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1.BASICECONOMICPROBLEM:
LEARNINGOUTCOMES:

At the end of this unit students will be able to:


define the nature of the economic problem (finite resources and unlimited wants);
define the factors of production (land, labour, capital, enterprise);
define opportunity cost and analyse particular circumstances to illustrate the concept;
evaluate the implications of particular courses of action in terms of opportunity cost.

1.1ProductionPossibilityCurve
:

Production Possibility
Curve/Production Possibility
Boundary/Production Possibility
Frontier
FromthepointofviewofanEconomy,thereisanopportunitycostofusingits
resources.ProductionPossibilitycurve(PPC)showsthemaximumcombinationsofgoodsand
servicesthatcanbeproducedbyaneconomyinagiventimeperiodwithitslimitedresources.

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Inthegraph,ifalltheresourcesareusedtoproduceSchoolsthentherewillbenoHospitals.If
youmovetotheotherendthenalltheresourceswouldbeusedtoproduceHospitalsandnot
Schoolswillbethereintheeconomy.Governmenthastomovealongthiscurveanddecidethe
bestpossiblecombinationofgoodstoproduce.ForexampleZ,showsthepossible
combinationsofSchoolbuildingsandHospitals.Thus,itisimpossibletobuildmoreSchools
withoutalsobuildingfewerHospitals.
ResourceshavetobeswitchedfrombuildingmoreHosipitalstobuildingmoreSchools.Thisis
knownasrellocationofresources.Beforetherellocationofresourceswewillhavetoconsider
thecostsofrellocatingtheseresourcesbetweenuses.Thiscostswillincluderetrainingcostof
ourworkforceandthetimeconsumedinthisrellocation.

AnypointoutsidethecurveisunattainableunlessthereisanoutwardshiftofthePPC.Thiscan
onlybepossibleifthereisanimprovementinthequantityand/orqualityoffactorsof
production.Thisisknownaseconomicgrowth.Itisaprocessofincreasingtheeconomys
abilitytoproducegoodsandservices

1.2FACTORSOFPRODUCTION:
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What are factors of Production?


Resourcesavailableonearthtomakegoodsandservicestosatisfyourneedsandwantare
limited.

Ineconomics,
factorsofproduction
(orproductive
inputs
)aretheresourcesemployedto
producegoodsandservices.Thesecanbecategorisedas
Land
:Allnaturalresourcesprovidedbynaturesuchasfields,forests,oil,gas,metalsandother
mineralresources.Thepaymentforlanduseandthereceivedincomeofalandownerisrent.
Labour:
Humaneffortusedinproductionwhichalsoincludestechnicalandmarketingexpertise.
Thepaymentforsomeoneelse'slabourandallincomereceivedfromonesownlabour
is
wages
.Labourcanalsobeclassifiedasthephysicalandmentalcontributionofanemployee
totheproductionofthegood(s).
Capital:
Humanmadegoods(ormeansofproduction)whichareusedintheproductionofother
goods.Theseincludemachinery,toolsandbuildings.
Enterprise:
Theskillandrisktakingabilityofthepersonwhobringstogetheralltheother
factorsofproductiontogethertoproducegoodsandservices.Usuallytheownerorfounderofa
business.

1.3
Scarcity, Choice and Opportunity cost:

Unlimited Wants

Humanbeings,inordertosurviveneedalotofthings.Someofthesethingsareveryimportant
forourexistence.Forexample,food,clothing,water,shelterandair.Thesethingscanbe
classifiedas
Needs
.Apartfromthistherearethingswhichareneededbyusbuttheyarenot
importantforoursurvivalandwecanlivewithoutthemalso.Forexample,goingonan
expensiveholiday,owninga57inchesPlasmaTV.Theseareknownas
Wants
.Thislistis
neverendingandiscontinuouslyincreasing.

Limited Resources
Ontheotherhand,wehavelimitedresourcestoproducethesegoodsandserviceswewant.
Therearenotenoughcarfactoriestoprovidecarstoeverybodyonearth.Everythingonthis

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planethassomelimitsexceptforourWants.
Whenunlimitedwantsmeetlimitedresources,itisknownasScarcity.

2.ALLOCATIONOFRESOURCES/Howthe
marketandmarketfailure:
LEARNINGOUTCOMES:

At the end of this unit students will be able to:


describetheallocationofresourcesinmarketandmixedeconomicsystems

demonstratetheprincipleofequilibriumpriceandanalysesimplemarketsituationswith
changesindemandandsupply

describethecausesofchangesindemandandsupplyconditionsandanalysesuchchangesto
showeffectsinthemarket

definepriceelasticityofdemandandsupplyandperformsimplecalculations

demonstratetheusefulnessofpriceelasticityinparticularsituationssuchasrevenuechanges,
consumerexpenditure

describetheconceptofmarketfailureandexplainthereasonsforitsoccurrence

evaluatethemeritsofthemarketsystem

defineprivateandsocialcostsandbenefitsanddiscussconflictsofinterestinrelationtothese
costsandbenefitsintheshorttermandlongtermthroughstudiesofthefollowingissues:

conservingresourcesversususingresource

publicexpenditureversusprivateexpenditure

2.1 What is demand?


Demandisdefinedaswantorwillingnessofconsumerstobuygoodsandservices.In
economicswillingnesstobuygoodsandservicesshouldbeaccompaniedbytheabilitytobuy
(purchasingpower)andisreferredtoaseffectivedemand.

Types of demand
Compositedemand:
Itiswhenagoodisdemandedfortwoormoreuses.Forexampleoilmay
beusedtorunacarorasafuelinafactory.
Jointdemand
:Itiswhentwogoodsareboughttogether.Mouseisboughtwithamousepad.
Deriveddemand:
Itiswhendemandforonegoodoccursasaresultofdemandforanother.
Example,Ifmoregoodsaremade,morelabourisneeded.Hencedemandforlabourisderived
demand.
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Law of demand
Itstatesthatwhenpriceincreases,theamountdemandedwillfallandwhenpricesfall,the
amountdemandedwillrise.
ThisphenomenonwhenplottedonagraphisknownasDemandCurve.

2.2
Changes in demand | extension, contraction, fall ,
rise
:

Movement along the demand


Curve
Extension of demand

Extensionofdemandistheincreaseindemandduetothefallinprice,allotherfactors
remainingconstant.

Contraction of demand
Contractionofdemandisthefallindemandduetotheriseinprice,allotherfactorsremaining
constant.

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Shift in the demand curve


Usuallydemandcurvesaredrawnbasedontheassumptionexceptforpriceallotherfactors
remainthesame.Buttheremightbeinstanceswhendemandmaybeaffectedbyfactorsother
thanprice.Thiswillresultinthechangeindemandalthoughthepricewillremainthesame.This
changeindemandmaycausethedemandcurvetoSHIFTinwardsoroutwards.

ShiftofdemandcurveOUTWARDSshowsanincreaseindemandatthesamepricelevel.Itis
knownasINCREASEINDEMAND.

ShiftofdemandcurveINWARDSshowsthatlessisdemandedatthesamepricelevel.Itis
knownasaFALLINDEMAND.

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2.3
Factors affecting demand:
Factors affecting demand:

Changeinpeoplesincome:
Morethepeopleearnthemoretheywillspendandthusthe
demandwillrise.Afallinincomewillseeafallindemand.
Changesinpopulation:
Anincreaseinpopulationwillresultinariseindemandandvice
versa.
Changeinfashionandtaste:
Commoditiesorwhichthefashionisoutarelessindemandas
comparedtocommoditieswhichareinfashion.Inthesameway,changeintasteofpeople
affectsthedemandofacommodity.
ChangesinIncomeTax:
Anincreaseinincometaxwillseeafallindemandaspeoplewill
havelessmoneyleftintheirpocketstospendwhereasadecreaseinincometaxwillresultin
increaseofdemandforproductsandservicesbecausepeoplenowhavemoredisposable
income.
ChangeinpricesofSubstitutegoods:
Substitutegoodsorservicesarethosewhichcan
replacethewantofanothergoodorservice.Forexamplemargarineisasubstituteforbutter.
Thusariseinbutterpriceswillseeariseindemandformargarineandviceversa.
ChangeinpriceofComplementarygoods:
Complementarygoodsorservicesaredemanded
alongwithothergoodsandservicesorjointlydemandedwithothergoodsorservices.Demand
forcarsisaffectedthechangeinpriceofpetrol.Sameway,demandforDVDplayerswillriseif
thepricesofDVDsfall.
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Advertising:
Asuccessfuladvertisingcampaignmayaffectthedemandforaproductor
service.
Climate:
Changesinclimateaffectsthedemandforcertaingoodsandservices.
Interestrates:
AfallinInterestratewillseeariseindemandforgoodsandservices.

2.4
What is supply
:
What is Supply?

Supplyreferstotheamountofgoodsandservicesfirmsorproducersarewillingandabletosell
inthemarketatapossibleprice.

Law of Supply
Itstatesthatwhenthepriceofacommodityrises,thesupplyforitalsoincreases.
Thehigherthepriceforthegoodorservicethemoreitwillbesuppliedinthemarket.The
reasonbehinditisthatmoreandmoresupplierswillbeinterestedinsupplyingthosegoodor
servicewhosepricesarerising.

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2.5
Changes in supply
:

Movement along the Supply


Curve
Extension of supply
Itreferstotheincreaseinsupplyofacommoditywiththeriseinprice,otherfactorsremaining
unchanged.

Contraction of supply
Itreferstothefallinsupplyofacommoditywhenitspricesfall,otherfactorsremaining
unchanged.

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Shift in Supply Curve


Whenfactorsotherthanpriceaffectthesupplyitresultsintheshiftofsupplycurve.Thesupply
curvemaymoveinwardoroutward.
Ashiftofsupplycurveoutwardstotherightwillmeananincreaseinsupplyatthesameprice
level.
Whenthesupplycurvemovesinwardstotheleftitmeansthatlessisbeingsuppliedatthe
samepricelevel.

2.6
Factors affecting supply
:

Factors affecting Supply


Priceofthecommodity:
Ariseinpricewillresultinmoreofthecommoditybeingsuppliedto
themarketandviceversa.
Pricesofothercommodities:
ForexampleifitismoreprofitabletoproduceLCDTVsthen
producerswillproducemoreLCDTVsascomparedtoPLASMATVs.Thusthesupplycurvefor
PLASMATVswillshiftinwardsi.e.afallinsupply.
Changeincostofproduction:
Increaseinthecostofanyfactorofproductionmayresultin
thedecreaseinsupplyasreducedprofitsmightseeproducerslesswillingtoproducethat
commodity.
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Technologicaladvancement:
Improvementintechnologyresultsinloweringofcostof
productionandmoreprofitsfortheproducerandthusmoresupplyofthatcommodity.
Climate:
Climateandweatherconditionsaffectthesupplyofcommoditiesespeciallyagricultural
goods.

2.7
Market Equilibrium | price determination:

Market Price-Equilibrium Price


Equilibriumpricecanbedefinedasthepriceatwhichthequantitydemandedisequaltothe
quantitysupplied.
MarketPricecanbedefinedasthepriceprevailinginthemarket.Pricesaredeterminedby
supplyanddemandforces.
ItisnotnecessarythatMarketPriceisequivalenttoEquilibriumprice.
Inthegraphbelowthepointatwhichthedemandcurvemeetsthesupplycurveisthe
equilibriumprice.

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Effect of change in Demand and


Supply
Demand Supply Equilibrium Equilibrium
price
quantity
Increase

Unchanged

Rise

Rise

Decrease

Unchanged

Fall

Fall

Unchanged

Increase

Rise

Rise

Unchanged

Decrease

Rise

Fall

2.8
Price Elasticity of demand:

Price Elasticity of demand


Theresponsivenessofquantitydemanded,orhowmuchquantity
demandedchanges,givenachangeinthepriceofgoodsorserviceis
knownasthepriceelasticityofdemand.

%changeinquantitydemanded
PriceElasticityofdemand(PED)=
%Changeinprice

Negative sign
Themathematicalvaluewhichisderivedfromthecalculationisnegative.Anegativevalue
indicatesaninverserelationshipbetweenpriceandthequantitydemanded.However,the
negativesignisignored.

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Range of PED
ThevalueofPEDmightrangefrom0to?
LetstakealookatvarioustypesofPED.

Perfectly Inelastic demand

InthiscasethePED=0Thatmeans,anychangeinpricewillnothaveanyeffectonthe
demandoftheproduct.Orinotherwords,thepercentagechangeindemandwillbeequalto
zero.Itishypotheticalsituationanddoesnotexistinrealworld.
PerfectlyelasticdemandInthiscasethePED=?
Thedemandchangesinfinitelyataparticularprice.Anychangeinpricewillleadtofallof
demandtozero.Itishypotheticalsituationanddoesnotexistinrealworld.
HoweverNormalgoodshavevalueofPEDbetween0and?.Thesecanbeclassifiedas
InelasticdemandWhenaproducthasaPEDlessthan1andgreaterthan0,itissaidtobe
haveaninelasticdemand.Thepercentagechangeindemandislessthanthepercentage
changeinpriceoftheproduct.

Demandforaproductissaidtobe
ELASTIC
ifthepercentagechangeisdemandismorethan
thepercentagechangeinprice.
ThevalueofPEDismorethan1.

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Whenthereisasmallerpercentagechangeinquantitydemandedascomparedtothe
percentagechangeinitsprice,theproductissaidtoprice
INELASTIC
.
ThevalueofPEDislessthan1.

Unitary Elastic Demand


Whenthepercentagechangeindemandisequaltothepercentagechangeinprice,theproduct
issaidtohaveUnitaryElasticdemand.Inshort,PED=1

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2.9
Cross elasticity of demand
:

Cross price elasticity of demand


(XED)
Crosselasticityofdemandis

theeffectonthechangeindemandofonegoodasaresultofachange
inpriceofrelatedtoanotherproduct.
Ineconomics,itisdenotedbythesymbolXED.
Theformulaforcrosselasticityofdemandis

%changeinquantitydemandedofgoodX
Crosselasticityofdemand=
%ChangeinpriceofgoodY
InXEDitisimportanttohavethepositive/negativesigninfrontofthevalue.
IfthevalueofXEDispositive,thismeansthatthetwogoodsbeingconsideredaresubstitute
goods.
Closesubstituteshavehighpositivevalue.Example:butterandmargarine.
Iftwogoodsarecomplements,anincreaseinthepriceofonewillleadtoareductioninthe
demandfortheothertheXEDisnegative.
Veryclosecomplementshavealowernegativevalue.
Iftwogoodsareunrelated,achangeinthepriceofonewillnotaffectthedemandforthe
othertheXEDiszero.

2.10
Income elasticity of demand
:

TheIncomeElasticityofDemand(YED)measurestherateofresponseofquantitydemanddue
toaraise(orlowering)inaconsumersincome.

Incomeelasticityofdemand=

%changeinquantitydemanded
%ChangeinIncome

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Normalgoods:
anincreaseinincomeleadstoanincreaseinconsumption,demandshiftsto
theright.ThusYEDispositivefornormalgoods.
Inferiorgoods:
Incomeelasticityisactuallynegativeforinferiorgoods,thedemandcurveshifts
leftasincomerises.Asincomerises,theproportionspentoncheapgoodswillreduceasnow
theycanaffordtobuymoreexpensivegoods.Forexampledemandforcheap/genericelectronic
goodswillfallaspeopleincomerisesandtheywillswitchtoexpensivebrandedelectronic
goods.
{xtypo_info}Distinguish,withreferencetoYED,betweennecessity(incomeinelastic)goodsand
luxury(incomeelastic)goods.{xtypo_info}
Basicornecessitygoodshavealowincomeelasticityi.e.,0<?<1.Quantitydemandedwillnot
increasemuchasincomeincreases(incomeelasticityforfood=0.2)
Luxurygoodshavehighincomeelasticityi.e.?>1.Quantitydemandedrisesfasterthan
income.Forrestaurantmealsincomeelasticityishigherthanforfood,becauseoftheadditional
restaurantservice.

Indifferenttypesofeconomies,thedemandforgoodsandservicesaredeterminedbythe
incomeelasticity.Aseconomiesgrow,firmswillwanttoavoidproducinginferiorgoods.The
reasonbeingasincomeincreasesmoreandmorepeoplewillswitchfrominferiorgoodsto
superiorgoods.

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2.11
What is an economic system
:

What is an Economic System?


Becauseofthefactthatthereisscarcityofresourcesandunlimitedwants,itisalwaysa
problemtoallocateresourcesinanefficientmanner.Weareconstantlyfacingthreebasic
questions.Theseare:

Whattoproduce?

Howtoproduce?

Forwhomdoweproduce?
Everycommunityorcountrymustchooseanddevelopitsownwayofsolvingtheseproblems.
Thewayacountrydecideswhattoproduce,howtoproduceandforwhomtoproduceiscalled
itEconomicSystem.
ThethreeEconomicSystemsexistingare:

MarketEconomicsystem

PlannedEconomicSystem

MixedEconomicSystem

Note:

TherearenoPUREcommandeconomies

TherearenoPUREmarketeconomies

Insteadthereisacontinuumofdifferentcharacteristics

2.12
Market economic system | features, advantages
and disadvantages
:

Thecentralthoughtofthissystemisthatitshouldbetheproducersandconsumerswhodecide
howtoutilisetheresources.Thus,themarketforcesdecidewhattoproduce,howmuchto
produceandforwhomtoproduce.

Features

Allresourcesareprivatelyownedbypeopleandfirms.

Profitisthemainmotiveofallbusinesses.

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Thereisnogovernmentinterferenceinthebusinessactivities.

Producersarefreetoproducewhattheywant,howmuchtheywantandforwhomtheywantto
produce.

Consumersarefreetochoose.

PricesaredecidedbythePricemechanismi.e.thedemandandsupplyofthegood/service.

Advantages

Freemarketrespondsquicklytothepeopleswants:
Thus,firmswillproducewhatpeople
wantbecauseitismoreprofitablewhereasanythingwhichisnotdemandedwillbetakenoutof
production.
WideVarietyofgoodsandservices:
Therewillbewidevarietyofgoodsandservices
availableinthemarkettosuiteverybodystaste.
Efficientuseofresourcesencouraged:
Profitbeingthesolemotive,willdrivethefirmsto
producegoodsandservicesatlowercostandmoreefficiently.Thiswillleadtofirmsusinglatest
technologytoproduceatlowercosts.

Disadvantages

Unemployment:
Businessesinthemarketeconomywillonlyemploythosefactorsof
productionwhichwillbeprofitableandthuswemayfindalotofunemploymentasmore
machinesandlesslabourwillbeusedtocutcost.
Certaingoodsandservicesmaynotbeprovided:
Theremaybecertaingoodswhichmight
notbeprovidedforbytheMarketeconomy.Thosewhichpeoplemightwanttousebutdont
wanttopaymaynotbeavailablebecausethefirmsmaynotfinditprofitabletoproduce.For
example,Publicgoods,suchas,streetlighting.
Consumptionofharmfulgoodsmaybeencouraged:
Freemarketeconomymightfindit
profitabletoprovidegoodswhichareindemandandignorethefactthattheymightbeharmful
forthesociety.
IgnoreSocialcost:
Inthedesiretomaximiseprofitsbusinessesmightnotconsiderthesocial
effectsoftheiractions.

2.13
Planned economy | features, advantages and
disadvantages
:

Inaplannedeconomy,the
factorsofproductionareownedandmanagedbythe
government
.ThustheGovernmentdecideswhattoproduce,howmuchtoproduceandfor
whomtoproduce.

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Features:

Allresourcesareownedandmanagedbythegovernment.

ThereisnoConsumerorproducersovereignty.

Themarketforcesarenotallowedtosetthepriceofthegoodsandservices.

Profitinnotthemainobjective,insteadthegovernmentaimstoprovidegoodsandservicesto
everybody.

Governmentdecideswhattoproduce,howmuchtoproduceandforwhomtoproduce.

Advantages

Pricesarekeptundercontrolandthuseverybodycanaffordtoconsumegoodsandservices.

Thereislessinequalityofwealth.

Thereisnoduplicationastheallocationofresourcesiscentrallyplanned.

Lowlevelofunemploymentasthegovernmentaimstoprovideemploymenttoeverybody.

Eliminationofwasteresultingfromcompetitionbetweenfirms.

Disadvantages

Consumerscannotchooseandonlythosegoodsandservicesareproducedwhicharedecided
bythegovernment.

Lackofprofitmotivemayleadtofirmsbeinginefficient.

Lotoftimeandmoneyiswastedincommunicatinginstructionsfromthegovernmenttothe
firms.

Examples of Planned economies

NorthKorea

Cuba

Turkmenistan

Myanmar

Belarus

Laos

Libya

Iran

Iraq(until2003)

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2.14
Mixed economy | features, advantages and
disadvantages
:

Mixed Economy

A
mixedeconomy
isaneconomicsystemthatincorporatesaspectsofmorethanone
economicsystem.Thisusuallymeansaneconomythatcontainsbothprivatelyownedand
stateownedenterprisesorthatcombineselementsofcapitalismandsocialism,oramixof
marketeconomyandplannedeconomycharacteristics.Thissystemovercomesthe
disadvantagesofboththemarketandplannedeconomicsystems.

Features

Resourcesareownedbothbythegovernmentaswellasprivateindividuals.i.e.coexistenceof
bothpublicsectorandprivatesector.

Marketforcesprevailbutarecloselymonitoredbythegovernment.

Advantages

Producersandconsumerhavesovereignty
tochoosewhattoproduceandwhattoconsume
butproductionandconsumptionofharmfulgoodsandservicesmaybestoppedbythe
government.
Socialcostofbusinessactivitiesmaybereduced
bycarryingoutcostbenefitanalysisby
thegovernment.
AscomparedtoMarketeconomy,amixedeconomy
mayhavelessincomeinequality
dueto
theroleplayedbythegovernment.
Monopolies
maybeexistingbut
underclosesupervision
ofthegovernment.

2.15
What is Market Failure
:

What is Market Failure?


Inamarketwherethereisequilibrium,theresourcesareallocatedinthebestpossiblemanner
andthereis'allocativeefficiency'.
AllocativeefficiencyiswhensituationwhereMarginalcostisequaltoMarginalrevenue.
However,thisisnotpossibleintherealworld.Marketfailureexistswhentheresourcesarenot
allocatedefficiently.Communitysurplusisnotmaximisedandthusthereismarketfailure.From
acommunity'spointofview,producersurplusisnotequaltoconsumersurplus.

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Marketfailureisthuscausedby

Abuseofmonopolypower

Lackofpublicgoods

Underprovisionofmeritgoods

Overprovisionofdemeritgoods

Environmentaldegradation

Inequalityindistributionofwealth

Immobilityoffactorsofproduction

Problemsofinformation

Shorttermism

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2.16
Social cost and Social benefit
:

Social Cost and benefits


Everybusinessactivitywhichtakesplacehassomebenefitsandcostsattachedtoit.The
benefitsgobothtotheownersofthefirmaswellastoexternalstakeholders.Inthesameway
theownersandtheexternalstakeholdershavetopayacostfortheactivitiesofthebusiness.
Talkingabout

Private cost
Itisthecostofsettingupthebusiness.Theowner(s)payforthehireofmachinery,buyingof
materials,paymentsofwages.ThisistermedasPrivateCost.

Private benefit
Themonetarybenefitsi.e.therevenueearnedbythefirmisabenefitfortheownerandis
termedasPrivatebenefit.

External Cost
Theproblemsthattheexternalstakeholdershavetobearduetothefirmsactivityareknownas
externalcost.Example:cleaningariverwhichhasbeenpollutedbyafirmswasteproducts.
Privatefirmsusuallyignoreexternalcost.

External benefits
Somefirmscancauseexternalbenefits.Thesearethebenefitstotheexternalstakeholdersdue
totheactivityoffirm.Forexample,afirmmaytrainworkers,whichmightgetthembetterwages
inotherfirms.Theseexternalbenefitsarefree.
Socialcostisthetotalcostpaidforbythesocietyduetotheactivitiesofafirm.Itisthesumof
alltheexternalcostandprivatecost.
Socialbenefitisthetotalbenefitarisingduetotheproductionofgoodsandservicesbyafirm.
Thisisequaltothetotalofprivatebenefitsandexternalbenefits.

3.
Individual as producer, consumer & brrower:
LEARNINGOUTCOMES:

describethefunctionsofmoneyandtheneedforexchange

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describethefunctionsofcentralbanks,stockexchanges,commercialbanks

identifythefactorsaffectinganindividualschoiceofoccupation(wagefactorsandnonwage
factors)

describelikelychangesinearningsovertimeforanindividual

describethedifferencesinearningsbetweendifferentoccupationalgroups(male/female
skilled/unskilledprivate/publicagricultural/manufacturing/services)

describetradeunionsandtheirroleinaneconomy

describethebenefitsanddisadvantagesofspecialisationfortheindividual

analysethedifferentmotivesforspending,savingandborrowing

discusshowandwhydifferentincomegroupshavedifferentexpenditurepatterns(spending,
savingandborrowing).

3.1
What is money?
Money
isanythingthatisgenerallyacceptedaspaymentforgoodsandservicesand
repaymentofdebts.

Functions of Money
A medium of exchange
Moneyovercomestheproblemofneedingadoublecoincidenceofwants.Itcanbeusedto
exchangeandisthereforeacomparativeobject,a
tertiumcomparationis
("athirdcomparative
unit").

A unit of account
Moneyactsasameasuringunitforvalue.Thusdifferentcommoditiescanbeexpressedin
termsofmoneyuniformly.Thissimplifiesthecomparisonofthevalueoftwoproductsor
services.

A store of value
Moneycanbeusedtostorevalue.Unlikebartersystemwherethecommoditiescouldnotbe
savedovertime,moneycanbestoredasitdoesnotlosevalueovertime.

A standard of deferred payment


Moneycanbeusedtopayovertimeforcommodities.Goodsandservicescanbepaidforin
instalmentsoveraperiodoftimee.ghirepurchase.Thiswasmuchmoredifficultand
complicatedinthebartersystem.

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3.2
Qualities of good money:
Followingarethequalitiesofgoodmoney:

General acceptance
Theessentialqualityofgoodmoneyisthatitshouldbeacceptabletoall,withoutanyhesitation
intheexchangeforgoodsandservices.

Portability
Itisalsoanimportantqualityofgoodmoneythatisshouldbeeasilytransferablefromoneplace
toanotherfordoingbusinessandmakingpayment.Thepapermoneyiseasiertocarrybecause
ithasminimumpossiblewaitthanmetallicmoney.

Storability
Moneyshouldbestorableanditshouldnotbedepreciatewithtime.Ifthemoneyusedis
perishableitwillloseitsvalueinfewdays.Papermoneyhasthisqualityofstorability.

Divisibility
Goodmoneyisthatwhichcouldbedividedintosmallunitswithoutlosinganyvalue.

Durability
Moneyshouldbedurable.Itshouldnotloseitsvaluewiththepassageoftime.Thegoldand
silvercoinsdonotwearoutquicklyandqualityofmoneyremainsthesame.

Economy
Itisimportantqualityofgoodmoneythatitshouldbemadeeconomically.Ifthereisheavycost
onissuingmoremoneythatisnotgoodmoney.Goodmoneyisthathaslowcostandmore
supply.Papermoneyhasthisqualityofeconomy.

3.3
Functions of Central Bank:

Central Banks

CentralBanksarechargedwithregulatingthesizeofanationsmoneysupply,theavailability
andcostofcredit,andtheforeignexchangevalueofitscurrency.Regulationoftheavailability
andcostofcreditmaybedesignedtoinfluencethedistributionofcreditamongcompetinguses.
Theprincipalobjectivesofamoderncentralbankincarryingoutthesefunctionsaretomaintain

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monetaryandcreditconditionsconducivetoahighlevelofemploymentandproduction,a
reasonablystablelevelofdomesticprices,andanadequatelevelofinternationalreserves.

Function of a Central Bank


Acentralbankusuallycarriesoutthefollowingresponsibilities:

Implementationofmonetarypolicy.

Controlsthenation'sentiremoneysupply.

TheGovernment'sbankerandthebankers'bank("LenderofLastResort").

Managesthecountry'sforeignexchangeandgoldreservesandtheGovernment'sstock
register

Regulationandsupervisionofthebankingindustry

Settingtheofficialinterestratesusedtomanagebothinflationandthecountry'sexchangerate
andensuringthatthisratetakeseffectviaavarietyofpolicymechanisms

3.4
Video Series | Role of Central Bank
:

TheprimaryobjectiveoftheECBsmonetarypolicyistomaintainpricestability.TheECBaims
atinflationratesofbelow,butcloseto,2%overthemediumterm.Theoperationalframeworkof
theEurosystemconsistsofthefollowingsetofinstruments:

Open market operations


Openmarketoperationsplayanimportantroleinsteeringinterestrates,managingtheliquidity
situationinthemarketandsignallingthemonetarypolicystance.
ClickhereonmoreinformationonOpenmarketoperations

Standing facilities
Standingfacilitiesaimtoprovideandabsorbovernightliquidity,signalthegeneralmonetary
policystanceandboundovernightmarketinterestrates.Twostandingfacilities,whichare
administeredinadecentralisedmannerbytheNCBs,areavailabletoeligiblecounterpartieson
theirowninitiative.
MoreinformationonStandingfacilities

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Minimum reserve requirements


Theintentoftheminimumreservesystemistopursuetheaimsofstabilisingmoneymarket
interestrates,creating(orenlarging)astructuralliquidityshortageandpossiblycontributingto
thecontrolofmonetaryexpansion.

3.5
Commercial Bank
:

Commercialbanksprovidebankingservicestobusinessesandconsumers.Theseareprofit
motivatedbusinesseswiththepowertomakeloansandacceptdeposits

fromcustomers.
Thenamecommercialbankwasfirstusedtoindicatethattheloansextendedwereshortterm
loanstobusinesses,thoughloanslaterwereextendedtoconsumers,governments,andother
nonbusinessinstitutionsaswell.Mostcommercialbanksofferavarietyofservicestotheir
customers,includingsavingsdeposits,safedepositboxes,andtrustservices.

Functions of Commercial banks


Commercialbanksareusuallyengagedinthefollowingactivities:

processingofpaymentsbywayoftelegraphictransfer,EFTPOS,internetbankingorother
means

Issuingbankdraftsandbankcheques.

acceptingmoneyontermdeposit

lendingmoneybywayofoverdraft,installmentloanorotherwise

providingdocumentaryandstandbyletterofcredit,guarantees,performancebonds,securities
underwritingcommitmentsandotherformsofoffbalancesheetexposures

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safekeepingofdocumentsandotheritemsinsafedepositboxes

Currencyexchange.

Sale,distributionorbrokerage,withorwithoutadvice,ofinsurance,unittrustsandsimilar
financialproductsasafinancialsupermarket.

3.6
Stock exchange | Its role in the economy
:

Stock Exchange

Itisanorganizedmarketforthesaleandpurchaseofsecuritiessuchas
shares,stocksandbonds.
Stockexchangesarelikemarketswherebuyersandsellersofshares,stocksandbondmeet.
Theseareknownassecondarymarket.
Oncesharesareissuedbycompanies,thesecanagainbeboughtorsoldthroughaStock
exchange.

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Role of Stock exchanges


Stockexchangeshavemultiplerolesintheeconomy,thismayincludethefollowing:

Raising capital for businesses


TheStockExchangeprovidescompanieswiththefacilitytoraisecapitalforexpansionthrough
sellingsharestotheinvestingpublic.

Mobilizing savings for investment


Whenpeopledrawtheirsavingsandinvestinshares,itleadstoamorerationalallocationof
resourcesbecausefunds,whichcouldhavebeenconsumed,orkeptinidledepositswith
banks,aremobilizedandredirectedtopromotebusinessactivitywithbenefitsforseveral
economicsectorssuchasagriculture,commerceandindustry,resultinginastrongereconomic
growthandhigherproductivitylevelsandfirms.

Facilitating company growth


Companiesviewacquisitionsasanopportunitytoexpandproductlines,increasedistribution
channels,hedgeagainstvolatility,increaseitsmarketshare,oracquireothernecessary
businessassets.Atakeoverbidoramergeragreementthroughthestockmarketisoneofthe
simplestandmostcommonwaysforacompanytogrowbyacquisitionorfusion.

Redistribution of wealth
Stocksexchangesdonotexisttoredistributewealth.However,bothcasualandprofessional
stockinvestors,throughdividendsandstockpriceincreasesthatmayresultincapitalgains,will
shareinthewealthofprofitablebusinesses.

Corporate governance
Byhavingawideandvariedscopeofowners,companiesgenerallytendtoimproveontheir
managementstandardsandefficiencyinordertosatisfythedemandsoftheseshareholders
andthemorestringentrulesforpubliccorporationsimposedbypublicstockexchangesandthe
government.

Creating investment opportunities for small


investors
Asopposedtootherbusinessesthatrequirehugecapitaloutlay,investinginsharesisopento
boththelargeandsmallstockinvestorsbecauseapersonbuysthenumberofsharestheycan
afford.ThereforetheStockExchangeprovidestheopportunityforsmallinvestorstoownshares
ofthesamecompaniesaslargeinvestors.

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Government capital-raising for development


projects
Governmentsatvariouslevelsmaydecidetoborrowmoneyinordertofinanceinfrastructure
projectssuchassewageandwatertreatmentworksorhousingestatesbysellinganother
categoryofsecuritiesknownasbonds.ThesebondscanberaisedthroughtheStockExchange
wherebymembersofthepublicbuythem,thusloaningmoneytothegovernment.

Barometer of the economy


Atthestockexchange,sharepricesriseandfalldepending,largely,onmarketforces.Share
pricestendtoriseorremainstablewhencompaniesandtheeconomyingeneralshowsignsof
stabilityandgrowth.Aneconomicrecession,depression,orfinancialcrisiscouldeventuallylead
toastockmarketcrash.Thereforethemovementofsharepricesandingeneralofthestock
indexescanbeanindicatorofthegeneraltrendintheeconomy.

3.7
Labour market | demand and supply of labour
:

What are wages?

WagesaretherewardtothefactorofproductionLabour.Wagesarealsoregardedasthe
Priceoflabour.Wagesarepaymentsmadetolabour.Priceoflabourisdeterminedbythe
marketforcesi.e.demandandsupply.

Demand for labour


Thedemandforlabourisaderiveddemand.Itmeansthatthedemandforlabourislinkedwith
theproductsorservicestheyproduce.Ifthedemandforthosecommoditiesrisesthedemand
forlabouralsorises.

Factors affecting the demand for


labour
Derived demand
Thedemandforlabourisalwaysderivedfromthedemandforthegoodorserviceitproduces.
Thusifthedemandforaparticulargoodsorserviceincreaseitwillleadtoariseindemandfor
labourusedtoproducethosecommodities.Recentlytherehasbeenanincreaseddemandfor
softwareprofessionalsduetotheincreaseddemandforITproducts.

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Wage rates
Afallinwageswillcauseanextensioninthedemandforlabourwhileariseinwagespaidto
workswillcauseacontractionindemand.

Technology used
Inindustrieswherethereisimprovedtechnologycanbeused,thedemandforlabourwilltendto
fallasproducerswillreplacelabourwithsophisticatedmachinery.

Supply of labour
Supplyoflabourincreaseswiththeriseinwagerate.Thesupplycurveoflabournormally
slopesupwardtotheright.

Factors affecting the supply of labour


Wage rate
Inmostcasesthesupplyoflabourwillincreasewiththeincreaseinwages.Thisisbecause
moreworkerswillbeattractedbyahigherwagerateandmoreovertheexistingworkforcemay
bewillingtoworkovertimeatahigherwagerate.

Size of the population


Anincreaseinpopulationwillleadtoanincreaseinsupplyoflabour.

Social factors
Withmoreandmorewomenenteringthelabourmarketthesupplyoflabourhasincreasedin
therecenttimes.

Working age
Loweringtheworkingageofwillincreasethesupplyoflabour.Anincreaseintheretirementage
willincreasethesupplyoflabour.

Educational requirement
Jobswhichneedspecialtrainingoreducationalqualificationswillseelesssupplyoflabouras
comparedtojobswhichdontneedhighlevelofeducationalqualification.

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3.8
Wage rate determination
:

How to wage rate is determined?


Thewagerateinaparticularindustryisdeterminedbythemarketforcesi.e.demandand
supply.
Thepointatwhichthedemandandsupplyoflabourwillintersectwilldeterminethewagerate
forthatparticularindustry.

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A rise in the demand for labour will


lead to a rise in the equilibrium wage
rate.

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A fall in the supply of labour will result


in a rise in the equilibrium wage rate.

3.9
Substitution and Income effect:

Substitution and Income effect


Asthepriceofagoodisraiseditssupplyalsoincreases.Thuswegetanormalupwardsloping
curve.Inthesameway,ahigherwageratewillinfluencepeopletoworkformorehours.This
wouldmeanthattheworkerwillspendlessonleisurebecausethepriceofleisurehasgoneup,
intermsofopportunitycost.Thisisknownas
Substitutioneffect.
Asaresult,thesupplycurvewillbeslopingupwards.Butwhenthehourlyraterisesabovea
certainlevelaworkermaywishtoworkfewerhoursperweek,becausehecanearnhigher
incomewithinashorterperiodoftime.Thisisknownas
Incomeeffect.
Thiswillresultinthe
supplycurvebendingbackward.
Thisisillustratedinthediagrambelow.

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3.10
Changing jobs at same wages:

Why workers change jobs at


same wages?
Therearemanytimeswhenaworkerdecidestomovetoanotherjobatthesamerateofpay
Thereasonsmightbe:

Sometimesworkersmovefromonejobtoanotheratthesamerateofpaybecausetheir
workingconditionsarenotgoodoracceptabletothemandtheyprefertochangejobeven
thoughtheyarenotpaidmore.

Theremaybetimeswhentheworkermayfindproblemsduetoextremeweatherconditionsor
geographicalfactors.

Workersalsochangejobsinexpectationofbetterprospectsofpromotionorprofessional
development,thoughtheyarenotgettinghigherwages.

Manyworkersmightfindthejourneytoworkverytiringandwouldprefertoworkclosetotheir
homes.

Someworkersmightrelocatetoalocationwhichtheypersonallylikeeventhoughtheymight
getthesamewages.

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Workinginlargecompanyisconsideredasastatussymbolbymanyworkersandtheymight
changejobtoworkinalargecompany.

ManybusinessesdontpayhighwagesbutcarefortheiremployeesbyprovidingFringe
benefitssuchassubsidisedmeals,healthscheme,leisureactivities.Thismayalsoinfluencea
workertomovetothesebusinesses.

3.11
Why work at low wages?

Theremaybetimeswhenaworkerwouldbepreparedtoworkforverylowwages?
Thereasonsmightbe

Theworkermightnotbeabletogetanotherjobandhastocontendwithlowwagestillhefinds
abetterpayingjob.

Lowskilledjobsusuallyhavelowwages.Theworkermightnotbetrainedtodoskilledjoband
thusgetlowwages.

Theworkermightchoosetoworkparttimeanddoesnotmindlowpay.Forexample,astudent
workingdoingaparttimejobtoearnhispocketmoneymaynotnegotiatetoomuchforhigher
wages.

Inthesameway,aworkermightviewthejobasatemporarymeasureuntilabetterjobis
availableandmaynotnegotiateforbetterwages.

Lackofinformationisalsoanimportantfactor.Workerswhodonotknowofalternativejobs
usuallylandupgettinglowerwages.

Agemaybeafactorwhichlimitstheworkertogethigherwages.

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3.12
Factors affecting individual's choice of job:

Factors affecting individual's


choice of job

Anindividualmightbeinfluencedbymanyfactorswhilechoosingajob.Thesefactorsare
dividedintowagefactorsandnonwagefactors.

Non-wage factors
Herearesomeofthenonwagefactorswhichmightinfluenceanindividual'schoice.

length/numberofholidays

workingconditions/environment

hoursofwork

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promotion/careerprospects

travellingdistance

sizeofcompany

social/canteenfacilities

provisionofinsurancescheme

companycar.

3.13 Why wages differ?


Reasonsfordifferencesinremuneration:

Skills/training:
Jobsrequiringhigherlevelofskillsandtrainingusuallyfetchhigher
remuneration
Education/qualifications:
Againjobsrequiringhigherlevelofeducation/qualificationarepaid
higherremunerations.
Experience:
Peoplewithvastexperiencewillgethigherremunerationascomparedtoaperson
withlesserexperience.
Levelofresponsibility:
Jobswithgreaterresponsibilitiesareusuallypaidmore.
Geographicalarea:
Jobslocatedinurbanareasareusuallycarryinghigherremunerations
becauseofhigherlivingcostsincities.Peopleworkingintrecherousgeographicalareasmay
getextraremunerationintheformofadditionalallowances.
Tradeunionmembership:
TradeUnionmembersmightendupnegotiatingbetter
remunerationsthennontradeunionmembers.
Demandfactors:
Firmsproducinggoodsandserviceswhicharehighindemandusuallypay
betterremunerationstotheirworkers.
Supplyfactors:
Industrieswherethereisashortageofworkerswillusuallypayhigher
remunerationtoattractworkers.

3.14
Factors affecting individual expenditure

Factors affecting individual


expenditure
Level of income/wealth

Anindividualwithhighincomewillusuallyspendmorethanapersonwhoseincomeisless.

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Family size and commitments


Anindividualwithalargefamilywillendupspendingmorefromhisincome.

Rates of interest
Wheninterestratesarehighpeopleusuallyspendlessassavingareamoreattractiveoption.

Availability of/knowledge about


savings schemes
Availabiliyandknoweledgeofsavingschemeswillresultinindividualsspendinglessandsaving
more.

Confidence in banking system


Astrongbankingsystemwillattractmoresavingsandhencelessspending.

Personal needs/lifestyle
Lifestyleofanindividualisamajordeterminentofhowmuchisspent.Individualsfollowing
lavishlifestyleswillendupsavinglessandspendingmore.

Health care
Individualshavinghealthissuesorpayingheavyhealthinsurancepremiumisoughttohave
moreexpenditureascomparedtoapersonhavinglessornohealthissuesornohealth
insurancepremiumliabilties.

Education
Peopleusuallywithhighereducationwillendupspendingmorecomparedtoalesseducated
person.Theprimereasonbeinganeducatedpersonwillhavevariedinterests.

Future expectations
Individualswhofeelmoreinsecuredabouttheirfuturewillsavemoreforthe'rainydays'and
hencehavewillspendless.

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3.15
Savings | Factors affecting savings

Saving

Savingisincomenotspent,ordeferredconsumption.

Factors affecting savings

Interestrates:
Higherinterestrateswillencouragepeopletosavemore.
Availabilityofappropriatesavingsschemes:
Withmoreoptionstosavemoneypeoplewill
beattractedtosavemore
Advertising
of/knowledgeaboutwhatisavailableatfinancialinstitutions
Confidence
/trustinfinancialinstitutions
Sizeofrealdisposableincome:
Disposableincomeistheincomeleftafterpayingtaxes.Thus
moremoneyleftinpocketswillencouragepeopletosavemore.
Rateofinflation:
wheninflationishighpeoplehavelessmoneyleftwiththemtosavebecause
amajorpartoftheirdisposableincomewillbespenttosatisfytheirneedsandwants.
Saveforafuturepurchase:
Peoplemightsavewiththemotivetocarryoutafuturepurchase
e.g.ahouse
Precautionaryfactors:
Peoplemightbesavingforarainyday
Tastesandpreferencesofconsumers:
Italsodependsonaindividualspreference.Some
peoplesavemorethanothers.
Consumerconfidence
/expectationsaboutfuturechangesintheeconomy,e.g.risk
ofunemploymentmayleadtopeoplesavingmore

3.16
Specialisation | Divsion of labour

Throughyears,productionhasdevelopedintoacomplicatedprocessandthusbrokendown
intoaseriesofhighlyspecialisedtask.Eachtaskisthenperformedbyaworker.Thisisknown
asDivisionofLabour.

Advantages of Division of Labour

Practisemakesperfect:
Workerspecialisesinaparticulartaskandgivesinthebest,thus
producinggoodsfasterandlesswastageofmaterial.
Useofmachinery:
Specialisedmachinerycanbeusedwhichisfurtherincreasethe
productivity.
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IncreasedOutput:
withimprovementinefficiencyanduseofmachineryoutputisincreased.
Savestime:
Thereisnotimewastedinswitchingofjobsandthusthemomentumofproduction
canbemaintainedwhichleadstolesswastageoftime.

Disadvantages of Division of Labour

Boredom:
Performingthesametaskoverandoveragainmayleadtoboredomfortheworkers.
Lackofvariety:
Thoughthenumberofgoodsproducedincreasesbuttheyareidenticalor
standardized.
Lowmotivationforworker:
Repeatedlyperformingthesametaskmayleadtolowmotivation
levelfortheworker.Theworkermightnothavethesenseoffulfillingacompletetaskasheis
performingonlyapartofthejob.
Lackofmobility:
Duetospecialisationworkersmightfinditdifficulttoswitchbetween
occupations.

3.17
What is a trade union ?

A
tradeunion
or
labourunion
isanorganizationofworkerswhohavebandedtogetherto
achievecommongoalsinkeyareassuchaswages,hours,andworkingconditions.Thetrade
union,throughitsleadership,bargainswiththeemployeronbehalfofunionmembersand
negotiateslabourcontractswithemployers.Thismayincludethenegotiationofwages,work
rules,complaintprocedures,rulesgoverninghiring,firingandpromotionofworkers,benefits,
workplacesafetyandpolicies.

ArallyofthetradeunionUNISONin
Oxfordduringastrike
Copyright
2006KaihsuTai

3.18
Why do workers join trade union?
Workersmightjoinatradeunionbecause

Theybelievethatthereisstrengthinnumberandtheywillbelistenedtowhentheyinagroup.

Tonegotiateabetterpay,moreholidaysandlesshoursofwork.

Topressurisetheemployertoprovidethemwithahealthierandsaferworkingenvironment.

Improvedbenefitsforretrenchedworkers

Togetthebenefitsofadvice,financialsupportandwelfareactivitiescarriedoutbyTrade
Unions.

Manyworkersmayalsojoinatradeunionbecausethereisa

closedshop

policy.

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Closed Shop
Itiswhereallemployeesmustbeamemberofthesametradeunion.

Single Union agreement


Itisanagreementbetweenthemanagementandworkers,wherethemanagementdealswith
onlyonetradeunionandnoother.

Collective bargaining
Itmeansthenegotiationsbetweenoneormoretradeunionsandoneormoreemployersonpay
andconditionsofemployment.

Productivity agreement
Itisanagreementbetweenthemanagementandworkerswherebythemanagementagreesto
increasethebenefitsforworkersinreturnforanincreaseinproductivity.

3.19
Types of industrial actions

Strike:
whenemployeesrefusetowork
Picketing:
Whenemployeesstandoutsidetheworkplaceandpreventthesmoothfunctioningof
thefirm.E.g.theymaystopthemovementofLorriesinandoutoffactory.
WorktoRule:
Itiswhenworkerspurposelyfollowalltherulesinordertodelaytheprogressof
work.
Goslow:
Itiswhentheemployeesworkataveryslowpace.
Noncooperation:
Itinvolvesworkersrefusingtofollowanewprocedureorrule.
Overtimeban:
Itiswhentheemployeesrefusetoworkovertimeorforadditionalhoursofwork
apartfromtheirnormalworkinghours.

4.
Private firm as producer and employer:

Learning outcomes

Attheendofthisunitstudentswillbeableto:
describethetypeofbusinessorganisationinthepublicandprivatesectors:soleproprietors,
partnerships,privatecompanies,publiccompanies,multinationals,cooperatives,public
corporations

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describeandevaluatetheeffectsofchangesinstructureofbusinessorganisations

describewhatdeterminesthedemandforfactorsofproduction

definetotalandaveragecost,fixedandvariablecostandperformsimplecalculations

analyseparticularsituationstoshowchangesintotalandaveragecostasoutputchanges

definetotalandaveragerevenueandperformsimplecalculations

describetheprincipleofprofitmaximisationasagoal

describepricingandoutputpoliciesinperfectcompetitionandmonopoly

describethemainreasonsforthedifferentsizesoffirms(sizeofmarket,capital,organisation)

describeandevaluateintegration,economiesanddiseconomiesofscale

discusstheadvantagesanddisadvantagesofmonopoly

4.1
What is a sole trader?

Thesoletraderiistheoldestandmostpopulartypeofbusiness.Itisaformofbusinesswhere
thereisonlyoneownerwhomanagesandcontrolsthebusiness.
Asoleproprietorship,isatypeofbusinessentitywhichlegallyhasnoseparateexistencefrom
itsowner.Hence,thelimitationsofliabilityenjoyedbyacorporationandlimitedliability
partnershipsdonotapplytosoleproprietors.Alldebtsofthebusinessaredebtsoftheowner.It
isa"sole"proprietorinthesensethattheownerhasnopartners.
Asoleproprietorshipessentiallymeansapersondoesbusinessinhisorherownnameand
thereisonlyoneowner.Asoleproprietorshipisnotacorporationitdoesnotpaycorporate
taxes,butratherthepersonwhoorganizedthebusinesspayspersonalincometaxesonthe
profitsmade,makingaccountingmuchsimpler.Asoleproprietorshipneednotworryabout
doubletaxationlikeacorporateentitywouldhaveto.
Asoleproprietormaydobusinesswithatradenameotherthanhisorherlegalname.Insome
jurisdictions,forexampletheUnitedStates,thesoleproprietorisrequiredtoregisterthetrade
nameor"DoingBusinessAs"withagovernmentagency.Thisalsoallowstheproprietortoopen
abusinessaccountwithbankinginstitutions.

Advantages to a Sole Proprietor


Anentrepreneurmayoptforthesoleproprietorshiplegalstructurebecausenoadditionalwork
mustbedonetostartthebusiness.Inmostcases,therearenolegalformalitiestoformingor
dissolvingabusiness.
Asoleproprietorisnotseparatefromtheindividualwhatthebusinessmakes,sodoesthe
individual.Atthesametime,alloftheindividual'snonprotectedassets(e.ghomesteador
qualifiedretirementaccounts)areatrisk.Thereisnotnecessarilybettercontrolorbusiness
administrationpossiblewithasoleproprietorship,onlyincreasedrisks.Forexample,asingle
membercorporationorlimitedcompanystillonlyhasoneowner,whocanmakedecisions
quicklywithouthavingtoconsultothers,buthastheadvantageoflimitedliability.

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Furthermore,inmostjurisdictions,asoleproprietorshipfilessimplertaxreturnstoreportits
businessactivity.Typicallyasoleproprietorshipreportsitsincomeanddeductionsonthe
individual'spersonaltaxreturns.Incomparison,anidenticalsmallbusinessoperatingasa
corporationorpartnershipwouldberequiredtoprepareandsubmitaseparatetaxreturn.
Asoleproprietorshipoftenhastheadvantageoftheleastgovernmentregulation.

Disadvantages to a Sole Proprietor


Abusinessorganizedasasoletraderwilllikelyhaveahardtimeraisingcapitalsincesharesof
thebusinesscannotbesold,andthereisasmallersenseoflegitimacyrelativetoabusiness
organizedasacorporationorlimitedliabilitycompany.
Itcanalsosometimesbemoredifficulttoraisebankfinance,assoleproprietorshipscannot
grantafloatingchargewhichinmanyjurisdictionsisrequiredforbankfinancing.
Hiringemployeesmayalsobedifficult.
Thisformofbusinesswillhaveunlimitedliability,sothatifthebusinessissued,theproprietoris
personallyliable.
Thelifespanofthebusinessisalsouncertain.Assoonastheownerdecidesnottohavethe
businessanymore,ortheownerdies,thebusinessceasestoexist.
Incountrieswithoutuniversalhealthcare,suchastheUnitedStates,asoleproprietorisalso
responsibleforhisorherownhealthinsurance,andmayfinddifficultyfindinganyifoneofthe
familymemberstobecoveredhasaprevioushealthissue.
Anotherdisadvantageofasoleproprietorshipisthatasabusinessbecomessuccessful,the
risksaccompanyingthebusinesstendtogrow.Tominimizethoserisks,asoleproprietorhas
theoptionofformingacorporation.IntheUnitedStates,asoleproprietorcouldalsoforma
limitedliabilitycompany,orLLC,whichwouldgivetheprotectionoflimitedliabilitybutwouldstill
betreatedasasoleproprietorshipforincometaxpurposes.

4.2
Partnership | features, advantages,
disadvantages
:

What is a Partnership?

A
partnership
isatypeofbusinessentityinwhich
partners
(owners)sharewitheachotherthe
profitsorlossesofthebusinessundertakinginwhichallhaveinvested.Partnershipsareoften
favoredovercorporationsfortaxationpurposes,asthepartnershipstructuredoesnotgenerally
incurataxonprofitsbeforeitisdistributedtothepartners(i.e.thereisnodividendtaxlevied).
However,dependingonthepartnershipstructureandthejurisdictioninwhichitoperates,
ownersofapartnershipmaybeexposedtogreaterpersonalliabilitythantheywouldas
shareholdersofacorporation.

Advantages of Partnership

Easy
tosetup
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Morecapital
canbebroughtintothebusiness.
Partnersbring
newskills
andideastoabusiness
Decisionmaking
canbemucheasierwithmorebrainstothinkaboutaproblem.
Partners
shareresponsibilities
anddutiesofthebusiness.
Divisionoflabour
ispossibleaspartnersmayhavedifferentskills.

Disadvantages of Partnership

Thereis
unlimitedliability
:Allthepartnersareresponsibleforthedebtsofthefirmandifthe
businessgoesbankrupt,allthepartnerswillhavetoclearthedebtseveniftheyhavetosellof
theirpersonalbelongings.
Disagreement
amongthepartnerscanleadtoproblemsforthebusiness.
Thereisa
limittothecapital
invested.Becauseofthefactthatmaximum20membersare
allowed,thebusinessmayfinditdifficulttoexpandafteracertainlimit.
Thereis
nocontinuity
ofexistence.Partnershipisdissolvedifoneofthepartnersdieor
resignsorbecomesbankrupt.

4.3
Partnership Deed
:

Beforestartingapartnershipbusiness,allthepartnershavetodrawupalegaldocumentcalled
a
PartnershipDeedofAgreement
.
Itusuallycontainsthefollowinginformation:

Namesofincludedparties
includesallnamesofpeopleparticipatinginthiscontract
Commencementofpartnership
includeswhenthepartnershipshouldbegin.Thedateofthe
contractisassumedasthisdate,ifnoneisgiven.
Durationofpartnership
includeshowlongthepartnershipshouldlast.Itisautomatically
assumedthatthedeathofoneofthecontractingpartiesbreaksthecontract,unlessotherwise
stated.
Businesstobedone
includesexactlywhatwillbedoneinthispartnership.Thissection
shouldbeveryparticulartoavoidconfusionandloopholes.
Nameoffirm
includesthenameofthebusinessentity.
Initialinvestments
includeshowmucheachpartnerwillinvestimmediatelyorbyinstallments.
Divisionofprofitsandlosses
includeswhatpercentagesofprofitsandlosseseachpartner
willreceive.Ifitisnotalimitedpartnership,thenthereisunlimitedliability(eachpartneris
responsibleforallpartners'debts,includingtheirown).
Endingofthebusiness
includeswhathappenswhenthebusinesswindsdown.Usuallythis
includesthreeparts:1)Allassetsareturnedintocashanddividedamongthemembersina
certainproportion2)onepartnermaypurchasetheothers'sharesattheirvalue3)allproperty
isdividedamongthemembersintheirproperproportions.
Dateofwriting
includessimplythedatethatthecontractwaswritten.
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4.4
Limited Companies | types, features and
advantages
Alsoknownas
Jointstockcompanies
.Thesearebusinesswhereanumberof
owner(shareholder)poolintheirresourcestodoacommonbusinessandtosharetheprofits
andlossesproportionally.
Inalimitedcompany,thedebtsofthecompanyareseparatefromthoseoftheshareholders.As
aresult,shouldthecompanyexperiencefinancialdistressbecauseofnormalbusinessactivity,
thepersonalassetsofshareholderswillnotbeatriskofbeingseizedbycreditors.Ownershipin
thelimitedcompanycanbeeasilytransferred,andmanyofthesecompanieshavebeenpassed
downthroughgenerations.

Difference between Limited companies and


partnership
Limitedcompaniescan
issueshares
whereaspartnershipbusinesscannot.
Shareholdersenjoy
limitedliability
inLimitedcompanies.Itmeansthatifthecompany
experiencefinancialdistressbecauseofnormalbusinessactivity,thepersonalassetsof
shareholderswillnotbeatriskofbeingseizedbycreditors.Whereaspartnershipbusinessdoes
nothavelimitedliabilityexceptforlimitedpartnerships.
SeparateIdentity:
Limitedcompaniesareconsideredashumanbeingsintheeyesofthelaw.
Theyarebornanddieintheeyesoflaw.Theycansueandgetsuedontheirownname.
Continuity:
Thereiscontinuityofexistenceinlimitedcompaniesandaretheirexistenceisnot
affectedbythedeath,bankruptcyorsicknessoftheirowner.ThisisnotthecaseinPartnership
orsoletraderbusinesses.
TherearetwomaintypesofLimitedcompanies.Theseare:

PrivateLimitedCompany

PublicLimitedCompany

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4.5
Private limited company | features, advantages,
disadvantages

Private limited Companies


Thesearecloselyheldbusinessesusuallybyfamily,friendsandrelatives.
Privatecompaniesmayissuestockandhaveshareholders.However,theirsharesdonottrade
onpublicexchangesandarenotissuedthroughaninitialpublicoffering.
Shareholdersmaynotbeabletoselltheirshareswithouttheagreementoftheother
shareholders.

Advantages
LimitedLiability:
Itmeansthatifthecompanyexperiencefinancialdistressbecauseofnormal
businessactivity,thepersonalassetsofshareholderswillnotbeatriskofbeingseizedby
creditors.
Continuityofexistence:
businessnotaffectedbythestatusoftheowner.
Minimumnumberofshareholdersneedtostartthebusinessareonly2.
Morecapitalcanberaisedasthemaximumnumberofshareholdersallowedis50.
Scopeofexpansion
ishigherbecauseeasytoraisecapitalfromfinancialinstitutionsandthe
advantageoflimitedliability.

Disadvantages
Growthmaybelimitedbecause
maximumshareholders
allowedareonly50.
Thesharesinaprivatelimitedcompany
cannotbesoldortransferred
toanyoneelsewithout
theagreementofothershareholders.

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4.6
Public Limited Companies and Stock Exchange
please visit this link to study more about 4.6 (
https://youtu.be/GnJCOof2HJk
)

4.7
Public Limited company | features, advantages,
disadvantages
LimitedcompanieswhichcansellshareonthestockexchangearePublicLimitedcompanies.
ThesecompaniesusuallywritePLCaftertheirnames.Minimumvalueofsharestobeissued(in
UK)is50,000.

Advantages

Thereis
limitedliability
fortheshareholders.
Thebusinesshas
separatelegalentity.
Thereiscontinuityevenifanyoftheshareholdersdie.
Thesebusinessescan
raiselargecapital
sumasthereisnolimittothenumberof
shareholders.
Thesharesofthebusinessare
freelytransferable
providingmoreliquiditytoitsshareholders.

Disadvantages

Therearelotof
legalformalities
requiredforformingapubliclimitedcompany.Itiscostlyand
timeconsuming.
Inordertoprotecttheinterestoftheordinaryinvestorthereare
strictcontrolsand
regulations
tocomply.Thesecompanieshavetopublishtheiraccounts.
Theoriginalownersmay
losecontrol.

PublicLimitedcompaniesarehugeinsizeandmayface
managementproblems
suchasslow
decisionmakingandindustrialrelationsproblems.

4.8
Franchsing | features, advantages, disadvantages

What is franchising?

Theterm"franchising"candescribesomeverydifferentbusinessarrangements.Itisimportant
tounderstandexactlywhatyou'rebeingoffered.

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Franchiseoccurswhentheownerofabusiness(thefranchisor)grantsalicencetoanother
personorbusiness(thefranchisee)tousetheirbusinessideaofteninaspecificgeographical
area.
Thefranchiseesellsthefranchisor'sproductorservices,tradesunderthefranchisor'strade
markortradenameandbenefitsfromthefranchisor'shelpandsupport.
Inreturn,thefranchiseeusuallypaysaninitialfeetothefranchisorandthenapercentageofthe
salesrevenue.
Thefranchiseeownstheoutlettheyrun.Butthefranchisorkeepscontroloverhowproductsare
marketedandsoldandhowtheirbusinessideaisused.
WellknownbusinessesthatofferfranchisesofthiskindincludeProntaprint,DynoRod,
McDonald'sandCoffeeRepublic.

Advantages and disadvantages of


franchising
Buyingafranchisecanbeaquickwaytosetupyourownbusinesswithoutstartingfrom
scratch.Buttherearealsoanumberofdrawbacks.

Advantages

Yourbusinessisbasedona
provenidea.
Youcancheckhowsuccessfulotherfranchisesare
beforecommittingyourself.
Youcanusearecognised
brandname
and
trademarks
.Youbenefitfromanyadvertisingor
promotionbytheownerofthefranchisethe"franchisor".
Thefranchisorgivesyou
support
usuallyincludingtraining,helpsettingupthebusiness,a
manualtellingyouhowtorunthebusinessandongoingadvice.
Youusuallyhave
exclusiverights
inyourterritory.Thefranchisorwon'tsellanyother
franchisesinthesameregion.
Financing
thebusinessmaybeeasier.Banksaresometimesmorelikelytolendmoneytobuy
afranchisewithagoodreputation.
Riskisreduced
andissharedbythefranchisor.
Ifyouhaveanexisting
customerbase
youwillnothavetoinvesttimelookingtosetoneup.
Relationshipswith
suppliers
havealreadybeenestablished.

Disadvantages

Costs
maybehigherthanyouexpect.Aswellastheinitialcostsofbuyingthefranchise,you
paycontinuingroyaltiesandyoumayhavetoagreetobuyproductsfromthefranchisor.
Thefranchiseagreementusuallyincludes
restrictions
onhowyourunthebusiness.Youmight
notbeabletomakechangestosuityourlocalmarket.
Thefranchisormightgo
outofbusiness,
or
change
thewaytheydothings.
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Otherfranchiseescouldgivethebranda
badreputation
.
Youmayfinditdifficultto
sell
yourfranchiseyoucanonlysellittosomeoneapprovedbythe
franchisor.
Reducedriskmeansyoumight
notgenerate

largeprofits
.

4.9
Cooperatives | features, types, advantages,
disadvantages

What is a Co-operative?
Acooperativeisdefinedasanautonomousassociationofpersonsunitedvoluntarily
tomeettheircommoneconomic,social,andculturalneedsandaspirationsthrough
ajointlyownedanddemocraticallycontrolledenterprise
.
Acooperativemayalsobedefinedasabusinessownedandcontrolledequallybythe
peoplewhouseitsservicesorwhoworkatit.
Therearedifferenttypesofcooperatives:

Housing cooperative
Ahousingcooperativeisalegalmechanismforownershipofhousingwhereresidentseither
ownsharesreflectingtheirequityinthecooperative'srealestate,orhavemembershipand
occupancyrightsinanotforprofitcooperativeandtheyunderwritetheirhousingthrough
payingsubscriptionsorrent.

Building cooperative
Membersofabuildingcooperative(inBritainknownasaselfbuildhousingcooperative)pool
resourcestobuildhousing,normallyusingahighproportionoftheirownlabour.Whenthe
buildingisfinished,eachmemberisthesoleownerofahomestead,andthecooperativemay
bedissolved.

Retailers' cooperative
Aretailers'cooperative(knownasasecondaryormarketingcooperativeinsomecountries)is
anorganizationwhichemployseconomiesofscaleonbehalfofitsmemberstogetdiscounts
frommanufacturersandtopoolmarketing.Itiscommonforlocallyownedgrocerystores,
hardwarestoresandpharmacies.Inthiscasethemembersofthecooperativearebusinesses
ratherthanindividuals.

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Utility cooperative
Autilitycooperativeisapublicutilitythatisownedbyitscustomers.Itisatypeofconsumers'
cooperative.IntheUS,manysuchcooperativeswereformedtoprovideruralelectricaland
telephoneservice.

Worker cooperative
Aworkercooperativeorproducercooperativeisacooperativethatisownedanddemocratically
controlledbyits"workerowners".Therearenooutsideownersina"pure"workers'cooperative,
onlytheworkersownsharesofthebusiness,thoughhybridformsinwhichconsumers,
communitymembersorcapitalistinvestorsalsoownsomesharesarenotuncommon.
Membershipisnotcompulsoryforemployees,butgenerallyonlyemployeescanbecome
members.However,inIndiathereisaformofworkers'cooperativewhichinsistsoncompulsory
membershipforallemployeesandcompulsoryemploymentforallmembers.Thatistheformof
theIndianCoffeeHouses.ThissystemwasadvocatedbytheIndiancommunistleaderA.K.
Gopalan.

Consumers' cooperative
Aconsumers'cooperativeisabusinessownedbyitscustomers.Employeescanalsogenerally
becomemembers.Membersvoteonmajordecisions,andelecttheboardofdirectorsfrom
amongsttheirownnumber.AwellknownexampleintheUnitedStatesistheREI(Recreational
EquipmentIncorporated)coop,andinCanada:MountainEquipmentCoop.
Theworld'slargestconsumers'cooperativeistheCooperativeGroupintheUnitedKingdom,
whichoffersavarietyofretailandfinancialservices.TheUKalsohasanumberofautonomous
consumers'cooperativesocieties,suchastheEastofEnglandCooperativeSocietyand
MidcountiesCooperative.
MigrosisthelargestsupermarketchaininSwitzerlandandkeepsthecooperativesocietyasits
formoforganization.
CoopisanotherSwisscooperativewhichoperatesthesecondlargestsupermarketchainin
SwitzerlandafterMigros.

Agricultural cooperative
Agriculturalcooperativesarewidespreadinruralareas.
IntheUnitedStates,therearebothmarketingandsupplycooperatives.Agriculturalmarketing
cooperatives,someofwhicharegovernmentsponsored,promoteandmayactuallydistribute
specificcomodities.Therearealsoagriculturalsupplycooperatives,whichprovideinputsinto
theagriculturalprocess.
InEurope,therearestrongagricultural/agribusinesscooperatives,andagriculturalcooperative
banks.Mostemergingcountriesaredevelopingagriculturalcooperatives.

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4.10
Multinational businesses

What are Multinational


Businesses?
Businesseswhichhavetheiroperations,factoriesandassemblyplantsinmorethan
onecountryareknownasMultinationalBusiness.Theyarealsoknownas
Transnationalbusinesses.

Advantages of being a Multinational

Multinationalcansetuptheirbusinessoperationsincountrieswherethe
labourandraw
materialischeaper
,whichcangivethemcostadvantageintheinternationalmarket.
Multinationalhaveaccesstomanymarketswhich
spreadstheriskoffailure
.Ifanyproduct
maynotbesuccessfulinaparticularmarket,itmightbesuccessfulinanother.
MNCsproduceinlargequantitiesthusachievinggreater
economiesofscales.

Amultinationalbusinessis
lessvulnerabletotradebarriers
.MNCssetuptheirlocal
operationsincountrieswherethereispotentialmarketforthemandgetawaywithimportduties
andrestrictions.
MNCscanlocatetheiroperationsnearthepotentialmarketwhichresultsin
lower
transportationcost
.

Advantages of Multinational to the host


country

Multinationalscreate
employment
.
Theybring
newtechnologyandtechniques
ofproduction.
MNCsusuallyprovide
training
totheirworkerwhichresultsinbetterskillsforthecountrys
workforce.
Multinationalbusinessesusuallyproduceinlargequantitiesandexporttoothercountrieswhich
canresultinvaluable
foreignexchange
forthehostcountry.
Theypayhuge
taxestothegovernment
whichcanbeusedforthedevelopmentofthehost
country.

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4.11
Sources of finance

Abusinessmighthaveaccesstovarioussourcesoffinancingitsneeds.Thesesourcesof
financecanbeclassifiedas:

Internal and external

Internal:
thisismoneyraisedfrominsidethebusiness.Itincludes
Salesofassets
:Businessmightselloffold,obsoleteassetswhicharenolongerusedbythe
businesstoraiseadditionalcashforthebusiness.

Advantage
Betteruseofcapital

Disadvantage
Anewbusinessmightnothaveany
oldorobsoleteassets

Retainedprofits:
Businesses(especiallylimitedcompanies)usuallykeepsomepartofthe
profiteveryyearforfutureuse.Thisisalsoknownasploughedbackprofit.Overaperiodof
timeitcantotaluptoahugeamountwhichcanbeusedforfinancingthebusiness.

Advantage Disadvantage

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Doesnotincrease
liabilities
Noneedtopayinterest

Notavailabletonewbusinesses

Reductioninworkingcapital
:Cuttingthestocklevelscanalsohelpthebusinesstoraise
additionalcash.

Advantage Disadvantage
Costsrelatedtostorageof Mayleadtoshortageofstock
stockisreduced
andlossofsales

4.12
External sources of finance | Long term, medium
and short term

External sources of finance


External:Thisisthemoneyraisedfromoutsidethebusiness.Itincludes

Short Term
Bankoverdraft:
Bankoverdraftisafacilitygivenbybankstoitsbusinesscustomers,people
havingcurrentaccounts.Throughthisfacilitythecustomerscanoverdrawtheiraccountstoa
greatervaluethanthebalanceintheaccount.Tooverdrawnamountisagreedinadvancewith
thebankmanager.Thebankassignsalimittooverdrawfromtheaccountandthebusinesscan
meetitsshorttermliabilitiesbywritingchequestotheextentoflimitallowed.

Advantage
Noneedforcollateralsorsecurity.
Moreflexibleandtheoverdraft
amountcanbeadjustedevery
monthaccordingtoneeds.

Disadvantage
Interestratesareusuallyvariable
andhigherthanbankloans
Cashflowproblemscanariseifthe
bankasksfortheoverdrafttobe
repaidatashortnotice.

TradeCredit:
Usuallyinbusinessdealingsuppliergiveagraceperiodtotheircustomerstopay
forthepurchases.Thiscanrangefrom1weekto90daysdependinguponthetypeofbusiness
andindustry.

Advantage

Disadvantage

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Nointeresthastobepaid.

Thebusinessmaynotgetcash
discounts.

Bydelayingthepaymentofbillsforgoodsorservicesreceived,abusinessis,ineffect,
obtainingfinancewhichcanbeusedformoreimportantexpenditures.

Factoringofdebts:
Itinvolvesthebusinesssellingitsbillsreceivabletoadebtfactoring
companyatadiscountedprice.Inthiswaythebusinessgetaccesstoinstantcash.

Medium Term
Hirepurchase:
Itinvolvespurchasinganassetpayingforitoveraperiodoftime.Usuallya
percentageofthepriceispaidasdownpaymentandtherestispaidininstallmentsforthe
periodoftimeagreedupon.Thebusinesshastopayaninterestontheseinstallments.
Leasing:
Leasinginvolvesusinganasset,buttheownershipdoesnotpasstotheuser.
Businesscanleaseabuildingormachineryandaperiodicpaymentismadeasrent,tillthetime
thebusinessusestheassets.Thebusinessdoesnotneedtopurchasetheasset.

Advantage

Disadvantage

Thebusinesscanbenefitfromtheasset Thetotalcostofleasingmayendup
withoutpurchasingit.
higherthanthepurchasingofasset
Usuallythemaintenanceoftheassetis
donebytheleasingfirm.

Mediumtermbankloan:
Abankloanfor1yearto5years.

Longterm

LongtermBankloan:
borrowingfrombankforalimitedperiodoftime.Thebusinesshasto
payaninterestontheborrowing.Thisinterestmaybefixedorvariable.Businessestakingloan
willoftenhavetoprovidesecurityorcollateralfortheloan.
Issueofshare:
Itisapermanentsourceoffinancebutonlyavailabletolimitedcompanies.
Publiclimitedcompaniescansellfurthersharesuptothelimitoftheirauthorizedsharecapital.
Privatelimitedcompaniescansellfurthersharestoexistingshareholders.

Advantage
Permanentsourceofcapital.
Incaseofordinarysharesbusinesswill
onlypaydividendsifthereisaprofit.

Disadvantage
Dividendshavetobepaidtothe
shareholders.

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Debentures:
A
debenture
isdefinedasacertificateofacceptanceofloanswhichisgiven
underthecompany'sstampandcarriesanundertakingthatthedebentureholderwillgetafixed
return(fixedonthebasisofinterestrates)andtheprincipalamountwheneverthedebenture
matures.Itisissuedforalongperiodsoftime.Debenturesaregenerallyfreelytransferrableby
thedebentureholder.Debentureholdershavenovotingrightsandtheinterestgiventothemis
achargeagainstprofit.
Salesandleaseback:
thisinvolvesafirmsellingitsassetsorpropertytoaninvestment
companyandthenleasingitbackoveralongperiodoftime.Thebusinessthuscanusethe
assetwithoutpurchasingitandcanusetherevenueearnedfromitssaleforotherpurposes.

4.13
What are resources

Resourcesofaneconomyarethefactorsofproductionortheinputswhichareusedtoproduce
anoutputi.e.goodsandservices.Thesecanbeclassifiedintofourcategories.

Land
Landincludesallresourcesfoundintheseaandonland.Theyarealsoknownasnatural
resources.Landissaidtobeimmobileandislimitedinsupply.Landissubjecttothelawof
diminishingreturns.
Lawofdiminishingreturnsstatesthatgivenafixedfactor,variablefactorsaddedtoitwill
eventuallyleadtoafallinmarginalproduct.

Labour
Labourreferstoinputofhumanefforts,bothphysicalandmental.However,onlythosehuman
effortsareconsideredineconomicsaslabourwhichhasthesolepurposeofreceivingrewards.
Anykindoflabourdoneforpleasureiscannotbeconsideredaslabour.
Labourhasgreatermobilitythanlandbutislessmobilethancapitalandcannotbestored.

Mobility of labour
Itreferstothemovementoflabour.Therearetwotypesoflabourmobility.Theseare:

Geographicalmobility
Itisthemovementoflabourfromplacetoanother.Buttherearemanybarrierstogeographical
mobilitywhichareasfollows:
1. Workersmayhaveinsufficientinformationorunawarenessoftheopportunitiesexistingin
differentplaces.
2. Sometimesagemaybeafactor.Olderworkersaremoreimmobilethanyoungerones.
3. Socialtiesorsentimentalreasonmaydiscourageworkerstomovetootherplaces.
Occupationalmobility
Itreferstothewillingnessandmobilityofworkertochangefromoneoccupationtoanother.
1. Labourmaylacknecessaryskillsandqualificationsneededtorelocatetoanotherjob.

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2. Certainoccupationmayhaveentryrequirementsandrestrictions.
3. Personallikingoftheoccupationmaydiscourageaworkertomovetootheroccupations.
4. Someworkersmaybetoocautiousintakingriskandmovingtoanotheroccupation.

Capital
Thesearemanmaderesourceswhichhelptoproducemanyothergoodsandservices.
Itcanbeclassifiedas:

Fixedcapital
Thesearephysicalassetswhichdonotvaryasthelevelofoutputvariesanditsformdoesnot
changeinthecourseofproduction.Examplesincludefactories,machines,anddockyardsand
soon.

Workingcapital
Itconsistsofstocksofrawmaterialsandstocksofsemifinishedandfinishedgoodsawaiting
purchaseofconsumers.Itvarieswiththelevelofoutput.Thus,whenoutputincreases,the
workingcapitalalsoincreases.

Entrepreneur
Entrepreneuristhepersonwhobringsallthefactorsofproductiontogetherandorganisesthem
toproducegoodsandservices.Anentrepreneurdecideswhattoproduce,howtoproduceand
forwhomtoproduce.

4.14
Location decisions

Factors affecting the choice of


location of a firm
Near to the Market
Themostimportantfactoraffectingthelocationofafirmisthenearnesstothemarket.Every
businesswantstobeneartoitscustomers.Thisisespeciallytrueforretailbusinesses.

Near to the raw materials


Incaseofmanufacturingfirmitismoreeconomicaltolocateneartothesourceofrawmaterial.
Thisresultsinlowtransportationcost.Iftheoutputofthefirmsismoreexpensivetotransport
thanitsinput,itisabulkdecreasingindustryandismorelikelytolocateneartothemarket.For
example,brewingindustrieslocateneartothemarketbecauseitisexpensivetotransport
finishedproduct.

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Ontheotherhand,iftherawmaterialusedbythefirmisbulkyandexpensivetotransport,itisa
bulkdecreasingindustry.Inthiscase,thefirmwouldlocateneartotherawmaterial.

Supply of labour
Ifafirmrequiresskilledlabour,thanthelocationdecisionmightbeaffectedbyavailabilityof
skilled,cheaplabour.ManymultinationalfirmsarelocatingtheirproductionfacilitiesinSouth
EastAsiancountriesjustbecausethelabourischeapinthesecountries.

Availability of cheap land


Firmswhichneedlargeareasoflandmightconsidercostoflandbeforelocating.Automobile
manufacturingplantsneedlargechunksofland.

Traditional locations
Locatinginanareathatcontainssimilarbusinesses,suppliersandmarketsmayalsobea
considerableadvantage.InIndonesia,mostofthewoodcraftbusinessesprefertolocateinBali
becauseofitslongreputationofproducingexcellentwoodcraft.

Amenities
Basicamenitiessuchasgas,electricity,water,wastedisposalanddrainagemayalsobe
considered.

Climate
Manyproductionprocessesmaybeaffectedbytheclimaticconditionsalso.Chipmanufacturers
prefertolocateindryareas,e.g.SiliconValley.

Safety requirements
Someproductsmaybehazardousforthecommunityandthusneedtobelocatedawayfrom
highdensitypopulation.Forexample,Nuclearpowerplants,Chemicalplants.

Managements Preference
Inmanycasesthelocationofafirmmaybeinfluencedbythelikesanddislikesofits
management.

Governments Influence
Governmentalsoinfluencesthelocationdecisionsofthefirms.Governmentmaygivespecial
incentivestofirmswhichlocateinunderdevelopedorhighunemploymentareasofthecountry.
TheseincentivesmaybeintheformofTaxholidays,subsidies,cheaplandetc.Afirminorder
toharnesstheseincentivesmaylocateintheseregions.

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4.15
Capital Intensive and Labour Intensive

Capital Intensive Vs. Labour


Intensive

Abusinessis
capitalintensive
ifitrequiresheavycapitalinvestmentinbuyingassetsrelative
tothelevelofsalesorprofitsthatthoseassetscangenerate.
Acapitalintensivebusinesswilltypicallyhavesomemixtureofthefollowingcharacteristics:
highdepreciationcosts

highbarrierstoentry

largeamountsoffixedassetsonthebalancesheet.

A
labourintensivebusiness
isoneinwhichthemaincostisthatoflabour,anditishigh
comparedtosalesorvalueadded.

Justacapitalintensivebusinessmayattempttoreduceoperationalgearingby,forexample,
leasingorrentingassets,alabourintensiveonemaytrytoreduceoperationalgearingby
outsourcingorautomation.

4.16
Meaning of Productivity

What is meant by Productivity?


Productivityistheratioofoutputstoinputs.Itreferstothevolumeofoutputproducedfroma
givenvolumeofinputsorresources.Ifthefirmbecomesmoreproductive,thenithasbecome
moreefficient,sinceproductivityisanefficiencymeasure.Productivitycanbe:

Labour productivity
Totaloutputinagiventimeperiod
= Outputperworker
Quantityoflabouremployed

Capital productivity
Totaloutputinagiventimeperiod

= Outputpercapitalinput

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QuantityorValueofCapitalemployed

How to improve productivity?


Productivitycanbeimprovedby:

Raisingtheskillleveloftheworkersthroughtraining

Usingmoretechnologicallyadvancedequipmentintheproductionprocess.

Improvingthemotivationleveloftheemployees

Bymanagingtheavailableresourceinamoreefficientway.

4.17
Types of cost | Fixed, variable, average, marginal
cost

What is Cost?
Allpaymentsmadebyafirmintheproductionofagoodorservicearecalledthecostof
production.Thesecostscanbeclassifiedindifferentways.

Types of costs
Fixed Cost and Variable cost
Fixedcosts
areexpensesthatdonotchangeinproportiontotheactivityofabusiness,
within
therelevantperiodorscaleofproduction
.Forexample,aretailermustpayrentandutilitybills
irrespectiveofsales.
Variablecostsbycontrastchangeinrelationtotheactivityofabusinesssuchassalesor
productionvolume.Intheexampleoftheretailer,variablecostsmayprimarilybecomposedof
inventory(goodspurchasedforsale),andthe
costofgoods
isthereforealmostentirely
variable.
Inmanufacturing,directmaterialcostsareanexampleofavariablecost.Anexampleof
variablecostsisthepricesofthesuppliesneededtoproduceaproduct.
Acompanywillpayforlinerentalandmaintenancefeeseachperiodregardlessofhowmuch
powergetsused.Andsomeelectricalequipment(airconditioningorlighting)maybekept
runningeveninperiodsoflowactivity.Theseexpensescanberegardedasfixed.Butbeyond
this,thecompanywilluseelectricitytorunplantandmachineryasrequired.Thebusierthe
company,themoretheplantwillberun,andsothemoreelectricitygetsused.Thisextra
spendingcanthereforeberegardedasvariable.

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Alongwithvariablecosts,fixedcostsmakeuponeofthetwocomponentsoftotalcost.Inthe
mostsimpleproductionfunction,totalcostisequaltofixedcostsplusvariablecosts.
Itisimportanttounderstandthatfixedcostsare"fixed"onlywithinacertainrangeofactivityor
overacertainperiodoftime.Ifenoughtimepasses,allcostsbecomevariable.
Inretailthecostofgoodsisalmostentirelyavariablecostthisisnottrueofmanufacturing
wheremanyfixedcosts,suchasdepreciation,areincludedinthecostofgoods.
Althoughtaxationusuallyvarieswithprofit,whichinturnvarieswithsalesvolume,itisnot
normallyconsideredavariablecost.
Variablecosts
areexpensesthatchangeinproportiontotheactivityofabusiness.Alongwith
fixedcosts,variablecostsmakeupthetwocomponentsoftotalcost.
DirectCosts
,however,
arecoststhatcanbeassociatedwithaparticularcostobject.Notallvariablecostsaredirect
costs,howeverforexample,variablemanufacturingoverheadcostsarevariablecoststhatare
notadirectcosts,butindirectcosts.
Forexample,amanufacturingfirmpaysforrawmaterials.Whenactivityisdecreased,lessraw
materialisused,andsothespendingforrawmaterialsfalls.Whenactivityisincreased,more
rawmaterialsisusedandspendingthereforerises.

Average cost per unit


Averagecost
isequaltototalcostdividedbythenumberofgoodsproduced.

Total cost/output

Itisalsoequaltothesumofaveragevariablecosts(totalvariablecostsdividedbyOutput)

Marginal cost
Marginalcost
isthechangeintotalcostthatariseswhenthequantityproducedchangesby
oneunit.Ingeneralterms,marginalcostateachlevelofproductionincludesanyadditional
costsrequiredtoproducethenextunit.So,themarginalcostsinvolvedinmakingonemore
woodentablearetheadditionalmaterialsandlabourcostincurred.

4.18
Production in Short run

Shortrunisaperiodoftimewhenatleastoneofthefactorsofproductionisfixed.Usually
labouristheeasiestfactortochange.Thusinshortrunafirmcanincreaseproductiononlyby
employingmorelabourbecausenomorelandorcapitalisavailable.Thus,labouristhevariable
factorintheshortrun.
'Shortrun'forvariousfirmsisdifferent.Itmaybefewdaysforsomeindustriesandmaybe
yearsforsomeindustries.

Production function
Itistheequationthatexpressestherelationshipbetweenthequantitiesofproductivefactors
(suchaslabourandcapital)usedandtheamountofproductobtained.Itstatestheamountof
productthatcanbeobtainedfromeverycombinationoffactors,assumingthatthemostefficient
availablemethodsofproductionareused.

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Principlesofeconomics,LibbyRittenberg

Law of increasing returns


Thisstatesthatasmoreunitsofvariablefactorareaddedtoafixedfactor,outputwillfirstrise
morethanproportionately.Thus,thefirmexperiencesincreasingreturns.

Law of diminishing returns


Thelawstatesthatasmoreunitsofavariablefactorareaddedtoafixedfactor,therewillcome
apointwhenoutputwillriselessthanproportionately.Thefirmexperiencesdiminishingreturns.

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Principlesofeconomics,LibbyRittenberg
Thisgraphshowsfirm'stotalproductcurvewiththerangesofincreasingmarginalreturns,
diminishingmarginalreturns,andnegativemarginalreturnsmarked.Thisfirmexperiences
increasingmarginalreturnsbetween0and3unitsoflaborperday,diminishingmarginalreturns
between3and7unitsoflaborperday,andnegativemarginalreturnsbeyondthe7thunitof
labor.

Marginal product
Marginalproductoflabouristhechangeintotaloutputwhenonemoreworkerisemployed.
Itcanbecalculatedas

Changeintotalproduct
Changeinnumberofworkers

Average product
Averageproductoflabouristhetotalproductdividedbythenumberofworkersproducingit.In
otherwords,outputeachworker.

Totalproduct
Numberofworkers

4.19
Diagrams |Cost curves in short run

Total Fixed Cost

Totalfixedcostwillremainconstanteventhoughoutputchanges.

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Average Fixed Cost


Averagefixedcostwillfallasoutputincreases.

Total Variable cost


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Asoutputincreases,totalvariablecostwillincreases.

Average Variable Cost


TheaveragecostcurveisUshaped.Asoutputincreases,averagevariablecostfallsbecause
ofspreadingofcost.

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Total Cost
Itcanbedefinedastotalvariablecostplustotalfixedcost.

Marginal Cost
Marginalcostwillinitiallyfall,reachtheminimumandfinallyrise.

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4.20
Production in the Long run | Cost curves

Production in the Long run

Inthelongruntherearenofixedfactorsofproduction.Allfactorsarevariable,andfirmsare
thereforeabletoadjusttheirinputofallfactorsofproduction.Theprocessofchangeofinputof
allfactorsofproductionisthechangeinthe
scaleofproduction
.
Whenafirmchangesitinputsbutthechangeinoutputismorethanthechangeinput,thefirms
issaidtobeexperiencing
increasingreturnstoscale.
Ontheotherhand,whenafirmsoutput
experiencesalessproportionateincreaseascomparedtotheincreaseininput,itissaidto
be
diminishingreturnstoscale
.
Afirmexperiencinganincreasedreturntoscalewillfinditsaveragecostsfalling.Thisistermed
as
economiesofscale
.Whereas,ariseinaveragecostofproductionduetodiminishingreturn
toscalearetermedas
diseconomiesofscale.

Long run cost curves


InthelongrunallthefactorsofproductionareVariableandafirmcanexpandordecreasethe
levelofoutputbyvaryingitsvariablefactors.
Thereisnotimedimensionastodeterminewhetheritisshortrunorlongrun.Whenthefirm
canalteritfixedfactors,itissaidtobealongrun.

Long run Total Cost (LRTC)


Itisthetotalcostincurredasaresultofproducingacommodityinthelongrun.Itcanstartfrom
0asthereisnotfixedcost.
Longruntotalcostwillinitiallyincreaseatadecreasingrateandthenatanincreasingratedue
tolawofreturntoscale.

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Long run Average Cost (LRAC)


ItisUshaped.Inthelongrun,asoutputincrease,theaveragecostwillfallduetointernal
economiesofscale.Asoutputincreasesfurther,averagecostwillremainconstantandifthe
outputisincreasedfurther,theaveragecostwillincreaseagainduetointernaldiseconomiesof
scale.

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4.21
Economies of scale

What are economies of scale?


Economiesofscalearethecostadvantagesthatenterprisesobtaindue
tosize,withcostperunitofoutputgenerallydecreasingwith
increasingscaleasfixedcostsarespreadoutovermoreunitsofoutput.

Type of economies of scale


Thesecanbeclassifiedintofivecategories:

Purchasing economies:
Whenbusinessbuysinlargequantities,theyareabletogetdiscountsandspecialprices
becauseofbuyinginbulk.Thisreducestheunitcostofrawmaterialsandafirmgetsan
advantageoverothersmallerfirms.

Marketing economies:
Thecostofadvertisinganddistributionrisesatalowerratethanrisesinoutputandsales.In
proportiontosales,largefirmscanadvertisemorecheaplyandmoreeffectivelythantheir
smallerrivals.

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Financial economies:
Alargercompanytendstopresentamoresecureinvestmenttheyfinditeasiertoraise
finance.Banksandotherlendinginstitutionstreatlargefirmsmorefavorablyandthesefirmsare
inapositiontonegotiateloanswithpreferentialinterestrates.Further,largecompaniescan
issuesharesandraiseadditionalcapital.

Managerial economies:
Alargecompanybenefitsfromtheservicesofspecialistfunctionalmanagers.Thesefirmscan
employanumberofhighlyspecializedmembersonitsmanagementteam,suchas
accountants,marketingmanagerswhichresultsinbetterdecisionbeingtakenandreductionin
overallunitcosts.

Technical economies:
Inlargescaleplantsthereareadvantagesintermsoftheavailabilityanduseofspecialist,
indivisibleequipmentwhicharenotavailabletosmallfirms.Largemanufacturingfirmsoftenuse
flowproductionmethodsandapplytheprincipleofthedivisionoflabour.Thisuseofflow
productionandthelatestequipmentwillreducetheaveragecostsofthelargemanufacturing
businesses.

4.22
Diseconomies of Scale

Diseconomies of Scale
Thesearethedrawbacksofbeingabigbusiness.Inotherwords,allthefactorsthoseleadtoan
increaseinaveragecostsasabusinessgrows.
Diseconomiesincludethefollowing:

Human relations
Itisdifficulttoorganizelargenumberofemployees.Thebusinessmightfinditselfspendingtoo
muchoncommunication.Theremightbelongchainsofcommandandinstructionswilltakea
longtoreachthedesireddestination.Moreovertheremightbedistortioninthemessage.There
willbelesspersonalcontactbetweendecisionmakersandstaff,whichcanleadtolowlevelof
morale,lackofmotivationandultimatelyindustrialrelationsproblems.

Decisions and co-ordinations


Therecouldbecoordinationproblems.Withalargerhierarchy,boththequalityofinformation
reachingfromthemanagementtotheworkersandviceversacouldleadtopoordecision
making.Therewouldbeconsiderablepaperworkandmanymeetings.

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External diseconomies
Recently,consumershavebecomemoreconsciousoftheactivitiescarriedoutbybigfirms.
Therefore,bigfirmshavetospendalotofmoneyonenvironmentalissuesandsocial
responsibilityact.Theseultimatelyleadtohigheraveragecostperunit.

4.23
What is revenue ?

What is revenue?
Itisthevalueofsalesofafirmsproducts.Itistheincomefromsalesofgoodsandservices.

QuantitysoldXPrice
TotalRevenue
isalsoknownasturnover.
Averagerevenuereferstotherevenueofthefirmbysellingperunitcommodity.Itiscalculated
as:
Totalrevenue/numberofproductssold
MarginalRevenue
isthechangeinthetotalrevenuefromthesaleofanadditionalunit.
Itiscalculatedas

Changeintotalrevenue/changeinquantity

4.24
Perfect Competition | Characteristics, Merits and
Demerits

Perfect Competition
Asituationwheretherearemanyfirmscompetinginthemarket,thereislotofcompetitionand
thefirmproducingthebestqualitygoodsandservicesatlowestpricewillbesuccessful.

Characteristics of Perfect Competition


Homogeneous products
Allfirmsproducetheidenticalproducts.

Many buyers in the market


Thoughtherearemanybuyersinthemarkettheycannotcontroltheprices.Theyareprice
takers.Thepricesaresetthroughthepricemechanism.

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Many sellers in the market


Therearemanysellersinthemarket.Thereisnodominatingfirm.Allfirmsareusuallysmall
andarepricetakers.

Perfect information
Allbuyersandsellershaveperfectknowledgeaboutthepricesinthemarket.

Freedom of entry and exit


Therearenobarrierstoentryandexitforfirms.Firmsarefreetoenterorexitthemarketattheir
discretion.Ifafirmismakingprofitotherfirmsmayenterthemarkettemptedbytheprofits.

No preferential treatment
Thereisnopreferencegiventoanyfirmbygovernmentoranybody.Allfirmsareequally
treated.

Merits of Perfect Competition

Thereisoptimalallocationofresourcesinthelongrun.

Maximumeconomicefficiencyasnosinglefirmcancontrolprices.Thereisnowastefulexcess
capacity.

Advertisingandpromotionalexpensesareeliminatedbecauseproductishomogeneousand
thereisperfectknowledgeamongtheconsumers.

Demerits of Perfect Competition

NoResearchandDevelopmentundertakenastheproductsarehomogeneous.

Pricesinperfectcompetitionarecontrolledbythepricemechanism.Itmayleadtoinstable
incomeandpricesduetofrequentchangeinequilibriumprices.

4.25
Monopoly | features, advantages, disadvantages

Monopoly

Monopolymeansamarketwherethereisonlyonesellerofaparticulargoodorservice.

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Characteristics

Onlyonesinglesellerinthemarket.Thereisnocompetition.

Therearemanybuyersinthemarket.

Thefirmenjoysabnormalprofits.

Thesellercontrolsthepricesinthatparticularproductorserviceandisthepricemaker.

Consumersdonthaveperfectinformation.

Therearebarrierstoentry.Thesebarriersmanybenaturalorartificial.

Theproductdoesnothaveclosesubstitutes.

Advantages of monopoly

Monopolyavoidsduplicationandhencewastageofresources.

Amonopolyenjoyseconomicsofscaleasitistheonlysupplierofproductorserviceinthe
market.Thebenefitscanbepassedontotheconsumers.

Duetothefactthatmonopoliesmakelotofprofits,itcanbeusedforresearchanddevelopment
andtomaintaintheirstatusasamonopoly.

Monopoliesmayusepricediscriminationwhichbenefitstheeconomicallyweakersectionsof
thesociety.Forexample,Indianrailwaysprovidediscountstostudentstravellingthroughits
network.

Monopoliescanaffordtoinvestinlatesttechnologyandmachineryinordertobeefficientandto
avoidcompetition.

Disadvantages of monopoly

Poorlevelofservice.
Noconsumersovereignty.
Consumersmaybechargedhighpricesforlowqualityofgoodsandservices.
Lackofcompetitionmayleadtolowqualityandoutdatedgoodsandservices.

5. Role of government in an economy

Learning Outcomes

Attheendofthisunitstudentswillbeableto
describethegovernmentasaproducerofgoodsandservicesandasanemployer

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describetheaimsofgovernmentpolicies,suchasfullemployment,pricestability,economic
growth,redistributionofincome,balanceofpaymentsstability

discussthepossibleconflictsbetweengovernmentaims

describethetypesoftaxation(direct,indirect,progressive,regressive,proportional)andthe
impactoftaxation

discussthegovernmentsinfluence(regulation,subsidies,taxes)onprivateproducers.

5.1
Economics objectives of Government

Mostofthegovernmentsroundtheworldhavefourmainobjectives.Theseare

Keepinflationundercontrol

Maintainalowlevelofunemployment

Achieveahighlevelofeconomicgrowthrate

Maintainahealthybalanceofpayments.

5.2
Government spending or expenditure

Governmentspending

or

governmentexpenditure

isclassifiedbyeconomistsintothree
maintypes.

Governmentpurchasesofgoodsandservicesforcurrentuseareclassed
as
government
consumption.
Governmentpurchasesofgoodsandservicesintendedtocreatefuturebenefits,suchas
infrastructureinvestmentorresearchspending,areclassedas
governmentinvestment
.
Governmentexpendituresthatarenotpurchasesofgoodsandservices,andinsteadjust
representtransfersofmoney,suchassocialsecuritypayments,arecalled
transferpayments
.

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5.3
Why do government spend

Therearemanyreasonsforgovernmentspending.Thesecanbe

To Provide Public goods


Publicgoodisthatgood,
consumptionbyoneindividualdoesnotreduceavailabilityofthe
goodforconsumptionbyothersandthatnoonecanbeeffectivelyexcludedfromusingthe
good.Thesegoodsareofimportancetothegeneralpublicandhenceareprovidedbythe
government.Exampledefence,streetlightingetc.

To provide Merit goods


A
meritgood
isacommoditywhichisjudgedthatanindividualorsocietyshouldhaveonthe
basisofanorm.Thegovernmentfeelsthateverybodyshouldenjoythesegoodsirrespectiveof
theirincomeForexample,healthandeducation.Inmostoftheeconomies,governmentsspend
amajorpartoftheirexpenditureonhealthandeducation.

To maintain and promote economic growth


Publicspendinghasanimportantroletoplayin
maintainandpromotingeconomicgrowth
in
theeconomy.Increasesingovernmentspendingonstateprovidedgoodsandservicesaddto
totaldomesticdemandandcanhavemultipliereffectsonthefinallevelofequilibriumnational
income.

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Ensure welfare of the state


Oneofthegovernmentsmainobjectiveistoprovidereducethegapbetweenrichandpoorand
thusgovernmentprovidesserviceslikehealthandeducationtotheeconomicallyweaker
sectionsofthesocietyfreeofcostoratasubsidisedrates.The
socialsecuritysystem
also
triestoprovidea
safetynet
forthosewhosufferunexpectedfallsinincomearisingfrom
unemployment,separationandbereavement.

5.4
Taxation | Purpose of taxation

Taxation

ATaxisafinancialchargeorotherlevyimposedonanindividualoralegalentitybyastateora
functionalequivalentofastate.Taxesconsistofdirecttaxorindirecttax.
Ataxmaybedefinedasa"pecuniaryburdenlaiduponindividualsorpropertytosupportthe
government[]apaymentexactedbylegislativeauthority."

Purposes of Taxation
Financing government spending:
Taxesarejustifiedastheyfundgovernmentexpenditureandactivitiesthatarenecessaryand
beneficialtosociety.

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Reduce gap between rich and poor


Progressivetaxationcanbeusedtoreduceinequalityinasociety.Accordingtothisview,
taxationinmodernnationstatesbenefitsthemajorityofthepopulationandsocialdevelopment.
Progressivetaxsystemwherehigherincomegroupshavetopaymoretaxisaneffectivewayof
reducinginequalityofincome.

Reduce consumption of demerit Goods


Taxescanbeusedasaneffectivetooltoreducetheconsumptionofdemeritgoodslikealcohol
andtobacco.Highertaxesonthesegoodsreducetheconsumption.Examplesincludecigarette
taxandexciseduty.

Control Inflation
Oneofthecausesofinflationis
toomuchmoneychasingtoofewgoods
.Governmentcan
takeawaytheextradisposableincomeofthepeoplethroughhighertaxesandthusreducethe
aggregatedemandintheeconomyandresultinginlowinflationrate.

Balance of payments
Tariffsaretaxesonimports.Governmentcancorrectanunfavourablebalanceofpayment
situationbyincreasingthetariffs.Thiswillresultinimportsbecomingexpensiveandwillcausea
fallindemandfortheimportedgoods.

Protecting local industries


Governmentusestaxesasameantoprotectlocal/infantindustries.Increasingtariffsonimports
andcharginglowertaxestolocal/infantindustriesmayboostthedemandforgoodsand
servicesproducedbydomesticindustry.

5.5
Classificationoftaxes|progressive,
regressive,proportional

Classificationoftaxes
Progressivetaxes
A
progressivetax
isataximposedsothatthetaxrateincreasesastheamountsubjectto
taxationincreases.Insimpleterms,itimposesagreaterburden(relativetoresources)onthe
richthanonthepoor.Itcanbeappliedtoindividualtaxesortoataxsystemasawhole.
Progressivetaxesattempttoreducethetaxincidenceofpeoplewithalowerabilitytopay,as
theyshifttheincidencedisproportionatelytothosewithahigherabilitytopay.Theresultis

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peoplewithmoredisposableincomepayahigherpercentageofthatincomeintaxthando
thosewithlessincome.

ExampleofProgressivetaxinNew
Zealand
Income(NewZealandDollar)

Taxrate(%)

Upto38,000

19.5

3800160,000

33

Above60,001

49

ExampleofProgressivetaxinAustralia
Income(AustralianDollar)

Taxrate(%)

Upto6000

600125000

15

2500175000

30

75001150000

40

Above150000

45

RegressiveTax
Theoppositeofaprogressivetaxisa
regressivetax
,wherethetaxratedecreasesasthe
amountsubjecttotaxationincreases.Itimposesagreaterburden(relativetoresources)onthe
poorthanontherich.Regressivetaxesattempttoreducethetaxincidenceofpeoplewith
higherabilitytopay,astheyshifttheincidencedisproportionatelytothosewithlower
abilitytopay.
Forexample,ifJanehas$10andJohnhas$5,ataxof$1onapurchasewouldresultina
differentpercentageoftotalincomeappliedtotaxation,20%forJohnand10%forJane.Thus,a
taxthatisfixedtothevalueofthegood/servicewouldlikely,ineffect,resultinahigherburden
oftaxationtopeoplewithlessmoney.

ProportionalTax
Aproportionaltaxisonethatimposesthesamerelativeburdenonalltaxpayersi.e.,wheretax
liabilityandincomegrowinequalproportion.Insimpleterms,itimposesanequalburden

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(relativetoresources)ontherichandpoor.Proportionaltaxesmaintainequaltaxincidence
regardlessoftheabilitytopayanddonotshifttheincidencedisproportionatelytothosewitha
higherorlowereconomicwellbeing.

5.6
Directtaxes|typesofdirecttaxes

Directtaxes

Taxeswhicharecollecteddirectlyfromincomeandwealthareknownasdirecttaxes.

TypesofDirecttaxes
Incometax
Incometax
iscollectedonallincomesreceivedbyprivateindividualsaftercertainallowances
aremade.InmostoftheeconomiesIncometaxisamajorsourceofGovernmentrevenue.

Corporationtax
Thistaxisleviedonprofitsearnedbycompanies.Itisaproportionaltaxwhichisleviedatthe
constantrate.

Petroleumrevenuetax
Itisataxleviedontheprofitsofcompaniesinvolvedindrillingofoilandgas.Thistaxmayor
maynotexistinothercountries.

Capitalgainstax
Capitalgainstaxischargedontheprofitrealizedonthesaleofanoninventoryassetthatwas
purchasedatalowerprice.Themostcommoncapitalgainsarerealizedfromthesaleofstocks,
bonds,preciousmetalsandproperty.Notallcountriesimplementacapitalgainstaxandmost
havedifferentratesoftaxationforindividualsandcorporations.

PropertyTax
ManycountrieshavePropertytax,ormillagetax.Itisthetaxwhichtheownerpaysonthevalue
ofthepropertybeingtaxed.
Thetaxingauthorityrequiresand/orperformsanappraisalofthemonetaryvalueofthe
property,andtaxisassessedinproportiontothatvalue.Formsofpropertytaxusedvary
betweencountriesandjurisdictions.

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Stampduty
Stampduty
isaformoftaxthatisleviedondocumentsrelatingtoimmovableproperty,stocks
andshares.Apartfromtransfersofsharesandsecurities,stampdutiesarealsochargedonthe
issueofbearerinstrumentsandcertaintransactionsinvolvingpartnerships.

5.7
Indirecttaxes|Valueaddedtax,exciseduty

IndirectTaxes

Indirecttax(suchassalestax,
valueaddedtax(VAT),
or
goodsandservicestax(GST))
isa
taxcollectedbyanintermediary(suchasaretailstore)fromthepersonwhobearstheultimate
economicburdenofthetax(suchasthecustomer).Theintermediarylaterfilesataxreturnand
forwardsthetaxproceedstogovernmentwiththereturn.Anindirecttaxmayincreasetheprice
ofagoodsothatconsumersareactuallypayingthetaxbypayingmorefortheproducts.
Exampleswouldbefuel,liquor,andcigarettetaxes.Anexcisedutyonmotorcarsispaidinthe
firstinstancebythemanufacturerofthecarsultimatelythemanufacturertransferstheburden
ofthisdutytothebuyerofthecarinformofahigherprice.Thus,anindirecttaxissuchwhich
canbeshiftedorpassedon.

AllIndirectTaxesareregressiveinnature.Thepoorwillfeelthepinchmorethantherich.

TypesofIndirectTaxes
ValueaddedTax
Valueaddedtax(VAT),orgoodsandservicestax(GST),isaconsumptiontaxleviedon
value
added
.Incontrasttosalestax,VATisneutralwithrespecttothenumberofpassagesthatthere
arebetweentheproducerandthefinalconsumerwheresalestaxisleviedontotalvalueat
eachstage,theresultisacascade(downstreamtaxesleviedonupstreamtaxes).
ExportsareconsumedabroadandareusuallynotsubjecttoVATVATchargedundersuch
circumstancesisusuallyrefundable.Thisavoidsdownwardpressureonexportsandultimately
exportderivedrevenue.
AVATisanindirecttax,inthatthetaxiscollectedfromsomeonewhodoesnotbeartheentire
costofthetax.

Exciseduties
Excise
dutyisatypeofindirecttaxchargedongoodsproducedwithinthecountry.
Lists
ofsuch
goodsarereadilyprovidedbygovernments.

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5.8
Fiscal policy and how it works

Fiscalpolicy
referstogovernmentpolicythatattemptstoinfluencethedirectionofthe
economythroughchangesingovernmenttaxesorthroughsomespending.
Thetwomaininstrumentsoffiscalpolicyare
governmentspending
and
taxation
.

Changesinthelevelandcompositionoftaxationandgovernmentspendingcanimpactonthe
followingvariablesintheeconomy:

Aggregatedemandandthelevelofeconomicactivity.

Thepatternofresourceallocation.

Thedistributionofincome.

How Fiscal Policy works?


Scenario one: High rate of Inflation
Highrateofinflationiscausedbytoomuchaggregatedemandintheeconomy.Government
willusedeflationaryfiscalpolicy.Governmentwilltrytoinfluenceaggregatedemandby
reducingitspublicspending.Thegovernmentwillspendlessonconstructionofroads,bridges
andotherpublicspendingandthusaggregatedemandwillfall.Ontheotherhand,Government
mayincreasethetaxrates.Anincreaseintaxrateswilltakeawaytheextradisposableincome
outpeoplespocketresultinginalowerdemand.

Scenario two: Low rate of Inflation


Inaneconomicrecession,aggregatedemand,outputandemploymentalltendtofall.Nowthe
Governmentwantstoincreaseemploymentintheeconomy,itcanattempttodosoby
increasingaggregatedemand.TheGovernmentwillincreasethepublicspendingresultingina
riseinaggregatedemand.Governmentmayreducethetaxratessothatpeoplehavemore
disposableincometospendandinstigatedemandintheeconomy.

5.9
Problems with Fiscal Policy

Reduce incentive to work

Raisingtaxesonincomeandprofitsreduceworkincentives,employmentandeconomicgrowth.
Anefforttoreduceaggregatedemandmaycausedisincentivestowork,ifthisoccurstherewill
beafallinproductivityandAggregatesupplycouldfall.

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Adverse effect of lowering Public Spending


ReducedgovtspendingtoIncreaseAggregatedemandcouldadverselyaffectpublicservices
suchaspublictransportandeducationcausingmarketfailureandsocialinefficiency.

Crowding out effect


Withanincreaseingovernmentexpenditure,therewillbegreatercompetitionforlimited
resources.Thiswilloffsetprivateinvestmentsresultinginshrinkingoftheprivatesector.

Inaccurate forecasting
IftheGovernmentsestimateorforecastingiswrongorinaccuratetheFiscalpolicywillsuffer.
Forexample,ifarecessionisexpectedandthegovernmentpractisesdeficitbudget,andyetthe
recessionturnsouttobeaboom,thiswillcauseinflation.

Implementation of the Policy


Planningforthespendingisdoneoncebymostofthegovernments.Ifthereisadelayinthe
implementationofthefiscalpolicy,itmightreducetheeffectivenessofthepolicy.Thusthetime
lagisimportant.

5.10
Monetary Policy

Monetarypolicy
istheprocessbywhichthegovernment,centralbank,ormonetaryauthorityof
acountrycontrols
1. thesupplyofmoney,
2. Availabilityofmoney,and
3. Costofmoneyorrateofinterest,
inordertoattaingrowthandstabilityoftheeconomy.
Monetarypolicyisgenerallyreferredtoaseitherbeinganexpansionarypolicy,ora
contractionarypolicy.
An
expansionarypolicy
increasesthetotalsupplyofmoneyintheeconomyandistraditionally
usedtocombatunemploymentinarecessionbyloweringinterestrates.
Contractionarypolicy
decreasesthetotalmoneysupplyandinvolvesraisinginterestratesin
ordertocombatinflation.
Itisarguedthatanincreaseinthemoneysupplycausesanincreaseintherateofinflation.
Maintainingalowandstableinflationisoneofthemainmacroeconomicobjectivesofthe
Government.Governmentdoessobycontrollingthesupplyofmoneytotheeconomy.This
policyisknownas
monetarypolicy.

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Monetarypolicyisconcernedwithcontrollingthesupplyofmoneyandtheinterestratesinthe
economy.Thegovernmentcannotcontrolboththesupplyofmoneyandinterestratesatthe
sametime.
MonetarypolicyinanycountryisusuallycontrolledbytheCentralBankofthatcountry.The
Centralbankalterstheinterestratesintheeconomyafterassessingtheinflationarypressures
inthemarket.

Evaluation of Monetary Policy


Monetarypolicyisconsideredtobemoresuccessfulduringinflationarytimesbecausean
increaseininterestratesreducestheborrowingsandthusstabilisestheprices.Whereas,
duringdeflation,Monetarypolicymaynotbeaseffective.Duringdeflationorrecession,thereis
uncertaintyinthemarketwhichdiscouragesentrepreneursandproducerstotakerisk.

5.11
Interest rates affect on economy

How a change in Interest rates


affects economy?
Controllingtheinterestratesaffectstheaggregatedemand,inflationrateandtheexchange
rate.

Scenario one: Increasing the interest rates


Anincreaseintheinterestrateswillreducethedemandforborrowingfromcustomersandfirms.
Iftheyborrowlessmoney,theywillhavelessmoneytospendandtheaggregatedemandwill
fallorrisemoreslowly.Moreover,individualswillbeencouragedtosavemoreduetohigh
interestrates.
Higherinterestratewillalsoraisethevalueofthecountrysexchangerateasmoreinternational
investorswillbeinterestedininvestingtheirmoneyinthecountry,togetbetterinterestrates.

Scenario one: Reducing the interest rates


Reducingtheinterestrateswillencouragepeopleandfirmstospendmoremoney.Asloans
becomecheaper,morepeoplewillbeinterestedintakingloansandpurchasinghousesand
cars.Evenfirmswillbeencouragedtoexpandasthecostofcapitalischeap,theywillfindit
easiertoraisefunds.Thiswillfueltheaggregatedemandintheeconomy.

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5.12
How the supply of money affects the economy

How the supply of money affects


the economy?
IftheGovernmentreducesthesupplyofmoney,banksandmoneylenderswillfindtheyhave
lessmoneytolendtopeopleandfirms.Thisshortageofthesupplyofmoneywillleadthemto
chargehigherinterestrate.Moreover,inordertoobtainmoremoneytheywillincreasethe
interestratestoattractsaverstoputmoneyindepositaccounts.Alltheseactionswillleadto
loweringtheaggregatedemandandthepriceswillcomedown.
Ontheotherhand,iftheGovernmentincreasesthesupplyofmoneytobanks,theywilllower
theinterestratesinordertoencouragepeopleandfirmstoborrowmore.Moreindividualsand
firmswillborrowthusboostingtheaggregatedemandandtheoutputoftheeconomy.Butifthe
increaseinsupplyisnotcalculatedproperlyitcanresultininflation.

5.13
How government controls the money supply

Moneysupplyincludesallthenotesandcoinsincirculationwiththepublicplusthemoneywith
banks.Italsoincludesthedepositsinbanksandbuildingsocieties.Thelaterismoresignificant
supplyofmoneyandisusuallythetargetofGovernmentsmonetarypolicy.Thewaysthrough
whichGovernmentcontrolsthemoneysupplyare:

Open market operations


Governmentusuallysellstreasurybillsandbondstoraisemoney.Privateindividualsinvestin
thesebondsandbillsinordertogetahealthyrateofinterest.Thisreducesthedepositswith
banksandthemoneysupply.

Variation of legal reserve requirements


Usually,thecommercialbankshavetomaintainacertainpercentageoftheirassetsasdeposit
withtheCentralBank.WhentheCentralBankwantstoreducemoneysupplyitwillincreasethe
limitofthedepositkeptbythebanks.Thecommercialbanksareleftwithlessmoneytolendto
theircustomers.

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5.14
Supply side policies

Mostsupplysidepoliciesaimtoenablethefreemarkettoworkmoreefficientlyandattemptto
promoteemployment,lowinflationandeconomicgrowth.ThemainideabehindSupplyside
policiesistoreduceGovernmentinterference.
Supplysidepoliciesinclude

Privatisation
Privatisationisthesellingofstateownedbusinessestoprivateindividualsandgroups.This
increasestheefficiencyoftheseorganisationsastheyfacemorecompetition.Profitmotive
increasestheincentivetoutilisetheresourcesinthebestpossibleway.

Deregulation
Deregulationinvolvesreducingbarrierstoentryinordertomakethemarketmorecompetitive.It
doesawaywithunnecessaryrulesandregulationsonbusinesswhichresultsinreducedcost,
increasedoutputandlowerprices.Moreover,itincreasesthecompetitionintheeconomy,
leadingtohigherefficiencyforbusinesses.

Increased education and training


Improvingthelevelofeducation,trainingandskillsoftheworkforcewillraisethelabour
productivityandincreasetheaggregatesupply.Governmentsusuallygivealotofimportanceto
educationandencouragemoreandmorepeopletoattenduniversitiesandcollegesand
enhancetheskillsoftheworkforce.

Labour Markets reforms


BycontrollingtheactionsofthetradeunionstheGovernmentcanensurethatthereisleast
disruptioninthebusinessactivities.

6. Economic indicators:

Learning outcomes
AttheendofthisUnitstudentswillbeableto

With regards to prices

describehowtheretailpriceindexiscalculated

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discussthecausesandconsequencesofinflation.

With regards to employment

describethechangingpatternsandlevelsofemployment

discussthecausesandconsequencesofunemployment.

With regards to output

defineGrossDomesticProduct(GDP)

describesimplemeasuresandindicatorsofcomparativelivingstandards,suchasGDPper
head,HumanDevelopmentIndex(HDI).

6.1 Inflation:

Measuring Inflation
The Retail price Index (RPI)

This is a price index that shows the general change in prices over
time as a %.
A hypothetical basket of goods and services which represents a
normal households spending.
The items are weighted to reflect the % of income spent on them.
Each month the prices of the goods & household spending patterns
are monitored and the RPI is calculated.
The index has a base year and the % change is measured from
this.

Causes of Inflation
Cost-Push Inflation

Increases in wages & raw material costs push production costs up


and result in higher prices.

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If increases in wages are matched by an increase in worker


productivity then unit costs should not rise.
A wage spiral may occur when workers demand higher wages
leading to higher prices & so workers then demand higher wages
again & so on.

Demand-Pull Inflation

Excess demand (an increase in demand without an equal increase


in supply) pulls prices higher.
Usually output can be increased to match demand but if there is full
employment then extra workers cannot be employed to increase
output. It could also be a shortage of a raw material that limits
supply.

Monetary

Increases in the money supply that are greater than increases in


output (more money chasing same output).
Can be classed as demand-pull inflation.

Effects of Inflation

The value of money falls (each $ buys less). Hyperinflation may lead
to loss in confidence of the currency.
Redistribution of income:
o

savers lose out as their savings lose real value & borrowers
gain as they repay less in real terms than they borrowed.
People on fixed incomes (pensioners, students) see their real
income fall unless it is index-linked (linked to the changes in
the rate of inflation).

Increased costs for firms: changing prices, labels, working out


future costs.

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Balance of Payments: increased prices make a countrys exports


less desirable & imports seem comparatively cheaper. This can
lead to further issues such as unemployment.

6.2 Unemployment:

Measuring Unemployment
Measured as the % of the labour force who are willing & able to work and
looking for a job.
Methods for measuring unemployment vary & generally the official rate is
lower than the actual number of people looking for work.

Types of Unemployment

Frictional unemployment
: people between jobs - tends to be short
term.
Structural unemployment
: industrial change over the long term
can leave sectors of the labour force with skills that the economy
no longer demands.
Seasonal unemployment
: labour only demanded at certain times
of the year (fruit pickers/ tour guides).
Cyclical unemployment
: high unemployment in times of recession.
Immobility of labour
: workers are generally fairly immobile (home,
family) & only seek work in their region.

Technology
: increases in technology have replaced some jobs and
reduced number of workers in others.
Minimum wage
: increased labour costs may force employers to
hire less workers.

Effects of Unemployment

Increases in unemployment lead to higher costs for the


Government (support & benefits) & at the same time less income for
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the Government (income tax). This could mean higher taxes for the
working population or reduced spending on
schools/hospitals/emergency services etc.

Increased unemployment means less output & so less goods and


services for people to share.
Increased costs to society through higher crime rates, higher health
bills (alcoholism/depression), increased rates of divorce.

6.3 Economic Growth:


Measuring Output

Gross Domestic Product (GDP)


Definition: The total value of the goods and services produced in an
economy over a given time period.
This is the standard measurement but there are several variations that
are used to provide a clearer picture of what is happening in the
economy.

Nominal GDP
: GDP valued using the current prices (no inflation
consideration).
Real GDP
: GDP that has had the effect of inflation removed.

Real GDP per capita


: average Real GDP per person in the country.
This allows any changes in the population size to be reflected.

Measuring Quality of Life


Human Development Index (HDI)
This is an index that takes into account 3 factors (each is an index itself):

Life expectancy index

Education index

Income index

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It generates a score between 0 and 1. The closer to 1 the higher the


quality of life.
It is considered a better measure of overall development then GNI or
GDP because it takes into account social factors aswell as purely
economic ones.

7. Developed and developing economies

Learning outcomes

At the end of this Unit students will be able to


describe why some countries are classified as developed and others are not;
recognise and discuss policies to alleviate poverty;
describe the factors that affect population growth (birth rate, death rate, fertility rate,
net migration) and discuss reasons for the different rates of growth in different countries;
analyse the problems and consequences of these population changes for countries at
different stages of development;
describe the effects of changing size and structure of population on an economy;
discuss differences in living standards within countries and between countries, both
developed and developing.

7.1
Difference between developed and developing
economy

Difference between developed


economy and less developed economy

Developed
Less
economy developed
economy
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Population

lowbirthrate
higherlifeexpectancy
lowdeathratedueto
bettermedicalfacilities
agingpopulation

Developingcountries
havehigherrateof
naturalincrease.Death
rateshavefallenfaster
thanbirthratesbirth
ratesaresignificantly
higherthanin
developedcountries,
whereasdeathratesare
onlysomewhathigher
thanindeveloped
countries.Tradition,lack
ofcontraception,
povertyandlackof
educationarethemain
causesofhigh
populationgrowthrate.

Education

Highlevelofliterary,
Highlytrainedworkforce.
Workersarepaidhigh
ratesofwages.

Lowlevelofliteracywith
lowskilllevelsofthe
workforceresultsinlow
wagesoftheworkforce.
Governmentisthemain
providerofeducation
servicesandhavelow
percentageofpublic
expenditureallocated
foreducation.

Economic
structure

Theseeconomies
usuallyhavealarger
tertiarysectorandmost
oftheworkforceis
engagedinservice
industries.Thecountry
producesandexports
hightechnologyproducts
orhighvalueadded
goods.

Primarysectoristhe
majorcontributortothe
GDPofthecountry.Low
GDPpercapitaisthere.
Usuallyexports
agriculturalgoodsor
naturalresourcesand
importsvalueadded
goodsfromdeveloped
countries.

7.2
Characteristics of a less developed economy

What are developing countries?


Thedevelopmentofacountryismeasuredwithstatisticalindexessuchasincomepercapita
(perperson)(GDP),lifeexpectancy,therateofliteracy.Countriesarecategorisedasless

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developedbecauseoftheirpovertyandlowaverageincomes,theirlackofgoodhuman
resourcesandtheirlowlevelofeconomicdiversification.
HOTQUESTION:
Explainwhatislikelytobetheoccupationaldistributionofthepopulationina
lessdevelopedcountry?
SUGGESTEDANSWER:
Mostoftheworkforceisengagedinagricultureandotherprimary
industries,withsomeinmanufacturingandsomeinserviceindustries.Manyofthesejobswill
bepoorlypaid.

Developingcountriesareingeneralcountrieswhichhavenotachievedasignificantdegreeof
industrializationrelativetotheirpopulations,andwhichhave,inmostcasesamediumtolow
standardofliving.Thereisastrongcorrelationbetweenlowincomeandhighpopulationgrowth.
Othertermssometimesusedarelessdevelopedcountries(LDCs),leasteconomically
developedcountries(LEDCs)

Characteristics of a less developed


economy
Theseeconomiesaremarkedbya

highbirthrate,

relativelyhighdeathrateand

alowlifeexpectancy

highpopulationgrowth

Highdependencyratio

LowGDPpercapita.

Lowerproportionofpopulationisenrolledineducation

Lowleveloflivingstandard

Poorhealthduetopoornutrition,lackofaccesstofacilitiessuchascleanwaterandproper
sanitation.

Healthcareprovisionsareofoftenpoor.

Structure of the Economy


Theseeconomiesaremorereliantonprimarysector.
Theyexportcertainprimarycommodities,agriculturalgoodsandlowtechnologyproducts.

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Advancedeconomies

Emerginganddevelopingeconomies(notleastdeveloped)

Emerginganddevelopingeconomies(leastdeveloped)

7.3
Example of Population Pyramid

The Population Pyramidwhat it


is and how it works
Bargraphsareahandywaytoillustratenumbers.Forexample,ifweweretographthenumber
ofmalesandfemalesinCanadaforvariousagegroupsaccordingtothe1961Census,the
resultwouldbetheillustrationsbelow.

(Clickonimagetoenlarge)

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Ifweweretodisplaythesegraphshorizontally,makeamirrorimageoftheoneforwomen,and
thenjointhemtogether,wewouldhavea
populationpyramid
exactlyasseenbelow.

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ThispopulationpyramidshowsataglancethedistributionoftheCanadianpopulationin1961.
Youcanseethatthepyramidnarrowstowardthetop.Thisisbecausethedeathrateishigher
amongolderpeoplethanamongyoungerpeople.
Therearealsoafewbulgesandnarrowerpartsinthemiddlepartofthepyramid.Forexample,
therearenotasmanypeopleintheir20sasintheir30sinCanadain1961.Thepeopleintheir
20sin1961werebornduringtheDepression,atimeofeconomichardshipinCanadawhen
peoplewerehavingfewerchildren.
In1961,thepyramidhadawidebase.Infact,whenweaddthepercentagesforthethree
lowestagegroups,wefindthat35%ofthepopulationwasunder15.Thesearethebaby
boomers,alargegroupofpeoplebornbetween1947and1966whentheeconomywas
growingandprospering.
Byanalysingpopulationpyramidsandidentifyingtrends,wecanlearnalotaboutoursociety.
Thesestatisticsgivegovernmentsandothersoneofthetoolstheyneedtomakeinformed
decisionsthatwillaffectourlivestodayandinthefuture.

StatisticsCanadainformationisusedwiththepermissionofStatisticsCanada.Usersare
forbiddentocopythedataandredisseminatethem,inanoriginalormodifiedform,for
commercialpurposes,withoutpermissionfromStatisticsCanada.Informationonthe
availabilityofthewiderangeofdatafromStatisticsCanadacanbeobtainedfromStatistics
Canada'sRegionalOffices,itsWorldWideWebsiteat
www.statcan.gc.ca,
anditstollfree
accessnumber18002631136.

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What is a developed economy?


Countrieswitheconomiesinwhichthetertiaryandquaternarysectorsofindustrydominateare
knownasdevelopedeconomies.Thislevelofeconomicdevelopmentisusuallydeterminedon
thefollowingfactors:

High income per capita


"
Highincomeeconomies"
aredefinedbytheWorldBankascountrieswithaGrossNational
Incomepercapitaof$11,456ormore.AccordingtotheUnitedNationsdefinitionsomehigh
incomecountriesmayalsobedevelopingcountries.Thus,ahighincomecountrymaybe
classifiedaseither
developed
or
developing
.

High Human Development Index (HDI)

The
HumanDevelopmentIndex
(
HDI
)isanindexcombiningnormalizedmeasuresoflife
expectancy,literacy,educationalattainment,andGDPpercapitaforcountriesworldwide.The
basicuseofHDIistorankcountriesbylevelof"humandevelopment",whichusuallyalso
impliestodeterminewhetheracountryisadeveloped,developing,orunderdevelopedcountry.

High gross domestic product (GDP) per


capita
Traditionally,CanadaandtheUnitedStatesinNorthAmerica,JapaninAsia,AustraliaandNew
ZealandandmostcountriesinNorthernEuropeandWesternEuropehavebeenconsidered
"developedcountries".TheseeconomiesgenerallyhaveapercapitaGDPinexcessof$10,000.

MapofDevelopedCountriesaccordingtotheCIAWorldFactbook2008

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7.4
Population

Pyramid

What is a Population pyramid?


A
populationpyramid
,alsocalled
agesexpyramid
and
agestructurediagram
,isa
graphicalillustrationthatshowsthedistributionofvariousagegroupsinapopulation(typically
thatofacountryorregionoftheworld),whichnormallyformstheshapeofapyramid.
Ittypicallyconsistsoftwobacktobackbargraphs,withthepopulationplottedontheXaxisand
ageontheYaxis,oneshowingthenumberofmalesandoneshowingfemalesinaparticular
populationinfiveyearagegroups(alsocalledcohorts).Malesareconventionallyshownonthe
leftandfemalesontheright,andtheymaybemeasuredbyrawnumberorasapercentageof
thetotalpopulation.

Young population
Generallyapopulationpyramidthatdisplaysapopulationpercentageofages114over30%
andages75andaboveunder6%isconsidereda"youngpopulation".
Thispatterngenerallyoccursindevelopingcountries,withahighagriculturalworkforce.

Ageing population
Apopulationpyramidthatdisplaysapopulationpercentageofages114under30%andages
75andaboveover6%isconsideredan"agingpopulation".
Usuallyfoundindevelopedcountrieswithadequatehealthservices,e.g.Australia).
Acountrythatdisplaysallornoneofthesecharacteristicsisconsideredneither.

Uses of Population pyramid

Populationpyramidscanbeusedtofindthenumberofeconomicdependentsbeingsupported
inaparticularpopulation.

Populationpyramidscanbeusedtoobservethenaturalincrease,birth,anddeathrate.

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7.5
Optimum Population

Optimum Population
Itisthenumberofpeoplethatwillproducethehighestpercapitaeconomicreturngiventhe
resourcesavailable,andtheirfullutilization.Shouldthepopulationriseorfallfromtheoptimum
theoutputpercapita,andstandardofliving,willfall.
Acountryissaidtobeunderpopulatedifithasinsufficientpeopletomakefulluseofthe
resourcesavailable.Ontheotherhandacountryisoverpopulatediftherearetoomanypeople
andfewresources.Therewillbediminishingreturns.

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7.6
Factors affecting population | Birth rate, death
rate, net migration

Factors affecting the population


The Birth Rate
Itistheaveragenumberofthechildrenborninacountrycomparedtotherestofthepopulation.
Inotherwords,itisthenumberofbirthsforevery1000peopleinthecountry.

Numberoflivebirths
Birthrate=

X1000
Totalpopulation

Factors affecting the birth rate in a country

Existingagesexstructure

Availabilityoffamilyplanningservices

Socialandreligiousbeliefsespeciallyinrelationtocontraceptionandabortion

Femaleemployment

Economicprosperity(althoughintheorywhentheeconomyisdoingwellfamiliescanaffordto
havemorechildreninpracticethehighertheeconomicprosperitythelowerthebirthrate).

Povertylevelschildrencanbeseenasaneconomicresourceindevelopingcountriesasthey
canearnmoney

InfantMortalityRateafamilymayhavemorechildrenifacountry'sIMRishighasitislikely
someofthosechildrenwilldie.

Conflicts

Typicalageofmarriage

The Death Rate


Thenumberofpeoplewhodieeachyearcomparedtoevery1000peopleinthepopulationis
knownasdeathrate.

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Death
rate=

numberof
deaths

X1000

Totalpopulation

Factors affecting Death rate in a country

Medicalfacilitiesandhealthcare

Nutritionlevels

Livingstandard

Accesstocleandrinkingwater

Hygienelevels

Levelsofinfectiousdiseases

Socialfactorssuchasconflictsandlevelsofviolentcrime

Net Migration
Emigration
iswhenapersonmovesoutofthecountry.
Immigration
iswhenapersonmovesintoacountry.
NetMigrationisthedifferencebetweenemigrationandimmigration
.

Ifnetimmigrationispositiveitwillleadtoapopulationincrease,anegativenetimmigrationwill
leadtoafallinpopulationofthecountry.

Dependency Ratios
Itisthenumberofpeopleinworkwiththetotalpopulationofthecountry.

Dependencyratio
=

TotalPopulation
Numberofpeopleinwork

DependentPopulationusuallyconsistsofchildren,students,housewives,theunemployedand
oldagepensioners.

Affects of increase in dependent population


Lowerstandardofliving
Anincreaseinthedependentpopulationwillmeanthatpeopleinworkhavemorepeopleto
supportandthusthelivingstandardofthecountrywillfall.

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Balanceoftrade
Ifthepeopleinworkcannotproduceenoughgoodsandservicestosatisfytheneedofthe
growingdependentpopulationthenthecountryhastospenditsincomeonimportingthese
goodsandservices,whichwillleadtoanunfavourablebalanceoftrade.

Changes in Population pattern as a


country becomes more developed
Asaneconomybecomesmoredevelopedthefollowingcharacterisiticsmightbenoticedinits
populationstucture.

ChangeinOccupationalstructure
primarysectorwillcontinuetofall

secondarysectorwillfirstrise,andthenfall

tertiarysectorwillcontinuetorise.

Agestructure
averageageofthepopulationwillrise

therewillbeanageingpopulation

BirthrateandDeathratewillfall

Geographicalstructure
therewillbeamovementoutoftheruralareasandintotheurbanareas.

7.7
Introduction to population

Changes in world Population


The
worldpopulation
isthetotalnumberoflivinghumansonEarthatagiventime.AsofJuly
2008,theworld'spopulationisestimatedtobejustover
6.684billion.
Inlinewithpopulation
projections,thisfigurecontinuestogrowatratesthatwereunprecedentedbeforethe20th
century,althoughtherateofincreasehasalmosthalvedsinceitspeakof2.2percentperyear,
whichwasreachedin1963.Theworld'spopulation,onitscurrentgrowthtrajectory,isexpected
toreachnearly9billionbytheyear2042.

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Further Research

WorldPopulationProspects
YearbyYearWorldPopulationEstimates:10,000B.C.to2007A.D.
WorldPopulation
ThePopulationProject
OptimumPopulationTrust
StateofWorldPopulation2007report

7.8
Barriers to growth

Barriers to growth of less


developed economies
RapidpopulationgrowthneutralisesgrowthinGDP.TheultimateeffectisthatGDPpercapita
remainsthesameorcomesdown.

Humanresources:
Lackoftrainingandhighlevelskillsmakestheworkforcelessproductive.
Lackofnaturalresources:
Ifthecountryislackinginnaturalresources,growthcanbedifficult.
Moreover,ifthecountryhasgoodnaturalresources,buttheyarenotmanagedproperlythen
therewillbelessdevelopment.
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Inefficientuseofresources:
Ifthereisnooptimumutilisationofworkforce,orifthefirmsare
inefficientduetolackofcompetition.
Toomuchdependenceonagriculturalproducts:
Developedcountrieswhichimportthese
productsfromlessdevelopedcountriesusuallypayverylowpricesforit.Moreover,theyfurther
processtheseproductsandsellitforhigherpricestoLDCs.
Poorinfrastructure:
Lackofinfrastructuresuchaspoortransportandcommunicationis
anotherreasonwhichhindersgrowthforLDCs.

8. International aspects

Learning outcomes

At the end of this unit students will be able to


describe the benefits and disadvantages of specialisation at regional and national levels;
describe the structure of the current account of the balance of payments;
define exchange rates;
discuss the causes and consequences of exchange rate fluctuations;
describe methods of protection;
discuss the merits of free trade and protection

8.1
Exchange rate | revaluation, devaluation,
appreciation, depreciation

Exchange Rate
Exchangerateistherateatwhichonecountryscurrencycanbeexchangedforanother
countryscurrency.

How is exchange rate determined?


Fixed Exchange Rate
Afixedexchangeratesystemreferstothecasewheretheexchangerateissetandmaintained
atsamelevelbythegovernmentirrespectiveofthemarketforces.

Floating Exchange Rate


Floatingexchangeratesystemmeansthattheexchangerateisallowedtofluctuateaccording
tothemarketforceswithouttheinterventionoftheCentralbankorthegovernment.

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Appreciation and Depreciation


Theexchangerateforanycurrencyusuallyfluctuates.Whenthevalueofthecurrencygoesup
ascomparedtoothercurrencyitisknownas
appreciation
.Whenthevalueofcurrencyfallsas
comparedtoothercurrencyitisknownas
depreciation
.
Usuallytheexchangeratesaredeterminedbythedemandandsupplyofthatcurrencyinthe
internationalmarket.

Demandforanycountryscurrencyontheforeignexchangemarketisdeterminedbydemand
forthatcountrysexportsofgoodsandservicesandbychangesinforeigninvestmentinthat
country.Thisisbecausewhenforeignersbuyanothercountrysexportsofgoodsorservices
theymustpayfortheseinthecurrencyoftheexportingcountry.
InthesamewaySupplyofanycountryscurrencyontheforeignexchangemarketis
determinedbythatcountrysimportsofgoodsandservicesandbyitsinvestmentinother
countries.
Thuswhenthedemandforacurrencyrisesitspricegoesupanditbecomescostlier.

Revaluation and Devaluation


Itreferstoofficialchangesinthepriceofacurrencyinafixedexchangeratesystem.

Devaluation
iswhenthepriceofthecurrencyisofficiallydecreasedinafixedexchangerate
system.
Revaluation
istheofficialincreaseinthepriceofthecurrencywithinafixedexchangerate
system.

What causes the fluctuation in


currency value?
Changes in the imports and exports of the
country
Anincreaseinexportsofacountrywillleadtoanincreaseindemandforthecurrencyandthus
thevaluerises.

Changes in Interest rate


Higherinterestratewillattractmoreforeigninvestorstoinvestinthecountryandthusthe
demandforcurrencywillrise,resultinginappreciationinvalueofthecurrency.

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Changes in Inflation rate


Higherinflationratewillmakethecountryuncompetitiveintheinternationalmarket.Theexports
willfallresultingindecreaseddemandforthecurrencyandhencelowervalue.

8.2
Balance of Payment | Current, Capital and
financial account

Balance of Payments
Itshowsallthepaymentsandreceiptsbetweenonecountryandalltheothercountriesittrades
with.BalanceofPaymentisclassifiedintothreecategories.Theseare:

The current account


Itincludes

Allthevisibleandinvisibletradeofthecountry

Wagesreceivedbycountriescitizensworkingoutsideinothercountriesorpaidtoforeign
workersworkinginthecountry.

Interestpayments,profitsanddividendsonshares

Taxesreceivedandpaidbythegovernmentfromforeignsources.

The Capital account


Itincludesflowofmoneyinandoutofthecountrybecauseof:

Changeofownershipoffixedassets

Saleoffixedassets

The financial account


Itrecordstheflowofmoneyinandoutofacountrybecauseof:

Investmentincapital,sharesandloans.

Directinwardinvestment.

Portfolioinvestments

BalanceofPaymentcanbefavourableorunfavourable(deficit).

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8.3
Exports and Imports | Visible trade and invisible
trade

Exports & Imports


Exportsarethemovementofgoodsorcommoditiesoutofthecountry.
Importsarethemovementofgoodsorcommoditiesintothecountry.

Visible Trade
Visibletradeinvolvestradingofgoodswhichcanbetouchedandweighed.Examplesinclude
tradeingoodssuchasOil,machinery,food,clothesetc.
VisibleTradeconsistsof

Visibleexports:
Sellingoftangiblegoodswhichcanbetouchedandweighedtoother
countries.
Visibleimports:
Buyingoftangiblegoodswhichcanbetouchedandweighedfromother
countries.

Balance of trade
Itisthedifferencebetweenthevalueofvisibleexportsandvalueofvisibleimportsofacountry.
IfthevalueofvisibleexportsismorethanvisibleimportsthecountrywillhaveaSurplus
balanceoftrade.
IfthevalueofvisibleimportsismorethanvisibleexportsthecountrywillhaveanUnfavourable
balanceoftrade.

Invisible trade
Invisibletradeinvolvestheimportandexportofservicesratherthangoods.Exampleinclude
servicessuchasinsurance,banking,tourism,education.

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IfaUKstudentcomestoSingaporetostudy,itwouldbeinvisibleexportforSingaporeasitis
earningforeignexchangebyprovidingeducationalservices.
IfaSingaporecitizentravelstoUKforaholiday.ItwillbeinvisibleimportforSingaporeand
invisibleexportforUK.

Balance of invisible trade


Itisthedifferencebetweenthevalueofinvisibleexportsandvalueofinvisibleimportsofa
country.

8.4
Comparative advantage | Theory and example

Thetheoryofcomparativeadvantagestatesthatacountryshouldspecialiseintheproductionof
goodorserviceinwhichithasloweropportunitycostanditshouldimportcommoditieswhich
haveahigheropportunitycostofproduction.

Example

Supposeforexamplewehavetwocountries
ofequalsize,

Northland
and
Southland
.Both
produceandconsumetwogoods,
Food
and
Clothes
.Theproductivecapacitiesand
efficienciesofthecountriesaresuchthatifbothcountriesdevotedalltheirresourcestoFood
production,outputwouldbeasfollows:
Northland:100tonnes

Southland:200tonnes
Ifalltheresourcesofthecountrieswereallocatedtotheproductionofclothes,outputwouldbe:

Northland:100tonnes

Southland:100tonnes
Assumingeachhas
constantopportunitycostsofproduction
betweenthetwoproductsand
botheconomieshavefullemployment
atalltimes.
Allfactorsofproduction
aremobilewithin
thecountries
betweenclothingandfoodindustries,butare
immobilebetweenthe
countries
.
Thepricemechanismmustbeworkingtoprovideperfectcompetition
.
SouthlandhasanabsoluteadvantageoverNorthlandintheproductionofFood.Bothcountries
areequallyefficientintheproductionofclothes.Thereseemstobenomutualbenefitintrade
betweentheeconomies.The
opportunitycosts
showsotherwise.Northland'sopportunitycost
ofproducingonetonneofFoodisonetonneofClothesandviceversa.Southland'sopportunity
costofonetonneofFoodis0.5tonneofClothes.TheopportunitycostofonetonneofClothes
is2tonnesofFood.Southlandhasacomparativeadvantageinfoodproduction,becauseofits
loweropportunitycostofproductionwithrespecttoNorthland.Northlandhasacomparative
advantageoverSouthlandintheproductionofclothes,theopportunitycostofwhichishigherin
SouthlandwithrespecttoFoodthaninNorthland.
Toshowthesedifferentopportunitycostsleadtomutualbenefitifthecountriesspecialize
productionandtrade,considerthecountriesproduceandconsumeonlydomestically.The
volumesare:

Food

Clothes

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Northland

50

50

Southland

100

50

Worldtotal

150

100

Production and consumption before trade


Thisexampleincludesnoformulationofthepreferencesofconsumersinthetwoeconomies
whichwouldallowthedeterminationoftheinternationalexchangerateofClothesandFood.
Giventheproductioncapabilitiesofeachcountry,inorderfortradetobeworthwhileNorthland
requiresapriceofatleastonetonneofFoodinexchangeforonetonneofClothesand
SouthlandrequiresatleastonetonneofClothesfortwotonnesofFood.Theexchangeprice
willbesomewherebetweenthetwo.Theremainderoftheexampleworkswithaninternational
tradingpriceofonetonneofFoodfor2/3tonneofClothes.
Ifbothspecializeinthegoodsinwhichtheyhavecomparativeadvantage,theiroutputswillbe:

Food

Clothes

Northland

100

Southland

200

Worldtotal

200

100

Production after trade


Worldproductionoffoodincreased.Clothingproductionremainedthesame.Usingthe
exchangerateofonetonneofFoodfor2/3tonneofClothes,NorthlandandSouthlandareable
totradetoyieldthefollowinglevelofconsumption:

Food

Clothes

Northland

75

50

Southland

125

50

Worldtotal

200

100

Consumptionaftertrade

Northlandtraded50tonnesofClothingfor75tonnesofFood.Bothbenefited,andnow
consumeatpointsoutsidetheirproductionpossibilityfrontiers.
AssumptionsinExample2
Twocountries,twogoods
thetheoryisnodifferentforlargernumbersofcountriesand
goods,buttheprinciplesareclearerandtheargumenteasiertofollowinthissimplercase.
Equalsizeeconomies
again,thisisasimplificationtoproduceaclearerexample.
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Fullemployment
ifoneorotheroftheeconomieshaslessthanfullemploymentoffactorsof
production,thenthisexcesscapacitymustusuallybeusedupbeforethecomparative
advantagereasoningcanbeapplied.
Constantopportunitycosts
amorerealistictreatmentofopportunitycoststhereasoningis
broadlythesame,butspecializationofproductioncanonlybetakentothepointatwhichthe
opportunitycostsinthetwocountriesbecomeequal.Thisdoesnotinvalidatetheprinciplesof
comparativeadvantage,butitdoeslimitthemagnitudeofthebenefit.
Perfectmobilityoffactorsofproductionwithincountries
thisisnecessarytoallow
productiontobeswitched
withoutcost.
Inrealeconomiesthiscostwillbeincurred:capitalwill
betiedupinplant(sewingmachinesarenotsowingmachines)andlabourwillneedtobe
retrainedandrelocated.Thisiswhyitissometimesarguedthat'nascentindustries'shouldbe
protectedfromfullyliberalisedinternationaltradeduringtheperiodinwhichahighcostofentry
intothemarket(capitalequipment,training)isbeingpaidfor.
Immobilityoffactorsofproductionbetweencountries
whyaretheredifferentratesof
productivity?Themodernversionofcomparativeadvantage(developedintheearlytwentieth
centurybytheSwedisheconomistsEliHeckscherandBertilOhlin)attributesthesedifferences
todifferencesinnations'factorendowments.Anationwillhavecomparativeadvantagein
producingthegoodthatusesintensivelythefactoritproducesabundantly.Forexample:
supposetheUShasarelativeabundanceofcapitalandIndiahasarelativeabundanceof
labor.Supposefurtherthatcarsarecapitalintensivetoproduce,whileclothislaborintensive.
ThentheUSwillhaveacomparativeadvantageinmakingcars,andIndiawillhavea
comparativeadvantageinmakingcloth.Ifthereisinternationalfactormobilitythiscanchange
nations'relativefactorabundance.Theprincipleofcomparativeadvantagestillapplies,butwho
hastheadvantageinwhatcanchange.
NegligibleTransportCost
Costisnotacauseofconcernwhencountriesdecidedtotrade.It
isignoredandnotfactoredin.
Assumethathalftheresourcesareusedtoproduceeachgoodineachcountry.
This
takesplacebeforespecialization
Perfectcompetition
thisisastandardassumptionthatallowsperfectlyefficientallocationof
productiveresourcesinanidealizedfreemarket.

8.5
Absolute advantage | definition and Examples

Acountryhasan
absoluteadvantage
overanotherinproducingagood,ifitcanproducethat
goodusingfewerresourcesthananothercountry.
ForexampleifoneunitoflaborinAustraliacanproduce80unitsofwoolor20unitsofwine
whileinFranceoneunitoflabormakes50unitsofwoolor75unitsofwine,thenAustraliahas
anabsoluteadvantageinproducingwoolandFrancehasanabsoluteadvantageinproducing
wine.

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AustraliacangetmorewinewithitslaborbyspecializinginwoolandtradingthewoolforFrench
wine,whileFrancecanbenefitbytradingwineforwool.

Example
Example1
CountryAcanproduceonewidgetusingoneunitoflabour.
CountryBcanproduceonewidgetusingtwounitsoflabour.
CountryAhasanabsoluteadvantageoverCountryBinproducingwidgets.

Example2
CountryAhas100unitsoflabor.Ituses20toproduce80unitsofParachutes,and80to
produce20unitsofBarbiedolls.
CountryBhas100unitsoflabor.Ituses40toproduce100unitsofBarbiedolls,and60to
produce20unitsofParachutes.
Ifthecountriesmaximizedtheirpotential,CountryAcouldproduce400unitsofParachutes,and
countryBcouldproduce250unitsofBarbiedolls.Throughtrade,thetwocountrieswould
achieveamoreefficientallocationofresourcesandincreasetheirprosperity.

8.6
Free trade | Benefits of free trade

What is Free Trade?

Freetradeisasystemoftradepolicythatallowstraderstotradeacross
nationalboundarieswithoutinterferencefromtherespective
governments.

Reasons for Free Trade


DomesticNonavailability:A
nationtradesbecauseitlackstherawmaterials,climate,
specialistlabour,capitalortechnologyneededtomanufactureaparticulargood.Tradeallowsa
greatervarietyofgoodsandservices.

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Costeffectiveness:
Itischeapertobuyfromothercountriesratherthanproducingthemselves.

Benefits of Trade
Lowerpricesforconsumers:
Whenthereisfreetrade,consumerscanfreetobuygoodsfrom
theproducerwhoiswillingtosellatthelowestprices.Henceconsumersgainfromlowerprices.
Greaterchoiceforconsumers:
Withfreetrade,consumershaveaccesstovarietyofgoods
andservicesfromdifferentproducersacrosstheglobe.Thismeansmorechoice.
Abilityofproducersto
benefitfromeconomiesofscale:
Producershaveaccesstoalarger
marketthustheycanproducemoreatlowercostandbenefitfromeconomiesofscale.
Abilityto
acquireneededresources:
Throughfreetradeproducerscannotonlysellinalarge
marketbutalsogainfrompurchasingfromsuppliersacrosstheworld.
More
efficientallocationofresources:
Whenthereisfreetrade,themostefficientproducers
gettheopportunitytoproduceduetotheircostefficiency.Thisleadstoproductiveefficiency.
Increasedcompetition:
Infreetradeproducersfromdifferentregionscancompetewitheach
otherintermsofprice,qualityandvariety.Increasedcompetitionleadstoefficientallocationof
resources.
Sourceofforeignexchange:
Freetradeinvolvesthetransactionofgoodsandservices
betweennations.Inordertopurchasegoodsfromabroad(imports),weneedforeigncurrency.
Thisispossiblethroughexportingofgoodstoothercountries.

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Free Trade diagrams

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8.7
Protectionism | Meaning and Methods

Protectionism

Policyofprotectingdomesticindustriesagainstforeigncompetitionbymeansoftariffs,
subsidies,importquotas,orotherhandicapsplacedonimports.Thechiefprotectionist
measures,governmentleviedtariffs,raisethepriceofimportedarticles,makingthemless
attractivetoconsumersthancheaperdomesticproducts.Importquotas,whichlimitthe
quantitiesofgoodsthatcanbeimported,areanotherprotectionistdevice.

Methods of Protectionism
Tariffs
Atariffisataxonforeigngoodsuponimportation.Tariffratesvaryaccordingtothetypeof
goodsimported.Importtariffswillincreasethecosttoimporters,andincreasethepriceof
importedgoodsinthelocalmarkets,thusloweringthequantityofgoodsimported.

Quotas
An
importquota
isatypeofprotectionistthatsetsaphysicallimitonthequantityofagoodthat
canbeimportedintoacountryinagivenperiodoftime.Thisleadstoareductioninthequantity
importedandthereforeincreasesthemarketpriceofimportedgoods.Quotas,likeothertrade
restrictions,areusedtobenefittheproducersofagoodinadomesticeconomyattheexpense
ofallconsumersofthegoodinthateconomy.

Administrative Barriers
Countriesaresometimesaccusedofusingtheirvariousadministrativerules(eg.regardingfood
safety,environmentalstandards,electricalsafety,etc.)asawaytointroducebarrierstoimports.

Embargo
An
embargo
istheprohibitionofcommerceandtradewithacertaincountry,inordertoisolateit
andtoputitsgovernmentintoadifficultinternalsituation,giventhattheeffectsoftheembargo
areoftenabletomakeitseconomysufferfromtheinitiative.

Subsidies
Governmentsubsidies(intheformoflumpsumpaymentsorcheaploans)aresometimesgiven
tolocalfirmsthatcannotcompetewellagainstforeignimports.Thesesubsidiesarepurportedto
"protect"localjobs,andtohelplocalfirmsadjusttotheworldmarkets.

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Anti-dumping legislation
Supportersofantidumpinglawsarguethattheyprevent"dumping"ofcheaperforeigngoods
thatwouldcauselocalfirmstoclosedown.However,inpractice,antidumpinglawsareusually
usedtoimposetradetariffsonforeignexporters.

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