levels In Subject CB2, the approximate split of assessment across the three skill types is: . Knowledge - 20% . Application - 60% . Higher Order skills — 20%. Assessment Assessment consists of a 3%-hour* examination. * The online exams provide an additional 5 minutes (ie 3 hours 20 minutes in total) for students to download and print the question paper.1.5 Page 6 a2: Study Guide Subject CB2 — frequently asked questions J have an older edition of the textbook, rather than the current eleventh edition. How does the new version differ from the old versions and what should | do to prepare for the new exam?? ‘There are a number of changes and additions to the textbook. The 2023 exams will be based on the eleventh edition of the textbook, so we recommend that you use it. What knowledge of earlier subjects should 1 have? No knowledge of earlier subjects is required. What level of mathematics is required? ‘There is some use of basic arithmetic and algebra in Subject CB2 and you may also need to use basic calculus. What other skills are required? Diagrams are part of an economist’s toolkit, so although you are not likely to be asked to produce diagrams to submit in the exam, itis still important to be able to draw clear and accurate diagrams. ‘You also need to use language precisely. For example, the observation that ‘prices are falling’ isnot the same as ‘the inflation rate is falling’. Should | read the various boxes in the textbook? ‘The boxes are part of the Core Reading on which you will be tested. However, the guidance issued by the Institute and Faulty of Actuaries states that you will nat be tested on the detail of illustrative examples but on the underlying theory and its application. This suggests that you do not need to know all of the information in the boxes. ‘Some units include content on the mathematical application of the concepts. You do not need to know the theoretical derivation of formulae but you should understand the numerical examples and be able to do similar calculations. Should | do the End of Chapter Questions in the textbook? Only if you find them interesting and have the time. It is probably more sensible to concentrate on practising the questions throughout and at the end of the modules, the assignments and, most importantly, the past exam papers. This is because these questions have been designed specifically to prepare you for the Subject CB2 exam and/or represent the types of questions you will actually need to answer in the Subject CB2 exam.82: Study Guide Pages? Qa What should | do if | discover an error in the course? If you find an error in the course, please check our website at: ActEd.co.uk/paper_corrections.html to see if the correction has already been dealt with. Otherwise please send details via email to CB2@bpp.com. Who should | send feedback to? We are always happy to receive feedback from students, particularly details concerning any errors, contradictions or unclear statements in the courses. Ifyou have any comments on this course in general, please email to CB2@bpp.com. Ifyou have any comments or concerns about the Syllabus or Core Reading, these can be passed on to the Institute and Faulty of Actuaries via ActEd. Alternatively, you can send them directly to the Institute and Faculty of Actuaries’ Examination Team by email to education.services@actuaries.org.uk.2.1 Page 18 a2: Study Guide General information and support Before you start When studying for the Institute and Faculty of Actuaries’ exams, you will need: . a copy of the Formulae and Tables for Examinations of the Faculty of Actuaries and the Institute of Actuaries, 2nd Edition (2002) - these are referred to simply as the Tables . a scientific calculator and/or software package to help with calculations. The Tables are available from the Institute and Faculty of Actuaries’ eShop. Please visit actuaries.org.uk. BPP learning support BPP’s Learning Support team offers a wide range of support for all students who disclose a learning difficulty or disability, including sensory difficulties, mobility difficulty, ADHD, Asperger Syndrome, mental health difficulties, dyslexia, dyspraxia and general health problems. This support is accessible to all ActEd students free of charge. This support includes: . accessible and inclusive learning facilities . a dedicated team that provides information, advice, guidance and support. Please contact the Learning Support team at LearningSupport@bpp.com for more information. Safeguar B Safeguarding means protecting people’s health, wellbeing and human rights, and enabling them to live free from harm, abuse and neglect. For ActEd, safeguarding is recognising when someone needs support to help them achieve their learning goals while maintaining their safety, both face-to-face and online. We want you to feel comfortable within our learning environment and safe in the knowledge that if you ever needed support, you would know where to go. If you need support, please contact BPP’s Safeguarding team at safeguarding@bpp.com or for urgent concerns call 07464 542 636.82: study Guide Page 19 The Prevent Duty ‘As a Government-regulated training provider, we are responsible for ensuring our learners are well informed and staying safe. The Prevent Duty is to protect people from radicalisation and being drawn into extremist views and terrorism. ActEd has a duty to ensure that our learners are well informed and stay safe, and to empower our students to know what to look for and when to report concerns. Please be aware of: i people sharing or accessing extremist materials * homophobic, disability-related, religious or racist bullying ‘An economy can produce either Good X or Good Y. The opportunity cost of producing an extra unit of Good X ‘A the value of the capital and labour used to produce Good X. B —_ the number of units of Good Y that must be given up in order to produce an extra unit of Good x. C the cost of producing Good x less the cost of producing Good Y. D _ the amount of Good x that would have been produced in the following year. 1) Define the two branches of economics: macroeconomics and microeconomics. 2) Describe and discuss the scope of economics in terms of the problems of the allocation of scarce resources. 15] Explain the differences between a command economy and a free-market economy. (20)* 18 12 13 14 (€82.01: Economie concepts and systems Pages Module 1 Solutions This question is Subject CT7, September 2014, Question 2. Option D. The definition of scarcity is ‘the excess of human wants over what can actually be produced to fulfil these wants’. [14] Option 8. The definition of opportunity cost is the cost ‘in terms of the best alternative foregone’. In this case, it is the amount of Good ¥ that would have to be given up to produce the extra unit of Good x. 4) This question is Subject CT7, September 2015, Question 27. ‘Macroeconomics is concerned with the economy as a whole and studies economic aggregates, such as national income, unemployment and the general level of prices. ta) ‘Microeconomics is concerned with individual parts of the economy (eg households, firms and industries) and the way they interact to determine the pattern of production and distribution of goods and services. a [otal 2] This question is Subject 107, September 2002, Question 27 (amended). There are two main approaches that economists use to tackle the problem of scarci 1, Atamacro level, the available resources should be fully and efficiently employed so that the full potential output is achieved and, over time, increased. al 2. Atamicro level, rational choices must be made concerning the precise use of the resources so that an efficient and fair allocation of those resources is achieved. al ‘The key microeconomic questions are: — What goods and services should be produced and in what quantities? The economy does not want to waste its resources producing goods that people do not want to buy. The opportunity cost must be considered. For example, if more nuclear weapons are produced, there might be fewer hospitals built. al — How should the goods and services be produced? For example, should the goods be produced in a labour-intensive way or a capital-intensive way? i — Who should receive the goods and services once they are produced? Should they be rationed or should people be free to spend their income as they wish? If the latter, the economy must consider how incomes are to be determined. fet] [Total 5)15 Pages 2.01: Economic concepts and systerns This question is Subject 107, September 2001, Question 32 (amended) Command economy Ina command economy, the state plans the allocation of resources, the plans being based on an estimation of people's wants and needs, the availability of resources and the state’s priorities. [1] Firstly, at a macro level, it decides on the balance between the production of investment goods {eg machinery, infrastructure) and consumer goods (eg food, clothing, cars). Investment goods will stimulate economic growth but the opportunity cost is the current consumption that will be foregone. (al Secondly, at a micro level, it plans the output of each industry and firm, the techniques that will be used and the resources that will be required. For example, the steel industry will be given a target output (which will be needed for various industries, eg the car industry) along with the required inputs (such as labour, coal, iron ore etc). fa) The state uses input-output analysis to show the sources of all inputs and the destination of all ‘outputs so that the overall demand for an industry's output will be equal to its supply. (a) ‘The state also plans the distribution of the output of goods and services produced. The state might decide to use direct rationing or it might allow individuals to earn an income (determined by the state itself) and have some choice about the goods and services consumed. fa) The distribution policy will be determined by its aims. It might distribute on grounds of people's needs, or it might wish to reward those who produce more. (a) Free-market economy In a free-market economy, there is no government intervention; instead resources are allocated to different uses by the price mechanism. (a The wishes of consumers and producers are reflected in the market forces of supply and demand, which together, determine prices and determine resource allocation. (a) For example, if there’s an increase in the demand for cars, the price of cars will increase, the profits from car production will increase and firms will produce more cars. fa) Markets also determine the production techniques used (eg labour-intensive or capital-intensive) because firms will consider the cost of resources and their productivity and choose a method of production that minimises costs. (a) The distribution of the output of goods and services is determined by the distribution of income, and income is determined by market forces. For example, if there's an increase in the demand for car mechanics, the wages of car mechanics will increase, and therefore they will be able to afford to buy more of the goods and services that have been produced by the economy. fa) [Maximum 10](€82.02: Main strands of economic thinking Pages Main strands of economic thinking syllabus objectives 1.2 Assess the main strands of economic thinking: © classical © Marxian socialism ‘* neoclassical, Keynesian, neo-Keynesian and post-Keynesian © monetarist © Austrian. Core reading Chapter 12, Box 12.7 Chapter 16 Additional Core Reading The textbook references given above are required for this syllabus objective but they assume background knowledge, which we will not cover until later in the course, so reading the textbook is not required ot this stage. These references will be given again when the topics are covered in detail later in the course. For the moment, a short summary of each school, incorporating the Additional Core Reading, will be given and will be sufficient.Page? 82-02: Main strands of economic thinking Introduction Economics is an evolving subject. Theories and economic models are suggested by economists and are used to explain and predict outcomes. They are tested in the real world and if they fail to explain or predict outcomes reasonably accurately they might be abandoned or amended. some societies and no others; or is because Interestingly, some theories might make accurate prediction: period of time but then seem to fail. theories have to make assumptions about how individuals and groups behave in certain situations. Human behaviour depends on the environment in which an individual lives, and over time this can change. might make accurate predictions for a certai In this module, an outline of the main schools of thought is presented. Further details on some of the schools of thought are given at relevant places throughout the course. Although some of the individual theories of some of the schools of thought have been discussed in previous syllabuses, the Subject CB2 syllabus gives a more complete picture of the range of schools of thought and greater emphasis to the development of economic thought. This module is presented slightly differently from the others. Since the textbook reading is not covered until later in the course, this module contains only ActEd Course Notes and additional Core Reading. The majority of this material was new to the Subject CB2 syllabus in 2019.11 12 13 (€82.02: Main strands of economic thinking Pages Main strands of economic thinking What’s included in this section * _Atimeline showing the development of economic thinking *_ ActEd Course Notes and Core Reading on: — the classical approach — Marxist socialism — the neoclassical approach — Keynesian schools of thought — the monetarist approach — __ thenew classical approach = the Austrian school Guidance This is an introduction to the schools of thought that are covered in this course and a reference that can be consulted throughout the course. In the checklist that follows the descriptions of each school, priority has been given to the concepts and issues that are not likely to be referred to in subsequent modules. Reading Task Ywhen completed Read the following ActEd Course Notes and Core Reading. o14 2S. Paget 82-02: Main strands of economic thinking Atimeline New classical economists, and ‘Adam Smith's KariMarx's 4M. Keynes’ Milton Friedman's increased influence Wealth of Nations Capital General Theory Chicago School _of Austrian schoo! 1776 | 7 ‘ ‘and ae. 1980s t ip ose Other classical Neoclassical Neo-Keynesian New Keynesian economists, eg Malthus, economists, ‘ond schoolas a Ricardo, Say, eg Jevons, Walrus, post-Keynesian response to late 18th/early 19th late 19th/early 20th schools new classical centuries centuries from 1950s school from 19805 The classical approach ‘Adam Smith is regarded as the founding father of classical economics. He argued that a free-market economy, in which individuals acted in their own self-interest, would bring about maximum social benefit. He said that intervention by the state would generally reduce the nation’s wealth, though he did support some state intervention for the common good, especially: in the control of monopoly power. Other classical economists supported the free-market economy too, though there were some who were concerned that the capitalist system could result in unemployment. The views of these dissenters were dismissed for over 100 years, largely because the 19th century saw the mainly free-market economy delivering growing output and low unemployment. Classical economists believed that even if unemployment did occur there was an automatic self-regulating mechanism that would return the economy to a full-employment level of output. ical econo! Classical econor (who were then called poli ists) were mainly interested in the process of wealth creation and the distribution of income among the classes (workers, landlords and capitalists). They argued that wealth could be increased by specialisation and trade, and argued among themselves about the con in that each of the classes made to output. From their work on production, they concluded that the value of a product is determined by its cost of production, ie the value of the resources used in its production. However, this theory was never fully developed and was later largely displaced by the subjective theory of value of the neoclassical economists. They believed that a product’s value to a consumer depends on the consumer's wants and needs. Alfred Marshall built on these two strands and developed the equilibrium model in which price is determined by supply and demand. A detailed explanation of the classical approach to macroeconomics is covered in Module 16.16 a (€82.02: Main strands of economic thinking Pages Marxist socialism An early economist advocating a fully planned economy was Karl Marx. In his book Capital in 1867, Marx used the labour theory of value to argue against capitalism. According to the theory of value, the value of a product is determined by the number of hours of labour used to produce the product. Marx argued that the theory can explain the value of all commodities including the commodity that workers provide and he called this ‘labour power’. This is the number of hours of work that is sufficient to sustain the workers and is the long-run wage rate. For example, if it takes six hours of labour per day for a worker to earn enough to afford his living expenses, and if one hour of work is equivalent to £1, then the wage rate would be £6 per day. Labour power is the combination of mental and physical capabilities that an individual has. This labour power can be sold to an employer in exchange for a wage. Marx argued that in a capitalist system, the value of labour power (the wage or the cost to an employer) is equal to is the minimum necessary for the survival of the working class, ie the subsistence necessary for the maintenance of life. What items are actually included in ‘a worker's necessary living expenses’ are the product of historical development and depend on the situation and conventions in the country. However, Marx argued, the owners of capital make the workers work in excess of what is necessary to sustain them; workers could work 10 hours but be paid £6. Marx viewed the value of capital invested. This surplus value is created by workers in excess of their own labour costs but is claimed and kept by the owners of capital. Surplus value is therefore equal to the value of the output workers have produced in excess of their own labour cost. Further, Marx predicted that competition amongst the capitalists would drive most capitalists out of the market and into the labour market and create monopolies. Eventually the workers would gain enough power to dismantle the whole system. A socialist system was an inevitable outcome. The message was adopted by political movements and socialist regimes were formed, notably the Soviet Union in 1922. The neoclassical approach The neoclassical approach was developed in the 19th century by economists such as Jevons and Walrus. Their approach was mainly concerned with marginal utility, consumer rationality and maximisation of utility as the main objective of consumers. Utility means satisfaction. Marginal utility is the additional satisfaction from consuming an additional unit of the product. According to this approach, competition in an economy leads to efficient allocation of resources by balancing supply and demand, where equilibrium is established. Many of the tenets of this approach form the basis of modern economics. Also, whereas classical economists believed that the value of a product derived from the cost of its production, the neoclassical view is that the price of a product depends on consumers’ perception of its value. The neoclassical approach and its assumption of rationality has come under criticism after the financial crisis of 2008.