Economics

IGSCE

Notes on Specification

Sec A: The Market System

I) Demand and Supply

1. The Market System
Markets exist wherever buyers and sellers can communicate and trade goods and/or
services in exchange for money. The amount of money needed to be paid for a certain item is
its price.
Countries where there are many markets operate together to form a Market System, also
known as Price Mechanism.
This system automatically determine two functions by its daily operations:
i Price determination; to determine the price of a product by communication.
ii Resource allocation; to allocate available resources to most successful uses.
Supply and Demand are two factors that arise in the market system.
i Supply refers to amount of a good or service that sellers are prepared to sell at given price
over a period of time.
ii Demand refers to the amount of a good or service that will be bought at given prices over a
period of time.
2. The Demand Curve
Effective demand; amount of good or service people can afford and willing to buy at given
prices over period of time.
Price affects the quantity of demand. Price and the quantity of demand are inversely related.
That means that if one falls, the other rises. For example, if the price of wheat falls, the quantity
of demand for wheat rises.
Graphs of the demand curve are used to show the inverse relationship these two factors
share. The graphs showing the demand curve are usually similar to either reciprocal functions
or functions of (x).
3. Factors that Affect Demand
Factors that affect demand, apart from price, include:
i Income; generally, as incomes rise, so does demand. With more money, the consumer has
greater spending power. However, this principal only applies on normal goods. On
inferior goods, an increase in income means a decrease in demand as people will be able to
afford better.
ii Fashion; demand of goods or services is often subject to mass appeal.
iii
Advertising; method used to increase appeal and thereby, demand.
iv
Demographics; as populations rises generally, so does demand. Additionally, several
segments of the global population are rising quicker at certain location as compared to
others. For example, the population of men may be rising quicker than women, meaning
demand of male clothing would probably rise quicker than female clothing.
v Complementary or Substitute Goods; the former being goods that are required for
functionality of a good. If the price of either rises, the demand for the other product can be
affected. A substitute good might be introduced that is cheaper or more efficient at the
same price. Would decrease demand for less efficient or more expensive good.
vi
Interest rates; since loans are often used to purchase goods such as houses or cars,
interest rates can play a role. For example, if the interest rates are high, people will be
reluctant to take loans and vice-versa.
If prices fluctuate, there is a movement along the demand curve. However, if other factors
change, the entire demand curve on a Price vs. Quantity graph shifts. For example, if incomes
rise, people will have the ability to buy more and therefore, general effective demand will rise.
As a result, the demand curve will move right on the Price vs. Quantity graph. This means that
people will be able and willing to demand more quantity at every price.
4. The Supple Curve
Supply is the amount of a good or service sellers are willing to sell at given prices over a
period of time.
As prices rise, so does the quantity of supply. Generally, there is a direct proportional-like
relationship between price and the quantity of supply. The supply curve is straight. If prices
change, there is movement along that curve.
Sometimes, there is a fixed supply. This means that at any given price, the quantity of supply
will remain constant. On a graph, the supply curve will be vertical. For example, the price of
seats available at a sports event will not affect quantity of supply.

5. Factors that Affect Supply

Apart from price, other factors that affect supply include:
i Subsidies; these are grants given by the government to a firm to encourage production of a
certain good or service in a certain condition. For example, a government may inject some
money into a bus company on the condition of providing services to unpopulated areas too
that will not be profit-generating activities. As the costs of production are aided with the
governments help, quantity of supply will increase.
ii Costs of Production; the costs of the factors of production which are land, labor, capital,
and enterprise can determine, to a large part, how much a firm can produce, and
therefore, quantity of supply.
iii
Technological Changes; change the costs of production. For example, automated
car-making reduces need for manual labor, so costs of labor are reduced. Also, since
technology makes production quicker, supply increases.
iv
Natural Factors; the production of several goods (i.e. fruits, wheat, meat, etc.) is
affected by natural factors such as natural disasters, weather, or infestation. Therefore,
quantity of supply will be affected.
v Indirect Taxes; taxes imposed by government will discourage firms to produce as they
represent cost for the firm.
vi
Prices of Other Goods; suppliers may switch to dealing with services or goods that
are more profitable, thereby decreasing quantity of supply for the former good or service.
If any of these factors changes in some way, the supply curve shifts on the Price vs. Quantity
graph. If price changes, the movement is along the supply curve only. For example, if the cost
of production rises, less profit would be yielded out of the revenue. Therefore, quantity supplied
would gradually decrease at all given prices. However, if the costs of production lower, selling
products would be more profitable. By principal, supply will rise in quantity for every given
price. The supply curve on a graph would move right.
6. Market Equilibrium
The equilibrium price is found when demand and supply are equal. It can be seen on a graph
where the demand curve meets the supply curve. The price coordinate of that point is the
equilibrium price. The quantity coordinate of that point is the amount of the goods both the
supplier and the customer are willing to deal on at the price mentioned.
At the equilibrium price, all stock will be bought as all that is supplied is demanded. Therefore,
this is known as the market clearing price.
By multiplying the x-coordinate and y-coordinate of the point where supply and demand meet,
we get total revenue.

Total Revenue=Price Quanitity

Total revenue is the amount of money generated by the sale of total output. It is equal to
total expenditure; which is the amount of money spent buying the firms output. Total
revenue concerns firms, or the suppliers; whereas total expenditure concerns consumer, or
demanders.
If demand increases due to factors other than price, then equilibrium prices rise. If demand
decreases due to factors other than price, then equilibrium prices fall. On the contrary, if supply
increases due to factors other than price, then equilibrium prices fall. If supply decreases due to
factors other than price, then equilibrium prices rise.
If the price is set lower than the equilibrium price, there is excess demand. This is because at
the price, there is not enough supply to meet demand. There is a shortage of goods or services.
If the price is set higher than equilibrium price, then there will be excess supply. At this price,
there is not enough demand to consume supply. There is excess of goods, or services, which will
not be sold. The market has been flooded.
7. Price Elasticity of Demand
For all items, demand generally slopes downwards when comparing with price. That is,
quantities of demand and price have an inverse relationship. However, the degree to which
demand slopes can vary.
Some items are deeply dependent on the price factor. A slight change in price can cause
massive changes in demand. On the other hand, some items are not that easily affected by
price. A significant change in price might actually cause a slight change in demand.
The relationship that exists between the responsiveness of demand to a change in price is
called price elasticity of demand (PED or Ed).

 The demand of goods or services that have a low response in terms of change of quantity of
demand due to change of price are said to be price inelastic. That is, a change in price will
cause a proportionally smaller change in demand. When the response of quantity demanded is
significant to a change in price, the demand of a good is said to be price elastic. In this case
meaning a change in price will cause a proportionally greater change in demand. Additionally,
they may be referred to as goods that have inelastic demand or elastic demand,
respectively.
To judge whether the demand of a good or service is price inelastic, or elastic, the following
formula is used (data from demand curve on the Price vs. Quantity graph):

Price Elasticity of Demand ( PED)=

quantity de manded( )
price ( )

If, for a product, the value of elasticity of demand is less than one, the products demand is said
to be inelastic. The demand curve is steep in this case. However, if a good or services elasticity
in terms of demand measures more than one, its demand is elastic. This will resemble a flat
line.
Ed > 1; Demand is price elastic.
Ed < 1; Demand is price inelastic.

The demand of some products is special. There are three such cases:
i Perfect Elasticity; some goods can only be demanded at one price. If the price changes

slightly, demand completely diminishes. Since their elasticity is infinite, the graph is
horizontal.
ii Perfect Inelasticity; the demand of some goods is absolutely immune to change in price,
demand always stays constant. Since they have zero elasticity, their graphs are vertical.
iii Unitary Elasticity; the demand of some goods respond correspondingly to change in price.
That is, a percentage of change in price would result in the same percent change in quantity
demanded. Since they are inversely proportional, they resemble reciprocal functions.
Ed = ; Demand is perfectly price elastic.
Ed = 0; Demand is perfectly price inelastic.
Ed = 1; Demand is unitarily price elastic.
Several factors affecting price elasticity of demand include:
i Availability of Substitutes; if substitute goods can be found for a product, consumers will

move to those if prices for that product rise. For instance if price of strawberry jam rises,
people will move to other types of jams instead. However, if no or little substitutes are
available, the demand for them will not move to other substitute goods. A good or service
with substitutes is therefore, elastic; whereas one without substitutes would be inelastic.
ii Degree of Necessity; the necessity of a good or service can affect its elasticity. Essential
products, like fruit or fuel for instance, will not easily lose demand due to changes in price,
making the demand of such inelastic. Luxury goods will have demand elasticity.
i Proportion of Income Spent on Product; peoples personal income play a big role too. If
a large proportion of them are spent on a certain good or service, it will be price elastic.
However, products whose price is insignificant to income will tend to be price inelastic.
ii Time Period; in the short term, all goods generally are demand inelastic. That is because
new circumstances need time to adapt the effectively as appropriate if prices fall or rise. For
instance, it will take time for consumers to find substitutes if prices rise .
8. Price Elasticity of Supply
For all items, supply generally slopes up with changes in price. That is, quantities of supply and
price have a variation relationship. However, the degree to which the demand slopes upwards
can vary.
The degree of response that price has upon quantity supplied varies with different goods or
services. This relationship is known as the price elasticity of supply (PES or Es)
The supply of goods or services that have a low response in terms of change of quantity of
supply due to change of price are said to be price inelastic. That is, a change in price will
cause a proportionally smaller change in supply. When the response of quantity supplied is
significant to a change in price, the supply of the good is said to be price elastic. In this case
meaning a change in price will cause a proportionally greater change in supply. Additionally,
they may be referred to as goods that have inelastic supply or elastic supply, respectively.
To judge whether the supply of a good or service is price inelastic, or elastic, the following
formula is used (data from supply curve on the Price vs. Quantity graph):

Price Elasticity of Supply (PES)=

quantity supplied ( )
price( )

If, for a product, the value of elasticity of supply is less than one, the products supply is said to
be inelastic. The supply curve is steep in this case. Additionally, the supply curve would cut the
quantity axis. However, if a good or services elasticity in terms of supply measures more than
one, its supply is elastic. This will resemble a flat line. In this case, the supply curve cuts the
price axis.
Ed > 1; Supply is price elastic.
Ed < 1; Supply is price inelastic.

The supply of some products is special. There are three such cases:
i Perfect Elasticity; some goods can only be supplied at one price. If the price changes

slightly, supplied completely diminishes. Since their elasticity is infinite, the graph is
horizontal.
ii Perfect Inelasticity; the supply of some goods is absolutely immune to change in price,
supply always stays constant. Since they have zero elasticity, their graphs are vertical.
iii Unitary Elasticity; the supply of some goods responds correspondingly to change in price.
That is, percentage of change of price equals percentage of change in quantity supplied. The
supply curve passes through the origin, making this a directly proportional line.
Ed = ; Supply is perfectly price elastic.
Ed = 0; Supply is perfectly price inelastic.
Ed = 1; Supply is unitarily price elastic.
Several factors affecting price elasticity of supply include:
i Time; the speed with which produces can react to changes in price is crucial to determining

the elasticity of good or services supply. If a producer can respond quickly, the supply of the
goods in that industry are price elastic. If it takes him a long time to respond, the supply is
price inelastic. The following factors can influence speed with which producers react:
- Stock Levels; if there is stored stocks of goods, producers can respond more effectively
to market. However, some goods are perishable or dangerous in storage.
- Production Sped; if it is easy to control speed of production, it would be easy to respond
to the changes in market prices.
- Spare Capacity; firms often are not using the factors of production available at full
potential. If they are, it isnt possible to increase production when prices rise. If there is
spare capacity, firms will want to fill potential as soon as they can.
- Barriers to Entry; the ease for producers to enter into markets that have experienced
changes in prices will have a big impact on supply too. For example, if there are barriers
to entry, supply would be harder to increase as the industry would keep other firms from
joining.
ii Producer Substitutes and the Mobility of Production Factors; if producers can locate
and allocate factors of production appropriately, for instance to use those resources on
different uses depending on the situation; the supply will be more flexible and thereby, more
elastic. This factor refers to the elasticity of the factors of production themselves.
9. Income Elasticity
The income has the largest effect on the quantity of demand after price. Income elasticity of
demand is the responsiveness of demand due to a change in income. For some products,
demand changes drastically as incomes rise or fall, whereas some products demand shifts
slightly.
The formula to find the income elasticity of the demand of a good or service is:

Income Elasticity of Demand (IED)=

quantity demanded ()
income( )

There are two sets of interpretations available from finding the income elasticity of a products
demand:
i If the value of the income elasticity of demand is greater than one, the demand is income
elastic. That is, if incomes rise, the demand of these goods or services will rise in greater
proportion. Conversely, if the value of the income elasticity of demand is less than one, the
demand of that good or service is income inelastic. That is, if incomes change, demand
changes in a smaller proportion.
IED > 1; Demand is income elastic.

IED < 1; Demand is income inelastic.

ii If the value of income elasticity is positive, the product is said to be a normal good. For all
normal goods, as income rises, so does the demand for it. On the other hand, if the income
elasticity is negative, the good is an inferior good. With inferior goods, demand falls as
income rises.
IED > 0; Normal good.
IED < 0; Inferior good.

The factor that determines whether goods or services are income inelastic or elastic is whether
those goods are necessities or luxuries, respectively.
i Necessities; include basic goods that are essential. With a decrease in income, demand
falls slightly, since people still need those goods. Also in this category are habitable or
addictive goods, such as drugs.
ii Luxuries; are goods that are not needed for survival, they are bought only if affordable.
With an increase in income, demand significantly increases. Spending on these goods is
discretionary, meaning it doesnt need to be undertaken. Studies show that imports are
also, similar to luxuries, income elastic.
10. Applications of Elasticity
Information about elasticity is often used by firms and government in various applications:
i Firms use info on price elasticity to control and optimize total revenue. For a good whose
demand is price inelastic, a rise in price means a rise in total revenue; likewise, a drop in
price would mean a drop in total revenue. On the other hand, goods with a demand that is
price elastic work different. A rise in price would decrease total revenue; and a drop in price
would increase total revenue. This information will supply firm with the knowledge of what a
price change will financially mean for the business. Furthermore, it is important to
understand that raising the prices on goods with unitary elasticity will lower the quantity
demanded by an equally proportionate amount. Therefore, total revenue will always remain
constant on such goods no matter how much the price has changed.
ii Firms are also interested in the income elasticity of the demand of a product for several
reasons. This is because they will be able to respond effectively to predicted changes in
income:
- Production Planning; based on the expected trend of incomes, production can be
planned effectively on goods whose demand is income elastic. If incomes are going to
rise, stocks can be placed appropriately to be used in production. On the other hand, if
incomes are to fall, firms may plan to cut output in order to not flood the market due to
falling demand and lose total revenue. However, firms producing inferior goods or services
may plan to increase output and productivity if a recession thereby meaning a fall in
income is expected.
- Production Switching; firms obtain resources that are used in multiple ways. Therefore,
those factors of production can be adapted to produce goods whose demand factor will
work profitably when incomes change. Goods with demand that is income elastic will have
increased production if incomes were to rise as total revenue would soar.
iii
Governments use information on price elasticity of demand for tax purposes. Although
extreme necessities such as water and food are avoided, taxes like VAT are placed on
products whose demand is price inelastic, since the price added will not affect quantity
demanded significantly. This will ensure that the tax will be paid and the items demand
wont be significantly affected.

II) The Role of the Market in Solving the Economic Problem

11. Resolving Scarcity
The four factors of production land, labor, capital, and enterprise exist in limited quantities;
that is, they are finite resources. This is known as scarcity. In addition to scarcity is the issue of
incapability as many developing countries are not able to exploit their own natural resources.
Humans have both of the following:
i Needs; physical needs such as food, water, or shelter; and psychological or emotional
needs such as love and security are essential for survival.

ii Wants; further desires which expand as the human imagination does. They can include
cars, vacations, computers, jewelry, etc. Wants are infinite, and often need to be replaced
frequently.
All nations and economies face the basic economic problem. That is, human wants are
infinite and ever-expanding, whereas the resources available are scarce and finite.
Infinite Wants > Scarce Resources
Demand > Supply

Decisions have to be made to overcome the economic problem and allocate a nations scarce
resources between different uses. This is the purpose of economics and economic thought.
These decisions include:
i What to produce? Which goods and services should the country allocate its scarce
resources to?
ii How to produce? How to organize the factors of production effectively and efficiently?
iii
For whom to produce? How to distribute and share produce between members of
population?
The search for an effective solution has given birth to several different economic systems and
ideologies.
Because of scarcity, choices have to be made since resources can be used to serve several
different purposes and thereby fulfill different wants. These choices are made by individuals,
firms, and governments. They have to choose how and where to spend their limited budgets.
Due to sacrifices that are made, an opportunity cost arises. This is the benefit of the next
best alternative. It is regarded as a cost because it was not pursued; its benefits are not
attainable.
Production possibility curves (PPC) are curves drawn on a Consumer Goods vs. Capital
Goods graph. A measurement of a nations production capacity is taken and plotted on the
graph. The PPC shows how consumer and capital production relate to each other and what the
different combinations of amounts at which each good can be produced by an economy if all
the nations resources are employed are. It shows the opportunity cost of raising the production
of either capital or consumer goods.
Economies are expected to push production up to aim at the PPC line. As an economy moves
along the PPC, an opportunity cost has risen. For instance, if an economy was previously
producing 36m units of consumer goods and 9m units of capital goods, a shift to producing 20m
consumer goods and 15m capital goods would present the opportunity cost of 16m consumer
goods. Therefore, choosing between combinations is important. Higher focus on consumer
goods ensures greater prosperity for now, whereas capital goods are investments into the
future while they lower quantity of consumer goods supplied.
Over time, the PPC shifts outwards. This is called economic growth and refers to the increases
in production capacities. This may be due to increasing population, discovery of natural
resources, or improved capital goods. As economies are always attempting to push production
up to the PPC, production will increase.
12. The Mixed Economy
Economy is a system of producing, distributing, and consuming while applying the principal in
the economic problem. The word economy is usually used in the national context. In any
economy, goods and services are produced by two distinct sectors. The power of each sector
varies with economic systems and ideologies:
i Private Sector; consists of individual or groups of individual who set up businesses with
which the supply good and service to anyone willing to buy.
ii Public Sector; consists of state-managed organizations that conduct economic activities.
Different economies have different approaches on providing goods and services. The type of
economy used to choose, produce, and distribute goods and services varies according to the
role the public sector is given. There are three main types of economies are:
i Market Economy or Free Enterprise Economy; relies least on the public sector for
economic activities. The private sector chooses, produces, and distributes goods and
services, and allocates resources, based on the market forces of supply and demand. The
economic activities of the public sector are minimalized to management of departments and
state services like defense in market economies. Additionally, the state ensures healthy
competition between businesses.
ii Command Economy or Planned Economy; relies entirely on public sector for economic
activity. The state chooses, produces, and distributes all goods and services. Consumers buy
them from state outlets at fixed prices. Market forces are ineffective in planned economies.

iii
Mixed Economy; utilizes both sectors and delegates powers and responsibilities. The
degree of mixing is different depending on nation.
In reality, all economies are mixed economies. The three choices that need to jointly decided
upon by the public and the private sector are:
i What to produce? Consumer goods and services are often delegated to the private sector
in mixed economies because the consumer gets a greater say in in private sectors
activities. Additionally, the market forces will allocate all resources available for private
sector use. Economic activities such as street lighting, education, or healthcare that the
private sector neglects are taken up by the public sector.
ii How to produce? Due to the economic factors of profit and competition, the private sector
will use any production method that maximizes quality and minimizes costs. Public sector
services will be provided in several different ways by different state organizations.
Occasionally, the state employs the private sector to carry out its services.
iii
For whom to produce? The goods or services produced by the private sector are for
anybody who can afford them. The public sector is responsible for providing free services
and social and financial benefits paid by taxes.
Due to scarcity, resources should be utilized as efficiently as possible to get optimal results
from factors of production:
i Produce at lowest costs possible.
ii Minimizing resources required for production.
iii
Only produce those goods and services that people want.
Due to lack of competition in the public sector, efficiency is often lacking in state-run services.
Conversely, healthy competition in private sector encourages efficiency as only the most
effective producers survive. However, due to market failure, resources are sometimes wasted.
This is why the public sector is often used. Market failure is when markets are leading to
inefficiency, which can happen for a number of reasons:
i Externalities; these are costs of production that a firm may impose onto a surrounding
community. These are known as negative externalities. For instance, a factory may
release a poisonous gas during production, for which the community will have to pay.
ii Lack of Competition; dominating firms and monopolies may charge higher prices and
abuse their customer base for self-gains. This, along with lack of competition itself, will
cause inefficiency.
iii
Missing Markets; consists of public goods, which are goods the private sector is
unlikely to provide, and merit goods, which the private sector will under-provide. The public
sector provides them for free instead.
iv
Lack of Information; if consumers do not know the nature, quality, and prices of
goods and services, they may be over-priced. Efficiency requires a free flow of
communication between buyers and sellers.
v Factor Immobility; efficiency requires mobility of the factors of production from one market
to the other. However, this is usually difficult due to specialized technology being made for
any specific purposes. Additionally, the constantly vibrant nature of the market heightens
this factor.

III) The Labor Market: An Example of a Market in a Mixed Economy

13. The Division of Labor
The people available to work in a nation represent the working population. There is an
overwhelming abundance of labor as all nations, including the G8, have unemployment of the
labor factor to a degree. However, that also may be due to inability of the labor to work, for one
reason or another.
Several notes about characteristics of labor as a resource:
i In contrary to machines, people can be inconsistent and reactive. They are difficult to
manage.
ii Globally, the supply of labor is increasing, even though not all current units are employed.
iii
They are an expensive resource. They require breaks, vacations, and can only work
certain hours.
Specialization, the production of a limited range of goods by individuals, firms, regions, or
nations, is important in todays business activities. Different firms specialize in the production of
different goods and services; for example, McDonalds produces fast food goods. Different

nations specialize in the making of different goods; for instance, China makes manufactured
goods.
Furthermore, in businesses, the production process is broken down into small parts and each is
allocated a specific task. This type of specialization known as division of labor. Workers are
employed based on their potential in a certain field. For example, in a school, teachers are
responsible for the teaching the students, whereas the director is responsible for managing
staff.
This practice of division of labor has advantages and disadvantages for the worker:
i Advantages; Each member of the production process is focused on one aspect of the
production process. Constant repetition makes that worker an expert in that field. Practicing
and expertise opens opportunities for them. Additionally, satisfaction is high if worker
focuses on one task.
ii Disadvantages; Repetition and monotony can make it boring for worker. This boredom may
affect motivation. In addition, specialized workers risk unemployment if their fields demand
decreases, or other similar factors.
There are several advantages and disadvantages of division of labor for the firm:
i Advantages; Efficiency improves greatly because workers get better at their specialized
field. Therefore, productivity will rise as production will be quicker and of higher quality
overall. A greater use of specialist machinery or equipment is possible with specialization.
Production time is also decreased as each person does their task and moves on the
production to the next in line; time is not wasted preparing and moving around the
workplace for the next task. Additionally, production is more organized as all workers do not
cross out of their place in line.
ii Disadvantages; The repetitive nature of specialization may bore a worker and thereby
decrease motivation; this may affect productivity and quality of work, both of which impact
profitability. Also, this could result in high labor turnover. There is interdependence, which
means that although each worker may excel in their field, the production process will halt if
one part failed. A skilled workers absence will disrupt production.
14. The Labor Market
The labor market is like any other market, it has buyers firms and sellers the working
population willing to exchange a service for money. However, when observing the demand
curve for labor, the price factor institutionalized for other goods is replaced by wage rate,
which refers to the payment need to be made to labor for their services over a period of time.
The demand curve for labor, as other demand curves, slopes from up to down. Wage rate and
quantity of demand for labor are inversely related, which means that as one increases, the
other decreases. For instance, the 500 units of labor could be demanded for a wage rate of
$600, but only 200 units of labor would be demanded for $1000. There are several reasons for
this, including higher wages mean higher production costs for the firm. In this case, production
would have cut, reducing amount of workers needed. The following are factors that affect the
demand of labor:
i Type of Production; since demand of labor is a derived demand, which means labors
demand is derived from the demand of the goods it can produce, the goods and services to
be produced themselves play a role.
ii Substitutes; costs and availability of substitutes for labor can affect demand of labor. A
prominent example is machinery, its efficiency and lower cost is causing the demand of
labor to decrease.
iii
Productivity; of labor can increase demand itself. If labor is being productive,
profitability is high and therefore, demand is going to increase.
iv
Additional costs; demand for labor is also affected by all the costs of the other
responsibilities that have to be attended to when employing a worker. Pensions and training
are examples.
Changes in these factors can cause a shift in the demand curve. For instance, cheaper
machinery will replace labor due to costs of production. Therefore, the demand curve will shift
to the left, meaning at all wage rates, quantity of labor demanded will decrease.
The supply curve of labor, as other supply curve, slopes upwards. This is because wage rates
and quantity of supply of labor are proportionately relative, meaning that the rise of one will
cause a rise in the other. For instance, 500 units of labor could be supplied at a wage rate of
$500, but at wage rate of $1000, 2000 units of labor are supplied. The main reason for this is
that higher wages give the working popular a higher incentive to work.

The following factors, all of which are determinants of the working population, can affect
supply of labor:
i Age Levels; since labor has boundary age levels, changes in those age limits would make
people part of the working population or otherwise, take them out.
ii Empowerment of Women; is increasing the supply of labor.
iii
Age Distribution of Population; can have an effect if the dependency ratio is
changing, which refers to the changes of the proportion of those who dont work on those
who do work. Aging populations, for instance, are placing greater burdens on society.
iv
Immigrant Workers; changes in the amount of foreign workers can swell up or
deflate the working population.
Changes in these factors cause shifts in the supply curve for labor. For instance, greater
empowerment of women by matching their worker expectancies to the same level as men is
raising the working population. This will move the supply curve to the right; meaning that for all
wage rates, more quantity will be supplied.
The equilibrium wage rate is found in the same way as the equilibrium price of a good, by
graphing the supply and demand curves of it and then observing the point at which they
interact. This is where supply and demand is equal to each other. Shifts in either curve can
cause a change in the equilibrium wage rate. For instance, the rise of demand for labor will
result in a higher equilibrium wage rate.
Different occupations have different wage rates. There are several reasons for this:
i The supply of labor varies from occupation to occupation due to factors such as
requirements, qualifications, level of hazard, unpleasant conditions, training, etc. Lower
supply would mean a higher equilibrium wage rate, whereas a high supply would mean a
lower one.
ii In expanding industries, demand for labor tends to rise, which would mean a higher
equilibrium wage rate. Declining industries work in the other way.
iii
Benefits and perks are sometimes considered to compensate for lower wage rates. An
example is with the low wage rates that are usually associated with public sector jobs due to
this.
iv
Workers in trade unions may get higher wages than those who arent in one.
The quality of labor also matters when employers are recruiting workers. Usually, workers who
have minimum education, are literate, are numerate, and have good communication skills are
preferred because educated and trained workers will be more productive generally. Additionally,
appropriate specialist skills are desired by firms.
15. Interference in the Labor Market
One way in which the government interferes in the Labor Market and disrupts market forces is
by setting a minimum wage, which is a minimum amount that needs to be paid to workers in
a time period, usually per hour. There are several reasons why legislation for minimum wage is
passed:
i Benefit disadvantaged workers; groups such as ethnic minorities, low income families,
and women benefit from minimum wages.
ii Reduce poverty; minimum wages moves individuals and families out of poverty.
iii
Help businesses; with greater equality and fairness among workers will motivate
them and raise productivity and reduce absenteeism and staff turnover.
If the government imposes a minimum wage that is above the equilibrium wage rate, then the
demand will fall short of the supply, resulting in a flooded market. That is, unemployment will
ensue as supply of quantity of labor will not be employed. However, evidence shows that, in the
UK, the minimum wage act hasnt caused swelling of unemployment. Furthermore, employment
in low-pay jobs has increased.
Trade unions are organizations that often interfere with forces of the labor market. They exist to
protect worker interests. Although specialized ones exist for different occupations, the principal
aims of all are:
i Negotiate pay and working conditions with employer.
ii Provide legal protection for members.
iii
Act as pressure groups that encourage government to pass legislation in favor of
workers.
iv
Provide financial benefits whenever necessary.
Due to growing power of trade unions on the economy, legislation has been passed in UK to
weaken them:
i Closed shops are illegal.

ii Require trade unions to have ballots before a strike, and only have a strike if all members
support.
iii
Secondary picketing is illegal.
iv
Businesses can sue for compensation if trade unions break law.
This has weakened their position and popularity. As a result, membership has decreased.
Powerful trade unions can force wages up in an economy by influencing the supply curve. The
supply will become less; that is, less quantity of labor will be supplied at every wage rate.
Although this will raise wages, the new demand will be lower, which means units of labor will
have to be unemployed as they are no longer necessary in the economy. However, this can be
combatted:
i If labor productivity rises at the same time.
ii If the employer can pass increased productions costs onto customers.
iii
If profit margins are decreased.

Sec B: Business Economics

I) Production
16.

Factors of Production and Productivity

Production is a process which involves transforming resources into goods or services. There
are four different types of resources, known as the factors of production:
i Land: This includes both the plot of land required to set up any premises which can facilitate
operations, and all natural resources, renewable or non-renewable.
ii Labor: This includes the workforce of the economy. Manual or skilled workers and managers
are members of a nations workforce. The value of the collective workforce or each workers
individual capability in known as human capital, which varies with education and training.
iii
Capital: This is a man-made resource. It is often divided in two groups: working, or
circulating, capital, and fixed capital. The former refers to both the stocks of raw
materials or components that will be used up in production, and stocks of finished goods.
The latter refers to factories, offices, shops, machines, or any other equipment that aids
production.
iv
Enterprise: This includes the role that entrepreneurs play in an economy. They
produce business ideas, own the business, take risks in order to benefit the business, and
manage and organize the other factors. The more effective all this can be carried out, the
greater the factor of enterprise.
To increase production of goods or services, an increase in the factors of production is required.
Production is often said to be labor intensive, if it relies relatively heavier on the labor factor
than capital, or capital intensive, if more capital is used in relation to labor. This difference
can depend on the availability of and the ease of managing either factor.
Production also increases by changing productivity, which is the amount of output which can
be produced given an amount of resources. It can be measured as output per unit of input.
Increasing productivity is desirable as profit will increase and costs will decrease overall.
Productivity is influenced by changing working methods, motivating workers, using efficient
machinery, and retaining workers to boost skill.

17. Sectors of the Economy

There are three sectors in the economy:
i Primary Sector is the sector of the economy which involves extracting raw materials from
the earth. It includes farming, fishing, forestry, and agriculture, for instance.
ii Secondary Sector is the sector where all the raw materials from the primary sector are
processed into finished or semi-finished goods occurs. Breweries and food processing are
examples of secondary sector activities.
iii
Tertiary Sector is the sector that produces and provides services in an economy.
Financial services or professional services are both examples of tertiary sector activities.
Different types of nations have different structures in their economies:
i Developed countries are going through a phase of de-industrialization. As the
industrial revolution shifted the focus of resources onto the secondary sector,
employment of resources in that sector is now decreasing. Manufactured goods are instead
being imported from developing countries like Brazil, India, and China. Additionally, since
demand for manufactured goods is diverting to services instead, the resources are also
appropriately shifting. The tertiary sector, conversely, is on the rise and many resources
are being pumped into this sector. This may be due to the idea that as nations and
populations grow and develop, public services also increase. The primary sector is already
significantly lesser in importance in relation to the other two. The reason that these
economic activities utilize a tiny percentage of all resources is due to technological
advancements that have replaced the need for labor.
ii Most developing nations are increasing their secondary sector activities, as was the trend
in 19th century Britain. However, many developing nations still allocate a great majority of
their resources to the primary sector. Tertiary sector activities are low, if any at all, in these
nations.
However, this is a general pattern. Many nations, due to various reasons, alternate from this
model.
18. Production Costs and Revenue
Average cost is the cost of producing a single unit of output, on average. Divide total cost by
quantity produced.

Average Cost=

Total cost
Quantity pro duced

The average cost curve, when plotted on a graph, is in the shape of a parabola.
Total costs are the expenses incurred in production over a period of time. Its composed of two
factors:
i Fixed costs are production costs that remain the same independent of levels of output.
They can include rent or interest payments.
ii Variable costs are production costs that vary with amount of output. As quantity of output
increases, so do variable costs. They include raw materials or labor.
Total costs are equal to the sum of fixed costs and variable costs. That is, TC = FC + VC
Total revenue is the amount of money a firm gets from selling its output.

Total revenue=Price Quanity sold

To find a profit or loss, you have to subtract total costs from total revenue. If it is a negative, it
is a loss. If it is a positive, it is a profit:

Profit=Total revenue tal costs

19. Economies and Diseconomies of Scale

Economies of scale refer to a trend in average costs that is observed when a business
expands. It can be seen on an average cost curve, which is a parabola opening on the top side.
The decreases of the average costs are due to enlargement of the scale of business activity.
The minimum amount that the average costs will go down to is known as the minimum
efficient scale (MES). This is where the size is ideal as average costs are least.
Internal economies of scale are the cost benefits that an individual firm can enjoy when it
expands. This includes:
i Purchasing economies; businesses that buy in bulk can get cheaper rates. Greater value
for money.

ii Marketing economies; several marketing economies exist. One such is that as a business
gets larger, it can utilize single promotional methods for a range of products, thereby
reducing average costs.
iii
Technical economies; large-scale production lets business use advanced and
specialist machinery and utilize it more efficiently. For instance, the practice of mass
production lowers average costs but can only occur if enough goods need to be produced. A
larger firm can also afford to invest more in research and development.
iv
Financial economies; large businesses have a lot more sources to obtain finance
from. For instance, large limited businesses can raise funds by selling shares, whereas small
traders cant. The availability and price of financing favors large businesses due to the
higher risk seen in investing in small businesses. Additionally, large businesses can exert
greater pressure on loaning bodies to ensure the price of loans stay low.
v Managerial economies; managers are likely to specialize in particular tasks or
departments. Specialist managers are likely to be more efficient, and thereby reduce
average costs, as they possess a high level of expertise, experience, and qualifications
compared to a single manager in a smaller firm.
vi
Risk-bearing economies; due to the size of business, it is involved in a wide amount
of markets with a great variety of products. Therefore, taking risks will not be as dangerous
as it will be for smaller businesses as the larger one has established institutions in the
markets.
External economies of scale are the cost benefits all firms in an industry can enjoy if the
industry expands. They are likely to rise if those firms are all located in a particular region. The
external economies include:
i Skilled labor; of which there will be a build-up in that certain industry, and possibly, in that
certain region. This workforce will have the skills and work experience that will, additional to
reducing training costs, increase the productivity of the business. Recruitment will be easier
and less costly due to large amount of supply.
ii Infrastructure; such as roads, buildings, and other facilities will gradually become
specialized appropriately and adapt to suit the industry and encourage optimum
performance if all firms are located in one region.
iii
Ancillary and commercial services; will be attracted towards locating near a region
where a relevant industry has been established. All firms will be able to benefit from easy
access to suppliers and services such as insurance.
iv
Co-operation; firms of an industry located close are likely to co-operate on ventures,
such as research projects.
Diseconomies of scale result in rising of average costs when firms become too big and
expand beyond their MES. This is due to production becoming inefficient. This might happen
due to:
i Bureaucracy; If a business becomes too large, too much of a proportion of resources will be
spent on administration. This can harm decision-making and communication channels in the
business.
ii Labor relations; If a firm becomes too large, the workers and the managers may become
alienated and estranged with their managers, which will lead to unrest and demotivation.
Resolving this can waste valuable resources.
iii
Control and co-ordination; Large businesses, due to large amount of workers,
unallocated money, or operational facilities will inevitably waste a large amount of resources
supervising and directing these resources to a purpose.
20. Productivity and Wealth Creation
By increasing productivity, a country can become wealthier. This can be observed on a PPC
graph. When productivity increases, the graph moves outwards, showing that either resources
have increased, or their capability and potential for production has increased. When it is the
latter case, this is known as greater wealth creation.
Land is a productive resource if it is fertile and can be worked on. Several methods are used to
increase productivity:
i Fertilizers and Pesticides; These are chemicals or biological agents used to improve crop
yields, better health of plants, and kill off pests. However, due to harmful effects to humans
and environment, their use is restricted.
ii Irrigation; This practice involves diverting water from bodies of water to land where
activities that require water for better performance are being conducted. It is used on land
where water is in short supply, or in dry seasons.

iii
Drainage; This is installed in areas that are frequently flooded to prevent any harm to
the crops.
iv
Genetically Modified Corps; This involves transferring desirable genes that will
increase a crops performance and resistance against harms from one crop to another.
However, the unpredictability of GM is a source of criticism.
Labor productivity is the average amount of output produced per worker:

Labour Productivity =

Total Output
Number of Workers

The productivity of labor can also be increased by improving the quality of human capital.
Several ways include:
i Education and Training; A higher investment in schools and quality of teaching and
education can provide a great return investment. Additionally, training provided in firms can
increase productivity of workers.
ii Improving Motivation; Workers with high levels of motivation are more productive.
Several schemes can drive workers including financial incentives, job rotation, team working,
and empowerment.
Improving and adapting working conditions for workers will increase productivity. Examples
include:
i Changing Factory Layout; This can make the factory more easy to use and production
smoother.
ii Increasing Labor Flexibility; Workers with the capability to switch jobs at short notice can
further ease production.
iii
Applying Lean Production; This involves reducing the waste that is produced in the
production process.
Improvements in terms of capital and technology can also increase productivity. It has affected
the three sectors:
i Primary Sector; All over the primary sector of the economy, technological advances have
increased output, improved working conditions, and more efficiency. Labor, as a result, has
been practically replaced by machines.
ii Secondary Sector; Technology, such as computers and computable machines, have taken
over large proportion of all manufacturing and production.
iii
Tertiary Sector; Although this sector of the economy enjoys being labor-intensive,
internet banking and shopping has eased the production process. Additionally, healthcare
has become very dependent on machines for medical date collecting, carrying out research
and development, and performing operations.
21. Externalities: Costs and Benefits
Externalities are the spillover effects of consumption and production that may impact anyone
but the ones responsible for the economic activity. They can be either positive or negative.
Positive externalities are known as external benefits and they include job creation, site
development, training and education, research and development, and new technology.
Negative externalities are known as external costs and include traffic congestion,
overcrowding, resource depletion, and noise, air, or water pollution.
Producing or consuming products results in imposing private costs and external costs.
Combined, they sum up to make the social costs. Such economic activity also provides
private benefits and external benefits. Combined, these two factors make social benefits.
Governments encourage positive externalities and discourage negative externalities in
several ways:
i Taxation; Taxes are often used to discourage economic activity that has many negative
externalities.
ii Subsidies; These can be used to encourage positive externalities and to reduce economic
activities that impose negative externalities on the surrounding community.
iii
Fines; These are enforced on activities that cause negative externalities.
iv
Government Regulation; Legislation is passed that regulates the economic activities
firms partake in.
v Other Measures; A range of measures are taken. For instance, intl pacts have formed,
such as the Kyoto Protocol.

II) Competition
22. Competitive Markets
Competition is the rivalry that exists between firms when they sell goods or services to the
same market. The following are common features for competitive markets:
i Large number of buyers and sellers.
ii The products sold by each firm are close substitutes of one another.
iii
Few barriers of entry. That is, there are only a few obstacles that might discourage a
firm from entering a market.
iv
No firm can individually affect the price of the goods or services.
v There is a free flow of information about the availability, prices, and methods of production
of the goods or services; and the cost and availability of production factors.
In a competitive environment, firms need to do several things in order to survive:
i Operate efficiently by keeping costs as low as possible.
ii Providing good quality products with high levels of customer service.
iii
Charging prices which are acceptable to customers.
iv
Innovating by constantly renewing products.
As a result of competition, firms of an industry will have lower profits as the competition will
drive prices down. Due to that consequence, firms do not usually welcome competition,
preferring to dominate the market instead.
Innovation, the commercial exploitation of a product based on a distinguishable idea, involves
a practice known as product differentiation. This practice encourages customers to associate
superiority with that product. This choice and variety can lead certain innovative firms to a
higher degree of success than others.
There are, however, several advantages of competition for the consumer:
i Lower Prices; Due to substitutes, all firms will have to bring the prices down to be
appealing to customers.
ii More Choice; Competition means that there are many suppliers to choose products from.
Constant innovation and differentiation between products emphasizes this idea.
iii
Better Quality; Firms will be pressurized to address the quality and benefit of the
products as a competitive market will empower consumers to be well-informed about the
quality of production of all firms.
Additionally, there are some disadvantages of competition for the consumer:
i Market Uncertainty; Due to the high risk of small and unsuccessful businesses failing in
competitive markets, consumers will not find it convenient to have their preferable provider
or supplier leaving the market.
ii Lack of Innovation; Due to the less profit that firms make in competitive markets,
innovation and progressive ideas may be discouraged.
Competition also impacts the economy by several factors including:
i As an advantage, resources will be allocated more effectively. Fewer resources are wasted.
However, competitive markets can also said to be wasting resources as a failed firm may
produce resources that are immobile; that is, they are unable to be used for another
function.
ii Innovation is also beneficial to the economy if effectively utilized by the firms of an industry.
As a result of this, people will have a better standard of living and the PPC will move to the
right.
23. Advantages and Disadvantages of Large and Small Firms
Several different methods can be used to measure the size of a firm, including: (All are general
concepts)
i Turnover; Firms with large amounts of turnover will be larger than firms with small turnover.
ii Number of Employees; The more workforce employed, the larger the firm is.
iii
Amount of Capital Employed; The more money invested in the business, the greater
it is.
Self-employment is increasingly giving birth to a blossoming generation of small firms, of which
there are many. The pros and cons are outlined ahead:
Advantages:
i Flexibility; As management is actively involved in the business, its quicker to react and
adapt to change.
ii Personal Service; As the directing bodies are more easily accessible, a more customized
service can be offered.

iii
Lower Wages; Workers of small firms arent involved in unions, which keeps pay less
costly and more stable.
iv
Better Communication; There is less diplomacy and a more trust-filled environment.
This encourages motivation.
v Innovation; Due to intense competition, there is a greater pressure to innovate.
Additionally, small firms are more ready to take a risk in the pursuit of innovation, as they
have less to lose than larger firms.
Disadvantages:
i Higher Costs; Economies of scale cant be exploited, which means average costs will be
high.
ii Lack of Finance; As they are risky, and due to other factors, they do not have many
sources of finance.
iii
Difficult Attracting Right Staff; Small firms may not be able to advertise vacancies
on a large scale or afford highly skilled staff.
iv
Vulnerability; If the economic circumstances and trading conditions take a turn for
the worst, they will be more vulnerable to falling or being taken over than established large
firms.
Large firms, on the other hand, are sparse, but contribute greatly to the economy. Following are
the pros and cons:
Advantages:
i Economies of Scale; These can be exploited, resulting in much lower average costs.
ii Market Denomination; A greater influence on the economic forces and a greater public
appeal in the market.
iii
Large-Scale Contracts; Lucrative contracts can be won, as large firms have enough
resources at their disposal.
Disadvantages
i Bureaucracy; Decision-making processes are slow and communication channels are often
inefficient. Additionally, a large amount of resources are used in administration. This can
lead to inefficiency.
ii Co-ordination and Control; With a very large amount of resources to manage, supervision
take up a lot as costs.
iii
Poor Motivation; People become alienated and disempowered. This leads to lack of
motivation.
24. The Growth of Firms
Firms grow because of the advantages offered due to expansion. Here are several of those
advantages:
i Survival; Often, firms that wish to survive need to grow to be able to bear the competition
from larger competitors. Also, growth will lower the risk of being taken over from larger
firms.
ii Economies of Scale; Efficiency and profitability increases as average costs will fall.
iii
Increase Profits; By having greater production and selling more products, there are
higher profits.
iv
Increase Market Share; As a large firm, a firm will be able to dominate the market
and utilize its position.
v Reduced Risk; Diversifying into new markets with new products will establish strong roots
for a firm.
Organic growth refers to internal growth achieved by expanding current business activities in
existing or new markets.
On the other hands, businesses also expand much faster by joining forces with other
businesses. This can be done by takeovers (or acquisitions), which involve the purchase of a
business by a larger firm; or by mergers, which is the joining of two businesses, usually to
establish a new one. There are several types of integration, as following:
i Horizontal Integration; This is when two firms of the same industry and at the same stage
of production integrate. As both deal with the same markets also, there is less of a
disruption, and thereby, a greater chance of success.
ii Vertical Integration; This involves two firms of the same industry, but at different stages
in production, joining into one. There are two types of this integration; forward vertical and
backward vertical integration, the former referring to joining with a business at a more
consumer-based stage, while the latter refers to joining with a business at a more supplierbased stage. Both offer a greater control over the market without much disruption.

iii
Lateral Integration; The joining of firms at the same stage of production that
produce similar goods or services but are not in the same market. However, production
techniques and distribution channels may be similar.
iv
Conglomerate or Diversifying Mergers; This is the integration of firms across
different industries, different stages of production, and different markets. Although this will
reduce risk as it establishes a larger firm, it will cause disruption due to lack of knowledge
and ability to deal with a different type of production.
There are several obstacles that prevent a firm from growing. Major ones are outlined following:
i Limited Market; If the market of some products is small, then a large firm wont be needed
until the market grows.
ii Lack of Finance; Growing requires great investment, but sources are few for small firms
due to risk involved.
iii
Aims of the Entrepreneur; Often, the owners are content with the current size and
do not wish to expand.
iv
Low Barriers to Entry; With few barriers to entry, fierce competition prevents any
individual firm from expanding.
v Diseconomies of Scale; Once the MES has been attained, a firm will not expand, to avoid
higher average costs.
25. Monopoly
Monopoly is a situation when there is one dominant seller in a market, in which it alone drives
all market forces at will. A pure monopoly exists when a market is supplied entirely by one firm,
not just dominated. Legal limits are set as to how much of a market has to be dominated in
order for a firm to be monopolist. In UK, for instance, it is at least 25%. Monopolies may be
local, regional, national, or global depending on the range of the market.
There are several common features in monopolized markets:
i Barriers to Entry; Monopolies often exist because any competition is discouraged, often by
the monopoly itself. These are known as barriers to entry. Cost barriers often stop
businesses as some markets require massive amounts of financial commitment, which cant
be met by most firms. Secondly, firms can use legal means to keep other firms from entering
into the market, such as patented licenses which grant permission to operate as sole
supplier of a product. Third, if a large business already dominates a market, it can exploit
economies of scale to keep costs much lower than any new competitor, thereby
disallowing any firm to enter. Lastly, marketing barriers involve the effect that established
and trusted brands have as being unable to be easily replaced by newcomers. Additionally,
lowering the pricing at extraordinarily low rates, often utilized by such monopolies, is used if
the threat of a newcomer exists. This is known as predatory pricing.
ii Unique Product; If a product is significantly distinctive, it is a pure monopoly as there is no
alternative choice.
iii
Control Over Market Forces; Monopolies, often known as price makers, usually
control factors such as quantity supplied, and thereby price charged.
There are several advantages of monopolies:
i More Research and Development; Since monopolies are larger and can exploit several
factors to increase profitability, they have more resources to invest in research and
development. As a result, consumers may benefit.
ii Economies of Scale; Since average costs are lower, monopolies can afford to supply goods
at lower prices.
iii
Natural Monopolies; In some markets, it is a more efficient allocation of resources if
only one firm supplies all consumers. A natural monopoly is a situation that occurs when
one firm in an industry can serve the entire market at a lower cost than would be possible if
the industry were composed of many smaller firms.
iv
International Competitiveness; If a firm is a monopoly in the domestic market, it
can effectively deal with multinational competition. This can improve the domestic economy
by raising national income and employment.
The key disadvantages of monopolies are:
i Higher Prices; Monopolists will tend to control output to force up the price. As it is a
monopoly, it is able to.
ii Restricted Choice; There is little, or in the case of pure monopoly none, choice over the
supplier that consumers may choose. This means that if consumers are unhappy with quality
or other factors, they cant switch providers.

iii
Lack of Innovation; Since no competition exists, there is little incentive for
monopolists to improve or develop their products. Additionally, consumers are forced to buy
from those firms.
iv
Inefficiency; Since there is no competition, economic activity may become sloppy in
terms of wasting unnecessary costs or giving little attention to customer and labor relations.
Additionally, they may incur diseconomies of scale.
26. Oligopoly
A market that is dominated by several, in relative terms, very large firms is known as an
oligopoly. Usually, many small firms also exist in oligopolies as they serve market niches
segments of the market that are not served by oligopolists.
Oligopolies often slightly differ in different circumstances. However, several key features are
common:
i Interdependence; There are interconnected links between firms in oligopolies. Economic
activities of one firm can affect the partner oligopolists.
ii Barriers to Entry; Firms in an oligopoly often benefit from the barriers to entering that
market. This may be due to factors such as high initial investment required to set up the
business, or the marketing roots large and established firms will have in that market;
thereby discouraging any other firms to join that particular economic activity.
iii
Price Rigidity; Prices remain constant for long periods of time because of the
reluctance of oligopolists to lower prices causing a price war to follow, which would lower
revenue for all. This would involve the initial change in price by a firm, which will result in a
chain reaction of price changes among all firms, as the lowest sells the most.
iv
Non-Price Competition; Firms also cause brand wars. In these corporate battles,
revenue is not lost by all the firms, so engaging in this marketing activity is preferable. It
involves creating brand loyalty, price differentiation, or any other relevant marketing act
that discourages consumers from trading with other firms.
v Economies of Sale; Large firms in an oligopoly exploit economies of scale as they
participate in large-scale production. Smaller firms tend to avoid direct competition with
large firms due to this disadvantage.
vi
Collusion; This involves informal agreements between firms to restrict competition. It
can be done so by sharing a market geographically, hiking up prices to a fixed rate, or to
restrict output, forcing up the price. It is often illegal.
Due to some, but limited, competition in oligopolistic markets, consumers benefit. The
advantages of oligopolies are:
i Economies of Scale; Due to lower costs for the firms, because of exploiting economies of
scale, consumers may be charged with lower prices.
ii Price Stability; Due to the reluctance of firms to engage in a price war, the prices stay
stable in oligopolies. If one does occur however, the consumer benefits as the price lowers.
iii
Choice; Due to intense competition in oligopolies between large firms, new brands and
distinctive products are continuously produced. Due to this choice, consumers benefit.
Unless there is competition in the market, consumers are unlikely to benefit from oligopolies.
Firms are tempted to form cartels, which partake in acts of collusion, and effectively act like
monopolists. They reduce choice and cause prices to rise, both harmful for consumers.
Additionally, intense competition results in huge advertising costs, which firms replenish by
forcing up the market prices of products.

III) Public and Private Sectors

27.

Public and Private Sectors

Firms owned and controlled by individuals or groups of individuals are in the private sector. In
the UK economy, most consumer goods are provided by this sector. The types of firms in the
private sector include:
i Sole Traders; owned and controlled by one individual. For example, plumbers.

ii

Partnerships; owned and controlled by more than two individuals. For example,
lawyers.
iii
Incorporated Companies; owned by shareholders who elect a board of directors. For
example, McDonalds.

Most of UKs firms are small, but some are large and contribute greatly to the economy. Some
are multinationals.

Owners, shareholders that is, decide the business aims in the private sector. Here are some
key aims:
i Survival; This may apply to a business that is starting off new and wishes to survive.
Additionally, it also pertains to larger businesses during intense and volatile economic
conditions.
ii Profit Maximization; This is an important objective as it reflects the wants the
shareholders, high dividends. Those come from profit, which firms want to make the most of
in the shortest amount of time.
iii
Profit Satisficing; This refers to aiming to making enough profit to satisfy owners.
Generally, higher profits are not aimed for due to lack of interest in growth.
iv
Growth; Potential benefit for firms as they will be able to enjoy economies of scale and
thereby, higher profits.
v Sales Revenue Maximization; Increasing sales revenue to the highest possible in the
shortest amount of time.
vi
Social Responsibility; To become responsible corporate citizens and thereby please a
wider range of stakeholders.
Organizations owned and controlled by the local or central government form the public sector.
Main firms of the UK in this sector include:
i Central Government Departments; This involves organizations such as the Ministry of
Defense, Department of Transport, or Department of Health. They are usually controlled by
boards led by a government minister.
ii Local Authority Services; Includes recreation such as sports halls, protection such as
police and fire services, and housing which provides council housing for homeless. Run by
councilors elected by local community.
iii
Executive Agencies; Provide services and are accountable to a government
department. Usually run by boards. The Office of National Statistics is an example, which
gathers economic and other data.
iv
Other Public Sector Organizations; Run by a trust or board led by an experienced
expert appointed by a government body. Examples include the BBC Trust or the Post Office.
Mostly, funding comes from tax revenue. However, the government may also charge prices on
some occasions.
Generally, organizations in the public sector do not aim to maximize profit or other likewise
ideals as many of those organization provides free services. Although aims are different,
common themes prevail in all public sector aims:
i Improving the Quality of Services; Generally aim for progress in terms of the quality of
the provided services.
ii Minimizing Costs; Costs in all areas should be cut in order to improve efficiency.
iii
Allow for Social Costs and Benefits; Since aim is not to make profit, impacts of
their economic activity on stakeholders, externalities, are always an important factor in the
firms functionality.
28. Government Regulation
Government regulation is to monitor the activities of monopolistic and oligopolistic markets to
avoid illegal practices:
i Increasing Prices; to levels above what they should be in a competitive market.
ii Restricting Consumer Choice; by refusing to supply products unless certain conditions
are met.
iii
Raise Barriers to Entry; Several mechanisms, like marketing campaigns, utilized to
keep new firms from entering.
iv
Market Sharing; Forming cartels by collusion, who collectively exploit consumers.
The government of the UK functions in the economy by promoting competition and preventing
anti-competitive practices by the following:
i Encourage the Growth of Small Firms; Several mechanisms, including lower taxes and
business start-up schemes, are available for small firms to encourage growth of small firms.
ii Lower Barriers to Entry; Legal barriers are being lowered or removed so that new firms
may join markets.
iii
Introduce Anti-Competitive Legislation; Several instances of legislation exist to
protect consumers from exploitation by monopolies, mergers, or restrictive practices:

- The Office of Fair Trading was set up to protect consumer interests and ensure fair
corporate competition in the UK. The key functions of the OFT are competition
enforcement, promotes competition and informs firms with legislation; consumer
regulation enforcement, protects consumers by encouraging codes of practice and
take action against unfair traders; and investigates and recommends, investigating
markets, publishing reports, and recommends appropriate action.
- The Competition Commission (CC) functions by investigating mergers or other markets
where consumers risk being exploited. If competition is visibly being restricted, the CC
can either stop economic activity by the perpetuators in the corrupted market or enforce
the conditions the market must meet.
Regulatory bodies are specialized bodies that exist to follow up on the status of competition
and prices in markets that were previously under the public sector but were privatized.
Examples include Ofwat (Office of Water Services) and Ofgem (Office of Gas and Electricity
Markets).
Governments also attempt to influence the location of operation of businesses by introducing
regional policy which functions as a mechanism to attract firms and associated economic
activity to areas suffering from economic issues:
i Reducing unemployment by offering incentives such as rent-free space or tax breaks, to
encourage firms to locate in areas of high unemployment in order to generate economic
activity.
ii Reducing congestion by offering firms incentives to relocate away from areas that are
over-bursting with economic activity. Such a situation can be observed with high traffic
congestions and housing shortages.
iii
Reducing income inequality across different regions by encouraging firms to invest
in areas with lesser development in order to uniform economic prosperity across entire
nations.
Assisted areas are areas of economic potential, which involves strong skilled and flexible
labor. They are helped by regional development agencies, which are government-funded
bodies that promote economic development.
The European Unions Structural and Cohesion Funds support social and economic structuring
across the EU. They are divided into three separate types:
i European Regional Development Fund (ERDF) aims to improving human capital and
developing human resources. For example, investing in training for skilled workers.
ii European Social Fund (ESF) provides money in disadvantaged regions to encourage
infrastructure development.
iii
Cohesion Fund, which provides money to strengthen economic and social cohesion
across the EU.
29. Privatization
Privatization is the transfer of public sector resources to the private sector. This can be carried
out in several ways:
i Sale of nationalized industries; This involves the process of selling shares of
nationalized industries, which were themselves industries brought into the public sector
from the private sector, to individuals in the private sector.
ii Deregulation; This involves lifting legal restrictions that prevent private sector competition
in an industry.
iii
Contracting out; This involves government or local authority services contracting out
to the private sector to supply services that were previously supplied by the private sector.
There are several reasons why privatization takes place in the UK:
i To generate income; The sale of state assets generates income for the government.
ii Inefficiency in nationalized industries; Lack of competition and incentive to make profit
decreases efficiency. Due to economic accountability firms have to their employees, theres
higher quality productivity in the private sector.
iii
As a result of degeneration; When legal barriers of entry are eliminated, firms from
the private sector rush in.
iv
To reduce political interference; Firms and their economic activities would not be
subject to political agendas.
Privatization has impacts on several different aspects of a nations economic system:
i Firms; Without government interference and lack of competition, firms change rapidly. The
objective of the business moves away from supplying the public a service to making a profit.
However, competition lowers the profits reaped. Investments for industries also rise usually

following privatization. Additionally, mergers, takeovers, and conglomerates emerge due

to the liberty of a firm in the private sector.
ii Consumers; Due to the competition usually prevalent in the private sector, consumers have
benefited from lower prices and better quality. However, if the market fails in a certain
industry, these benefits do not apply. In fact, monopolies and oligopolies, along with other
market conditions, could be harmful for consumers. Additionally, any loss-making economic
activity, like servicing less-populated areas, will be avoided, to the detriment of a consumer.
iii
Workers; Due to the importance of economic output and private sector competition,
industries pressurize workers to raise productivity levels. Additionally, to lower costs,
privatized industries make a lot of workers redundant. However, if a privatized industry
results in high competition, more factors of production could be utilized.
iv
Government; Governments benefit from privatization as they can raise funds in the
issuing and selling of shares, although the marketing for such sales can be costly.
Additionally, as the government is no longer responsible for these industries, attention can
be effectively diverted to governmental operations. As a cost of privatization, governments
will no longer have prominent influence in the economic activities of privatized industries,
but this can be dealt with by forming regulatory bodies.
v The economy; Due to the empowerment of the invisible hand, guided by market forces,
increased competition would lead to lower costs, less waste of resources, and better
allocation of resources. However, most public corporations exist in the public sectors as
monopolists. The privatization of such industries would result in private sector monopolies,
which can have numerous unintended side effects.

Sec C: Government and the Economy

I) Macroeconomic Objectives
30. Macroeconomic Objectives
The study of economics is branched into two:
i Microeconomics; the study of the individual and fundamental components of the economy.
ii Macroeconomics; the study of the economy as a whole and its more large-scale functions.

 Often, the political viability of a government depends on the economic performance during their
reign. To measure the economy, several indicators are used to show different aspects of
economic performance, each with its own degree of importance. These are known as
macroeconomic objectives and governments are interested in them as they are often
assumed responsible for fulfilling them:
i Economic growth; Governments often emphasize the importance of creating institutions
and opportunities to sustain economic growth. An internationally recognized indicator of
economic growth is the gross domestic product, which is the total value of the nations
economic output over a time period. With a greater and more efficient economy, living
conditions improve.
ii Inflation; Although this always occurs as a side effect of economic growth, governments
aim to keep it marginal and under control. If inflation occurs to an abnormal degree, it can
have several consequences for the economy and the nation. If it rises quicker than incomes,
the power of purchasing drops. Additionally, rampant inflation can make the economy
unstable and confusing as it would distort the value of money. Due to these factors, living
conditions can fall, which is why it is of concern to the government.
iii
Unemployment; This involves the issue of a lack of employment of labor resources.
As a result, resources are said to be being wasted. In addition, unemployed members of
society will face more hardships than those who do work, creating inequality and instability
in society. As wasted resources lower the GDP, governments are interested in controlling
unemployment rates and encouraging employment opportunities.
iv
Current account; Governments find it important to address imports and exports and
ensure that the value of exports is higher than the value of imports, as that would achieve at
least a balance. This is an important source of activity for the national economy. The current
account records the values of goods and services traded and a balance of payments shows
the total value of international transactions.
v Protecting the environment; People are becoming more aware of the environmental
harms from economic activity. As a result, governments aim to act to reduce damage to the
environment.
31. Economic Growth
When economies grow, it is said that national incomes rise. This can refer to several
equivalent values: all income generated within or abroad; all output or production; all spending
in the economy. The most common measure of national income is gross domestic product
(GDP).
Growth rates refer to the percentage by which GDP may have grown, whereas the total growth
shows the actual value, in monetary terms, by which the GDP grew.
Although GDP is a common indicator of economic progress, there are some limitations:
i Inflation; GDP fails to account for inflation, and thereby, fluctuation in the value of money.
Real GDP is then used as a measurement, which is the difference between the inflation rate
and the growth in money GDP.
ii Population changes; GDP doesnt take into account whether the growth is sufficient to suit
population changes. Therefore, GDP per head/capita is used to show the growth of GDP per
person in the population.
iii
Statistical errors; As millions of documents needed to be collected from all firms
from all industries and sectors, mistakes are often made when calculating the GDP.
iv
The value of home produced goods; When home produced goods and services are
lived upon rather than traded, they are not recorded as economic output. As a result, they
are not included in the GDP.
v The hidden economy; Money generated in informal, black, or hidden markets goes
unrecorded, therefore not becoming part of the GDP.
vi
GDP and living standards; Although GDP is used to indicate status of living
standards, it alone cant show the entire picture as several other factors also need to be
considered to conclude that life has improved.
Although GDP is generally expected to grow, the rate of growth fluctuates. This principal is
modeled by what is known as the trade, business, or economic cycle. Following are the
phases(in consecutive order):
i Boom; This is the peak of the cycle as it is the point where GDP is rapidly growing. With
businesses expanding and new firms forming, jobs are created, profits will be rising, wages
will be increasing, and demand will be high. However, prices will also rise, as a side effect to
increased demand.

ii Downturn; The economy grows, but at a slower rate. Firms will decrease expansion, and
some firms may leave the market; resulting in rising unemployment. Wage increases slow
down, and demand flattens out or begins falling, resulting in lower inflation.
iii
Recession or depression; The lowest point in the cycle, where the GDP becomes flat.
Non-essential produce loses its demand. Often, such periods are associated with hardship as
unemployment rockets, bankruptcies become rampant, prices become flat or fall, and
business activities lose confidence.
iv
Recovery; GDP begins to rise again as a result of several factors. Consumers and
suppliers regain confidence, unemployment decreases, demand rises, and prices increase.
There are several benefits of economic growth to living standards, which is why governments
prioritize it:
i Increased incomes; Higher GDP means people will have more income, which means that
citizens of the economy may purchase goods and services in better quantity and quality.
ii More leisure time; With economic growth, efficiency of production rises. This leads to less
work demanded from labor resources.
iii
Greater life expectancy; Due to economic growth, people can afford healthier food
and better medical procedures, resulting in longer and more healthy lives.
iv
Better public services; As both incomes and spending are linked with tax revenues,
the tax revenues correspondingly increase when the economy grows. This tax collected can
be reinvested to develop public services, thereby improving living standards.
Economic growth, however, can also impose problems, as outlined below:
i Regional differences; Economic growth will not be shared to all members under the
economy in equity. On the contrary, it will be shared according to existing discriminatory
procedures, which will breed discontent.
ii Environmental damage; The economic growth is often damaging to the environment,
many environmentalist groups would argue. This is due to several corporate activities that
may impose environmental costs, but are condoned because of the economic growth they
may reap.
iii
Unsustainable growth; When non-renewable resources are exploited, they cannot
also be utilized for future generations. Therefore, any growth resulting from the exploitation
of those resources is unsustainable.
iv
Inflation; If economic growth is too rapid in relation to its time period, the economy
may overheat, resorting to abnormal inflation.
32. Inflation
Inflation is a general and persistent rise in prices that occurs naturally in all markets as the
economy grows. As prices increase across the board, it is said that the cost of living has
increased. Deflation also occurs, if the economy slows down; when the aggregate demand
total demand in the economy including consumption, investment, government expenditure, and
exports minus imports falls.
Governments regulate inflation by monitoring the prices of goods and services that are
purchased by families. The measurements are portrayed through the consumer price index
(CPI) or the retail price index (RPI). The former is a measure of general price level (excluding
housing costs), and is used in Europe; whereas the latter measures the general price level,
including house prices and council tax.
Different economists have different views on the causes of inflation. However, there are three
recognized causes that can be significant reasons for initiating inflation:
i Demand-pull inflation; This type of inflation occurs due to rises in demand. If demand
increases in a market, the prices correspondingly rise; similarly if aggregate demand
increases in a market, all prices generally rise. Such inflation can be caused by: rising
consumer spending due to tax cuts or low interest rates; sharp increases in government
spending; rising demand for resources by firms; and booming demand for exports.
ii Cost-push inflation; This types of inflation occurs when costs rise. If the costs of
production rise for a firm, they have to pay for the higher costs by selling products at a
greater price in order to keep their marginal profit high. The reasons why this type of
inflation might ensue include: rising costs of imported goods; wage increases impose greater
costs on firms; and increases in taxation.
iii
Money supply inflation; Monetarists believe that there is a strong link between
growth in the money supply and inflation. Their proposition is that when banks supply
money more freely, spending powers cause demand to go up, resulting in this type of
inflation.

33. Consequences of Inflation

Inflation can have undesirable effects on households, firms, and the economy in several ways:
i Reduces purchasing power; Inflation will always result in a depreciation of the currency
as the currency will only be able to buy a portion of the good or service, as its value has
risen. The only exception is if incomes rise as quickly as inflation. Otherwise, general living
standards will fall as less goods or services can be purchased.
ii Reduces the value of savings; If inflation rises higher than interest rates, savings will
depreciate over time.
iii
Increased business costs; Inflation can impose numerous costs on businesses. To
start off with, firms will have to pay more for the resources the factors of production.
Although raising prices subsequently is an easy fix, it is not always possible in competitive
markets. Furthermore, at time of inflation, workers want higher wages to be able to
compensate with the loss of purchasing power; presenting another cost to the firm.
iv
Balance of payments problems; If inflation rises in a particular region, it would
make exports from there expensive. As market forces imply, importers from there would
rather look elsewhere for those goods; resulting in a fall of demand for the regions
international market. As a result, the current account would fall in deficit, further harming
the economy. On the other hand, if imports are cheaper than domestically-produced
products, then demand for them would rise, furthering the adverse effect on the current
account.
v Increases in government spending; A lot of government expenditure also rises with
inflation. For example, state benefits are index linked, which means that they rise in
correspondence with the increase in RPI.
Money has quite a few functions in the economy:
i Medium of exchange; Money can be used as a medium in trade to be exchanged for
goods or services.
ii Store of value; Money can be saved and used at a later date as it will still hold a value,
whether big or small.
iii
Unit of account; Money can be used to place values on different items, thereby
allowing comparison.
iv
Standard for deferred payments; Money can be used as credit or to settle a debt.
Inflation can have an impact relating to each of these functions of money. Firstly, in cases of
extreme inflation hyperinflation money becomes so worthless that people would prefer using
other mediums such as commodities or gold. Secondly, inflation can cause stored money (i.e.
savings) to lose value if inflation rates are higher than interest rates. Thirdly, monetary values
of goods and services became distorted and misleading in inflation. Lastly, inflation benefits
those in debt as inflation would cause money to lose purchasing power, or become less
valuable, thereby being easier to pay off.
34. Unemployment
Unemployment is defined by the Intl Labor Organization (ILO) as people seeking work but
unable to find any. In UK, the Labor Force Survey is used to measure levels of unemployment.
Additionally, a claimant count can also provide a number of the majority of the unemployed as
it is a count of all those who claim Jobseekers Allowance which wont include some marginal
groups of the unemployed illegible for the allowance.
There are several causes of unemployment, as outlined below:
i Cyclical or demand deficient unemployment; this occurs when an economy falls from
the boom into a downturn. As a result of slowed growth and less confidence, firms conserve
their money by lowering costs. In the drive for lowering costs, labor resources are also often
unemployed.
ii Structural unemployment; as the structure of the economy develops and changes,
sectors or industries could perhaps lose their purpose as other sectors or industries grow,
thereby making all workers qualified in the former work redundant. This type of
unemployment is further divided into three:
Sectoral unemployment; is when unemployment is due to a declining industry.
Technological unemployment; is what occurs when machine replaces labor.
Regional unemployment; this is due to the varied levels of unemployment across
different regions.
iii
Frictional unemployment; this is the state of unemployment that occurs when
someone is transferring jobs. On most accounts, it is not a problem as it has to happen in
any economy. A period of 8 weeks is used as a timeframe to define frictional unemployment.

iv
Seasonal unemployment; this is the unemployment linked with work that is only
required at certain annual point, that is, seasonally. There is little that can be done to reduce
this as it is climate-based.
v Voluntary unemployment; this involves those members of society who willingly evade
employment, which may be due to various reasons, including individual preference or
inability to agree with wages.
Unemployment is always undesirable due to its numerous affects upon all structures in the
economy:
i Costs to the individual; workers that have become unemployed get lower incomes as
state benefits are generally lower than wages. This can bring several hardships upon the
individual, including risk of losing home.
ii Costs to business; firms are also challenged with unemployment in several ways. Cutting
workers requires the firm to pay redundancy money. In addition, workers may become
demotivated in the anticipation that the cuts may affect them. Spare capacity of firms will
increase. Machines that no one is skilled to use become wastes of capital. Lastly, with high
unemployment, people have less to spend, leading to fall in sales and demand.
iii
Costs to the economy; Unemployment is a wastage of resources, as potential
workers are making no contribution the economy, resulting in lower levels of national
income. Due to a fall in income and spending, taxes will also accumulatively decrease,
meaning the government will have less financial resources to fund public services. Rising
unemployment will only aggravate this issue as they will require government benefits. To
address this, the government may begin borrowing money or raising taxes.
iv
Costs to local communities; As rising unemployment puts economic barriers upon a
community, limits are made upon the freedoms and liberties of people within communities.
Eventually, the spirit may run low, resulting in disappointing and shabby-looking
communities.
35. Balance of Payment on the Current Account
Goods and services sold overseas are known as exports, whereas goods and service bought
from other nations are imports. In these different types of trading, economists distinguish the
following:
i Visible trade; this is to do with the exports and imports of physical goods. The
measurement of the difference between exports and imports is known as the balance of
trade.
ii Invisible trade; this involves the exchange of services. The balance of exports and imports
in invisible trade is known as invisible balance.
All transactions relating to intl trade will be recorded as the balance of payments. It is
divided into two parts:
i Current account; this includes all the imports and exports over a period of time, both
invisible and visible trade. From the invisible balance, the balance of trade, income balance,
is deducted the current account balance, which either exists as a deficit if incomes are
higher, or a surplus if exports are higher.
ii Capital account; this records the flow of money into and out of a country resulting from
transactions relating to numerous items, such as savings, investments, and speculation.
Current accounts can be used to predict consequences a nation may face depending on
whether:
i It is a persistent current account deficit;
An increase in external debt.
A rise in unemployment due to preference towards imports rather than domestic
products.
Falling exchange rate, leading to expensive imports, further contributing to inflation.
Shows structural weakness and lack competitiveness against international market.
ii It is a persistent current account surplus;
Rising exports will generate opportunities and economic growth.
A nation can build foreign currency reserves or lend money overseas.
Domestic shortages, if too much produce is sent overseas.
Rising exchange rate, leading to expensive exports.
A high surplus can indicate the existence of rampant deficits in other nations, leading
to intl instability.
Governments also intervene in the economy in order to manage deficits and ensure that they
are marginalized so that a neutral position, if not a surplus, can be attained.

36. Protection of the Environment

Globally, governments are becoming more concerned with the environment. Governments have
enforced several methods of protection to help reduce environmental damage resulting from
economic activity:
i Governmental regulation; huge range of legislation, regulations, guidelines, and codes of
practice designed to protect environment exist in UK. (e.g. Clean Air Act 1993, Environment
Act 1995, Water Resources Act 1991)
ii Environment agency; this agency enforces environmental protection laws. In addition, it
assists firms to incorporate environmental-friendliness in their activities.
iii
Taxation; many governments charge high taxes on those industries that impose high
social costs by their economic activities or products. This can, in turn, discourage the use of
the product.
iv
Subsidies; these are offered to firms as incentives for reducing environmentally
harmful activities. Additionally, subsidies are offered to firms that produce positive
externalities.
v Compensation; firms and industries that conduct activities resulting in negative
externalities will have to pay compensation to the victims of these externalities.
vi
Recycling; such opportunities to recycle items like paper or steel can increase
resources for the economy.
vii
Intl targets; international agreements, such as the Kyoto Protocol, have formed to
protect the environment.

II) Policies: to Deal with Economic Growth, Inflation, Unemployment, the

Balance of Payments on the Current Account, and Protection of the
Environment
37. Economic Policy and Policy Instruments
The government can manipulate policy instruments economic variables such as the rate of
interest, rate of taxation, and government expenditure; all controllable by the establishment
to achieve macroeconomic objectives as these variables can, in turn, affect other variables in
plans known as economic policies:
i Demand side policy: these involve using policy instruments to control aggregate demand
in the economy.
Fiscal policy; this involves the manipulation of taxation and government expenditure.
Monetary policy; this involves the control of factors such as the interest rate.
ii Supply side policy; these are designed to increase productive potential, thereby aggregate
supply, of the economy. Markets such as the labor market, capital market, and goods market
have been targeted.
iii
Other economic policies; various other economic policies are also used for other
purposes. This includes policies that are implemented to protect the environment or to
achieve current account surplus, for example.
38. Fiscal Policy
The decision plans about government spending, taxation, and borrowing are detailed in the
governments fiscal policy. These variables indirectly affect aggregate demand. The
government also keeps annual plans on how total expenditure will be funded and spent in the
budget. Main areas of public spending in the UK include: (2008/09)
i Social protection (173bn) e.g. state benefits, pensions, child benefits, and disability
allowances.
ii Health (103bn) e.g. NHS salaries of doctors, and admin staff; drugs and medicine;
surgical equipment.
iii
Education (83bn) e.g. teachers salaries, equipment for schools.
iv
Defense (36bn) e.g. maintenance of the armed forces (navy, army, and airforce).
v Debt interest (34bn) e.g. the interest paid on government borrowings on PSNCR.
vi
Public order and safety (33bn) e.g. police force, fire service, prison service, the
justice system.
vii
Personal social service (27bn) e.g. spending on the care of children, the elderly,
and disabled people.
viii
Other categories e.g. transport, housing and the environment, industry, agriculture,
and recreation.

 A budget deficit is created if the government had to borrow money to complete their
spending, as government revenue wasnt sufficient. Borrowed money is known as the public
sector net cash requirement (PSNCR). A budget surplus is when revenue exceeds public
spending. The surplus is used to repay government debts.
Government expenditure can be divided, as it is in some nations, into mandatory spending and
discretionary spending. The former includes payments that are determined by existing
protocols, whilst the latter is new.
Taxation is imposed for reasons outlined below:
To pay for public sector services.
To discourage the trade of certain items.
To discourage involvement in undesirable activities.
Taxes can be used to control aggregate demand in the economy.
Wealth can be shared across the society on a fairer basis.
Government taxes can be either of the following:
i Direct taxes; imposed on incomes of firms or individuals. The key direct taxes in the UK
are as follows:
Income tax; levied on peoples incomes. Most important tax in UK.
National Insurance contributions; also levied on peoples incomes, but used for
specific purposes.
Corporation tax; levied on the profits made by limited businesses.
Capital gains tax; levied on financial gain made when selling assets at a profit.
Inheritance tax; charged on money inherited upon someones death.
ii Indirect taxes; are imposed on spending. The key indirect taxes in the UK are as follows:
Value added tax (VAT); charged on all goods and services but exempt the more
necessary ones.
Duties; heavy taxes to discourage the purchase on a range of goods.
Vehicle excise duty; levied on vehicle owners based on engine size.
Customs duties; imposed on imports from outside EU.
Council tax; levied according to residential property for local services.
Business rates; levied according to business property for provision of local
community services.
Stamp duties; on the purchase of certain assets.
iii
Environmental taxes; these are designed to protect the environment:
Landfill tax; charged on the disposal of waste in landfill sites.
Climate change levy; imposed on suppliers of electricity, coal, or gas, for example.
Aggregate demand; levied on sand, gravel, or rock dug from the ground.
Fiscal policy can also be used to control aggregate demand in the economy. An expansionary
fiscal policy involves measures designed to stimulate demand in the economy, spending more
and taxing less; whereas contractionary fiscal policy aims at reducing demand, by spending
less and taxing more. Either are adapted for certain conditions:
i Inflation; if caused by rising aggregate demand, a contractionary fiscal policy will
reduce that inflation as higher taxes and lower government spending will neutralize the
rising aggregate demand.
ii Economic growth; can occur as a result of expansionary fiscal policy, as lower taxes will
stimulate aggregate demand and higher government spending on institutions such as
schools and healthcare are key to growth.
iii
Unemployment; can be reduced if expansionary fiscal policy is implemented. That
is due to the jobs that are usually created in correspondence with increasing aggregate
demand in the economy.
iv
Current account deficit; can be combatted using a contractionary fiscal policy,
as that will discourage the demand for imports.
v Fiscal policy and the environment; fiscal policies can be used to protect the
environment. For example, taxes against environmentally-harmful practices and subsidies
for environmentally-friendly practice.
39. Monetary policy
Governments also indirectly influence aggregate demand in a desired direction by manipulating
the variables of interest rates and money supply in economy. A policy built on this approach is
known as monetary policy. Though its often the responsibility of a central bank, it helps the
government achieve their macroeconomic objectives.

i Interest rates; in UK, the monetary policy community (MPC) is responsible for setting a
base rate, from which all other rates in the economy are derived. This base rate will be
based on the target for inflation, set by the government, as the MPC aims at keeping
inflation under control.
ii Money supply; this is the amount of money circulating in the economy. Due to its vague
definition, controlling this policy instrument has proved to be challenging for governments.
Qualitative easing is an example of monetary policy in which money is pumped into the
economy with the purchase of government bonds from commercial banks by central banks.
The rate of interest can impact aggregate demand in a range of ways:
i Consumption; with cheaper loans, demand for goods or services such as cars, houses,
furniture, or holidays increases. Additionally, mortgages become easier to pay and savings
lose profitability, resulting in spending, generating increases in aggregate demand.
ii Investment; as money used to finance investment is mostly borrowed; cheaper borrowing
will lead to vaster investing. In addition, loans can be repaid easily on low interest rates. Due
to this lowering of costs, profits are available for investment.
iii
Exports and Imports; lowering interest rates also results in reduced exchange rates.
This would make exports cheaper, resulting in a rise in demand for exports and revenue for
domestic firms. Conversely, imports will become more expensive. Therefore, aggregate
demand will rise overseas and domestically.
It is important to note that an increase in money supply leads to a fall in interest rates. The
reason for this is that a rise in the supply money will lead to a lower price interest rate for
money. They have an inverse relationship.
Monetary policy can be used to help governments achieve macroeconomic objectives:
i Inflation; monetarists say that inflation is a direct result of money supply growing too
quickly. Therefore, the way to stop inflation is implementing tight monetary policy that is,
increase interest rates to lower demand.
ii Unemployment; since a loose monetary policy would generate aggregate demand to rise,
opportunities are created for jobs. This would mean a reduction in unemployment.
iii
Economic growth; as a loose monetary policy will assist an economy out of a
recession, monetary policy can help smoothen out fluctuations in the economic cycle.
iv
The current balance; a government can also use a monetary policy when dealing
with current account deficits. For example, it could tighten the monetary policy resulting in a
lower demand for exports. However, if the exchange rate was to correspondingly rise along
with the interest rate, then exports would become expensive, resulting in a fall of foreign
demand. Additionally, imports would become even cheaper, diverting demand from
domestic suppliers to foreign markets. Unless these imports are income elastic, such a policy
will not fix a deficit. A loose monetary policy, on the other hand, will allow imports to
increase even higher.
40. Supply Side Policies
Supply side policies are government measures used to help increase aggregate supply in an
economy. This serves several functions:
Improve flexibility and restore incentive to work by removing restrictions and lowering
taxes.
Promote competition through privatizing, regulating, and helping small firms.
Increase investment by improving the flow of capital around economy.
Increasing productivity from the workers would increase productive potential of the economy.
Following are examples of elements contained in supply side policies in the UK to build on
this approach:
i Improving flexibility; trade unions have been weakened by legislation to stop letting them
negatively affect productivity, as they encourage higher wages and discourage new working
practices and technology.
ii Restoring incentive; lowering taxes has proved to encourage productivity, as income
taxes and other financial restrictions prove discouraging and harmful to productivity among
workers.
iii
Increasing the quality and quantity of labor; by improving training and education,
the workforce becomes more productive as they are better equipped for work. In addition,
increasing the size of the workforce also makes the economy more productive as the factor
of production of labor has been increased in resources.
Supply side policies also involve making production more efficient in order to generate
aggregate supply:

i Privatization; this endorses competition as corporations in the private sector cant draw on
public money and therefore have to compete to survive in the economy. As a result,
companies aim at being as efficient as possible, in order to lower costs and higher profits.
Additionally, competition will lower prices.
ii Deregulation; red tape in business generally refers to the paperwork, licenses, or other
tedious restrictions that often make discourage growth. To encourage development, such
rules have been removed or lowered.
iii
Helping small firms; since the creation or expansion of small firms will increase
aggregate supply, in the UK measures have been designed to help small firms, including
advising, lowering taxes, and reducing red tape.
Investments increase productive potential of the economy. Therefore, if there is more
investment from the public sector into infrastructure, education, and healthcare, for instance,
the workforce and other economic resources could be more efficiently assessed and prepared
for economic activities. In addition, by operating in a stable economy and lowering tax
restrictions, firms have the confidence to endorse higher investments.

III) Relationship between objectives and policies

41. Relationship between objectives and policies
Governments use various policy instruments to address the macroeconomic objectives. Which
policies are implemented depends on the economic circumstances. It is understood that
governments globally wish to:
Promote economic growth
Keep inflation under control
Reduce unemployment
Prevent a large current account deficit
Protect the environment
Different types of demand-side policies have different effects on the economy:
i Expansionary fiscal policies involve lowering taxes and increasing spending and
investment.
Positive effects
Increased spending and investment will lead to;
- Unemployment will fall as jobs are created.
- Economy growth, leading to a rise in GDP.
- Tax revenues will increase financial resources for governments.
Increased government expenditure may result in;
- As jobs will be created in public services, unemployment will drop.
- As aggregate demand will increase, economy will grow. That is, higher GDP.
- Better living standards due to improvement in public services.
- Better infrastructure.
Negative effects
- Demand pull inflation due to increase of aggregate demand, especially if economy
has limited capacity.
- Tax cuts may lead to rise in expenditure in foreign markets, rather than benefiting
domestic economy, and worsening current account.
- Government debt will increase, meaning they will have to borrow.
ii Contractionary fiscal policy involves raising government taxes and reducing public
spending.
Positive effects
- Inflationary pressures in an overheating economy will dampen.
- Government revenues will increase from taxes and reduced borrowing.
- As demand for imports will drop, current account will more towards surplus.
Negative effects
Fall for consumption will result in unemployment.
Economic growth will slow down, GDP may even contract.
Living standards may suffer.
iii
Tight monetary policy involves raising interest rate and restricting money flow.
Positive effects
- Reduce aggregate demand, inflationary pressures will subside.

- Savings will benefit.

- Strengthening of exchange rate makes imports cheaper.
Negative effects
- Lower consumption and investment leads to fall in aggregate demand.
- Unemployment rises.
- Economic growth will slow down.
- If exchange rates also rise, current account may fall into a deeper deficit as exports
become expensive.
iv
Loose monetary policies involve pumping money into the economy and lowering
interest rates.
Positive effects
- Increase aggregate demand, leading to economic growth.
- Lower exchange rate leads to more demand for cheap exports. Current account
improves.
- Interest on government debt will decrease, leading to higher financial resources for
government.
- Higher investment may lead to higher inefficiency and lower unemployment.
Negative effects
- If increase in aggregate demand is too strong and quick, inflation will ensue.
- Demand for imports will increase, worsening current account.
- In addition, lower exchange rates will lead to expensive imports. May contribute to
inflation.
Because each policy has undesired negative effects too, trade-offs have to be accepted. This is
why it is difficult to achieve all macroeconomic objectives.
Government measures on environment, however, do not impact other macroeconomic
objectives. This is because environmental initiatives take a small portion of government
expenditure. However, there are several connections between environment and other
macroeconomic objectives. For instance, unemployment may rise due to the imposing of
environmental constraints; and revenues collected from environmental taxes will fund policies
designed to pursue other macroeconomic objectives.

Sec D: The Global Economy

I) Globalization
42. Globalization and Multinational Companies
Many markets today are global. That is, firms can carry out operations anywhere in the world. In
addition, firms and people act as if there is no separation in nations and economies; showing
the integration of all national economies into a single universal economy. This development is
known as globalization. Several features include:
i Trading occurs freely across intl borders as no government restrictions that prohibit such
activity exist.
ii Multicultural societies are common, where people from various origins live and work.
iii
Interdependence between nations and economies is increasing. This means that
fluctuations in one nation or economy could hold massive implications for the rest of the
global economy.
iv
Capital can flow freely between countries. That is, borders hold no implications for
transfer of financial assets.
v Interchange of technology and intellectual property results in the merging of legal systems,
when regarding economic matters, of different nations.
There are several reasons why modern globalization has spawned:
i Due to technological advances its ability to build rapid transferring portals the world has
become a more connected place. This, in turn, is good ground to allow the global community
to become smaller.
ii International transport networks have become both more efficient and more available. This
helps economic activities happen regardless of borders.
iii
Due to privatization, economic deregulation, and other ways in which governments are
losing influence in economic matters, economies are becoming more open to intl trade.
Monetary and legal systems are also conforming to a global standard in order to ease trade.
iv
Firms such as multinational corporations want to operate in the global economy, as
they can benefit greatly from international trade where, due to several reasons, costs can be
minimized.
v Our move to a more pleasure-deriving society and greater spare money allows tourism to
flourish.
Multinational corporations are large and powerful companies that conduct operations intl
all over the world. They exist for several reasons:
i Economies of scale; in many industries, economies of scale can be easily exploited.
Multinationals are powerful enough to pressurize suppliers to lower prices. They also have
access to cheap resources.
ii Marketing; firms that have been able to successfully establish a brand name in the global
market through effective marketing become multinationals.
iii
Technical and financial superiority; these firms can afford in research and
development on a large scale. They have experience in their fields and have access to the
most efficient resources. They are diversified and can afford to take huge risks, which could
result in increasing their power greatly.
43. Foreign Direct Investment and Development Aid

 Inward investment, or foreign direct investment (FDI), refers to investment a firm makes
in foreign nation. Usually, this is undertaken by multinationals collaborating with companies in
host nations on developing a business venture.
Governments may do any of the following to attract intl corporations to their nations:
Offer tax breaks, subsidies, grants, and low interest loans
Lift restrictions and relax regulations to make it easier for foreign firms to invest
Invest in their own infrastructure
Invest in education so that people can get jobs with foreign companies
Development aid is money, or other forms of assistance, that is given to less developed
countries by governments in developed countries. Its purpose is to fund long-term development
programs in a nation. There are several different types of development aid:
i Bilateral and multilateral aid; the former is given directly from one to the other, whereas
the latter involves an intermediary, usually an international organization, such as the World
Bank, which redistributes the aid.
ii Grants; these are free financial sums, or alternative forms of aid, that can fund long-term
projects.
iii
Loans; this financial assistance is provided with low-interest rates sometimes, they
may be interest-free that are required to be repaid in the future.
iv
Tied aid; this is aid provided in exchange with something else.
The flow of money associated with acts of aid-giving lead to markets opening up, economic
interdependence between nations enlarges, and globalization gathers pace. Since investment
often leads to economic growth, market opportunities grow and nations are brought into the
global free market.
44. Winner and Losers of Globalization
Developed nations are benefiting greatly from globalization:
i Higher profits for multinational; multinationals are the main winners of globalization.
They benefit in various ways, including lower costs due to cheaper resources, access to
unexploited markets, greater profile leading to better recognition.
ii Higher income, output, and employment; the gains multinationals receive from FDI
contribute to the wealth of the nation they originate from, leading to greater GDP.
iii
Lower prices; since multinationals exploit cheaper costs in less developed nations,
prices tend to decrease.
iv
Increase in the quantity of labor; due to globalization, labor has become more
mobile, allowing the allocation of human resources as appropriate. Workforce may migrate
from saturated to unsaturated markets, leading to universally balanced growth and
development in equity.
v Greater consumer choice; due to the global variety, in all terms, available easily because
of cheaper transport as a result of globalization, consumers have a greater choice.
vi
Less conflict; due to the developing of interdependence of nations as a consequence
of intl trade between nations, possibility of war and conflict between separate units is
falling.
Globalization also holds benefits enjoyable by developing nations:
i Increase in income; globalization will bring economic growth to developing nations, raising
living standards.
ii Increase in tax revenue; profits made by multinationals will be taxed, leading to greater
tax revenue and public spending in the host nation. In addition, government services would
improve.
iii
Increase in exports; multinationals and globalization allow economic borders of
nations drop and the nations economy immerse in the global market, leading to a surge in
exports. This will help fix current balance.
iv
Increase in employment; FDI fund projects that can create jobs across undeveloped
economies. In addition, multinationals create jobs when they open operations or factories in
countries.
v Transfer of technology; with globalization, improved technologies are utilized by
developing nations. Multinationals encourage this by opening their operations in such
nations.
vi
Improvement in the quantity of human capital; when entered onto the world
stage, workforce of developing nations will be exposed to better education and working
practices, leading to an increase in human capital.

vii
Enterprise development; with emergence of multinationals, local population may be
encouraged to indulge in enterprise themselves, leading to economic growth.
However, globalization also has several disadvantages:
i Impacts on the natural environment; due to increased utilization of transport facilities
and similar activities that increase as a result of economic growth, non-renewable resources
will exhaust at a quicker rate. In addition, greater use of resources like fossil fuels will result
in irreversibly harming the environment.
ii Exploitation of less development countries; there are several examples displaying how
globalization endorses the exploitation of developing nations. The production of primary
products is transferred to such nations, which will restrain any prominent economic growth.
Multinationals take advantage of cheap resources in developing nations, employing child
labor for low wages, for instance. Resources are extracted from the nation for the benefit of
the developed world, in which case only a small amount of money goes to the host nation,
as taxes are usually minimal. Lastly, the profits are transferred back to rich nations, rather
than putting into the nations financial resources what money was generated by that
nations resources.
iii
Higher commodity prices; with a surge of rapid economic growth globally,
commodity prices will rise as most commodities originate from developing nations. This may
lead to famine among the developing nations that depend on others for food if food
commodities rise too rapidly, for instance.
iv
Interdependence; as economic borders become translucent and capital is allowed to
flow freely between nations, the world will become vulnerable to fluctuations in economies
across the world.
v Intl (or external) debt; this is the debt that is exclusively to intl creditors rich nations or
intl financial institutions that have provided loans. Usually, these account for a large
portion of the total debt in LDCs.
It is important to note that globalization has more benefits for developed nations than for
developing nations. The development gap between the two, therefore, increases in a selfperpetuating fashion.

II) International trade

45. International Trade
There are several reasons why nations participate in intl trade, including:
i Obtaining goods that cannot be produced domestically; many countries import goods
that they cannot supply due to lack of relevant natural resources.
ii Obtaining goods that can be bought more cheaply from overseas; as some nations
can produce goods or services more efficiently than other countries, buying from overseas is
more cost-effective for the consumer.
iii
Improving consumer choice; intl trade allows variety of goods and services from
corporations globally be available in one market. This increases choice for consumer.
iv
Selling off unwanted commodities; some countries have a surplus of commodities;
that is, it is more than abundant to feed domestic consumers. Therefore, the excess is sold
to other nations.
The amount of countries encouraging free trade is increasing. This is trade between nations
that is unrestricted by government regulatory procedures. The main advantages of free trade
are as follows:
i Choice; free trade allows corporations from all over the world sell a variety of goods in
markets, allowing all consumers in any single market a much wider and diverse choice of a
global standard.
ii Competition; because of intl competition, firms have to produce the highest quality and
operate at the peak efficiency in order to constantly generate intl demand. Domestic
producers will improve quality and efficiency in order to compete with multinationals in the
domestic market. This can lead to improved standards globally.
iii
Growth and GDP; free intl trade allows the advantages of specialization be applied
on a national scale. As some countries can produce in an industry more efficiently than the
rest of the world, it can specialize in that industry. As the industry grows and economies of
scale are increasingly exploited, the products will be more cost-effective to buy for the whole
world, leading to a growth in the exports of that nation.

 There are also several negatives to free trade, including:

i Overspecialization; domestic economies may become too centered on a narrow range of
goods and industries. If primary goods, for instance, are focused on too much, the economy
would not be able to keep up if the global economy were to expand.
ii Unemployment; if demand patterns reduce globally, unemployment can result in that
industry. If a nations economy is centered on that industry, this will have disastrous results.
iii
Environmental damage; as demand increases, non-renewable natural resources are
being used up quick. In addition, increased opulence results in greater need for transport,
which will result in more carbon emissions.
iv
Cultural hegemony; dominating forces in the intl trade may spread cultural
influence in the markets they operate in. A popular example of this is Americanization.
v Political disempowerment; as the invisible hand takes over in controlling the market,
government decisions on the economy are marginalized, reducing the sovereignty of the
state.
46. Protectionism

Although economists argue that free trade is desirable, some states believe that intl trade
should be restricted in respective domestic economies. This is known as protectionism. They
utilize trade barriers as a mechanism of restricting intl trade, as some examples show below:
i Tariffs; this involves tariffs, or custom duties, which is a special tax levied on imports in
order to divert the demand on them to domestically-produced goods or services. In addition,
public revenue increases.
ii Quotas; this involves placing a physical limit on the quantity of a certain import allowed in
the country. As a result, domestic firms will be less threatened and demand will be diverted
to them as prices for imports rises.
iii
Subsidies; this involves giving financial support to domestic industries and firms in
order to allow them to offer products at a cheaper rate. This could lead to their
predominance over foreign imports due to demand.
iv
Administrative barriers; this involves setting high amounts of regulatory procedures
upon imports. This will reduce demand due to the time-consuming factor if domestic
industries can provide an alternative product.
v Depreciating exchange rate; dropping the foreign exchange rate will reduce imports, as
they will become more expensive, lowering demand; and increase exports, as they will get
cheaper, so higher demand.
There are several reasons why states feel restricting intl trade is sometimes justified:
i Protecting jobs; trade barriers may be used to save jobs in domestic industries that
would otherwise compete with large intl firms who are at a comparative advantage due to
resources and recognition.
ii Protecting infant industries; new industries that are yet to establish themselves need
protection in order to grow without the threat of intl competition that will otherwise lead to
a total lack of that industry in an economy.
iii
Preventing dumping; trade is restricted to prohibit dumping, which is selling a
product at a very low price in a foreign market, as this can divert domestic demand to
imports instead of domestic producers
iv
Raising revenue; if tariffs are imposed on imports, the government can raise revenue
to fix deficit or use in public spending.
v Preventing the entry of harmful or undesirable goods; protectionism is utilized if
governments are trying to discourage the purchasing of goods that may cause harm within
their society.
vi
Improving the current balance; a state may use trade barriers to fix current
balances and avoid deficits.
There are also several problems with states subjecting their economies to protectionism:
i Loss of free trade benefits; the benefits of free trade may be wasted as a result of
protectionism.
ii Retaliation; trade wars may result from hostilities based on the economic decisions a state
has made that impact anothers economy.
iii
Other policies may be more effective; trade barriers are not the best way to deal
with the justifications mentioned above due to their negative side-affects. Others, such as
supply-side policies, would be more effective.

47. World Trade Patterns and Trading Blocs

There are several reasons why world trade has increased:
i Better transport and communications; more efficient transport systems have allowed
goods to be shipped more quickly and cheaply. In addition, improved and faster
communications allow intl trade to flourish through intl systems such as the internet.
ii Relaxing of trade barriers; countries have realized that the free markets improve
economic growth, resulting in greater intl trade contracts.
iii
Development of multinationals; multinationals of each industry operate in the
areas where costs can be most minimalized, resulting in the meltdown of global trade
barriers. In addition, they supply a great amount of countries and bridge trade between
nations.
iv
Travel and consumer awareness; with a greater knowledge of the choices available
in the world, people are more likely to take advantage of diversity. In addition, people realize
that imports can relegate the economic problem.
v Trade agreements; trade agreements have increased bilaterally resulting in formations of
trade blocs.
The world is economically divided among trading blocs, which are a group of countries
situated in the same region that join together and enjoy trade free of trade barrier. Here are
some examples of trading blocs:
i European Union (EU); this is made up of 27 European countries that has grown from a
foundation of six members in 1958 to eight additions since then till 2004, from when there
have been 13 more additions, mainly from East Europe due to the breakdown of Soviet rule.
UK is part of this trade bloc.
ii North American Free Trade Association (NAFTA); this is made up of three countries:
America, Canada, and Mexico. In 2008, they collectively had a population of 445m and a
GDP of over $17.0 trillion.
iii
The Caribbean Community (CARICOM); this is made up of 15 members located in
and around the Caribbean. Activities involve co-coordinating economic policies and
development planning, helping the less-developed nations, operating as a single market,
and handling regional trade disputes.
Trading blocs provide several benefits to their members:
i Belonging to a trade bloc allows for the benefits of the free market to be exploited.
ii FDI may increase due to the opportunities corporations will have in a larger market.
iii
Countries will increase cooperation. They will aid each other in times of devastation, if
required.
iv
Due to the increased interactions between nations, possibility of conflict is
minimalized.
However, there are also some disadvantages of trading blocs:
For members;
i Trade blocs encourage regional trade as opposed to global trade. Therefore, they do not
fully exploit the benefits of the global free market.
ii The financial cost of belonging to a trade bloc, used to maintain the intl institution that
manages the bloc, may be high, especially if there is a great difference of the general
opulence between member states.
iii
Firms within the bloc may merge, resulting in regional monopolies that may exploit
consumers in the bloc.
iv
Nations may become too dependent upon the trade in the bloc. This will harm their
economic growth as it reduces a nations independence. In addition, it will make them
vulnerable to changes in price and demand patterns within the bloc.
v If part of a trade bloc, a nation loses its economic sovereignty as that is mainly passed on
to the free market. In addition, nations also risk losing their cultural and political autonomy
as those may also be homogenized.
For non-members; trade blocs may encourage members to collectively impose trade
barriers in the bloc, which may hold implications for the other nations. This is done in order to
encourage regional, rather than global, trade.
48. The World Trade Organization
The World Trade Organization is an intl organization that promotes free trade by persuading
countries to abolish trade barriers. It policies free trade agreements, settles disputes between
governments, and organizes trade negotiations. It has helped the process of globalization.
There are several activities that the WTO engages in:

i Encouraging and enforcing free trade by relaxation of trade barriers.

ii Settling trade disputes between members.
iii
Monitoring and reviewing trade policies of its members and ensuring agreements are
clear and documented.
iv
Administrating and monitoring the application of the WTOs rules for trade in goods,
services, and intellectual property rights.
The WTO has frequently been opposed, mainly by anti-globalization bodies and environmental
groups, for several reasons. The reasons include undemocratic practices, favoring of corporate
rights above those of workers, harm towards environment, favoring of wealthy nations over
poorer ones, and causing hardships in undeveloped world.
49. Developed and Developing Countries
Overall, there are more than underdeveloped countries in the world. Many share these
common characteristics:
i Low GDP per capita; this shows the amount derived from the GDP divided by population.
ii Low life expectancy; people in developing nations do not live as long as those in
developed nations.
iii
Low literacy levels; only a small portion can read and write due to a lack of
education.
iv
High population growth; due to lack of knowledge of contraception and tribal
traditions.
v Poor infrastructure; they suffer from a lack of roads, railways, schools, hospitals, and
production facilities.
vi
Poor health; poor sanitation, lack of clean water, and diseases keeps health
standards low.
vii
Low labor productivity; due to low factors of human capital low education and
training.
There are some notable recent trends in developing countries:
i An increase in net migration; people are leaving developing countries to find work in
developed countries.
ii Increased FDI in Africa; China has become a major trading partner with Africa.
iii
Less reliance on commodities; countries have become less dependent on the sale
of commodities. However, many developing nations still rely heavily on commodities.
iv
FDI continues to be important; for developing countries.
v Debt cancellation; developing nations will benefit from the cancellation of debts from
developed nations.
vi
Reduction in barriers; potential gains from doing this are considerable. They also
help fix current accounts.
The developed nations continue to dominate the process of increasing world trade. Some recent
trends in developed countries are outlined below:
i Loss of trade in manufacturing; manufacturing has transferred from western to eastern
developed countries.
ii More air travel; as people can afford it more, air travel in the developed world is becoming
cheaper.
iii
Widening of the development gap; the rich nations are growing much quicker than
the poorer nations.
iv
Increase in regional trade agreements; regional trade agreements and trade blocs
have flourished.

III) Exchange rates

50. Exchange Rates and their Determination
As different nations and economies use different currencies, the exchange rate mechanism is
used to value a currency in terms of another currency. This allows different currencies to be
exchanged.
The prices of currencies are also subject to market forces. They are sold like commodities in the
foreign exchange market. The currency market is affected by several things. The factors
affecting demand and supply are:
i The demand for exports/imports; firms which sell products to foreign customers expect
to be paid in their local currency. Therefore, if exports were to rise, demand for the local

currency would rise. In addition, with the purchasing of the local currency, the supply of
foreign currency would increase.
ii Inward/outward FDI; as investment capital is used to fund development programs in
foreign nations, foreign currency will need to be bought. Therefore, outward FDI will increase
supply of the local currency. For the nation on the receiving end, inward FDI would result in a
rise of demand for the local currency.
iii
Speculation; this is the practice of buying or selling currencies based on the trend of
exchange rates. Speculators may be firms, individuals, or large financial institutions. Large
ones are able to emphasize the effects of rising or falling foreign exchange rates.
iv
Foreign/local interest rates; if interest rates are higher in a nation, people may
want to save in their banks. However, foreign currency would need to be bought, resulting in
a rise of demand for it. At the same time, the local money that is pumped into the foreign
currency market increases supply of the local currency.
51. Changing Exchange Rates and Government Policies
Because currencies are subject to market forces, exchange rates, which are the prices of one
currency in terms of another currency, fluctuate continuously. Here are a few effects these
changes may have on exports and imports:
i Depreciating exchange rates/improving current account; in this case, the currency
would become cheaper. That would make exports cheaper, increasing demand for them; and
would make imports expensive as the foreign currency has relatively appreciated
decreasing demand for them. The current account would thereby move towards a surplus.
ii Appreciating exchange rates/declining current account; in this case, the currency
would become more expensive. That would make imports cheaper, increasing demand for
them; and exports more expensive as the foreign currency will have relatively devalued
decreasing demand for them. The current account would thereby move towards a deficit.
To fix current account deficits, governments may choose to devalue their currency. This would
bring the current account towards a surplus. This may be accomplished by toning down interest
rates. However, this strategy of devaluation will only work if both imports and exports are
price elastic. Price inelastic imports would be equally demanded whether prices rise or not; and
the same for price inelastic exports in foreign markets.