IGCSE ECONOMICS 0455 Notes

Contents:
1 The basic economic problem……………………………………………………………………..….2
The first section of the syllabus introduces the fundamental ideas and concepts that underpin the study of
economics including the basic economic problem, factors of production, opportunity cost and production
possibility curves.

2 The allocation of resources……………………………………………………………………......…5

The fundamental principles of resource allocation are considered through the price mechanism in a

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market economy. The market forces of demand and supply, market equilibrium and disequilibrium, and
elasticity form the core of this section.

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3 Microeconomic decision makers………………………………………………………………...…..19
The microeconomy is an important area of study, and the approach to learning taken here is through the

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role of the major decision makers: banks, households, workers, trade unions and firms.

4 Government and the macroeconomy…………………………………………………....................35

Governments have different macroeconomic aims, and conflicts often arise between the choice of
measures used to achieve them. Variables must be measured to consider the causes and consequences of
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change, and appropriate policies applied.

5 Economic development…………………………………………………..…………………….…….52
As an economy develops there will be changes in population, living standards, poverty and income
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redistribution. Therefore, the effects of changes in the size and structure of population and of other
influences on development in a variety of countries are explored.

6 International trade and globalisation………………………………………………………...……...63

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The importance of trade between countries and the growth of globalisation is explored. Principles such as
specialisation, the role of free trade, the role of multinational companies, foreign exchange rates and
balance of payments stability are considered.
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1.1 The nature of the economic problem

The nature of the economic problem:
People’s wants are unlimited and the resources to provide for them are limited therefore scarcity exists.
We must choose what is produced and give up other things (opportunity cost).
An economic system must decide what is produced, how it is produced and for whom it is produced.

Wants: Goods and services that people want but are not necessary for survival (e.g. TVs...)
Needs: Goods and services that are necessary for survival (e.g. shelter, food, water, clothing…)

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Free goods: A good that is not scarce, and therefore is available without limit and has zero

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opportunity cost to society. (e.g. Sea water, air, webpages)
Economic goods: Goods that are scarce and therefore have an opportunity cost (e.g. Food, clothing,
housing)

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1.2 Factors of Production
Factors of production:
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The scarce resources used in the production of goods and services (e.g. land, labour, capital, enterprise)
FOP Definition Reward

Land The natural resources used in the production of goods and services. (e.g. Rent
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land, sea, water, coal, forests, rivers, mineral ions, natural gases…)

Labour The physical and mental contribution of workers to the production process. Wage
(e.g. lawyers, teachers…)
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Capital Any man-made resource that is used to produce other goods and services. Interest
They are aids to production. (e.g. machines, factory, buildings, offices…)

Enterprise An entrepreneur takes a risk with their money and time to combine the other Profit
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3 factors of production to start a business in order to earn profit.

Mobility of the factors of production: refers to the extent that resources can be changed from one
production process or another.
FOP Influences on the mobility of the FOP

Land ● The revenue gained from alternative use (i.e. if the price of houses go up, then the
price of land to build houses on will also go up, therefore more land will be transferred
from agricultural uses to provide housing)

Labour ● The demand for a good or service: As labour is derived demand, if the demand for a

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good or service increases, the demand for the labour that produces that good or
service will increase
● Differences in the price and availability of housing in different areas and countries
● Family ties: people may be reluctant to move because they do not want to live far
away from friends and relatives → less mobile

Capital ● The different uses the capital can be put to. The more specialised a machine is in one
area, the less mobile it is to be moved into another area

Enterprise ● Enterprise is the most mobile factor of production. The skills involved can be applied
in every industry.

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Ways to increase quality and quantity of factors of production:

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Quality Quantity

Land Fertilisers Land Reclamation

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Capital Research and Development to Investment
increase innovation

Labour/Enterprise Education and training Increase in population (birth rate)

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Increase in immigration

1.3 Opportunity Cost

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Opportunity Cost: The benefit lost from the next (second) best alternative given up when making a
decision.

Importance of opportunity cost: Shows that a choice must be made when making a decision because
resources are too scarce to meet all out wants (as wants are unlimited but resources are limited)
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1.4 Production possibility curve (PPC) diagrams

Production Possibility Curve: It shows the maximum potential of two goods or services that can be
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produced using all the resources that an economy has available

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Meaning

Point on the PPC Maximum potential that can be produced using all resources available

Point under the PPC There is unemployment of resources as the economy is producing less
than the maximum potential

Point beyond the PPC Currently unattainable as the fops are limited and scarcity exists.

Movement along the PPC Producing more of one good than the other

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Shifts of the PPC Growth in production possibilities
Achieved by increasing the quality and/or quantity of factors of
production

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PPC short to long term effect:
Short run: In a PPF showing consumer goods and capital goods, an increase in the production in capital

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goods will come with the opportunity cost of consumer goods
Long run: increased production of capital goods will shift the PPF outwards and increase the potential
amount of capital and consumer goods that can be produced.
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AY
TT
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2.1 Microeconomics and macroeconomics

Microeconomics Macroeconomics

Study of the decision making of Study of economic behaviour and decision making
individuals, households and firms. It is (usually by the government) in the whole economy. It
concerned with the economic factors that looks at aggregated demand and aggregate supply and
affect their choices. their effect on the price level and national output.

2.2 The role of markets in allocating resources

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The types of economic system chosen decides:

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1. What should be produced?
2. How should it be produced?
3. For whom should it be produced?

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Market System

What to produce Firms will produce what makes the highest profit. If consumers increase their
demand for a good, prices will increase (and therefore profits) so firms will
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produce more.

How to produce In order to make a profit firms need to keep their costs as low as possible.
Therefore they must combine the 4 fops in the most efficient way to keep
costs down.
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Who to produce for Those who have the willingness and ability to pay.

Private Sector Public Sector

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The part of the economy where the price The part of the economy where the government
mechanism allocates resources. allocates resources.
Firms are owned by individuals. Governments run organisations.
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Price mechanism: The interaction between demand and supply in competitive markets, which
determines the price and output.

2.3 Demand
Demand: The willingness and ability to buy a product.
Law of demand: As the price of a good decreases, the
quantity demanded increases and vice versa,
assuming ceteris paribus.

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Movement along the demand curve VS Shifts of the demand curve:

● Price changes, ceteris paribus → change in quantity demanded → movement along
● Non-price determinant of demand changes → change in demand → shift in the demand curve
Movement along the demand curve Shifts of the demand curve

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Individual demand: the demand of one person for a product
Market demand: the sum of all individual demands for a good/service
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Factors that shift demand Explanation

Changes in income Normal goods: increase in income → increase in demand

Normal goods: Clothing, household appliances
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Inferior goods: Increase in income → decrease in demand

Inferior goods: second-hand clothing, used goods

Changes in tastes and If something is in fashion then demand for it will increase and when it is
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fashion out of fashion demand will decrease.

Changes in population If the population is ageing and the working population is ageing then the
demands for state pensions will increase.
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Price of other goods – ↑ price of substitute good → increase in demand

substitutes Substitute goods: Pepsi and Coca cola

Price of other goods – ↓ price of a complementary good → increase in demand

complimentary Complementary goods: petrol and cars

Advertising Good advertising → increase in demand

Seasonal fluctuations Most of the world experiences seasons where it is cold in the winter and
warm in the summer. A firm selling ice cream is likely to see an increase
in demand in the summer and a decrease in demand in the winter.

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Interest rates If interest rates rise it will be more expensive for people to borrow to
purchase goods and services therefore the demand for goods and
services will fall (and vice versa).

2.4 Supply
Supply: The amount of a product which suppliers will offer to
the market at any given price at a particular time.

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Law of supply: As the price of a good increases, the
quantity supplied increases and vice versa, assuming
ceteris paribus. There is a positive relationship between

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price and quantity supplied.

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Market supply: The total quantities of a good/service producers are willing and able to offer for sale at
different prices. It is the sum of all individual supplies of that good.
Movement along the supply curve VS Shifts of the supply curve:
● Price changes, ceteris paribus → change in quantity supplied → movement along
● Non-price determinant of supply changes → change in supply → shift in the supply curve
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Movement along the supply curve Shifts of the supply curve
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TT
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Shifts in supply caused by Explanation

Costs of production ↓ Cost of FOPs → production more profitable → increase in supply

Technology New improved technology → lowers cost of production → production is

more profitable → increase in supply

Indirect taxes Indirect tax → ↑ cost of production → decrease in supply

Subsidies Subsidy → ↓ cost of production → increase in supply

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Weather Good weather → high crop yield → increase in supply

Prices of other goods The price of good X may affect the supply of good Y. For example, if a
farmer grows carrots and wheat and the price of carrots rises then it is
logical that the farmer will swap some or all of his/her wheat production
into carrot production. This decreases the supply of wheat.

2.5 Price determination

Equilibrium: Where the demand and supply curve intersect. There is no pressure for price to change

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(there is balance).

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Disequilibrium:
Excess Supply Excess Demand

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Excess supply occurs when price is Excess demand occurs when price
set above equilibrium price. is set below equilibrium price.
There is a contraction of demand There is a contraction of supply and
and an extension of supply. an extension of demand.
Therefore, supply is greater than Therefore, demand is greater than
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demand – excess supply. supply – excess demand.

2.6 Price changes

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Increase in Demand
Excess demand = Shortage Price increases
Decrease in Supply

Decrease in demand
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Excess supply = Surplus Price decreases

Increase in supply

INCREASE IN DEMAND DECREASE IN DEMAND

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INCREASE IN SUPPLY DECREASE IN SUPPLY

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Answer structure for the written analysis:

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1. Curve: Demand/Supply shifts to the right/left and increases/decreases from S1 to S2/D1 to D2. This is
because of [reason].
2. Price: Price increases/decreases from P1 to P2
3. E/C of the other curve: There is a(n) extension/contraction of [the other curve – demand/supply] as
more/less is supplied/demanded at the higher/lower price.
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2.7 Price elasticity of demand (PED)
Price elasticity of demand (PED): A measure of the responsiveness of quantity demanded to change in
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price.
𝐹𝑖𝑛𝑎𝑙 𝑄𝑑 − 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑄𝑑
𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 ×100 %∆𝑄𝑑
PED =
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑄𝑑
𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
= 𝐹𝑖𝑛𝑎𝑙 𝑃 − 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑃 = %∆𝑃
𝐼𝑛𝑖𝑡𝑖𝑎𝑙𝑃
×100
TT

Types of PED Definition PED Value Diagram

Elastic A % change in price leads to a >1

Demand greater % change in quantity
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demanded.

The quantity demanded is relatively

responsive to price changes

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Inelastic A % change in price leads to a <1

Demand smaller % change in quantity
demanded

The quantity demanded is relatively

unresponsive to changes in price.

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Perfectly A % change in price leads to an ∞
elastic infinite % change in quantity
demand demanded.

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The quantity demanded is infinitely
responsive to changes in price

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Unitary Elastic A % change in price leads to the 1
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demand same % change in quantity
demanded.
AY
TT

Perfectly A % change in price leads to no % 0

inelastic change in quantity demanded.
demand
The quantity demanded is
completely unresponsive to price.
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Relationship between PED and total revenue:

Total revenue (TR): Amount of money received by firms when they sell a good or service. It is equal to
the price (P) of the good multiplied by the quantity (Q) of the good. TR = P x Q

PED Price Sales Revenue

Inelastic Increase Increase

Decrease Decrease

Elastic Increase Decrease

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Decrease Increase

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Unitary Change Constant

Determinants of PED:

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Determinant of PED Explanation

Number of substitutes Many substitutes → good likely to be elastic in demand

Few substitutes or none → good likely to be inelastic in demand
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Necessity or luxury Necessity → likely to be inelastic in demand
Luxury → likely to be elastic in demand

Proportion of income Good takes low proportion of income → likely to be inelastic (change in
price hardly noticed)
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Good takes high proportion of income → likely to be elastic in demand

Time Short run → likely to be inelastic in demand (as takes time for consumers to
find substitutes)
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Longer run → likely to be elastic as consumers will find substitutes

Why is knowing PED useful for firms Why is knowing PED not useful for firms
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Because PED determines the effect of a price change on Price of a product is only one of the
demand and therefore sales revenue. things that affect demand. Changes in
the prices of other products and changes
For example: in the incomes of consumers will also
If a firm has an elastic product, a percentage decrease in affect demand and revenue.
price will lead to a greater percentage increase in quantity
demanded and therefore sales revenue increases PES is also important. For example, if
If a firm has an inelastic product, a percentage increase in demand is elastic, lowering price will
price will lead to a smaller percentage decrease in quantity lead to a higher percentage increase in
demanded and therefore sales revenue increases quantity demanded, but if supply is
perfectly inelastic then no more can be
supplied.

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Significance of PED for the government:

Governments usually increase taxes on inelastic goods such as cigarettes, petrol and alcohol. This is
because they are highly inelastic in demand and therefore an increase in price due to the imposition of
indirect taxation will lead to a smaller percentage decrease in quantity demand and therefore the
government will gain a lot of tax revenue.

2.8 Price elasticity of supply (PES)

Price elasticity of supply (PES): A measure of the responsiveness of quantity of a good supplied to a
change in price.

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𝐹𝑖𝑛𝑎𝑙 𝑄𝑠 − 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑄𝑠
𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑠𝑢𝑝𝑝𝑙𝑖𝑒𝑑 ×100 %∆𝑄𝑑
PES =
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑄𝑠
𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
= 𝐹𝑖𝑛𝑎𝑙 𝑃 − 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑃 = %∆𝑃
×100

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𝐼𝑛𝑖𝑡𝑖𝑎𝑙𝑃

Types of PES Definition PES Value Diagram

UD
Elastic Supply A percentage change in price leads >1
to a greater percentage change in
quantity supplied.

The quantity supplied is relatively

ST
responsive to price changes
AY

Inelastic A percentage change in price leads <1

Supply to a smaller percentage change in
quantity supplied.
TT

The quantity supplied is relatively

unresponsive to changes in price.
CA

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Perfectly A percentage change in price leads ∞

elastic supply to an infinite change in quantity
supplied.

The quantity supplied is infinitely

responsive to changes in price

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Unitary A percentage change in price leads 1
elastic supply to the same percentage change in
quantity supplied.

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UD
ST
Perfectly A percentage change in price leads 0
inelastic to no percentage change in quantity
supply supplied.

The quantity supplied is completely

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unresponsive to price.
TT

Determinant of PES Explanation

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Time Primary sector goods take time to extract/grow, therefore:

* In the short run they are likely to be inelastic in supply.
* In the long run they are likely to be elastic in supply.
Secondary sector goods likely to be elastic in supply in the short and long run.

Availability of In a boom, resources are scarce therefore supply is more likely to be inelastic.
resources In a recession, supply is more likely to be elastic.

Ability of the good If a good can be stocked (it’s not perishable) and stocks are available then
to be when price rises the stocked goods can be released onto the market – this
stocked/availability makes the good more elastic in supply.
of stock

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Mobility of the If the fops that produce a good are highly mobile, then if prices rise these fops
factors of can move into the industry and increase supply – this makes the good more
production elastic in supply

Importance of PES to:

Consumers When demand and the price of a good increases, the PES will determine how long
the price will remain high.
With elastic PES, supply would increase quickly → lowering the price of a good.
Therefore consumers would prefer if a good has an elastic PES.

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Producers A firm would rather have goods that are elastic in supply as if price rises they can

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increase their supply quickly and gain the extra profit.
Firms can increase the elasticity of their products by::
● ensuring greater mobility of the fops

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● creating spare capacity (more machinery)
● training staff to improve productivity

Government A government is a provider of key services in the economy such as education and
healthcare. How quickly their services can be increased in quantity when the
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population increases will be determined by their PES. (elastic PES = better)
Governments also provide subsidies for goods they want to see produced in greater
quantities. How quickly the quantity supplied increases depends upon PES.

All the above (consumers, producers, the government) would rather goods be elastic in supply
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2.9 Market economic system

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Free In a free-market economic system, resources are owned by private individuals. The what
Market to produce question is answered by the consumer, the how to produce question is
answered by the producer and the price mechanism (supply and demand) rations
resources so that they are allocated (answers the for whom question) - usually to those
who can pay the price of the good. (e.g. Hong Kong)
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Planned Resources are owned by the government (public sector). The what/how/for whom
questions are decided by the government/public sector. Non-price rationing is used to
allocate resources - the government decides. (e.g. North Korea)

Mixed A mixed economy is one in which there is both a private sector (in which resources are
allocated by the price mechanism) and a public sector (in which resources are allocated by
the state/government).

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Advantages Disadvantages

Free market ● Consumer sovereignty ● Widespread of income (capitalism can create

system ● Greater variety of goods and very wealthy people and very poor people)
(capitalism) services ● Merit goods are underprovided (education)
● More incentives (profits) for ● De-merit goods are overproduced (drugs)
innovation as producers try
to meet consumer demands

Planned ● More equal distribution of ● Little or no consumer sovereignty (gov decides

economy goods and services (people what’s produced)

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(socialism) can get goods and services ● Few incentives to innovate
even if very poor) ● Availability and quality of goods are poor

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● Greater awareness of social ● The dominance of government may lead to a
needs loss of personal liberty and freedom of choice

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2.10 Market failure
Market failure: Occurs when the market (Supply and Demand) does not work efficiently and therefore it
results in an under or over production/consumption of a good.
ST
Merit goods De-merit goods

Goods about which there is a lack of information Goods about which there is a lack of
about how beneficial they are for the consumer. information as to how harmful they are for the
AY

This leads to them being underconsumed consumer leads to them being overconsumed.

E.g. Education, healthcare, vaccines E.g. Cigarettes, Alcohol

Externalities: something that results from a business’ activity that is felt by the community or
TT

environment. They can be either costs or benefits.

Private costs: The costs a firm pays (i.e. the cost Private benefit: The sales revenue received by a
of the land labour and capital involved in the firm from selling its products.
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production of a product.)

External costs: Costs generated by a firm’s External benefits: Benefits which a firm generates
activities which the firm does not pay. but does not receive any payment for. The positive
Society usually ends up paying firms’ external results from a business’ activities felt by those
costs. (e.g. pollution and congestion) outside the business. (e.g. training employees)

Private costs + external costs = social costs

Private benefits + external benefits = social benefits
Public goods: Goods that are non-rivalrous and non-excludable (e.g. street lights, lighthouse). They
would not be provided at all in a free market and this results in market failure.

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Causes of Explanation
market
failure

De-merit Goods about which there is a lack of information as to how harmful they are for the
goods consumer leads to them being overconsumed → market failure

Merit goods Goods about which there is a lack of information about how beneficial they are for the
consumer. This leads to them being under consumed → market failure

External Firms do not pay external costs → lower costs of production → overproduction →

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costs market failure

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External The producer or consumer does not receive all the benefits and therefore it is under
benefits produced/consumed → market failure.

Public goods Due to non-excludability, it is impossible for firms to receive any revenue from

UD
providing a public good, therefore none is provided → market failure.

Abuse of Monopoly might abuse their monopoly power by increasing price to increase profits →
monopoly lower demand → under-consumption → market failure
power
ST
Factor Geographical immobility: Occurs when it is difficult to move a fop from one
immobility geographical area to another.
For example, unemployed people may not live in an area where there are job
vacancies → firms in that area being unable to expand → underproduction → market
AY

failure.
Occupational immobility: A mismatch between the skills that labour has and the skills
that are required to fill available job vacancies.
This can lead to firms being unable to expand → underproduction → market failure
TT

Cause Consequence Examples

Demerit good A lack of information on It is over consumed relative to the Cigarettes,
how bad the product is social optimum level of consumption alcohol, junk
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when consumed food

Merit good A lack of information on It is underconsumed relative to the Healthcare,
how beneficial the social optimum level of consumption education
product is when
consumed
External costs Third parties pay a cost Producing firm does not pay all their Air pollution,
for the production and costs (pollution) → charge a lower noise pollution,
consumption price → greater demand → congestion
overproduction and consumption.
External Benefits to a third party Underproduced and under consumed Training,
benefits from the consumption/ education,
production healthcare

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Public good Non excludable- cannot These goods will not be provided in a Street lights,
exclude those who have market economy by firms as no military
not paid from revenue can be made → defence,
consuming the service underproduction. Government lighthouses
therefore have to supply them
Abuse of Higher price set by Under consumption Markets with a
monopoly monopolist leading to single seller –
power decreased demand Vietnamese
electricity
Factor FoPs unable to move Underproduction in that industry Geographical
immobility into the industry they and

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are needed in occupational
immobility

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2.11 Mixed economic system

UD
Mixed A mixed economy is one in which there is both a private sector (in which resources are
allocated by the price mechanism) and a public sector (in which resources are allocated by
the state/government).
ST
Government policy Advantages Disadvantages

Maximum price below equilibrium: Maximum - some consumers will benefit - some consumers will be
price is a price set by the government below as they will be able to worse off as they will not
equilibrium above which a good or service may purchase the good/service at be able to obtain the good
AY

not be sold. the lower (maximum price) as there is less supplied at

price the lower price
- a maximum price on a - market failure as less than
country’s exchange rates can the optimal amount is not
improve international price produced by the market
TT

competitiveness (a - there may be queues

depreciated exchange rate) outside shops as shortages
are present
CA

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Minimum price above equilibrium: Minimum - increases the amount of - may cause unemployment
price is a price set by the government above people that want to work and The increase in wage may
equilibrium below which a good or service may therefore decrease market lead to a contraction in
not be sold. failure demand for labour and
- reduces poverty by raising therefore unemployment
the living standard of the (therefore increasing
lowest paid workers market failure)
- prevents exploitation of
workers who have poor
bargaining strength in the
labour market i.e. no access to

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trade unions

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UD
Indirect Taxation: An indirect tax is a tax on - Provides an incentive for - May not decrease
expenditure. It increases the cost of production consumers to decrease their demand for demerit goods
and therefore causes a leftwards shift in the consumption, reducing the by much as they are usually
supply curve, increasing price and decreasing consumption of demerit highly inelastic in demand.
demand. Example – tax on cigarettes goods. - Difficult to put a monetary
ST
- A taxation on pollution value on negative
provides an incentive for firms externalities and therefore
to decrease their external difficult to find the right
costs level of tax
- Provides revenue for the
AY

government which can then

be used to treat the negative
externalities of the
consumption of the good
(cancer wards in hospitals
TT

from cigarette tax!)

Subsidy: A subsidy is a sum of money paid by - To guarantee an increase in - Opportunity cost – could
the government to a firm per unit of output to the supply of products that the money have been used
CA

lower their cost of production and encourage the government deem as to build a hospital
output. desirable (merit goods)
- To lower the price of
essential goods, such as milk,
to consumers.
- To enable domestic
producers to compete with
foreign competition, therefore
decreasing imports and
protecting domestic
employment

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Regulations: The imposition of government - Easy for governments to pass - May lead to a black
rules backed by penalties that are intended to regulations market and smuggling from
modify the behaviour of individuals or firms. - Consumption of demerit which the government will
goods can be reduced receive no revenue (if
(cigarettes/alcohol) something is banned)
- Consumption of merit goods - Banning a good needs the
can be increased (education) support of the public or
else it won’t work i.e.
prohibition in America

Privatisation: The transfer of state owned assets - Can create competition (if - If a public sector

S
(electric company etc) to the private sector. public sector monopoly is monopoly is transferred to
If a state owned monopoly is split up and broken up), there decreasing the private sector without
privatised then it can solve the problem of abuse monopoly power breaking it up, then a

IE
of monopoly power. - Provides a one off cash private sector monopoly is
windfall for the government created. This will lead to a
- Private sector organisations greater abuse of monopoly
are thought to be more power.

UD
efficient in the delivery of - Public sector firms are
some services more socially minded and
do not just consider their
private benefits. Less likely
to pollute
ST
Nationalisation: Government transfer of private - Public sector organisations - Public sector
sector organisations into the public sector. operate with social objectives organisations may be more
A government can overcome the abuse of inefficient and less
monopoly power in say the electricity industry incentive to cut costs
by nationalising it
AY

Direct provision: Governments may decide to - Guarantees provision - Expensive

simply provide a service itself. This is particularly - Economies of scale are
the case with public goods and merit goods. attainable
TT

Information provision: The over consumption of The under consumption of De-merit goods such as
de-merit goods such as cigarettes and alcohol merit goods such as cigarettes and alcohol are
occurs partly due to the lack of information by healthcare (vaccinations) and highly addictive, so
consumers of the harmful effects. This can be healthy foods can be information alone may not
overcome by a government information overcome by government have much effect on
CA

campaign to make consumers aware and information campaigns as to reducing demand.

therefore decrease the amount of the positive effects – reducing
overconsumption – reducing market failure. market failure.

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Policies to correct the following causes of market failure

Demerit good Taxation
Government regulations
Information provision
Merit good Subsidies
Direct provision
Information provision
Government regulation
Maximum price below equilibrium

S
External costs Taxation
Regulations

IE
External benefits Subsidies
Direct provision

Public good Direct provision

UD
Subsidies
Abuse of monopoly power Regulations (anti-competitive)
Privatisation
Nationalisation
ST
Factor immobility Subsidies
AY
TT
CA

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3.1 Money and banking

Money: Anything that is generally accepted as a means of payment for goods and services.

Forms of money

Commodity money Any commodity can be used as money - gold, silver etc because these metals
have value in their own right (intrinsic).

Fiat money Notes and coins. The basis of all modern money systems. The value of fiat
money is determined by its exchange rate to other currencies.

S
Fiduciary money Today’s monetary system is highly fiduciary. This means that banks’ notes and

IE
coins have no intrinsic value (they are not made from valuable metals etc),
their value is dependent on being backed by a country’s central bank.

UD
Functions of money Explanation

A medium of exchange Money can be used to buy and sell things. People must be willing to accept
(generally acceptable) money as payment of goods and services they provide.
Before money there was barter (exchange). However, this relied upon a
ST
double coincidence of want and that the items being exchanged were of
equal value.

A measure of value (a Money acts as a measure of value. The value of an item can be measured in
unit of account) how many units of a currency it is worth. We can compare the value of one
AY

item with another item by measuring its monetary value

A store of value Money has value. $1,000 deposited in your wallet will hold its value (more or
less depending on the rate of inflation) for a week. Because it stores value it
can be used to accumulate wealth
TT

A standard of deferred Money enables people to borrow money and pay it back at a future date.
payment An agreement can be reached about the amount to be repaid in the future

Characteristics of money:
CA

1) Durability: Money should be long lasting and easily replaced when it becomes worn.
2) Acceptability: Widely recognised and accepted as a medium of exchange.
3) Divisible: It must be possible for money to be divided into different values in order to pay for goods
and services that cost different amounts and for change to be given.
4) Portable: Easy to carry and move around.

Central Banks: In most countries Central Banks are owned by the government but run independently of
the government

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3. Microeconomic decision makers Written by Cattaystudies

Function of central banks:

● It operates the government’s monetary policy.
● Issues/prints notes and coins for the nation’s currency, therefore influences money supply
● It supervises the banking system, regulating the conduct of banks, holding their deposits and
transferring funds between them.
● It manages payments to and from the government
● Tax revenue which a government receives will be held in an account in the Central Bank.
● Manages a country’s national debt
● It is ‘lender of last resort’ to the commercial banking system

S
Importance of central banks to…

IE
Consumers Consumers must be confident in the banking system as they deposit their money in
banks.
The central bank sets the interest rates which will determine the cost of borrowing

UD
and therefore how much consumers borrow.

Producers The central banks set interest rates which will determine the costs of borrowing from
commercial banks. Interest rates up = businesses borrow less.
ST
The central bank regulates commercial banks and determines how much funds are
available for lending – this will affect a businesses’ ability to borrow.

Government Role in issuing currency, controlling monetary policy and acting as banker to the
government and commercial banks
AY

Commercial Banks: Standard Chartered, HSBC etc.. The services Commercial Banks provide for
individuals and businesses is to:
● Accept deposits of money from individuals and businesses, providing a secure place to save
TT

● Provide loans to individuals and businesses at an interest rate

Importance of commercial banks to…

Consumers Allows consumers to deposit their money in a safe place in which they can earn
CA

interest.

Producers Provides loans to businesses to allow them to Invest in capital equipment and
therefore grow.
Provides advice to businesses who need loans for expansion.
Provides foreign exchange that producers use to purchase imported raw materials.

Government Increase/decrease interest rates in line central bank changes.

Lends money to producers and consumers.

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3. Microeconomic decision makers Written by Cattaystudies

3.2 Households
The factors influencing spending, saving and borrowing for households:
Factors affecting spending Factors affecting saving Factors affecting borrowing
Income Income Income
As incomes rise so does total As incomes rise so does total saving, Low income groups borrow to
spending, but spending as a % but it also increases as a % of purchase necessities (food and
of income falls. income rent). High income groups
borrow to purchase expensive
items such as houses.

S
Interest rates (illustrate) Interest rates (illustrate) Interest rates

IE
I/r down, borrowing cheaper, I/r down, less returns on savings, I/r down, borrowing cheaper,
therefore borrowing and savings down. therefore borrowing and
spending up. I/r up – other way round spending up.
I/r up – other way round I/r up – other way round

UD
Consumer confidence Consumer confidence Consumer confidence
If confidence is high (job If confidence is low (job insecurity), If confidence is high
security/income rising), saving increases. Vice versa. consumers and firm will
spending increases. Vice borrow to spend, confident
ST
versa. that they can repay their
loans. Vice versa.
Age Age Age
People in their twenties and People in their late 30s, 40s and 50s Borrowing peaks between 25
people with children tend to tend to save more – to finance their to 40 when people tend to buy
AY

spend more than their pension. expensive items such as

income. houses.
Elderly people tend to use
their saving to finance their
TT

spending.

Household type Household type Household type

The more children in the The more children in the house the Low income groups borrow to
house the more spending that less saving that will occur. Also purchase necessities (food and
CA

will occur. Also depends on depends on the number and age of rent). High income groups
the number and age of adults adults in the household (see ‘age’) borrow to purchase expensive
in the household (see ‘age’) items such as houses.
Wealth Wealth Wealth
Wealth can generate income Wealth can generate income – Wealth is assets (collateral)
– renting out houses etc, so renting out houses etc, so therefore that individuals can use to
therefore the more wealth, the more wealth, the more saving. borrow more.
the more income, the more Vice versa. Poor individuals have no/little
spending. Vice versa. assets.

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3. Microeconomic decision makers Written by Cattaystudies

Influences on an individual’s decision to borrow money from a bank:

● Rate of interest = the cost of borrowing.
● The ability to repay the loan
● The need for a loan
● The availability of loans from banks

Should a government be worried if more people in a country decide to save a large proportion
of their income
Worried: Not Worried:
● Money that is being saved is not being ● Money being saved will eventually be spent

S
spent therefore withdrawal from circular ● Money that is saved in banks is available to lend
flow increases and AD decreases to others – this could provide the funds for

IE
● If the level of demand falls there will be businesses to expand
an increase in unemployment (labour is ● Increased savings will decrease inflationary
derived demand) pressure.

UD
3.3 Workers

Individual’s choice of occupation (wage factors)

ST
Wage Payment for carrying out a particular job.
Time rate paid per hour (over time possible)

Salary A fixed annual amount paid monthly (no overtime)

AY

Overtime Payment for work in excess of the standard contracted hour.

Paid at a higher hourly rate.

Bonus Extra payment acting as an incentive for performance above that usually expected.
TT

Commission Payment based on the percentage of sales a worker makes

Profit Sharing Employees get a share of the company’s profit

CA

Individual’s choice of occupation (non-wage factors)

● Working hours
● Promotion prospects
● Job security
● Fringe benefits
● Pension entitlement
● Holiday entitlement
● Quality of working environment
● Job satisfaction
● Training opportunities

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3. Microeconomic decision makers Written by Cattaystudies

Reason why some people are prepared to work in low paid occupations:
● High non wage factors
● They’re unskilled and therefore can’t get well paid jobs
● No other work available
● Job near home
● The work is interesting

The wage rate is determined by:

Demand for labour ● The demand for labour is derived demand (depends upon the demand for

S
what the labour produces)
● The productivity of labour (greater productivity = higher demand)

IE
● The profits of a firm (greater profits = higher demand for labour to gain
more profits)
● The cost of capital equipment

UD
Supply for labour ● Size of working population, determined by:
- Changes in retirement age (People living longer = retirement age has
increased → larger working population)
- Immigration (in) and emigration (out) In developed countries immigration
has increased the amount of labour. In less developed countries emigration
ST
has decreased the amount of labour available.
- 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.
- Increased role of women in the workforce In the last 50 years there has
AY

been a change in the attitudes towards women working – more acceptable

nowadays. This has increased the amount of labour supplied.
● Non wage factors
TT

Bargaining power of The bargaining power of labour is determined by:

labour ● How skills a person is (more skilled = more productive = more valuable)
● Whether a person is part of a trade union or not and how strong the trade
union is
CA

Government policy Minimum wage: An amount of pay set by the government below which an
(including minimum employer cannot pay an employee.
wage)

Government policy Anti-discrimination legislation

(anti-discrimination Anti-discrimination legislation will allow greater labour force participation by
legislation, income ethnic minorities etc and therefore increases the supply of labour.
tax)
Changes in income tax
An increase in income tax may decrease the supply of labour as some people
may not feel that it is worth their while working (disincentive of taxation).

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3. Microeconomic decision makers Written by Cattaystudies

Skilled and unskilled Primary, secondary and tertiary Private and public
workers sector
Skilled workers are Tertiary sector workers are usually Trade unions are
scarcer and more most skilled (but not always) and often more powerful
Relative productive therefore therefore have more bargaining in the public sector.
bargaining they have more power. The secondary sector is In the private sector,
strength bargaining strength usually the most unionised and the secondary sector
therefore has more bargaining is usually the most
power. unionised….
Whilst laws removing Enforcement of
discrimination will benefit workers anti-discrimination

S
Discrimination in all sectors, it will be most laws is easier in the
laws beneficial to tertiary sector public sector as it is

IE
workers as this is where large controlled by the
number of women are employed. government.
The introduction of Low paid workers are usually in The government

UD
policies like the the primary and tertiary sectors decides on the level
Government minimum wage will (cleaners, shop workers) and of public sector pay
policy benefit unskilled therefore they will benefit most and this may result in
workers as their wage from a minimum wage. it being less than
is low private sector pay.
ST
PED of skilled workers PED of primary, secondary and Skilled workers will be
is inelastic (necessary some (unskilled) tertiary sector in high demand in
– non replaceable workers is elastic. both the private and
PED skills). public sector.
Skilled workers most often found
AY

PED for unskilled in the tertiary sector whose PED is

workers in elastic. inelastic.
PES for skilled workers PES of primary, secondary and In many countries
is inelastic (takes time some (unskilled) tertiary sector there is a greater
to train etc). workers is elastic due to little skill supply of labour into
TT

being required (less training time the public sector

PES PES for unskilled needed). (making it more
workers is elastic elastic in supply) as
Skilled workers most often found they are seen as
CA

in the tertiary sector whose PES is secure jobs with good

inelastic. pensions.

Specialisation: This is a process by which individuals, firms, regions and economies concentrate on
producing those goods and services in which they have an advantage. The specialisation of labour is
called ‘division of labour

Specialisation of labour: Occurs when a task is broken up into many smaller tasks in which one person
specialises on each smaller task. Rather than one person doing all the tasks, many people do one small
repetitive task each. This increases productivity.

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3. Microeconomic decision makers Written by Cattaystudies

Adv/Dis of Advantages Disadvantages

specialisation to…

Government 1. If the good produced has a high or 1. Greater dependence on other

rising price then it will mean increased countries.
export revenue for the country (Oil 2. Risks for a country. If the demand
exported from Brunei) for a product that a country is highly
specialised in fall then the export
2. A country specialising in one industry revenue of that country declines.
will increase their expertise in this area Moreover for countries that are
and may benefit from external

S
specialised in finite goods (oil etc)
economies of scale, reducing costs for they will eventually run out.
all firms in the industry and increasing 3. Mechanisation and automation

IE
international competitiveness. can create unemployment in short
term

UD
Firms 1. More goods can be produced. As 1. Training costs may increase
people specialise in one task they can 2. Quality may suffer as workers
complete the task very quickly leading become bored with the lack of variety
to greater productivity. This may in their work
decrease labour cost per unit.
2. It makes full use of everybody’s
ST
ability because people specialise at
what they are good at.
3. It allows the use of machinery.
Repetitive tasks can be mechanised. As
AY

more capital is used productivity will

increase.

Workers 1. Workers may receive higher pay for 1. Workers may become bored.
specialised work/higher productivity Doing repetitive tasks increases the
TT

2. It makes full use of an individual’s chances of boredom which will lead

ability because people specialise at to demotivation.
what they are good at. 2. Workers may eventually be
replaced by machinery as repetitive
tasks are mechanised.
CA

3.4 Trade unions

Trade union: An organisation that workers join, which represents them in negotiations with company
managers. The Trade Union speaks for everybody (collective bargaining) and therefore the workers have
strength in numbers and are more likely to have their demands met by managers.
Collective bargaining: A process of negotiation over pay and conditions between a trade union, who
represents the workers, and employers.

Industrial action: An action taken by trade unions to try to force an employer to give in to their
demands. E.g. strikes, go slow, work to rule

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3. Microeconomic decision makers Written by Cattaystudies

Functions of a Trade Unions:

● negotiates with management to improve workers’ wages, working conditions etc…
● pressure government to pass legislation favourable to employees (shorter working week)
● protecting employment which includes:
○ trying to guard against redundancies
○ representing workers in disputes with their employer where they might be sacked

Advantages of trade unions to workers Disadvantages of trade unions to workers

● Trade Unions (through collective bargaining) ● increased wages may mean that firms cannot

S
increases the chances of workers having afford to employ all the workers they used to
their interests met i.e. increased wages, and therefore some workers may be made
improved working conditions unemployed

IE
● Trade Unions offer their members a range of ● Workers have to pay to be a member of a Trade
benefits such as legal representation in Union and this will reduce their take home pay
disputes with their employer ● Industrial action by a Trade Union can be

UD
● Trade Unions can influence the government disruptive. Workers lose their wages during a
to pass more worker friendly legislation strike.

Advantages of trade unions to firms Disadvantages of trade unions to firms

● it is easier to negotiate with Trade Unions ● Trade Unions increase costs for firms. This
ST
than every single worker. It saves time. means that the price of firms’ goods rise and
● if workers have their needs met it is likely demand falls.
they will be more motivated and therefore ● A union may undertakes industrial action which
more productive. This increase in could be costly for a firm.
productivity may offset the increased cost
AY

incurred by having a union

Advantages of trade unions to the economy Disadvantages of trade unions to the economy

● Trade Unions raise the income of the poorest ● Trade Unions increase the costs for businesses
TT

who spend all their income on goods and therefore making them less price competitive
services. This increases demand in the internationally. Therefore exports and the
economy and therefore decreases balance of payment will suffer.
unemployment ● Strikes by Trade Unions can affect firms and may
CA

● Governments can receive advice on work cause them to lose business. This can be
related legislation from unions damaging for their survival prospects.

Factors that affect the strength of a Trade Unions (and therefore its ability to raise wages etc)
● The percentage of the workforce in the trade union (higher % = more strength)
● Level of economic activity. Boom = labour scarce, therefore firms more likely to give in to TU
demands as they will not want to lose them.
● How much profit the firm makes. The more profitable a firm is the more likely it is that unions
will be able to increase wages.
● How substitutable capital is for labour

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3. Microeconomic decision makers Written by Cattaystudies

3.5 Firms

Primary sector Secondary sector Tertiary sector

Firms involved in the growing Firms in manufacturing and Firms involved in the provision
and extraction of raw materials construction are in the of services are in the tertiary
are in the primary sector. secondary sector. sector.
(e.g. Farming, fishing, mining.) (e.g. manufacturing and (e.g. banking, retailing,
construction) communication and education.)

S
Public sector Organisations Private sector Firms

Public sector organisations are in the public The private sector is made up of firms that are

IE
sector They are owned by the people of a country run and owned by individuals. Their main
(the public) and run by the government. Their objective is to make a profit
main objective is to provide a good service.

UD
Size Description

Small Less than 50 employees and sales revenue less and 10 million
ST
Medium Between 51-250 employees and sales revenue between 10m – 50m

Large More than 250 employees and sales revenue over 50m
AY

Advantages of small firms Disadvantages of small firms

● Convenient locations (small shop compared ● No economies of scale and therefore small
to supermarket) businesses’ prices are usually higher
● Personalised service ● Difficulties raising finance
TT

● React quicker to changes in demand ● Difficulties attracting and retaining workers

● Good communication and relationships with ● Vulnerable to recession due to lack of
workers and customers resources
● Less customer recognition due to decreased
CA

ability to spend on advertising.

Advantages of large firms Disadvantages of large firms

● Large firms provide more employment ● Large firms can acquire monopoly power
● Large firms get economies of scale → cost (restrict supply and raise price), this is bad for
savings may be passed onto the customer in consumers and international competitiveness
the form of lower prices ● Large firms may suffer from diseconomies of
● Large firms get economies of scale and these scale and become too bureaucratic
costs savings allow it to compete ● Workers may become alienated and suffer
internationally → improve current account from poor motivation
● Ability to manage large contracts

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3. Microeconomic decision makers Written by Cattaystudies

Why some firms stay small:

● Objectives of owner
● Size of the market
● Lack of availability of finance

Merger: An agreement by shareholders and managers of two businesses to bring both firms together
under a common board of directors with shareholders in both businesses owning shares in the newly
merged business.
Takeover/acquisition: when a company buys over 50% of the shares of another company and becomes
the controlling owner

S
Type of Advantages Disadvantages Impact on stakeholders
integration

IE
Horizontal ● Eliminates one ● Many lead to monopoly ● Consumers have
integration competitor investigation if the less choice
Integration with ● Economies of scale combined business ● Workers may lose

UD
firms in the ● Increased power exceeds certain size their jobs if roles
same industry over suppliers limits are duplicated
and at the same ● Possible diseconomies
stage of of scale
production
ST
Vertical forward ● Business is able to ● Lack of experience in ● Workers may have
integration control the this sector of the greater job security
Integration with promotion and industry as the business has
firms in the pricing of its own secure outlets
AY

same industry products ● More varied career

but a customer ● Secures an outlet opportunities
of the existing for the firm’s ● May have lack of
business products - may now competition in the
exclude retail outlet so less
TT

competitors’ choice.
products

● ● ●
CA

Vertical Gives control over Lack of experience in More varied career

backward quality, price and this sector of the opportunities
integration delivery times of industry ● Consumers may
Integration with supplies ● Supplying business may obtain improved
firms in the ● Encourages joint become complacent quality, innovative
same industry R&D into improved having a guaranteed products
but a supplier of quality of supplies customer ● Control over
the existing of components supplies to
business ● The business may competitors may
control supplies of limit competition
materials to and choice for
competitors consumers.

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3. Microeconomic decision makers Written by Cattaystudies

Conglomerate ● Diversifies the ● Lack of experience in ● Greater career

integration business away from the acquired business opportunities for
Integration with its original industry sector the workers
firms in a and markets → ● May have a lack of clear ● More job security
different spread the risk focus and direction now because risks are
industry ● The business may that the business is spread across more
expand into a spread across more than one industry.
faster-growing than one industry
market

S
Internal economies of scale: The factors that lead to a decrease in unit cost for one firm as more is
produced. Managerial, Marketing, Purchasing, Financial, Technical and Risk spreading are the factors that

IE
lead to a reduction in unit costs.
Managerial When firms grow they can hire specialised workers who will do their job more
efficiently therefore reducing unit costs

UD
Marketing the cost of advertising is divided by the amount of units produced, therefore the
more units produced the lower the marketing cost per unit

Bulk-buying bigger firms can buy in bulk and therefore reduce the costs of their inputs which will
ST
reduce their unit cost

Financial Bigger firms have more collateral, therefore banks see them as less of a risk to lend
money to. Therefore they charge them a lower interest rate which reduces their unit
cost of borrowing.
AY

Technical Bigger firms can use their capital equipment all the time because they produce
more. Therefore the cost of the capital equipment is divided by a larger amount of
output therefore reducing the cost of machinery per unit of output.
TT

Internal diseconomies of scale: The factors that lead to an increase in the unit cost of production as
output increases past a certain point. Examples: bureaucracy, labour relations and control &
coordination.
CA

Communication As firms become bigger communication tends to slow down and the amount of
problems paperwork increases. This decreases productivity which leads to a higher unit cost.

Labour relations Larger firms have greater division of labour which usually leads to a lower unit cost.
However, if taken too far it can alienate and demotivate workers, therefore their
productivity decreases and unit cost increases.

Control & The larger the business the more difficult it is to coordinate the activities of all
coordination employees efficiently (i.e. ensuring that they’re all doing what they’re supposed to
do) so unit cost increases

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3. Microeconomic decision makers Written by Cattaystudies

External economies of scale: Factors that lead to a lower unit cost for firms in the same industry or
region. Examples: Skilled labour, ancillary firms and co-operation
Skilled labour firms located in the same area can take advantage of each other’s trained
employees when they leave their present employer. This decreases their
training costs when hiring employees and therefore decreases their unit cost.

Ancillary and When similar firms locate in one area, support firms will locate near them. For
commercial example, where big car manufacturing firms are located, component
services manufacturers are located nearby → decrease unit cost for manufacturer

Co-operation When firms set up close to one another they can do certain things to help each

S
other and therefore decrease their unit cost of production.

IE
Infrastructure If a particular industry dominates a region the roads, railways, ports, buildings
and other such facilities will be shaped to suit that industry’s needs → lower
unit costs

UD
External diseconomies of scale: Factors that lead to a higher unit cost for all firms in the same industry
or region. Examples: Congestion, Increased competition for resources
Congestion As industry gets bigger within a country it will cause more congestion on roads etc.
This will increase journey time for firm’s deliveries and other inefficiencies, increasing
ST
their unit cost.

Increased As an industry grows there will be more competition for the resources that that
competition industry needs e.g. specialist raw materials and labour. Due to the increased demand
for resources for these scarce resources their price will rise and this will add to a businesses’ cost
AY

increasing their unit cost.

3.6 Firms and production

TT

Labour intensive production Capital intensive production

Labour intensive production is a production Capital intensive production is a production

process that employs mostly labour as a means process that employs mostly capital (machinery)
CA

of completing tasks rather than capital. For as a means of completing tasks rather than
example making clothes labour. For example car production

Why production is sometimes labour intensive Why production is sometimes capital intensive

● Some jobs are labour intensive in their ● Allows firms to mass produce standard
nature – car repair/hairdressing and cannot products such as coke cans.
be made capital intensive ● The unit cost of production of capital
● Labour intensive output allows a firm to give intensive produced items is relatively
a personalised service i.e. a tailor made suit low as expensive labour is used less.
● Human error can be reduced.

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3. Microeconomic decision makers Written by Cattaystudies

● In many (developing) countries labour is

plentiful and therefore the cost of labour is
cheap → labour intensive
● In many (developing) countries capital
(machinery etc) is expensive or simply not
available.

Productivity: The amount of outputs (goods or services) that can be produced from a given amount of
inputs (factors of production) over a given period of time.
Production: The total output over a period of time e.g. week.

S
Ways to increase productivity:

IE
1. producing more outputs with the same amount of inputs
2. producing the same amount of outputs with less inputs

UD
Productivity can be measured per unit of input, per worker, per machine or per shift.
𝑇𝑜𝑡𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡
𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑖𝑡𝑦 = 𝑤ℎ𝑎𝑡𝑒𝑣𝑒𝑟 𝑦𝑜𝑢 𝑎𝑟𝑒 𝑚𝑒𝑎𝑠𝑢𝑟𝑖𝑛𝑔 𝑡ℎ𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝑜𝑓

Ways to increase productivity

ST
Increase spending on The better trained and educated workers are the more productive
education and training they will be. Therefore, to increase productivity, a government could
increase spending on education and training or provide incentives
(grants etc) to firms who provide training courses for their workers.
AY

Decrease interest rates The lower interest rates are the more likely firms will be to borrow to
invest in capital equipment. The more capital equipment a firm has
the greater their productivity.
TT

Decrease income tax Income tax is a disincentive for employees to work hard (increase
their productivity) and earn more money (as more will be taken in
income tax). Decreasing income tax decreases this disincentive.
CA

What affects productivity?:

● The amount of capital equipment labour has access to - A person with an earth mover can get
more done than a person with a shovel
● The amount of education/training (human capital) a person has - The more education and
training a person has, the more they can get done
● Healthcare - A person in poor health is not very productive.
● Effective management - Helps combine the factors of production in the most efficient way to
maximise output.

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3. Microeconomic decision makers Written by Cattaystudies

3.7 Firms’ costs, revenue and objectives

Profit Total sales revenue

Sales revenue – total costs Selling price x quantity sold
It is the profit made on all units of output sold
Fixed costs Variable costs
Costs that do not change as the quantity of output Costs that change as output changes. For
changes. For example, rent and insurance example, labour and raw materials
Break even Total costs
The amount of units that need to be sold in order for a Fixed cost + variable costs = Total costs

S
firm not to make a loss. At breakeven a firm neither
makes a profit or a loss.

IE
Average revenue Average costs
Sales revenue divided by quantity sold Total costs divided by quantity
Average fixed costs Average variable cost

UD
Fixed costs divided by the amount produced. Variable costs divided by quantity

Wages are a variable cost Salaries are fixed costs

Wages are paid by the hour. Therefore the more Salaries are a fixed amount of pay a person
ST
hours a person works the more wages they receives each month regardless of how many
receive = variable cost. hours they work = fixed cost.

Objectives of a firm include:

AY

1. Profit maximisation: Profit maximisers seek to make as much profit as possible (where the
difference between total revenue and total costs is at its greatest).
2. To increase sales/growth. Increase the amount of sales by selling into new markets etc
3. Survival
TT

4. Social welfare

3.8 Market structure

Competitive markets: In a competitive market a large number of firms are in competition with each
CA

other to satisfy customers

Features of a competitive market:

1. There are many sellers (firms) and buyers in the market
2. Firms are price takers; they accept that they have little ability to raise the price of their product
3. There are low barriers to entry
4. Similar or identical products sold in the market

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3. Microeconomic decision makers Written by Cattaystudies

Advantages to consumers of Disadvantages to consumers of competitive markets

a competitive markets

1. Decreased price (due to 1. Firm too small to gain economies of scale and therefore they may
many firms) have a high unit cost
2. Improved quality 2. Too much price competition can lead to firms cutting costs and
3. Improved level of producing low quality products. Important when safety is an issue
innovation as firms try to e.g. airline industry
differentiate themselves from 3. (Possibly) Lower levels of innovation because firms have less
the competition profit to invest in R&D

S
4. More choice because more 4. Firms may produce too many adverts with exaggerated claims
firms trying to persuade consumers to purchase products they don’t need

IE
Monopoly: A firm with 100% of the market (only one seller)

A monopoly market has the following features:

UD
1. One firm
2. Firms are price makers
3. Unique product/service
4. High barriers to entry and exit
ST
Advantages of a monopoly Disadvantages of a monopoly

1. Research and development: Monopolies can make large 1. Monopolist can restrict output to
profits and therefore invest more in research and raise prices
AY

development, resulting in new/improved products 2. Poor customer services due to lack

2. Economies of scale: Monopolies are large firms and of competition
therefore enjoy economies of scale. -- They may pass 3. Lack of choice (only one producer)
savings on to consumers in the form of lower prices, at the 4. Lack of innovation (monopolist
very least they are using fewer resources to produce their under no pressure to improve product)
TT

output. Illustrate (vs competitive market). 4. Inefficiency - lack of competitive

3. International competitiveness: A firm with a domestic pressure means it is not necessary to
monopoly (a national champion) may be well placed to cut costs
compete internationally.
CA

Evaluation of a monopoly

It depends on how well the authorities regulate pure monopolies. The Office of Fair Trading should
ensure that there are no restrictive practices by monopolists therefore helping ensure that price is
reasonable. If the monopoly was created by privatisation then the industry regulator should help
ensure that consumers are offered a reasonable service and price.

The extent to which an industry enjoys economies of scale, and whether these savings are passed to
customers (possibly through regulation) is a key determinant of the costs or benefits of monopoly.

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3. Microeconomic decision makers Written by Cattaystudies

Advantages of working for a large firm:

- More promotion opportunities
- Large firms are less likely to go bankrupt so there is a greater amount of job security
- Large firm usually have better training opportunities (training per employee is cheaper to provide for
large firm rather than small firms)

Is price likely to be higher in a monopoly than in a competitive market.

Price likely to be higher in monopoly: Price might be higher in competitive markets:

S
• lack of competition gives a firm monopoly • a monopoly may be able to take advantage of
power and if profit maximisers may push economies of scale (bulk buying) which will lower
up price by restricting supply. Consumers average costs, which they may pass on to the consumer

IE
will have little option but to buy the in the form of lower prices.
product. • with high profits, a monopoly may be able to spend
• In PC consumers can switch to rival more on research and development/new technology

UD
producers if a firm raises price. This helps this can reduce costs of production enabling a
keep prices down.
ST monopoly to charge a lower price
AY
TT
CA

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 4. Government and the macroeconomy Written by Cattaystudies

4.1 The role of government

Government roles (local) Government roles (national) Government roles (international)

● Managing public ● Providing public services, ● Negotiating trade agreements

transport e.g. police ● Imposing trade restrictions
● Providing local services ● National defence ● Providing aid to other countries
(e.g. rubbish collection) ● Building infrastructure
● Enforcing laws, e.g. ● Printing notes and coins
building restriction ● Collecting taxes

S
4.2 The macroeconomic aims of government

IE
Macroeconomic Objectives
1. Economic Growth (2-3%)

UD
2. Low Inflation (2% or less)
3. Low Unemployment (less than 5%)
4. Balance of Payment equilibrium
5. Redistribution of income to improve income equality
ST
Possible conflicts between macroeconomic aims
Conflict between objectives: A policy conflict occurs when a government implements a policy
designed to achieve one objective and consequently harm another.
● Full employment VS Stable prices
AY

● Economic growth VS Balance of payment stability

● Full employment VS Balance of payment stability

4.3 Fiscal policy

TT

Fiscal policy: The use of taxation and government spending to achieve macroeconomic
objectives e.g. low inflation

Reasons for government spending

CA

● Providing merit goods (e.g. education)

● Providing public goods (e.g. street lights)
● Providing welfare services (e.g. unemployment benefits)
● Providing infrastructure (e.g. roads)
● Providing other public services (e.g. rubbish collection)

Reasons for taxes

● To raise revenue for government spending
● To discourage the consumption of demerit goods
● To redistribute income
● To protect domestic industries

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Progressive taxation Regressive taxation Proportional taxation

a tax system that takes a higher a tax system that takes a higher a tax system that takes an
proportion of the income of proportion of the income of low equal proportion of income
high earners than low earners earners than high earners from all earners

Direct tax Indirect tax

A tax paid directly to the government by the A tax on expenditure. It is regressive. Indirect
persons on whom it is imposed. tax increases the cost of goods and services.

S
Examples: An example of Indirect Tax is GST.
Income tax: This is a tax on individuals’ incomes

IE
Corporation tax: A tax on companies’ profits.

Principles of taxation. What makes a good tax?

UD
● Fairness - should be based on ability to pay
● Certainty - it should be clear how much should be paid and when
● Convenience - it should be collected in a manner and at a time suitable for the payer
● Efficiency - it should be cheap to collect
ST
Impact of higher direct taxes on firms’ profits Impact of higher indirect taxes on firms

● Lower profits (higher corporation tax) and ● Higher costs

therefore lower Investment ● Fall in sales as higher costs are passed
AY

● Reduced incentive for entrepreneurs to start a onto the consumer in the form of higher
business as profits will be lower prices
● MNCs might relocate to other countries
● Increased tax evasion and avoidance
TT

Impact of higher direct taxes on consumers Impact of higher indirect taxes on consumers

● Reduced consumer spending (higher income tax, ● Higher prices

lower disposable income) ● Reduced consumption of goods that are
● Reduced incentive to work as worker will have taxed (e.g. demerit goods)
CA

less money left over after higher income tax

● Increased tax evasion and avoidance will increase
as tax rises

Impact of higher direct taxes on the government Impact of higher indirect taxes on the
government

● Higher tax revenue which can be used for ● Higher tax revenue which can be used for
government spending or paying down the government spending or paying down the
national debt national debt
● Achievement of macroeconomic objectives
through contractionary fiscal policy

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 4. Government and the macroeconomy Written by Cattaystudies

● Achievement of macroeconomic
objectives through contractionary fiscal
policy

Impact of higher direct taxes on the economy Impact of higher indirect taxes on the
economy

● Lower inflation ● Higher inflation as indirect taxes increases

● Lower growth prices
● Higher unemployment ● Fall in living standards of poor households
● A more equal distribution of income as indirect tax is regressive

S
● Reduced incentives to work or start a business

IE
Advantages of indirect taxation Disadvantages of Indirect Taxation

1. Relatively cheap to collect 1. Tend to be regressive

UD
2. Can be used to reduce externalities (increase 2. Increase prices (inflationary)
price of goods with large externalities)
3. Does not increase disincentive to work

Advantages of Direct Taxation Disadvantages of Direct Taxation

ST
1. It’s progressive therefore helps redistribution 1. Increases disincentive to work (income tax)
2. Decreases investment by firms (corporation tax)
as there is less profit left over after tax to invest.
Also, incentive to invest has been reduced as firms
AY

keep a smaller percentage of their profits.

Expansionary fiscal policy Contractionary fiscal policy

TT

Increases in government spending and/or Decreases in government spending and/or increases in

decreases in taxation in order to increase taxation in order to decrease aggregate demand (AD)
aggregate demand (AD)
CA

Demand Side Policies: Fiscal Policy and Monetary policy. They are used to influence the total
level of demand in the economy

Expansionary fiscal policy Contractionary fiscal policy

Examples include: Examples include:
● Higher government spending on ● Lower government spending on
infrastructure or public services (higher infrastructure or public services (lower G in
G in AD) AD)
● Income tax cuts (higher C in AD) ● Income tax increases (lower C in AD)
● Corporation tax cuts (higher I in AD) ● Corporation tax increases (lower I in AD)

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 4. Government and the macroeconomy Written by Cattaystudies

Expansionary fiscal policy can be used to Contractionary fiscal policy can be used to achieve
achieve ● Lower inflation (lower AD means less
● Higher economic growth (higher AD demand for goods and services so
means more demand for goods and businesses are reluctant to increase prices)
services so higher real GDP) ● Improves the current account (lower AD
● Lower unemployment (higher real GDP means less demand for imports)
means more demand for workers as
labour is derived demand)

Income tax up – consumers have less Indirect tax up (tax on expenditure) - consumers

S
disposable income – C down – therefore AD spend less on goods and services – C down –
down – by how much depends on the size of the therefore AD down – by how much depends on the

IE
increase in income tax and vice versa size of the increase in indirect tax and vice versa

Corporation tax up – businesses invest less – I Government spending down – workers have less
down – therefore AD down – by how much money/Ue higher – C down – therefore AD down –

UD
depends on the size of the increase in by how much depends on the size of the decrease in
corporation tax and vice versa government spending and vice versa

Example of how fiscal policy can achieve lower Example of how fiscal policy can achieve
ST
unemployment: higher economic growth:
Income tax down (Expansionary fiscal policy), Government spending on healthcare increases
therefore consumers have more disposable (Expansionary fiscal policy), therefore more
income, therefore Consumption and AD up. More hospitals are built and more doctors and nurses
workers are employed to produce the extra goods are employed, therefore increasing their
AY

and services demanded as labour is derived incomes and spending power. This increases G
demand, therefore unemployment decreases (and and C and therefore AD which increases
vice versa) economic growth (and vice versa)

Example of how fiscal policy can achieve lower Example of how fiscal policy can achieve
TT

inflation: current account surplus:

Income tax up (Contractionary fiscal policy), Income tax up (Contractionary fiscal policy),
therefore consumers have less disposable income, therefore consumers have less disposable
therefore Consumption and AD down. This income, therefore demand for imports
CA

decreases demand pull inflation (and vice versa) increases. This may lead to a Current Account
surplus (and vice versa)

Fiscal policy and the distribution of income

Progressive taxation takes a higher proportion of income from higher earners thus decreasing their
take home net income. This taxation can therefore be used to increase social security benefits for the
least well off, provide free education and healthcare for the poor and provide job opportunities
through government spending. This will narrow the distribution of income

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 4. Government and the macroeconomy Written by Cattaystudies

Budget: A plan of a government’s future income from taxation and expected spending over a period of
time (usually a year)

Budget deficit Budget surplus Balanced budget

G>T. Requires a Public Sector Net Cash T>G. Surplus can be used to Government
Requirement (PSNCR), which increases the repay part of the national debt. spending = Taxation
national debt.

Public Sector Net Cash Requirement (PSNCR): The money a government needs to borrow if it

S
runs a budget deficit for the year. Adds to national debt.
National debt: The total amount of money borrowed by the government - cumulative PSNCRs

IE
Expansionary fiscal policy (spending rises or Contractionary fiscal policy (spending decreases or
taxation falls) is likely to: taxation increases) is likely to:

UD
● increase a budget deficit or ● decrease a budget deficit or
● decrease a budget surplus ● increase a budget surplus

Budget deficits are not considered a problem if: Budget deficits are considered a problem if:
ST
● They are small ● They are big
● Are often balanced by budget surpluses ● They are not balanced by budget surpluses
● The National Debt is small ● The National Debt is large
AY

4.4 Monetary policy

Monetary policy: When the central bank controls the money supply (usually by changing
TT

interest rates) in order to achieve certain macroeconomic objectives.

1. Changing interest rates (MOST IMPORTANT)
2. Quantitative easing
3. Changing exchange rates
CA

Money supply: The amount of money in circulation in an economy

Expansionary monetary policy Contractionary monetary policy

An increase in the money supply through A decrease in the money supply through raising i/r or
lowering i/r, QE or devaluing the currency revaluing the currency leading to a fall in aggregate
leading to a rise in aggregate demand. demand

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 4. Government and the macroeconomy Written by Cattaystudies

S
IE
UD
ST
AY

How an increase in interest rates affects How an increase in interest rates affects
TT

unemployment: economic growth:

Interest rates down therefore cost of borrowing Interest rates down therefore cost of borrowing
down therefore consumers will borrow to spend down therefore consumers will borrow to spend
and firms will borrow more to invest. This increases and firms will borrow more to invest. This
C & I, which increases AD and therefore more increases C & I, which increases AD and
CA

workers are employed to produce the extra goods therefore more goods and services are
and services demanded as labour is derived produced = more economic growth (and vice
demand, therefore unemployment decreases (and versa)
vice versa)

How an increase in interest rates affect inflation: How an increase in interest rates affects the
Interest rates down therefore cost of borrowing Current Account:
down therefore consumers will borrow to spend Interest rates down therefore cost of borrowing
and firms will borrow more to invest. This increases down therefore consumers will borrow to
C & I, which increases AD and therefore more spend. This will increase the demand for
goods and services demanded, therefore demand imports and may therefore cause a Current
pull inflation (and vice versa) Account deficit (and vice versa)

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 4. Government and the macroeconomy Written by Cattaystudies

Monetary policy and the redistribution of income

Expansionary monetary policy will increase economic growth and therefore reduce unemployment,
this could help improve the incomes of poorer citizens and therefore reduce income inequality.

Quantitative easing: an expansionary monetary policy measure which increases the money supply and
therefore AD. The central bank creates some new money. This money is then lent to commercial banks
who lend it to consumers and businesses therefore boosting C and I and therefore AD.

Changing foreign exchange rates:

S
Devaluation Revaluation

A fall in the value of a currency due to a A rise in the value of a currency due to a

IE
government intervening in the foreign exchange government intervening in the foreign exchange
market. market.

UD
If a central bank devalues their currency this If a central bank revalues their currency this
means that it is worth less in foreign currency. means that it is worth more in foreign currency.
Therefore: Therefore:
-exports are cheaper, increasing demand for -exports become more expensive, decreasing
them and causing more money to flow into the demand for them and causing less money to flow
economy into the economy
ST
-Imports become more expensive and therefore -Imports are cheaper and therefore more are
less are purchased, therefore less money flows purchased, therefore more money flows out of the
out of the country. country.
Expansionary monetary policy Contractionary monetary policy
AY

4.5 Supply-side policy

Supply side policies: Any government action which leads to an increase in aggregate supply in
TT

an economy by improving either the quality or quantity of the factors of production.

Productive capacity: When aggregate supply in an economy increases, this indicates an

increase in the economy’s productive capacity. This means that the economy is capable of
CA

producing more goods and services.

Supply side policy Explanation

Education and training If the government improves the quality and quantity of education students
receive then the economy’s labour force will become more productive, which
shifts AS to the right and the economy’s PPC outwards indicating a rise in
the economy’s productive capacity.

Lower income tax Lower income tax will encourage more people to join the labour force
because workers will get to keep more of their income.
This will increase the quantity of labour and therefore shifts AS to the right

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 4. Government and the macroeconomy Written by Cattaystudies

and the economy’s PPC outwards indicating a rise in the economy’s

productive capacity.

Lower corporation tax Lower corporation tax will mean that firms get to keep more of their profits
which they can use Invest. Increases in investment will increase the quantity
of capital in the economy and therefore shifts AS to the right and the
economy’s PPC outwards indicating a rise in the economy’s productive
capacity.

Deregulation Deregulation makes it easier for firms to enter a market, this increases
competition and therefore the amount of goods and services which can be

S
produced. This increases the quantity of capital and therefore shifts AS to
the right and the economy’s PPC outwards indicating a rise in the

IE
economy’s productive capacity.

Privatisation Privatisation is when the ownership of a public sector business is transferred

to the private sector. Private owners are motivated by profit . And therefore

UD
are more likely to ensure that workers are productive. This improves the
quality of labour and therefore shifts AS to the right and the economy’s PPC
outwards indicating a rise in the economy’s productive capacity.

Subsidies Subsidies and grants reduce production costs and make it more attractive to
ST
start a business. This increases the quantity of capital and therefore shifts AS
to the right and the economy’s PPC outwards indicating a rise in the
economy’s productive capacity.

Labour market reforms Reducing the power of trade unions can reduce wages. This reduces firms’
AY

costs. This provides more funds for expansion and investment. This increases
the quantity of capital in the economy and therefore shifts AS to the right
and the economy’s PPC outwards indicating a rise in the economy’s
productive capacity.
TT

Improving Infrastructure improvements make it easier for firms to transport raw

infrastructure materials and finished goods. This reduces firms’ costs. This provides more
funds for expansion and investment. This increases the quantity of capital in
the economy and therefore shifts AS to the right and the economy’s PPC
CA

outwards indicating a rise in the economy’s productive capacity.

Grant: A sum of money given by the government to a business which does not have to be
repaid.
Deregulation: The removal of laws, rules and regulations making it easier for a business to
enter and operate in a market.

4.6 Economic growth

Economic Growth: The percentage change in the value of goods and services produced in an
economy over time (usually a year) measured by GDP

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Policies to increase economic growth:

1.Expansionary fiscal policy
2. Expansionary monetary policy

Real GDP Money (nominal GDP)

The total value of all goods and services The total value of all goods and services produced
produced by an economy in a year - adjusted for by an economy in a year - not adjusted for
inflation. inflation.

S
Final goods and service: Goods and services that are ready to be used by the end consumer (both
households and firms) when they are purchased e.g. TVs, machinery

IE
Real GDP per Capita Formula: Measures the average amount of goods and services an
individual within a country has access to.

UD
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 𝑝𝑒𝑟 𝐶𝑎𝑝𝑖𝑡𝑎 = 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛

Recession: A fall in GDP in 2 consecutive quarters (6 months). Negative economic growth.

Business Cycle:
ST
AY
TT

Boom (peak) Recession Slump (trough) Recession (expansion)

CA

rGDP and employment are Less being produced Economic activity at rGDP and employment
high. The economy may than before. rGDP its lowest point. begin to increase.
well be working beyond its and employment Unemployment will Unemployment begins
capacity. This leads to falls, tax revenue be high, Consumption to fall. Consumption
inflationary pressure. falls and wage and Investment low. and Investment begin to
Consumption and demands moderate. There could also be rise. Wage levels also
Investment will be high. Inflation falls. deflation. start to move upwards.
Aggregate Demand/GDP is made up of:
● Consumption by individuals/households
● Investment by firms in capital equipment
● Government spending

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● Exports - Imports (X-M)

Aggregate supply: All the individual supply curves of all the producers in an economy added
together. The aggregate supply curve shows what happens to the total output of all the goods
and services in the economy as the general level of prices changes.

Demand side causes of economic growth Demand side causes of economic growth
A rise in Consumption caused by: A rise in Government spending caused by:
-Expansionary monetary/fiscal policy - -Increased government spending on areas like education
develop point and healthcare

S
-Lower unemployment therefore -The creation of jobs as a result of government spending
increased consumer incomes

IE
-Increased consumer confidence A rise in net exports (X-M) caused by:
therefore more consumer spending -Increased incomes of trading partners means they will
buy more of your exports.

UD
A rise in Investment caused by: -A currency depreciation = X cheaper, M more expensive,
-Expansionary monetary policy - develop therefore more exported and less imported.
-Higher consumer spending requires -Lower inflation compared with trading partners making
more machinery to produce the extra exports relative less expensive
goods -Trading partners removal of trade barriers means you can
-Increased business confidence therefore export more
ST
increased investment -Imposition of domestic trade barriers mean less will be
imported

Demand side causes of a recession Demand side causes of a recession

A fall in Consumption caused by: A fall in Government spending caused by:
AY

-Contractionary monetary/fiscal policy - -Decreased government spending on areas like education

develop and healthcare
-Higher unemployment therefore -The creation of fewer jobs as a result of less government
decreased consumer incomes spending
TT

-Decreased consumer confidence

therefore less consumer spending A fall in net exports (X-M) caused by:
-Decreased incomes of trading partners means they will
A rise in Investment caused by: buy less of your exports.
-Contractionary monetary policy - -A currency appreciation = X more expensive, M cheaper,
CA

develop therefore less exported and more imported.

-Lower consumer spending requires less -Higher inflation compared with trading partners making
machinery to produce the extra goods exports relative more expensive
-Decreased business confidence -Trading partners imposition of trade barriers means you
therefore decreased investment can export less
-Decrease of domestic trade barriers mean more will be
imported

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Consumer confidence Business confidence

The extent to which consumers feel optimistic The extent to which consumers feel optimistic
about the future - greater confidence means about the future - greater confidence means more
more spending (c) and less saving. spending (c) and less saving.

Supply side causes of economic growth Supply side causes of a recession

An increase in AS caused by an increase in the A recession can be caused by a fall in AS which
quantity and quality of factors of production such reduces the quantity and quality of factors of
as: production caused by:

S
-more labour/enterprise = immigration -the depletion of natural resources such as oil
-more productive labour/enterprise = -natural disasters such as floodings and

IE
education/training earthquakes
-more land = reclamation -emigration
-more productive land = irrigation/fertilisation -Cost push inflation - moves AS to the left and
-more capital = lower i/r less is produced.

UD
-more productive capital = innovation

Benefits of economic growth Drawbacks of economic growth

ST
For individuals For individuals
Employment opportunities. Economic growth Exploitation of labour and reduced quality of life.
means more goods and services are being In some developing countries workers are
produced, therefore more workers are needed exploited. Moreover, increased production of goods
as labour is derived demand. increases pollution which decreases the quality of
AY

life for particularly the poor.

For firms For firms

Rising sales and profits. Economic growth Rising production costs. Economic growth leads to
means consumers’ incomes are rising, leading greater demand for labour and raw materials and
TT

to more Consumption. This leads to greater this increases their price. This increases firms’ costs
demand/sales for firms and therefore - cost push inflation.
increased profits.

For the government For the economy

CA

Higher tax revenue. Economic growth can Pollution. Increased production tends to result in
result in workers earning higher incomes and more air, water and soil pollution.
pay more income tax and firms making bigger Increased use of non-renewable resources.
profits and earning more corporation tax. Inflation. Increased demand for goods and services
can lead to demand pull inflation. See above for
For the economy cost push inflation.
Lower unemployment. Economic growth = Inequality. Often the owners of fops, such as land
more goods and services. Labour is derived and capital, are the main recipients of the benefits
demand therefore more people are employed of economic growth. This can lead to a widening
gap between the rich and poor.

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4.7 Employment and unemployment

Employment: The state of having paid work
Unemployment: The state of being willing and able to work but being unable to find work
Full employment: Occurs when there is no cyclical unemployment, although other forms of
unemployment may exist.
Labour force: All individuals of working age that are either employed or unemployed
Formal economy: The official economy that is controlled by the government and subject to
taxation.
Informal economy: The unofficial economy, which is not taxed or controlled by the

S
government.
Natural rate of unemployment: A certain amount of unemployment that will always exist in an

IE
economy.

Why developed economies have few workers in the primary and secondary sector and many in the

UD
tertiary:
In developed economies the cost of labour/wages is high. This means that:
- machinery is used in the primary and secondary sector instead of labour
- manufacturing firms relocate to developing countries in search of cheaper labour
ST
- well paid workers demand a greater amount of services - restaurants/holidays/entertainment and
therefore the tertiary sector grows in developed countries

Why developing economies have many workers in the primary and secondary sector and few in the
tertiary
AY

In developing countries the cost of labour/wages is lower. This means that:

- labour is used in the primary and secondary sector instead of machinery
- manufacturing firms relocate to developing countries in search of cheaper labour
- there is less demand for services as workers are paid less - less use of restaurants etc and therefore the
TT

tertiary sector does not grow so much in developing countries

Changes in the pattern of employment

CA

More workers in the formal More women in the More employment in the private sector
economy when economies labour force
develop

As economies develop more Changes in social In recent decades, many governments have
companies set up offering attitudes mean an moved away from planned economies to
formal employment which is increased proportion market economies. Privatisation has moved
more likely to be protected of women are in the many public sector organisations into the
by labour market regulations labour force private sector, therefore less public sector
(e.g. minimum wage) employment and more private sector
employment.

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Measuring unemployment

Labour force survey Claimant count

A survey of households conducted by the government under Counting the number of people
the guidance of the International Labour Organisation (ILO). who register as unemployed by
The UK government surveys 40,000 households every 3 counting the amount of people
months. Those that are considered unemployed: claiming unemployment benefits.
-without a job
-willing and able to work
-actively seeking work

S
-available to start within two weeks

IE
Advantages of labour force survey Disadvantages of labour force survey

1. Based on ILO (International Labour Organisation) 1. Expensive due to extent (40, 000

UD
standards therefore valid comparisons can be made households).
with other countries whose unemployment
measures are based on the same standards.
2. Extensive, therefore greater chance of accuracy
ST
Advantages of Claimant count Disadvantages of claimant count

Easy to compile as numbers are already available 1.Can’t be used for international comparison
2.Not all unemployed workers will claim
unemployment benefit
AY

Calculating the unemployment rate

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑒𝑜𝑝𝑙𝑒 𝑢𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 = 𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒
× 100
TT

Types Definition Remedy

Frictional The time spent between leaving one job More job centres to ensure that those
and finding another. who are unemployed are aware of
CA

vacancies.

Seasonal Demand for certain types of workers is More job centres to ensure that those
higher in one part of the year and lower in who are unemployed are aware of
others e.g. hotel workers. vacancies.

Technological When new technology (capital equipment) Retrain the unemployed so they can
replaces workers. Serious problem because gain employment in growing industries
those made unemployed may not have the
skills to find another job easily. Mismatch Problem: Retraining takes a long time
of skills. and is expensive to provide. Some
people may not want to be retrained.

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Structural Occurs when there is a change in the Retrain the unemployed so that they
structure of an economy. This means that can work in growing industry
the skills of the economy’s labour force no
longer match the jobs that are available. Problem: Retraining takes a long time
Serious problem as long term. and is expensive to provide. Some
people may not want to be retrained.

Cyclical (AKA Occurs in a recession when demand for Increase AD through expansionary
demand goods and services falls in the economy. monetary or structural policy.
deficient) Labour is derived demand and therefore
less workers are needed. Problem: May cause inflation and

S
current account deficit.

IE
Costs of unemployment to:

Individual Lower income and living standards resulting in poverty. Often causes

UD
mental health problems.

Moreover, individuals in employment may have to pay more taxation

in order to fund payments to the unemployed.
ST
Firms Disadvantage:
Lower demand for goods and services, therefore lower revenue and
possible risk of failure.
Advantage:
Increased supply of available labour and therefore lower wage
AY

demands.

Government Reduced tax revenue as fewer people paying income tax

Increased spending on unemployment benefits
Therefore less money is available to spend on public services.
TT

Economy Disadvantage:
Falling economic growth (less being produced)
Increased poverty due to more people not have paid employment
Advantage:
CA

Lower inflation. Higher Ue is caused by lower AD and therefore the

Price Level (inflation) decreases

Policies to reduce unemployment:

1. Expansionary fiscal policy
2. Expansionary monetary policy

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4.8 Inflation and deflation

Inflation Deflation

A persistent rise in the general prices of goods Deflation is the sustained fall in the general level of
and services over a period of time, usually prices of goods and services in an economy over
measured yearly. time.

Policies to control inflation:

1.Contractionary fiscal policy

S
2. Contractionary monetary policy

IE
Measuring inflation: Inflation is measured using a weighted price index, such as the consumer price
index (CPI).

This is constructed using the following steps

UD
1. Conduct a household expenditure survey
2. Select a basket of goods
3. Collect price data
4. Assign a weight to each item in the basket of goods
ST
5. Calculate a weighted average of the price change of each good
6. Convert to index form

Weighted price index: An index (with a base year of 100) in which prices of goods are weighted
according to their importance
AY

Consumer price index: A measure of the changes in the prices of a selection of goods and services
normally purchased by a typical household
Weighted average: Attained by calculating the percentage change in an item by its weight
Basket of goods: A selection of goods and services normally purchased by a typical household which is
TT

used in the calculation of the CPI.

Weighing: Indicates the importance or a good when compiling a CPI. The higher the weighting, the
greater percentage of household income is spent on the good.
Base year: A random year allocated a value of 100 index points against which other years are compared.
CA

The inflation rate is calculated by finding the percentage change in the price index

Cause/type of inflation 1: Demand pull Cause/type of inflation 2: Cost push

Occurs when Aggregate Demand increases more Inflation caused by an increase in

rapidly the Aggregate Supply and therefore prices rise. production costs (labour, raw materials)
An increase in C or I or G or (X-M) will cause demand which causes firms to increase their
pull inflation, particularly when an economy is close to prices to consumers.
full employment or during a boom when AS is unable
to keep up with increases in AD.

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Purchasing power: The value of money in terms of the quantity of goods and services in can buy
Cost of living: Day to day living expenses incurred by an individual
Fixed income earners: People who receive a set amount of income and have no power to increase it e.g.
pensioners.
Menu costs: The costs incurred by firms when changing their prices
Shoe leather costs: The costs incurred by businesses when searching for the best prices from their
suppliers.
Wage-price-spiral: The inflationary cycle of higher wages, leading to higher production costs, leading to
higher prices and living costs (cost push inflation), leading to higher wage demands and so on

S
Consequences of inflation for:

IE
Consumer Reduces the purchasing power of their money. A real problem if they can’t increase
their wages.

UD
Fixed income Reduces the purchasing power of their money. A real problem as they can’t increase
earners: their income.

Savers Inflation can erode the value of savings as the value of their savings decrease over
time (not the amount)
ST
Lenders Receive the same amount of money from debtors (people they have lent money to),
but the value of the money will have fallen.

Borrowers People who have borrowed money from banks with a fixed interest rate gain from
AY

inflation as inflation will erode the value of the money they pay back.

Workers Highly skilled and therefore scarce workers can increase their wage by at least the rate
of inflation so are not affected.
Unionised workers with strong bargaining power will be able to increase their wage by
TT

the rate of inflation so are not affected..

Low skilled workers that are not unionised will not be able to increase their wage by
the rate of inflation as they are easily replaceable by another worker or machinery and
therefore their purchasing power will fall over time.
CA

Firms 1. Menu costs:

During periods of high inflation firms will have to make frequent adjustments to the
price at which they sell and therefore incur menu costs.
2. Shoe leather costs:
During periods of high inflation firms will have to recheck prices before purchasing
stock etc and as the costs of supplies are changing constantly and they will want to get
the lowest price. This involves costs: time etc
3. Wage price spiral
In times of high inflation workers wages demands will increase, leading to higher
production costs for firms, leading to higher prices and living costs (cost push inflation)
for consumer/workers, leading to higher wage demands by workers…

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 4. Government and the macroeconomy Written by Cattaystudies

The economy 1. High inflation leads to higher prices therefore exports down and imports up. This
decreases AD, economic growth and increases unemployment.
2. High inflation makes future costs are revenues uncertain for firms and therefore the
economy is less likely to attract MNCs

Causes of deflation
● Decreasing aggregate demand
● Increasing aggregate supply as costs (raw materials, wages) fall.

S
Consequences of deflation for:

Consumer Expect the price of goods to be cheaper in the future therefore they delay their

IE
purchases, therefore decreasing AD, employment and economic growth.

Workers Either lose their jobs and therefore have less spending power or have job insecurity and

UD
therefore save more therefore decreasing C and worsening AD employment and
economic growth.

Savers Savers save more as deflation increases the purchasing power of their money as prices
fall over time therefore decreasing C and worsening AD employment and economic
ST
growth.

Lenders Lender gain as the value of the money repaid will increase.

Borrowers Borrowers will borrow less as the value of the money they repay will increase as prices
AY

are falling therefore decreasing C and worsening AD employment and economic growth.

Firms Firms demand will decrease → lay workers off therefore decreasing C and worsening AD
employment and economic growth. Also, as demand is falling firms will invest less
therefore decreasing I and worsening AD, employment and economic growth.
TT

Economy The economy. Deflation will decrease the costs of exports and increase the relative cost
of imports, therefore X up and M down helping to increase AD and therefore increase
employment and economic growth.
CA

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5. Economic development Written by Cattaystudies

5.1 Living standards

Living standards: refer to the general economic wealth, wellbeing and quality of life of a country's
population.
Real GDP per head = Real GDP/population
Relationship between rGDP per head and living standards.
The higher the rGDP per head the more goods and services the average person has access to therefore
the greater the economic wealth and standard of living.

S
Advantages of Real GDP per head as a Disadvantages of Real GDP per head as a measure of living
measure of living standards: standards:

IE
1. It is calculated using income, which is 1. Ignores factors other than income that contribute to quality
a good indicator of living standards. of life such as levels of healthcare, education, pollution etc
2. It can be used to compare living 2. rGDP is given as an average therefore it doesn’t consider

UD
standards between countries as all how much inequality may be present - may be that a small %
countries record GDP and population of pop have most of wealth
figures. 3. Doesn’t consider what’s being produced. If consumer goods
3. The data needed to compile rGDP is such as computers then good for development, if military
readily available and easy to access hardware then less good
4. Doesn’t take into account the informal economy
ST
Human development index (HDI): a measure of human development and wellbeing that takes into
account the three dimensions of GNI per capita, health and education
AY

HDI measures 3 areas equally:

1. GNI per head
2. Life expectancy: the number of years a person in a country is expected to live
3. Years of schooling
TT

Added together makes a country’s HDI score from 0 to 1.

Gross national income (GNI): total income earned by the residents of a country (individuals and
businesses) at home and abroad
CA

Advantages of using HDI as a measure of Disadvantages of using HDI as a measure of living

living standards standards

1. Takes into account 3 measures (GDP per 1. It does not take into account all factors that
capita, Education and Healthcare) therefore a influence living standards such as environmental
wider measure than rGDP per capita alone. factors, political freedom etc.
2. Measurable (numbers) – no value judgments 2. Each of the three areas is an average so equality is
not fully explored

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5. Economic development Written by Cattaystudies

Why do living standards and income distribution differ within countries?

Economic growth Owners of factors of production (owner of factories etc) and the highly skilled
unevenly spread tend to gain a large share of economic growth.
Those without fops or skills gain little.

Employment by Usually people employed in the primary sector have few skills and therefore the
sector supply of workers is high (anyone can do it) and therefore wages are low.
Usually people employed in the secondary sector(construction workers) have
moderate skills and the supply of workers is moderate therefore wages are

S
reasonable.
Usually people employed in the tertiary sector have high skills (solicitors, doctors

IE
etc) and the supply of workers is low therefore wages are high.

Education and The greater amount of quality education and training an individual has the greater

UD
training their income is likely to be.
Children in rural areas may not have access to good local education. In other
countries, school fees are charged and therefore the poorest may only be able to
afford very limited education.
ST
Government Government policy regarding the distribution of wealth greatly affects its
policy outcome. A government that enacts a progressive tax system and uses the funds
to provide free education and unemployment benefits will narrow the distribution
of income.
AY

Why do living standards and income distribution differ between countries?

Level of economic Developed countries with high incomes and a very progressive tax system which
development funds free education and healthcare for all will have a high standard of living that
TT

is relatively equally spread (narrow distribution of income).

Countries that have little progressive tax may still be seen as wealthy, but the
wealth will not be equally spread (wide distribution of income).
CA

Factor Some countries have large factor endowments (Brunei has enormous stores of oil)
endowments and therefore this can generate GDP and a high standard of living.

The state of the Countries that are suffering from poor economic conditions such as high inflation
economy and high unemployment will see their GDP decrease and therefore their standard
of living falls

The effectiveness Responsible government that encourage trade, and invest in healthcare and
of government education will see their economy grow providing a greater standard of living

War and conflict Countries engaged in conflict will lose some of its fops (labour, capital etc) and
therefore its standard of living will decrease.

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5.2 Poverty
Poverty: An obstacle which prevents individuals from enjoying opportunities that should be available to
everyone and therefore their quality of life is decreased. Opportunities include necessities like clothes
and food.

Absolute poverty Relative poverty

A situation in which an individual does not have A situation in which an individual does not have
enough income to satisfy their most basic needs enough money to buy goods and services

S
of food, clothes, clean water, shelter, education normally consumed by members of that society
and healthcare. Living on less than $1.9 a day.

IE
7 Causes of poverty

UD
Unemployment Unemployed individuals receive no income from work. In developed countries
with unemployment benefits these individuals will receive a subsistence
allowance and will be relatively poor. In developing countries without
unemployment benefits these individuals will be absolutely poor.

Low wage Unskilled workers are forced to accept low wages which usually means that
ST
they are relatively poor. The less developed a country is the less education and
training opportunities there are and therefore the greater amount of relative
poverty.

Old age Elderly people are unable to work. In developed countries they may have
AY

access to a state pension provided by the government and also a personal

pension and therefore may not be in poverty. In developing countries elderly
people often rely on their children for support who themselves have little,
therefore they may well experience relative or absolute poverty.
TT

Sickness and Sickness and disability can mean that an individual is unable to work. In
disability developed countries with sickness benefits these individuals will receive a
subsistence allowance and will be relatively poor. In developing countries
without sickness benefits these individuals will be absolutely poor.
CA

Increasing household Increasing household debt due to excessive spending on consumer goods has
debt led to an increase in relative poverty in many countries. Debt has to be repaid
with interest therefore it makes people poorer.

Lack of opportunity Absolute poverty happens mostly in rural regions as most employment is in
in rural regions the agricultural sector which is poorly paid. Moreover, due to droughts etc
farmers yields and therefore their incomes are erratic, leading to poverty.

War and conflict Individuals, fearing for their safety, are often displaced due to war and conflict
and become refugees and therefore suffer absolute poverty.

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Policies to alleviate poverty and redistribution income

Policy Advantages Disadvantage

Progressive Progressive taxation is when a Allows government to May lead to greater tax
taxation greater proportion of income generate revenue which avoidance/evasion by
is taken in tax as incomes rise. they can use to fund those on high incomes
education etc

Welfare Use of government funds to Eliminates absolute May lead to an increase

S
benefits provide a safety net for the poverty (but not relative in taxation
unemployed, elderly and sick. poverty) (contractionary

IE
monetary policy)

Education Free education and training Increases the quantity and Policy will take a long
and training for all will increase quality of labour and time to have an affect

UD
employment opportunities for therefore the productive
the poor and allow them to potential of the economy
earn a good salary in the long
term.
ST
Minimum An amount of money below reduces poverty by - a minimum wage can
wage which an employer cannot pay raising the living standard cause unemployment
legislation an employee of the lowest paid workers because it increases the
- prevents exploitation of cost of employing
workers who have poor workers and therefore
AY

bargaining strength the demand for these

type of workers
decreases

Job creation The government can create An increase in G and a An increase in G can
TT

employment through reduction in i/r boost AD cause a budget deficit.

spending on infrastructure etc. which will create
employment
opportunities for the poor
CA

Subsidies Subsidies for basic necessities Ensures a minimum level Costly for the
such as rice and flour reduce of nutrition for the government.
their price and ensures even population.
the poorest can afford

Direct Providing essential goods and Education and healthcare Many governments do
provision of services such as education increases the quantity and not have the funds to
essential directly to the poor. quality of labour and implement these
goods and therefore the productive programmes.
services potential of the economy.

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Encouraging Encouraging FDI (foreign firms Provides employment - MNCs may lead to the
MNCs into a setting up factories in a Generate tax revenue for closure of domestic
country country) will mean job the government firms who cannot
opportunities compete.

Educate Some governments seek to Makes the household Some households may
people about educate the population to self-reliant. not have the extra
how to budget their finances so that income to save as all
manage their they only purchase what they their income goes to
finances can afford and therefore don’t buying necessities.

S
fall into debt which is a major
cause of poverty.

IE
Create new Elderly people who are unable Allows income and dignity Many elderly people
income- to rely on their children are for elderly people. may not be able to
generating given job opportunities work due to illness etc.

UD
opportunities
for the
elderly

5.3 Population
ST
Population growth: The change (increase or decrease) in the number of people living in a particular
geographical area.
AY

Birth rate: The number of live births for every Death rate: The number of deaths for every 1,000
1,000 people in a country in a year. An increase people in a country in a year. An increase may
may increase the size of the population. decrease the size of the population.

Fertility rate: The average number of children per Infant mortality rate: The number of babies who
TT

woman of childbearing age (15 to 44 years) in a die before their first birthday for every 1,000 live
country. births in a country in a year.

Immigration Emigration
CA

The movement of people into a country who will The movement of people out of a country to
reside there permanently. reside permanently elsewhere.

Net migration: Net inward migration Net outward migration

The difference between immigration into a Total immigration greater Total emigration greater
country and emigration out of a country. than total emigration than total immigration

Population growth rate: The rate of change as a percentage in the number of people residing in a
country.

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Subsistence economy: An economy in which people are self-sufficient, producing only enough to satisfy
their basic needs of food, clothing etc.
Ageing population: The increase in the median age of the population of a country over time.
Remittance: A sum of money sent by a worker in a foreign country to relatives in their home country.
Dependent population: Consists of people who do not earn an income themselves and rely on others to
provide the goods and services they need. Includes children, the elderly, the disabled etc

Why do population growth rate differ between countries:

1. Variations in birth rates between countries
2. Variations in death rate between countries

S
3. Variations in net migration between countries

IE
1. Variations in birth rate between countries for 2. Variations in death rates between countries
the following reasons: for the following reasons:
The cost of raising children: Age structure of the population:

UD
The higher the cost of raising children the lower the The higher the median age of the population,
birth rate the higher the death rate
Subsistence farming Access to healthcare:
Countries that heavily rely on subsistence farming Access to healthcare will obviously affect the
may have a high birth rate as many children are death rate. In developing countries many
ST
needed as labour to work the land. people die from treatable diseases increasing
Support for the old their death rate
It is important that a male heir is secured to take Lack of education and awareness.
care of the parents in old age in countries where In developing countries there is often a lack of
there are no welfare pension payments. education and awareness regarding nutrition,
AY

Infant mortality rate hygiene etc.., increasing the death rate.

The higher the infant mortality rate the higher the Higher incomes
birth rate will be in order to ensure that some In developing countries incomes are higher.
children survive to adulthood. This buys good nutrition and healthcare etc
TT

Social attitudes towards women at work which lowers the death rate.
Workers who work in well paid jobs will not have Safe drinking water and sanitation:
many children as it would mean they have to give In developing countries many diseases are
up work and the opportunity cost is too high. spread through unclear drinking and open
CA

Age of marriage sewers increasing their death rate.

In developed countries where women have well Health and safety laws.
paid jobs, they tend to marry later in life and In developed countries laws regarding health
therefore have less children. and safety are strictly implemented i.e. laws
A young population: regarding hygiene, workers safety. Moreover as
The younger the median age of the population, the most people work in the tertiary sector they are
more women will be of childbearing age and the engaged in less dangerous employment.
higher the birth rate. War and conflict.
Awareness and availability of contraception Developing countries tend to have more war
The greater the awareness and availability of and conflict (Yemen, Central African Republic)
contraception the lower the birth rate. and therefore a higher death rate.

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3. Variations in net migration between countries for the following reasons:

a) Movement in migrants
People tend to migrate from developing countries to developed countries. This slows population
growth in developing countries.
b) Movement of refugees
Refugees tend to leave developing countries and settle in developed countries.

Advantages and disadvantages to developing countries as a result of net outward migration

Advantages Disadvantages

S
- Emigrants send money back to relatives (remittances) - Highly skilled people emigrating from

IE
which increases their standard of living. developing countries is a brain drain and
- Emigrants may return to their country in the future and reduces the productive potential of the
bring their knowledge and skills they learnt in the economy in the long run.

UD
developed country, thus increasing the productive - Emigration may decrease the working
potential of the country. population, therefore decreasing the
- Emigration will slow population growth rate and help workforce and increasing the dependency
to ensure that overpopulation does not occur. ratio.
ST
Overpopulation Underpopulation

A situation where there are not enough resources A situation where some of the resources of a
to sustain the population of a country. country are left unused or wasted because there
are not enough people to fully exploit them.
AY

Overpopulation can lead to excess demand for Underpopulation can lead to excess supply of
resources such as food and housing as there are resources as there are not enough people to
too many people for the available resources. This make optimal use of the available resources,
can be remedied by: leading to wasted resources.
TT

● Decreasing the size of the population e.g. This can be remedied by:
China’s one child policy ● Increasing the size of the population
● Increasing the quantity or quality of through immigration etc
resources (SSPs) e.g. better use of land to ● Making more efficient use of the
CA

provide food etc resources

Optimal population: A situation where a population is sufficient to ensure that all resources in a
country are fully utilised and output is maximised. There is no shortage or surplus of resources.

Age distribution: The proportion of the population who fall into certain age groups, e.g. young (0-14)

Occupational mobility Geographical mobility

The ease with which an individual can change The ease with which an individual can change
from one job in a particular industry to a job in from one location to another for work purposes.
another industry.

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The effects of an increase in population size. The effects of a decrease in population size.

1. Increased competition for a country’s resources. 1. Lower demand in the economy:

water, food, housing is likely to experience increased Lower population = lower demand = lower
competition when a population increases. If the economic growth and higher unemployment.
country is already overpopulated this can lead to a 2. Lower productive capacity of the economy:
serious lack of resources for food etc. This can be Labour is a factor of production therefore a
remedied by importing extra resources, but this can decrease in population decreases the labour
lead to a Current Account deficit. force and decreases the productive capacity of
2. Overcrowding the economy.

S
In developing countries overcrowding leads to slums 3. Inefficient use of resources:
with the associated problems of inadequate If a country is underpopulated then a decrease

IE
sanitation. in population will lead to even greater
3. Increased demand for goods and services inefficiency in the use of its resources.
This increases AD and therefore employment as 4. Reduction in overcrowding:
labour is derived demand 5. Change in government spending:

UD
4. Competition for jobs If the population is decreasing due to a serious
Increased population = increased working epidemic such as HIV/AIDs which increases the
population increasing competition for low skilled death rate then this will lead to increased
jobs in particular (increased supply of labour). This spending on healthcare etc.
decreases wage rates and can cause poverty to If the population is decreasing due to a
ST
occur. Less of a problem for skilled workers as the decrease in the birth rate then this will lead to
supply is less. a decrease in spending.
5. Increase in the dependent population
An increase in population means more children who
are dependents, therefore the size of the dependent
AY

population increases.
6. Depletion of natural resources and higher
pollution levels.
Increased population -= increased demand for goods
TT

and services therefore they are depleted quicker and

pollution is greater.

Advantages of an ageing population: Disadvantages of an ageing population:

CA

1. Increase in productivity 1. Increase in dependent population

Older workers tend to have more Ageing population means more retired people and therefore
knowledge, skills and experience and an increase in the dependency ratio.
therefore older workers are often 2. Higher income taxes and increased government spending
more productive than younger In order for the government to cover the4 increased
workers leading to higher output and spending on pensions and healthcare of the increased
economic growth. elderly, income tax will have to be increased on the working
2. Indicator of high living standards population.

3. Shortage of workers

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5. Economic development Written by Cattaystudies

The working population as a percentage of the whole

population will decrease as the population ages and the
dependency ratio rises. This can reduce the productive
potential of the economy.
4. Reduced labour mobility
Younger workers tend to be more occupationally and
geographically mobile (as they are not yet fully tied to a
particular industry or region). As the population ages this will
decrease.

S
Government response to an ageing population:
1. Encourage people to have more children

IE
Some governments give young adults financial incentives to have more children. Also, quality subsidised
childcare so that both parents can return to work after childbirth is also used.
2. Raise the retirement age

UD
This keeps people in the working population for longer and out of the dependent population for longer,
thus decreasing the dependency ratio.
3. Encourage migration
4. Push towards capital intensive production of goods and services
Less reliance on labour.
ST
Population density: The number of people living in a certain area, usually one square kilometre.
Population pyramid: Shows the age and gender distribution of the population of a country.
AY

5.4 Differences in economic development between countries

Economics development: An improvement in the living standards and quality of life of the population of
a country as it transitions from being reliant on the primary sector for employment and output towards
TT

the secondary and tertiary sector.

Developed country Developing country

CA

A country that has high income and living A country that has a low income and is generally
standards with most of its economic activity reliant on the agricultural industry for its
based in the tertiary sector. employment and output.

Developed countries tend to have: Developed countries tend to have:

- Low GDP and low HDI ranking - High GDP and high HDI ranking
- Absolute poverty - No absolute poverty
- Difficulty in generating tax revenue and - A progressive taxation system that
therefore less/no welfare benefits such as finances welfare benefits such as
pensions and unemployment benefits pensions and unemployment benefits
- Lower levels of healthcare and education - Advanced healthcare and education
- Low life expectancy - High life expectancy

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- Poor infrastructure that makes private - Good infrastructure that encourages

sector investment more difficult private sector investment
- Very high percentage of workers in the - Very high percentage of workers in the
primary/secondary sector tertiary sector

Corruption: The dishonest behaviour of people in power for their own personal gain.

Difference Developed Developing

GDP per head Developed countries have well educated Developing countries have less well

S
highly skilled workforces that concentrate educated and skilled workforces that
on producing high value adding tertiary concentrate on producing low value

IE
sector services, therefore GDP per head is adding primary sector products,
high. therefore GDP per head is low.

UD
Distribution of Developed countries usually have Developing countries have difficulty in
income and progressive taxation which they use to generating tax revenue and therefore
wealth provide merit goods and welfare benefits less/no welfare benefits such as
narrowing the distribution of income and pensions and unemployment benefits
wealth. and less is spent on merit goods
ST
widening the distribution of income
and wealth.

Population Developed countries have slow (if any) Developing countries have high
growth population growth rates. population growth rates
AY

Size of Developed countries have the vast Developing countries have the vast
primary, majority of their labour force in the high majority of their labour force in the
secondary and wealth generating tertiary sector. low wealth generating primary sector.
TT

tertiary sectors

Saving and In developed countries: high incomes = In developing countries: low incomes =
Investment high savings = high investment in capital low savings = low investment in capital
CA

equipment = high productivity = high equipment = low productivity = low

incomes etc - virtuous circle incomes etc - vicious circle

Education In developed countries: high quality In developing countries: low quality

education = high productivity = high education = low productivity = low
incomes = high savings = high investment incomes = low savings = low
in capital equipment = high productivity = investment in capital equipment = low
high incomes etc - virtuous circle incomes etc - vicious circle (poverty
cycle)

Healthcare In developed countries: high quality In developing countries: low quality

healthcare = high productivity (fit and able healthcare = low productivity

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workforce) = high incomes = high savings = (workforce with illness and disease) =
high investment in capital equipment = low incomes = low savings = low
high productivity = high incomes etc - investment in capital equipment = low
virtuous circle incomes etc - vicious circle

Infrastructure Developed countries have good Developing countries have poor

infrastructure that encourages private infrastructure that makes private
sector investment sector investment more difficult

S
IE
UD
ST
AY
TT
CA

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6.1 International specialisation

Specialisation: This is a process by which individuals, firms, regions or countries concentrate on
producing those goods and services in which they have an advantage. Countries tend to specialise in the
goods that they are most efficient at producing, determined by the factor endowments
International trade: The importing and exporting of goods and services between countries
Factor endowments: The factors of production that a country has available to produce goods and
services

S
Specialising at the national level

Advantages Disadvantages

IE
Consumers ● Increased choice. Consumers have access ● External influences (prices and
to efficiently produced products from availability of products will be
abroad. affected by external factors, e.g.

UD
● Lower prices as goods will be produced exchange rate changes)
by the most efficient country ●

Firms ● Lower costs (as firms can grow by ● Reliance on imported raw
exporting to foreign markets they can materials that foreign countries
ST
benefit from economies of scale, have specialised in. Issues with
therefore lowering unit cost) getting supplies on time etc.
● Increased productivity (as factors of ● Exchange rate uncertainty
production as used to produce the goods (exchange rate changes will
that they are most suited to) influence import and export prices)
AY

Economy ● Increased output and therefore economic ● Overdependence (if there is a fall
growth (as the economy can focus on in demand for the products a
producing the goods and services that its country is specialised in this could
TT

factor endowments are most suited to) lead to widespread unemployment

● Increased efficiency. Producing what you and a fall in economic growth)
are best at makes the best use of the
world’s resources.
CA

6.2 Globalisation, free trade and protection

Globalisation: The integration of local markets into a single global market

Multinational companies (MNCs): An MNC is a business that produces in more than one country.
Home country Host country

A country where the MNC was originally established Any country in which an MNC produces that is
and where the headquarters is based not its home country

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Benefits of MNCs to their home country Costs of MNCs to their home country

1. Inflow of profit into home country from the 1. Loss of jobs when MNC moves abroad for
overseas operation of the MNC cheaper labour, which particularly affect workers
2. Improved reputation overseas of MNCs’ in the home country.
country as they produce high quality products, 2. Outflows of capital when building factories
leading to greater sales of products for other overseas
firms from the country

Benefits of MNCs to the host country Costs of MNCs to the host country

S
1. Lower unemployment as MNCs will need 1. Low skilled jobs may be the only ones created
workers in the host country for local workers as expats will fill the high skilled

IE
2. Lower prices for consumers as MNC will gain E jobs.
of S 2. Local firms may close as they cannot compete
3. Inflow of capital investment (FDI) with MNCs leading to unemployment
4. Increased economic growth as the goods and 3. Depletion of natural resources as MNC usually

UD
services produced by MNCs contribute to GDP need non-renewable resources
5. Transfer of knowledge and skills from MNC to 4. Exploitation of labour if MNC provide low wage
host country workers, which should lead to employment with poor working conditions
productivity of domestic in longer term 5. Outflow of profits to the home country
6. Increase in tax revenue - Corporation tax on 6. Increased pollution as production by NMC's
ST
MNCs’ profits, Income tax on MNCs’ workers will lead to higher levels of air, water and soil
7. Improved Current Account as MNC will usually pollution
increase exports 7. Limited tax revenue if host government offers
8. Local suppliers to MNCs will increase their generous tax breaks for MNC set up in host
profits country
AY

Free trade: The exchange of goods and services between countries without any government imposed
restrictions on volume or price (no tariffs, quotas etc)
Free trade agreement (FTA): An agreement between two or more countries to reduce restrictions on
TT

some or all products traded between them

Barriers to trade: Restrictions imposed by a government that prevents the free trade of exports and
imports between countries
CA

Advantages of free trade to Disadvantages of free trade to

Consumers ● Increased choice. ● Unequal distribution of the

● Free trade results in a greater variety of benefits of trade (e.g. those on
goods and services being available to lower incomes will not be able to
Consumers enjoy expensive luxury imports)
● Lower prices .
● Greater competition due to free trade
results in lower prices

Producers ● Access to overseas markets. ● Decreased sales for domestic firms

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● Increases sales revenue and profits due to competition from abroad

● Economies of scale
● Increased output for export leads to
lower costs per unit
● Improved innovation:
● Additional competition provides an
incentive for firms to innovate to
maintain competitiveness
● Imports of capital easier due to free
trade

S
Economy ● Lower unemployment: ● Higher unemployment:
● Sales of exports may create additional ● Increased competition from

IE
demand for labour foreign producers may lead to
● Lower inflation: unemployment
● Increased competition from foreign ● Environmental damage:

UD
imports may put downward pressure on ● As fossil fuels are used to
prices transport goods and services
● Unequal distribution of the gains
from trade:
● Poorer countries may be exploited
ST
for cheap labour the natural
resources
● May lead to a current account
deficit:
● If free trade leads to greater
AY

imports than exports

Protection (or protectionism): Occurs when a government imposes trade barriers (tariffs, quotas,
subsidies, embargoes) that restrict free trade between countries.
TT

Protectionist policy Advantages Disadvantages

Tariff: Tax on ● decreases the demand for ● consumers have to pay more for
imports. Increases imports imported goods
price and therefore ● the tariff provides tax revenue ● foreign governments may retaliate
CA

decreases the for the government with tariffs of their own leading to a
demand for imports. fall in exports

Quota: Physical limit ● protects domestic producers ● there is restricted access for domestic
on the number of from foreign competitors consumer to cheaper or better quality
imports of a ● limits imports (helps improve foreign products
particular good balance of payments) ● foreign governments may retaliate
with quotas of their own leading to a
fall in exports

Subsidies: Money ● Decrease the demand for ● Subsidies decrease the need for
given to producers imports as it makes producers to increase efficiency to

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in order to lower domestically produced produce at a lower price to stay

their cost of products cheaper competitive.
production and ● Subsidies given to exporting ● The domestic consumer must pay for
encourage an firms makes them more price the subsidy given to producers in the
increase in output. competitive internationally form of higher taxes.

Export subsidy A subsidy is designed to increase exports i.e. given to exporters

Embargoes A complete ban on the import of a product or all products from a certain
country.

S
Infant industry: An emerging or newly-established industry that is still too small to benefit from internal
economies of scale and is therefore unable to compete with large foreign rivals.

IE
Declining industry: An industry that is experiencing falling sales due to a change in the structure of the
economy.
Strategic industry: An industry that is important to the long term well being of a country.

UD
Dumping: The sale of imported goods at a price below what cost to produce them

Protectionism – reasons for:

1. Protecting domestic jobs. A government may feel that domestic industries need protection from
ST
overseas competition to safeguard domestic jobs
2. Protection of strategic industries. To ensure a country’s national security, many governments protect
defence related industries that do not enjoy comparative advantage. Most governments want to avoid
being dependent on military imports in case conflict develops with the supplier country.
3. Protecting infant industries (small strategic industries that need to be given a chance to grow without
AY

the pressure of competition).

4. Protect declining (sunset) industry
A declining industry is one which is no longer internationally competitive for a country e.g. shipbuilding
TT

in the UK declined because it lost competitiveness to South Korean firms.

5. Preventing dumping (overseas firms exporting goods at below cost price).
6. Raising tax revenue. A tariff is a tax; more tariffs equal more tax revenue for the government.
7. Improve Current Account. Tariffs and quotas will decrease imports, therefore improving the Current
Account position.
CA

Overall consequences of protectionism

Advantages Disadvantages

Consumers - Likely to increase the price of imported consumer goods

- Reduced choice for consumers and therefore a decrease
in living standards

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Firms - Increased protection for - Probable retaliation by foreign governments and

domestic industries and therefore a reduction in exports by domestic firms and
therefore greater sales therefore a decrease in sales revenue and employment.
revenue and employment - Increased cost of imported raw materials

Economy - Increased tax revenue - Retaliation by foreign governments and therefore a

from tariffs decrease in exports
- Decreased imports and - Cost-push inflation due to increased cost of imported raw
therefore a possible materials
current account - Inflation due to increased cost of finished goods

S
improvement
- Decreased
unemployment due to job

IE
protection

6.3 Foreign exchange rates

UD
Exchange rates: An exchange rate is the price of one country’s currency expressed in terms of another
country’s currency. For example: £1 = 1.5 euros.
ST
Appreciation – currency becomes stronger Depreciation – currency becomes weaker

When a currency increases in When a currency decreases in

strength/appreciates against another currency it strength/appreciates against another currency it
means that it can buy more of that currency due means that it can buy less of that currency due to
AY

to market forces. market forces

Foreign Exchange Market (Forex): The place where buyers and sellers meet to trade foreign currencies.
Floating exchange rate system: The value of a currency is determined by the market forces of demand
TT

and supply in the Foreign Exchange Market.

Fixed exchange rate system: When the price of a currency is fixed to another currency. Requires the
government to buy the currency when the value falls and sell the currency when the value rises.
CA

Revaluation Devaluation

An increase in the value of a currency due to A decrease in the value of a currency due to
government intervention in a fixed exchange rate government intervention in a fixed exchange rate
system system

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Factors affecting exchange rates in a floating exchange rate system

Demand ● Demand for a country’s exports

● Inward Foreign Direct Investment
● Interest rates. Number of foreigners wishing to deposit funds in a country
● Currency speculation

Supply ● Demand for imports

● Outward Foreign Direct Investment
● Interest rates. Number of a country’s citizens wishing to deposit funds abroad
● Currency speculation

S
Demand for ● If the demand for exports increase then the demand for that currency

IE
imports and increases (appreciation)
exports ● If the demand for imports increases then the supply of that currency increases
(depreciation)

UD
Inward and ● Inward investment (MNCs) into a country from foreigners will increase the
outward demand for a currency (appreciation)
foreign ● Outward investment (MNCs) from a country will increase the supply of a
investment currency (depreciation)
(MNCs)
ST
Interest ● ↑ interest rates in a country increases demand for its currency (more foreigners
rates wish to deposit funds in the country) (appreciation)
● ↓ interest rates in a country increases the supply for its currency (foreigners will
move their deposited funds out of that currency) (depreciation)
AY

Currency ● If speculators think the price of a currency will rise in the future they will buy it.
speculation This increases the demand for it (appreciation)
● If speculators think the price of a currency will fall in the future they will sell it.
This increases the supply of it (depreciation)
TT

SPICED acronym:
S tronger
CA

P ound (or another currency)

I imports
C heap
E xports
D ear (old fashioned work for expensive)

Advantages of having a strong currency

1) Cheaper imports can improve living standards
2) Cheaper imports can reduce costs for businesses that import raw materials. This can lead to
lower prices and lower inflation

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Advantages of having a weak currency

1) Exports appear cheaper in foreign countries. This increases demand for exports which leads to
higher AD, higher economic growth and lower unemployment
2) Can help improve the current account

Advantages of floating exchange rate Disadvantages of floating

exchange rate

1) Automatically stabilises the current account Disadvantages of floating

A Current Account deficit should lead to a depreciation in the value of a exchange rates:

S
currency because: 1) Increased uncertainty,
- Less is exported, therefore the demand for the currency falls making trade more
- More in imported → greater supply of a currency difficult.

IE
This depreciation of the currency will: Floating exchange rates
- Decrease the price or exports and therefore demand for exports means firms have more
should grow uncertainty when

UD
- Increase the price of imports and therefore demand for imports calculating the costs of
should fall their imported raw
This will help decrease a Current Account deficit. materials and the revenue
2) Because a floating exchange rate can move freely it does not need to from goods sold abroad.
be manipulated by interest rates. This leaves monetary policy free to
ST
pursue objectives such as low inflation. 2) Increased speculation
3) Because a floating exchange rate can move freely it does not need to which may destabilise the
be manipulated by the buying and selling of foreign reserves. value of the currency

Advantages of fixed exchange rates Disadvantages of fixed

AY

exchange rates

1) Reduced uncertainty for firms regarding prices of raw materials 1) Monetary policy can’t be
bought from abroad and revenue from goods sold abroad; encouraging used to achieve the
trade. government’s objectives
TT

2) Fixed exchange rates should ensure that there is no speculative 2) The central bank will
demand for the currency need to hold large amounts
3) Governments can manipulate the currency to benefit the economy. of foreign currency
For example, they can devalue the currency to boost exports and reserves
employment. 3) Selecting the correct
CA

exchange rate is difficult

6.4 Current account of balance of payments

Current Account: records all the international trade of goods & services and primary and secondary
incomes. The current account is part of the balance of payments. The balance of payments records all
transactions between one country and the rest of the world

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Current Account consists of:

1. Balance of Trade, ie export and import of physical goods, eg machinery, food (visibles)
2. Balance of Invisibles, ie export and import of services, eg banking, tourism, interest
3. Primary income (AKA income balance) measures the flow of Profit, Interest and Dividends into and
out of a country
4. Secondary income (AKA transfers) foreign aid paid overseas, money given to and received from the
EU (UK)

Credit and debit items: Any money flowing into a country’s current account is known as a credit item. Any money

S
flowing out is known as a debit item.
Balance of trade Balance of Invisibles:

IE
Export and import of physical goods, e.g. Export and import of services, e.g. banking,
machinery, food (visibles). tourism, interest, communications.

UD
When more goods are exported than imported When more services are exported than imported
there is a balance of trade surplus. there is a balance of invisible surplus.
When more goods are imported than exported When more services are imported than exported
there is a balance of trade deficit. there is a balance of invisibles deficit.
ST
Primary income Secondary income:

Earnings that come from a factor of production Income received through current transfers
(land, labour, capital or enterprise)
AY

Dividends: The portion of a firm's profit that is paid to shareholders who are the owners of the business.
Current transfers: A transfer is a sum of money that is given to an individual, firm or government but not
in payment for a good or service. For example government aid to foreign countries or money sent home
TT

by migrant workers.
Current Account Deficit Current Account Surplus

When the money flowing out of a country from When the money flowing into a country from
CA

trade in goods, services and primary and trade in goods, services and primary and
secondary income is greater than the money secondary income is greater than the money
flowing in. flowing out.

Net errors and omissions: A balancing item included in the balance of payments which accounts for
mistakes made in calculating inflows and outflows of money to and from a country
Foreign currency reserves: A store of foreign currency held in a country’s Central Bank.
Capital Account/Financial Account: A record of the money flowing into and out of the country from
investments, savings and foreign currency transactions to stabilise the exchange rate.

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Causes of a current account deficit Causes of a current account surplus

1. Strong exchange rate (cheaper imports 1. Weak exchange rate (expensive imports reduces
increases import spending, and expensive import spending, and cheaper exports increases
exports reduces export revenue) export revenue)
2. Higher inflation than trading partners 2. Lower inflation than trading partners (cheap
(increased export prices reduces export export prices increases export revenue)
revenue) 3. Low levels of consumer income (consumers less
3. High levels of consumer income (consumers likely to purchase luxury imports)
more likely to purchase luxury imports) 4. Use of protectionist policies (tariffs, quotas etc)

S
4. Lack of protectionist policies (tariffs, quotas 5. High productivity (this reduces unit costs,
etc) therefore could lead to lower prices and increased
5. Low productivity (this increases unit costs, exports)

IE
therefore could lead to higher prices and 6. MNCs (if MNCs are producing goods for exports
reduced exports) then this will increase export revenue)

UD
Impact of a current account deficit Impact of a current account surplus

1. Reduced GDP - (X-M) down therefore AD down 1. Increased GDP - (X-M) up therefore AD up
2. Higher unemployment (falling GDP and so falling 2. Lower unemployment (rising GDP and so
demand for labour as labour is derived demand) rising demand for labour as labour is derived
ST
3. Lower inflation (lower AD leads to less demand demand)
pull inflation) 3. Higher inflation (higher AD leads to demand
4. Weaker currency (falling demand for exports pull inflation)
mean less demand for the currency and increased 4. Stronger currency (rising demand for exports
demand for imports increases the supply of the mean more demand for the currency and
AY

currency) reduced demand for imports reduces the supply

of the currency)

How to remedy a current deficit

TT

1. Monetary/fiscal CA deficit normally in a boom → Government can use contractionary fiscal or

policy monetary policy to bring the economy out of a boom (imports income elastic).
However, this does have the negative effect of decreasing economic growth and
increasing unemployment.
CA

2. Protectionism – A government can reduce the amount of imports entering the country through
tariffs and quotas tariffs and quotas.
However, tariffs increase the price the consumer has to pay and may lead to
retaliatory action by foreign governments.

3. Protectionism - A government can give subsidies to exporting firms to make their goods more
subsidies price competitive internationally, therefore increasing exports.
However, the domestic consumer must pay for the subsidy given to producers
in the form of higher taxes, encourages inefficiencies and may lead to retaliatory
actions

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4. Devaluation A government can pursue a policy of targeting a lower exchange rate (exports
cheaper, imports expensive)
However, it does not remedy the underlying problem of why the current
account deficit occurred (country uncompetitive in goods and/or services).

5. Supply side Supply side policies, e.g. increased government spending on education, would
policies to increase increase productivity. This would lower firms’ unit cost and allow them to
productivity charge lower prices for exports.

S
IE
UD
ST
AY
TT
CA

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