The Basic Economic Problem

The Nature of the Economic Problem

There are too few resources to make all the goods and services that consumers need and want.
Unlimited wants and limited resources
The scarcity of resources is the basic economic problem
Economic and Free Goods
Economic goods: A good or service that requires resources to produce and has a degree of scarcity and,
therefore, an opportunity cost.
Free goods: A good or service that is not scarce and is available in abundance. For example, the air we
breathe.
The Factors of Production
Consumers are people or firms who need and want goods and services
Resources or factors of production are used to make goods and services
LLCE
Land: natural resources used in production (e.g. land)
Labour: human resources used in the production of goods/services (e.g. workers)
Capital: the manufactured resources that are used to produce goods/services (e.g. tractor)
Enterprise: the skills and willingness of a business person to take the risks required to organize
productive activities
Entrepreneurs organize and combine resources in firms to produce goods and services
Durable consumer goods last a long while (e.g., furniture) non-durable consumer goods (e.g., food) do
not
Capital goods and semi-finished goods or components are used in production
Rewards for Factors of Production
Land - Rent
Labour - Wages
Capital - Interest
Enterprise - Profits
Mobility of Factors
Refers to the degree of mobility while changing from one production area to another.
Geographical Mobility Occupational Mobility

Refers to the willingness and the ability of a person to Refers to the ease with which a person can
relocate from one area to another due to employment change between jobs.
purposes.

Reasons why many workers are not willing to relocate - This would vary depending on the cost,
Family Ties and Related Commitments, Cost of Living training period and the educational
professions.
Changes in the Quantity or the Quality of Factors of Production
Cost (Labour Costs, Raw materials costs)
Government Policies (Taxes, Subsidies)
New Technology
Migration of Labour
Improved Education and Healthcare
Weather Conditions (Agricultural Products)
Opportunity Cost
Opportunity cost is the cost of the next best alternative while choosing the uses of a resource.
Choosing one use will always mean giving up the opportunity to use resources in another way, & the loss
of the next best goods & services they might have produced instead.
The problem of resource allocation is choosing how best to use limited resources to satisfy as many
needs and wants as possible and maximize economic welfare.
Economics aims to find the most efficient resource allocation
Example 1: A person invests $10,000 in a stock
He could have earned interest by leaving 10,000 dollars in a bank account instead
The opportunity cost of the decision to invest in stock is the value of the potential interest
Example 2: A city decides to build a hospital on vacant land; it owns
Could have built a school or sports centre
Opportunity cost is the value of the benefits forgone of the next best thing which could have been done
Production Possibility Curves (PPC) Diagrams
Opportunity cost can be shown using a production possibility curve (PPC)
It shows the maximum combinations of two goods and services that an economy can produce in each
time period with its limited resources
Each combination is a choice
An economy shouldn’t have any unemployment of factors of resources to be on the PPC
A point within the curve signifies like X, represents inefficiency
A point outside the curve, like Y, represents combinations that cannot be produced due to the lack of
resources

Movement in PPC and Shift of PPC

Movement in PPC Shift in PPC

Movement along the PPC is when the The shift of PPC occurs when the PPC line is moved. This may be due
resources utilized are moved from one to better availability of resources (due to the Discovery of new
product to another. For example, the materials, Better Technology and more), which causes an outward shift
movement from Point A to Point B is of the PPC or a decrement in resources (due to natural disasters, war
shown in the above diagram. and more) which causes an inward shift of the PPC. An example is
given below.
The Allocation of Resources
Microeconomics and Macroeconomics
Microeconomics
It is the study of particular markets and segments of the economy. It looks at issues such as consumer
behaviour, individual labour markets, and the theory of firms.
It involves supply and demand in individual markets, Individual consumer behaviour, and individual
labour markets
Example - A consumer considering his options while buying a product
Macroeconomics
Study of the whole economy. It looks at ‘aggregate’ variables, such as aggregate demand, national
output and inflation.
Involves decisions made by the government regarding, for example, policies
Example - Governments deciding on the tax rates
The Role of Markets in Allocating Resources
The Market System
A market economy is an economic system in which economic decisions and the pricing of goods and
services are guided by the interactions of supply and demand- the market mechanism.
Key Resources Allocation Decisions
The basic economic problem of scarcity creates three key questions
What to produce?
How to produce?
For whom to produce?
Introduction to the Price Mechanism
It aids the resource allocation decision-making process. The decision is made at the equilibrium point
where supply and demand meet.
Features of Price Mechanism
Private Economic Agents can allocate resources without any intervention from the government.
Goods and Services are allocated based on price (Higher Price means more supply, and lower price
means more demand)
Allocation of Factors of Production is based on financial returns
Competition creates choices and opportunities for firms, private individuals and consumers.
Demand
Demand refers to the willingness and ability of customers to buy a good or service at a given price level.
 The higher price of a good = fewer people demand
that good; hence, demand is inversely related to the price
Price∝1DemandPrice∝Demand1
Factors that affect demand
Price
Advertising
Government Policies
Consumer tastes/preferences
Consumer Income
Prices of substitute/ complementary goods
Interest rates (price of borrowing money)
Consumer population (population increase = demand increase)
Weather
The individual demand is the demand of one individual or firm
The market demand represents the aggregate of all individual demands
Movement along the Curve Shift of the Curve

A Change in the price of the good or Changes in Non-Price factors cause the demand curve to shift.
service will cause movement along the These factors include tastes, prices of substitute goods,
curve. The movement can be either consumer incomes and many more.
contraction or extension.
 Movement along the Curve Shift of the Curve

Contraction is caused when the demand An increase in demand causes the demand curve to shift
falls due to a price increase; This causes rightwards, and a decrease in demand shifts the curve towards
the point to go upwards. Extention is the left.
caused when the demand increases
because of a price decrease; This causes
the point to go downwards.
Supply
Supply refers to the ability and willingness of suppliers to provide goods and services at a given price.

The higher price of good = higher quantity supplied;

hence, quantity is directly proportional to the price
Price∝Quantity suppliedPrice∝Quantity supplied
Factors that affect supply
Cost of factors of production
Prices of other goods/services
Global factors
Technology advances
Business optimism/expectations
The individual supply is the supply of an individual producer
The market supply is the aggregate of the supply of all firms in the market.
Price Determination
Market Equilibrium
When supply & demand are equal, the economy is said to be at an equilibrium.

At this point, the allocation of goods is at its most efficient because the amount of goods being supplied
is the same as the amount of goods being demanded & everyone is satisfied
Market Disequilibrium
Excess Supply Excess Demand

If the price is set too high, excess supply will be When the price is set below the equilibrium price.
created within the economy, and there will be Creates demand that exceeds production due to the
allocative inefficiency low price.
Price Changes
Causes of Price Changes
A change in supply
A change in demand
Consequences of Price Changes
An inward shift of the supply curve will increase prices and vice versa
An inward shift of the demand curve will decrease prices and vice versa
Price Elasticity of Demand (PED)
Definition: The responsiveness of demand to a change in price
Inelastic Demand Elastic Demand

PED lower than 1 PED greater than 1

The necessity of the product is high – it is either The necessity of the product is relatively low
essential or habitual

A change in price has little effect on the change in Demand would respond quickly and more
demand drastically

PED=% change in quantity demanded% change in pricePED=% change in price% change in quantity dem
anded
When demand is price inelastic:
An increase in price would raise revenue
When demand is price elastic:
A decrease in price would raise revenue
Factors that affect PED:
The number of substitutes
The period of time
The proportion of income spent on the commodity
The necessity of the product
Special Situation with PED
Perfectly Price Inelastic Perfectly Price Elastic Unitary Price Elastic

Changes in price do not affect Any changes in the price will lead to The percentage change in price is proportional
the quantity demanded the quantity demanded being zero the percentage change in quantity demanded
Price Elasticity of Supply (PES)
Definition: The responsiveness of quantity supplied to a change in price
 Inelastic Supply Elastic Supply

It has a PES of less than 1 It has a PES of more than 1

A large price change will have little effect on the A large price change will have a large effect on the
amount supplied amount supplied

PES=% change in quantity supplied% change in pricePES=% change in price% change in quantity supplied
Factors that affect PES:
Time
Availability of resources
Supply available to meet demand
Spare production capacity available
Factor substitution available
Market Economic System
Market Economic System is the economic system that relies on the market forces of demand and supply
to allocate market resources with minimal involvement of the government.
This system is run by private firms and individuals
They produce a wide variety of goods and services if it is profitable to do so, but only for those
consumers who are willing and able to pay for them
Market failures can cause scarce resources to be allocated to uses that are wasteful, inefficient or even
harmful to people and the environment
Advantages Disadvantages

Wide variety of goods/services Serious market failure

The profit motive encourages the development of new and Only profitable goods are provided
more efficient products & processes.

Quick response to changes in consumers’ tastes and Firms will only supply products to
demand consumers with the ability to pay

No taxes on incomes and wealth or goods and services Resources will only be provided if it is
 Advantages Disadvantages

profitable to do so

Harmful goods may be readily available to

buy.
Market Failure
Market failure occurs when the market mechanism fails to allocate scarce resources efficiently, so social
costs are greater than social benefits.
Social Costs = Private Costs + External Costs
Social Benefits = Private Benefits + External Benefits
Private Costs are the production and consumption costs of a firm, individual or the government
Private Benefits are the benefits of the production and consumption to the firm, individual or
government.
External Costs are the negative side-effects on third parties for which the consumer doesn’t pay.
External benefits are the positive side-effects enjoyed by third parties.
Consequences of Market Failure
Only goods and services that are profitable to make will be produced
Public goods and services such as street lighting won’t be provided as the private sector can't earn
profits from them
Resources are only employed if profitable – people may be left unemployed without an income
Harmful goods may be produced and sold freely
Producers may ignore environmental impacts
Monopolies dominate the supply of products and charge high prices
Mixed Economic System
It has a private sector & a public sector
A government can try to correct market failures in a mixed-economic system
It can allocate scarce resources to provide goods and services that people need
Can introduce laws and regulations to control harmful activities
Maximum Prices (Price Ceiling)
This is a price control method that involves the government setting the price below the equilibrium point
to make things more affordable.
Minimum Prices (Price Floor)
The government sets the price above the equilibrium to encourage the supply of certain goods.
This involves the National Minimum Wage (NMW) as well.
Government Intervention
Produce merit goods such as education for the needy
It can provide public goods such as street lighting
The public sector can employ people, and welfare benefits can be given to the needy
Laws to make goods illegal or high taxes to reduce consumption
Laws and regulations would protect the natural environment
Monopolies can be broken up or regulated to keep prices low
Educating consumers about the private costs of consuming demerit goods
Privatisation and Nationalisation
Privatisation transfers all assets from the public to the private sector.
Nationalisation is the purchase of all assets by the government
Microeconomic Decision Makers
Money and Banking
Functions of money
Medium of Exchange: accepted as means of payment
Unit of account: for placing a value on goods/services
Store of value: can save money since it keeps its value
The Standard for Deferred Payment: borrowers can borrow money and pay it back later
Characteristics of money
Acceptability: Anything can be used as money as long as it’s generally accepted
Durability: Good money must be hard-wearing
Portability: It should be easy to carry around
Divisibility: Must be able to divide it into smaller values
Scarcity: Should be limited in supply to create value
Barter System
Commercial Banks
Accepting deposits of money and savings
Helping customers make and receive payments
Making personal and commercial loans
Buying and selling shares for customers
Providing insurance
Operating pension funds
Providing financial and tax planning advice
Exchanging foreign currencies
Central Banks
Printing notes & minting coins that are legal tender
Destroying torn notes & worn-out coins
Setting interest rates
Lender of last resort: if a bank needs cash in a hurry, they can borrow from the central bank
Supervising monetary policy: heads of the central bank hold meetings with officials from other banks to
determine interest rates and the quantity of money in the economy
Banker for commercial banks & the government:
Government accounts & spending are carried out with the central bank
Helps government to borrow money
The total amount the government owes is the national debt
Manage international financial system: governments of different nations lending each other money
Households
Influences on Spending, Saving and Borrowing
Disposable income: amount of income left to spend or save after direct taxes have been deducted
Spending: enables a person to buy goods/services to satisfy their needs/wants
Saving: involves delaying consumption
As interest rates rise, people may save more
Borrowing: allows a person to increase their spending, enabling them to buy goods they cannot afford
now
People with low disposable incomes may spend less in total than people with high incomes
But will tend to spend all or most of their income meeting their basic needs
Increase in… Spending Saving Borrowing

Real income ↑ ↑ ↑
 Increase in… Spending Saving Borrowing

Direct tax ↓ ↓ ↕

Wealth ↑ ↓ ↑

Interest rates ↓ ↑ ↓

Availability of saving scheme ↓ ↑ ↓

Availability of credit ↑ ↓ ↑

Consumer confidence ↑ ↓ ↑
Workers
Entry: Young employees will receive low earnings due to a lack of work skills and experience; they can
become an apprentices or join a management training scheme to become more skilled
Skilled workers: the more skilled a worker is, the more opportunities he has for increasing his earnings;
bonuses will be given a higher rate of overtime paid
End-of-career employees: if workers keep updating their skills, they will continue to have opportunities
to increase wages; however, when they stop this, their demand will fall & income will diminish, finally
reaching a stop when retired
Factors that influence the choice of occupation
Level of Challenge
Career Prospects
Level of Danger involved
Length of training required
Level of education required
Recognition in the job
Personal satisfaction gained from the job
Level of experience required
Why firms change demand for labour
Changes in consumer demand for products
Changes in the productivity of labour
Changes in price and productivity of capital
Changes in non-wage employment costs
Why labour supply might change
Changes in net advantages of an occupation
Changes in provision and quality of education and training
Demographic changes
Factors that Cause Occupational Wage Differentials
Different abilities and qualifications
‘Dirty jobs’ and unsociable hours
Job satisfaction
Lack of information about jobs and wages
Labour immobility
Fringe benefits
Factors that cause wage differentials in the same job
Regional differences in supply and demand of labour
Length of service
Local pay agreements
Non-monetary agreements
Discrimination
Specialisation
Division of labour: The production process is broken up into a series of different tasks
Specialization: workers concentrate on a few tasks and then exchange their product for other
goods/services
Advantages for Individual Disadvantages for Individual

Employees can make the best use of their

Doing the same job or repetitive tasks is tedious and
talents/skills and increase them by repeating
stressful
tasks.

Employees can produce more output and reduce Individuals must rely on others to produce goods and
business costs services they want but cannot produce themselves

More productive employees can earn higher Many repetitive tasks can now be done by machines,
wages leading to the unemployment of low-skilled workers.
Trade Unions
An organization of workers formed to promote & protect the interest of its members concerning wages,
benefits & working conditions
Functions
Negotiating wages & benefits with employers
Defending employee rights and jobs
Improving working conditions
Improving pay and other benefits, including holiday entitlement, sick pay and pensions
Encouraging firms to increase worker participation in business decision-making
Developing skills of union members by providing training and education courses
Supporting members taking industrial action
Types of Trade Unions
General Unions: represent workers across many different occupations
Industrial Unions: represent workers of the same industry
Craft Unions: represent workers with the same skill across different industries
Non-manual unions/Professional unions: represent workers in non-industrial and professional
occupations
Collective Bargaining
Process of negotiating wages and other working conditions between trade unions and employers
A trade union will be in a strong bargaining position to negotiate higher wages and better conditions if:
It represents most or all of the workers in a firm
Union members provide goods/services that consumers need, which have few alternatives
Industrial Action
Industrial action is taken when collective bargaining fails to result in an agreement
Taking industrial action can help a union force employers to agree to their demands
Industrial actions:
Overtime ban: workers refuse to work more than their normal hours
Work to rule: workers deliberately slow down production by complying with every rule & regulation
Go slow: workers deliberately work slowly
Strike: workers protest outside their workplace to stop deliveries/non-unionized workers from entering
Impact of Trade Unions
Possible Advantages Possible Disadvantages

Could help to bring about minimum working It might cause lack of flexibility in working practices
standards

Could help keep pay higher This could be major problem as fashions change
very quickly

Could help maintain Employment/enhanced job This could lead to some firms going out of business
security

Could lead to improvement in health and safety Workers made redundant

Workers will need to pay union membership fees.

Firms
Classification of Firms
Primary Sector - Extracting raw materials from the earth (fishing, mining, farming and more)
Secondary Sector - Manufacturing Goods (Construction, Refining and more)
Tertiary Sector - Service Sector (Retail Shops, Lawyers and more)
Public and Private Sector
Private Sector firms are owned and run by private individuals and owners. The main objective of this
sector is to earn profit.
The government owns Public Sector firms, and their main aim is to provide services.
Size of Firms
Number of employees: less than 50 are classified as small
Amount of capital employed: large firms invest a lot in fixed assets such as machinery & equipment
Market share: relative size of firms compared by percentage share of total market supply/revenue
Organization: large firms may be divided into many departments & be spread over many locations
Small Firms
Advantages Disadvantages

The size of the market is small Markets cannot raise enough capital to expand their business

Consumers like tailored goods/services

Governments provide help

Types of Economies and Diseconomies of Scale

Economy of Scale Diseconomy of Scale

Cost savings due to increased scale of Rising costs because a firm has become too large
production
 Economy of Scale Diseconomy of Scale

Financial: larger firms often have access to Management: larger firms must manage so many
cheaper sources of finance different departments in different locations, making
communication/ decision-making difficult

Marketing/Selling: fixed costs such as Labour: demotivated workers lead to a decrease in

advertising and transportation are spread across productivity due to boring, repetitive tasks
a larger number of products, lowering per-unit
cost

Technical: larger firms invest in specialized Excess Agglomeration: A company takes over or merges
production equipment and highly skilled with too many other firms producing different products,
workers; they develop new products making it hard for business owners and managers to co-
ordinate all activities

Risk-bearing: the ability to spread risk over

many investors & reduce market risks by selling
a range of products in different locations

Purchasing: when raw materials are bought in

bulk, suppliers may provide bulk discounts,
lowering per unit cost of production
Integration
Growth often involves integration with other firms
Takeover: a company acquires ownership & control of another a company by purchasing its shares
Merger: two or more firms agree to form an entirely new company & issue new shares
Types of Integration
Horizontal integration: occurs between firms at the same stage of production producing similar products
Vertical integration: occurs between firms at different stages of production
Forward: taking over the firm at a later stage of production
Backwards: integration is the opposite
Lateral integration or conglomerate merger: occurs between firms that are involved in totally unrelated
business activities.
Firms and Production
Demand for “Factors of Production”
Demand for goods & services by consumers: higher demand = more labour/capital firms will need
Price of labour & capital: higher cost = less labour & capital demanded
Firms may also decide to substitute labour for more capital and vice versa
Productivity of labour & capital: more output/revenue labour & capital helps to produce, more profit will
generate over & above the cost of employing them
Capital-intensive Production: where the use and cost of capital are higher than other factors of
production
Labour-intensive Production: where the cost of labour is higher than other factors of production
Labour-intensive production method primarily involves labour, whereas capital-intensive methods
primarily involve machinery
Productivity & Production
Productivity: the ratio of output to input
Labour Productivity:
Output per Labour=Total OutputNumber of LabourOutput per Labour=Number of LabourTotal Output
Capital Productivity:
Value per Capital=Total Output ValueValue of CapitalValue per Capital=Value of CapitalTotal Output Value
Productivity refers to the efficiency of a business, whereas production refers to output only.
Firms’ Costs, Revenue and Objectives
Fixed Costs: Costs that have to be paid regardless of the output, e.g. interest on loans
Variable Costs: Costs that change with the output. The higher the output, The higher the variable costs
Breakeven: where total revenue = total cost
Total Revenue: the total receipts a seller can obtain from selling goods or services to buyers
Average Revenue: the revenue generated per unit of output sold
Average Fixed Cost=FixedCosts/OutputAverage Fixed Cost=FixedCosts/Output
Average Variable Cost=Variable Costs/OutputAverage Variable Cost=Variable Costs/Output
Total Variable Cost=Variable Costs×OutputTotal Variable Cost=Variable Costs×Output
Total Cost=Total Variable Cost+Total Fixed CostTotal Cost=Total Variable Cost+Total Fixed Cost
Average cost=(Total Cost)/OutputAverage cost=(Total Cost)/Output
Total Revenue=Price Per Unit×Quantity SoldTotal Revenue=Price Per Unit×Quantity Sold
Profit or Loss=Total Revenue−Total CostProfit or Loss=Total Revenue−Total Cost

Objectives of firms
Survival
Social welfare
Profit maximisation
growth
Market Structure
Competitive Markets
Businesses will charge the same price, a minimum price they can charge without going out of business
Price will be equivalent to the lowest average cost of producing goods
The average cost of production would be the same as the average revenue for selling
No firm would risk charging more than the market price
A business would be a price taker; the market price
Monopoly Markets
Firms with monopolistic powers control all of the market shares
Able to influence the price; price makers
Can restrict competition with artificial barriers to entry & other pricing strategies
One firm controls the entire market supply
May use predatory pricing to force competing firms out
Other firms deterred from competing due to a lack of capital
Advantages of Monopolies
It avoids duplication & wastage of resources
Economics of scale: benefits can be passed to consumers
High profits can be used for research & development
Monopolies may use price discrimination, which benefits the economically weaker sections of the
society
Monopolies can afford to invest in the latest technology & machinery to be efficient & avoid competition
Disadvantages of Monopolies
May supply less & charge higher prices
May offer less consumer choice and lower quality products than if they had to compete with other firms
They may have higher production costs because they are poorly managed
Restrict competition using barriers to entry
Barriers to entry
Natural Artificial

Cost savings from large-scale production Predatory pricing strategies to force smaller firms out

Lots of capital equipment that other firms Preventing suppliers from selling materials & components to
can’t afford other firms by threatening to switch to rival suppliers

Large customer base built up over years Forcing retailers to stock & sell only their product

Developed advanced products or

processes that are protected by patents

Government and The Macroeconomy

The Role of Government
Local Role: Fund local services (Garbage Collection, Street Lighting, Schools, Hospitals and more)
National Role: Achieve macroeconomic goals (Economic Growth, Low Inflation, Stable Prices and more)
International Role: Trading of goods and services
The Macroeconomic Aims of the Government
Economic Growth
Governments aim for economic growth because producing more goods and services raises living
standards, improves health and housing, and supports other economic goals. Growth increases
employment and provides more tax revenue to help the poor. In the long term, it can also stabilise prices
by matching demand and improve trade through exports.
Low Unemployment
Unemployment represents a waste of resources. The unemployed may face various challenges, including
reduced income, while the government may need to allocate tax revenue to support them.
Low Inflation/Stable Prices
Governments aim for price stability to ensure economic certainty and maintain international
competitiveness. It allows firms, households, and workers to plan confidently without fear of rising costs,
preventing actions that could drive future price increases.
Balance of Payment Stability
If a country’s spending on imports consistently exceeds its income from exports, it will be living beyond
its means and accumulating debt. Conversely, if export revenue surpasses import spending, the country's
residents may not be enjoying as many goods as they could.
Redistribution of Income
Income and wealth inequality can lead to poverty. Governments aim to reduce poverty due to its
hardships, but inequality can worsen without intervention. The wealthy often marry within their class,
access better education, and have more savings opportunities. A large gap between the rich and poor
can also lead to social unrest as the disadvantaged may feel socially unjust.
Conflicts between the Macroeconomic Aims
Full Employment vs Stable Prices
Achieving full employment can lead to increased consumer spending, which may drive up demand and
result in inflation. Higher inflation can compromise price stability, as rising prices erode purchasing
power.
Economic Growth vs Balance of Payment Stability
Rapid economic growth can lead to increased imports as consumers and businesses demand more goods
and services. This can worsen a country’s balance of payments, creating deficits if exports do not keep
pace with imports.
Full Employment vs Balance of Payment Stability
High employment levels can boost domestic consumption, leading to increased imports. This may strain
the balance of payments if the increase in imports outpaces export growth, potentially resulting in trade
deficits.
Economic Growth vs Stable Prices
Economic growth often involves increased production and consumption, which can lead to higher
demand for goods and services. If this demand outstrips supply, it can result in inflation, compromising
price stability.
Fiscal Policy
Budget: Financial planning of revenues and expenditures of the government
Reasons for Government Spending
To supply goods and services that are not supplied by the private sector, such as defence; merit goods,
such as education
To achieve improvements in the supply side of the macro-economy, like providing subsidies
Reasons to Tax
To finance public expenditure, building schools and infrastructure
To discourage certain activities, e.g. taxes on cigarette
To discourage the import of goods, tariffs are import taxes and can be levied as a % of the value of
imports or a set tax on each item
To redistribute income from the rich to the poor
To achieve other macro-economic objectives
Types of Taxation Description Examples

Progressive Tax Tax rate rises with income; higher income = higher tax Income tax

Regressive Tax Tax rate falls with income; higher income = lower tax VAT

Proportional Tax Everyone pays same effective tax rate Corporate income tax

Direct Tax Levied on individuals Capital gains tax

Indirect Tax Added to the price of commodities Tariffs

Principles of Tax
Equitable
Economic
Transparent
Convenient
Fiscal Policy
It is the use of taxation and government spending to influence aggregate demand
Policy About

Expansionary Fiscal Reducing taxes and increasing government spending to boost demand, so
Policy employment and output rise. It may be used to reduce recession.

Contractionary Fiscal Increasing taxes and reducing government spending to reduce demand. It may be
Policy used to reduce price inflation.
Effects of fiscal policy on govt. macroeconomic aims
Expansionary fiscal policy can reduce unemployment
Expansionary fiscal policy can increase economic growth
Contractionary fiscal policy can reduce high inflation
Monetary Policy
It is the use of interest rates, direct control of the money supply and the exchange rate to influence
aggregate demand
Policy About

Contractionary It may be used to reduce price inflation by increasing interest rates charged by the
Monetary Policy central bank. This means commercial banks will also raise interest to encourage
more savings.

Expansionary May be used during a recession & to increase employment by cutting interest rates
Monetary Policy
Effects of monetary policy on government macroeconomic aims
Expansionary monetary policy can reduce unemployment
Expansionary monetary policy can increase economic growth
Contractionary monetary policy can reduce high inflation
Supply-Side Policies
Supply-side policies aim to increase economic growth by raising productive potential of the economy
An increase in the total supply of goods & services will require more labour & other resources to be
employed
It will reduce market prices & provide more goods & services to export
Instrument Effect on Macroeconomic Aims

Tax Incentives Reducing taxes on profits and small firms can encourage enterprise. It can also
encourage investments in new equipment.

Subsidies/Grants To reduce production costs and help firms fund research and development of
new technologies.
 Instrument Effect on Macroeconomic Aims

Education and Training Teaching new/existing workers new skills to make them more productive.

Labour Market Include minimum wage laws to encourage more people to work and legislation
Regulations to restrict the power of trade unions.

Competition Policy Regulations that outlaw unfair trading practices by monopolies and other large,
powerful firms.

Free Trade Removing barriers to international trade allows countries to trade their goods
Agreements and services more freely and cheaply.

Deregulation Removing old, unnecessary and costly rules and regulations on business
activities
Economic Growth
Economic growth is the annual increase in the level of the national output i.e the country’s GDP
Important as it increases the standard of living
Measurement of Economic Growth
Gross Domestic Product (GDP) is the main measure of total value of all the goods and services produced
in a given period of time.
An increase in prices will increase nominal GDP but this is measured in current dollars thus includes
inflations
Real GDP=NominalCPI×100Real GDP=CPINominal×100
Real GDP Per Capita=Real GDPNumber of PopulationReal GDP Per Capita=Number of PopulationReal GD
P
Recession
It is a significant decline in economic activity spread across the economy, lasting more than a few
months, normally visible in real GDP growth, real personal income, employment, industrial production,
& wholesale-retail sales
A recession would cause the economy to produce at a point that is within the PPC
Causes of Economic Growth
Discovery of more natural resources
Investment in new capital and infrastructure
Technical progress
Increasing the amount and quality of human resources
Reallocating resources
Consequences of Economic Growth
An increase in output can improve the living standards of people
Higher output and incomes increase government tax revenue. This can increase govt. spending without
increasing tax rates
However, it can increase pollution lead to the depletion of non-renewable resources and damage the
natural environment
Policies to Promote Economic Growth
Expansionary fiscal policy
Expansionary monetary policy
Supply-side policies
Employment and Unemployment
Indicators Recent Trends

Labour force Risen as the world population has grown

Participation Rate: labour force as a proportion Risen in many countries especially among females as it is
of total population of working age now socially acceptable

Poverty and rising living costs in developing countries

has forced many women to work

Employment by Industry: Number of people Employment in services has been growing while
employed in different industrial sectors employment in agriculture and other primary sector
industries has fallen

Employment Status: Number of full-timers, part- Most employees work full-time

timers or with temporary contracts

Part-time employees have grown rapidly, especially

among female employees

Unemployment: Number of people registered as Tends to rise during economic recessions

being without work

Almost half the unemployed are young unskilled workers

Unemployment Rate: Unemployment as a Relatively stable in the recent years but did increase in
proportion of labour force 2008 during a global financial crisis
Types of Unemployment
Cyclical Unemployment: occurs during recession due to falling consumer demand & incomes
Firms reduce output & lay off workers
Structural Unemployment: caused by changes in industrial structure of an economy
Entire industries close due to a permanent fall in demand for their goods/services
Frictional Unemployment: refers to transitional unemployment, which occurs when people are moving
between jobs.
Seasonal Unemployment: occurs because consumer demand for goods/services change with seasons;
e.g. no job for a ski instructor when/where there is no ice
Measurement of Unemployment
Taking claimant count
Labour force survey
Unemployment Rate = Number of Unemployed Persons / Labor ForceUnemployment Rate = Number of
Unemployed Persons / Labor Force
Consequences of Unemployment
Personal Economical

Loss of income and reduced ability to buy goods & services Unemployment is a waste of human resources
 Personal Economical

Unemployed people de-skill if long out of work Fewer goods & services produced

Unemployed people may become depressed & ill Total output & income in the economy is lower

The strain on family relationships & health services Government tax revenues also lower

People in work may have to pay more taxes

Government spending on welfare may rise

Policies to Reduce Unemployment
Expansionary monetary policy
Expansionary fiscal policy
Increase in quality and quantity of education and training
Inflation and Deflation
Inflation: general & sustained increase in the level of prices of goods/services in an economy over a
period of time
Deflation: decrease in the general price level of goods and services and occurs when the inflation rate
falls below 0%
Measurement
Base year: the first year with which the prices of subsequent years are compared
Inflation rate: percentage change in annual CPI
CPI in Year x=Weighted Average Price in Year xWeighted Average Price in Base Year×100CPI in Year x=Wei
ghted Average Price in Base YearWeighted Average Price in Year x×100
Causes of Inflation
Demand-pull Inflation: caused by total demand rising faster than total output, causing market prices to
rise
Cost-push Inflation: The cost of production increases, so firms try to pass costs to consumers through
higher prices
Causes of Deflation
Fall in the money supply
Decline in confidence
Lower production costs
Technological advances
Increase in unemployment
Increase in the real value of debt
Policies to Control Inflation & Deflation
Contractionary fiscal and monetary policy for inflation
Expansionary fiscal and monetary policy for deflation
Supply-side policy can increase aggregate supply and thus control both inflation and deflation
Economic Development
Living Standards
Standard of Living refers to the social and economic well-being of the individuals in a country.
Real Gross Domestic Product (GDP) Per Capita
GDP is the main measure of the total value of all goods and services produced in a given period of time
An increase in prices will increase nominal GDP, but this is measured in current dollars, thus includes
inflations
Real GDP=NominalCPI×100Real GDP=CPINominal×100
Real GDP Per Capita=Real GDPNumber of PopulationReal GDP Per Capita=Number of PopulationReal GD
P
If the economy has an extremely rich person & everyone else is poor, it brings up the Real GDP per capita
Human Development Index (HDI)
Used by the United Nations to make comparisons of human & economic development in different
countries
Combines three different measures for each country
Standard of living, measured by average incomes
Being educated, measured by adult literacy rate
Living a long, healthy life, measured by life expectancy
Single index with a value between 0 and 1
Greater than 0.8 = high human development. Less than 0.5 = low human development
Reasons For Low/Varying Economic Development
Over-dependence on agriculture
Domination on international trade by developed nations
Lack of capital
Insufficient investment in education, skills & Healthcare
Low levels of investment in infrastructure
Lack of efficient production and distribution systems
High population growth
Other factors like a corrupt govt. or war
Poverty
Absolute poverty Relative poverty

Number of people living below a certain income Measures the extent to which a household’s financial
threshold or number of households unable to afford resources fall below an average income level.
certain basic goods & services

Occurs when people do not have access to basic Occurs when people are poor relative to other people
food, clothing and shelter in the country, unable to participate fully in normal
activities of the society they live in
Causes of Poverty
Unemployment
Low wages
Illness
Age
Poor Healthcare
Low literacy rates
High population growth
Poor infrastructure
Low FDI (Foreign Direct Investment)
High public debt
Reliance on primary sector output
Corruption and Instability
Alleviating Poverty
Governments will use policies to help alleviate poverty in their country, or in another country:
Policy Why is it needed? What are the problems?

Food aid Poor farming methods produce Free food supplies can force farmers out of
insufficient food business

Financial aid LEDCs lack the capital to invest in an Loans have to be repaid sometimes with
industrial base and modern machinery interest
and infrastructure.

Tech aid LEDCs lack access to modern machinery Most people lack the skill to use modern
and equipment and knowledge of technology; instead of using machinery,
modern production methods. more jobs are needed to employ people.

Debt relief Relieving LEDCs of debt will allow them This may encourage LEDCs to borrow more
to use money for economic money, or corrupt governments may misuse
development instead. money.

Removing LEDCs may have natural supplies can be MEDCs will force down their price
overseas trade exported for money
barriers

Economic Governments in LEDCs lack economic Advice is not enough; LEDCs need more
Advice knowledge capital & stability
* LEDC- Less Economically Developed Countries
* MEDC - More Economically Developed Countries
Population
Factors that affect population growth
Birth rate
Death rate
Net migration
Immigration & emigration
Dependency Ratio
Comparison of people in employment with the number of people who are not in the labour force.
Reasons for different population growth rates
Varying Birth Rates
LEDCs have:
Large families to help produce food & work for money
High infant mortality rate
Low supply of contraceptives/forbidden to use them
In MEDCs, people marry later in life, so birth rates fall
Varying Death Rates
MEDCs have:
Better food, housing, hygiene & high life expectancy
Fatty foods, smoking, and lack of exercise have increased rates of diabetes, cancer & heart disease
Improved medicine & healthcare; prevents many diseases & increased life expectancy
LEDCS have:
Widespread diseases which lower life expectancy
Natural disasters, famines, wars
Population Structure
The Demographic Transition Model:

This shows that population growth occurs in stages

Population Pyramid: a type of graph that shows the age and sex structure of the country

Stage 1: high birth rate; high death rates; short life expectancy; less dependency (since there are few old
people and children must work anyway)
Stage 2: high birth rate; fall in death rate; slightly longer life expectancy; more dependency due to more
elderly
Stage 3: declining birth rate, declining g death rate, longer life expectancy, more dependency
Stage 4: low birth rate, low death rate, highest dependency ratio, longest life expectancy
International Trade & Globalisation
International Specialisation
Specialisation at a National Level
Countries specialize in the production of those goods and services in which they have an absolute
advantage or comparative advantage over other regions or countries
A country has an absolute advantage if it can produce a given amount of a good or service with far fewer
resources and, therefore at an absolute cost advantage over any country
A country has a comparative advantage in the production of a good or service if it can be produced it at a
lower opportunity cost relative to other countries
Advantages of Specialisation
Efficiency Gains
Labour Productivity
Increased Productive Capacity
Economies of Scale
Improved Competitiveness
Disadvantages of Specialisation
Overspecialisation
Lack of variety for consumers
High labour turnover
Low labour mobility
Higher labour costs
Globalisation, Free Trade and Protection
Globalisation: The process by which businesses or other organizations develop international influence or
start operating on an international scale.
Multinationals
Operates in more than one country
Some of the largest companies in the world
Governments often compete to attract multinationals
Can provide jobs, incomes, business knowledge, skills and technologies which can help other firms
Pay taxes on their profits to boost government revenue
Headquarters are based in one country
Advantages Disadvantages

Can reach many more consumers globally & sell far more Can switch profits to other countries to avoid
than other types of businesses paying taxes on profits

Can minimise transport costs by locating plants in Can force smaller local firms out of business
different countries to be near raw materials or big
markets

Minimise wage costs by locating in countries with low May exploit workers in low-wage economies
wages

Can enjoy low average production costs May use their power to get generous subsidies
& tax advantages from the government
Benefits of Free Trade
 For Consumers To Producers To Governments

Cheaper products Larger markets Exports increase jobs, GDP,

incomes

Better products Economies of scale But imports take them away

Lower Prices – Better More produced, more profit Increased competition from
Qualities international companies

International trade increases the International Trade

number of products you make

Workers more productive

Trade Protection
Tariffs: Tax on imports, which increases costs for foreign firms
Subsidies: Form of government assistance which helps cut down production costs of firms
Quota: Quantitative limit on the sale of imports
Embargo: Ban of trade with a certain country
Excessive quality standards and bureaucracy
Protection
Arguments For Possible Consequences

Protection of a young industry Other countries will retaliate with trade barriers

To prevent unemployment It protects inefficient domestic firms

To prevent dumping The loss of domestic jobs from overseas competition will only
be temporary.

Because other countries use barriers Trade barriers have increased the gap between rich and poor
to trade countries

To prevent over-specialisation
Foreign Exchange Rates
The exchange rate is the price of a country’s currency in terms of another country’s currency
Most countries have a floating exchange rate, which means no set value for their currency compared
with any other currency
Currency is a commodity. Thus, the value of a currency is dependent on the demand and supply of that
currency in the foreign exchange market.
An appreciation in the value of currency means its exchange rate against other countries has risen
A depreciation in the value of currency means its exchange rate against other countries has fallen
Exchange Rate Fluctuations
Demand for a currency comes from foreign money flowing into the country. If demand rises, the
currency’s value will rise in relation to the other currency
Supply of the currency comes from domestic money flowing out of the country. If supply rises, the
currency’s value will fall
A currency might depreciate because: A currency might appreciate because:

Demand for other currencies rises as domestic There is a balance of payments surplus
consumers buy more imports

There is a balance of payments deficit Demand for the currency rises as overseas consumers
buy more exports

Interest rates fall relative to other countries Interest rates rise relative to other countries

People move their savings to bank accounts This attracts savings from overseas residents
overseas

Inflation rises relative to other countries. This Inflation is lower than in other countries, so exports
makes exports more expensive, and demand for will be cheaper, and overseas demand for them, and
them and the currency needed to buy them falls the currency required to pay for them, will rise

People speculate that the currency will fall in value, People speculate that the currency will rise in value,
and they sell their holdings of the currency and they buy more of the currency
Consequences of Exchange Rate Fluctuations
An appreciation of the currency will make exports more expensive and imports will be cheaper, and vice
versa
If PED<1 for exports, an exchange rate appreciation will improve a current account deficit
If PED<1 for imports, an exchange rate depreciation will worsen a current account deficit
Types of Exchange Rate
Floating exchange rate: it is determined by the forces of the market supply and demand
Managed floating exchange rate: it is influenced by the state intervention
Fixed exchange rate: it is set by the government and maintained by the central bank buying and selling
the currency and changing interest rates
Floating Exchange Rate
Advantages Disadvantages

Automatic stabiliser Uncertainty

Frees internal policy Lack of investment

Management Speculation

Flexibility

Can avoid inflation

Lower reserves
Fixed Exchange Rate
 Advantages Disadvantages

Elimination of uncertainty and risks Foreign exchange reserves needed

Speculation deterred Internal objectives sacrificed

Prevents currency depreciation Restricts international competition

Attracts foreign direct investment

Current Account of Balance of Payments
Structure
Visible trade account: the difference between the export revenue and import spending on physical
goods, e.g. cars, washing machines
Invisible trade account: measures the difference between export revenue from and import spending on
services, e.g. banking, insurance and tourism
Income flows: e.g. interest, profit and dividends flowing in and out of the country
Current transfers: e.g. grants for overseas aid.
Secondary Income - Income transfers between residents and non-residents of a country.
Balance of Payments Deficit Balance of Payments Surplus

Money flowing out greater than in. Money flowing in greater than out.

Current + Capital + Financial is negative. Current + Capital + Financial is positive.

Trade Deficit
This means people are buying more imports and may be spending less on products made by domestic
firms
Deficit may be a symptom of a declining industrial base
Foreign exchange for the national currency is likely to fall
Increases prices of imports and cause import inflation
Trade Surplus
This means people are buying fewer imports and may be spending more on products made by domestic
firms
Surplus may result of economic growth
Foreign exchange for the national currency is likely to rise
Increases in the prices of exports
Policies to achieve balance of payments stability
Supply-side policy will increase domestic production and exports which can correct a current account
deficit
Expansionary fiscal policy, by reducing taxes and increasing government expenditure can increase the
total demand for imports to fix current account surplus, and vice versa
Contractionary monetary policy can correct a current account deficit, and vice versa
Definitions
The basic economic problem
Wants- desires for goods and services
Resources- factors used to produce goods and services
The economic problem - unlimited wants exceeding finite resources
Scarcity- a situation where there is not enough to satisfy everyone's wants
Economic good - a product which requires resources to produce it and therefore has an opportunity cost
Free good- a product which does not require any resources to make it and so does not have an
opportunity cost
Capital/Capital goods- human-made goods used in production
Consumer goods- goods and services purchased by households for their own satisfaction
Entrepreneur- a person who bears the risks and makes the key decisions in a business
Occupationally mobile - capable of changing use

Geographically mobile - capable of moving from one location to another location

Mobility of labour- the ability of labour to change where it works or in which occupation
Mobility of capital-the ability to change where capital is used or in which occupation
Mobility of enterprise- the ability to change where enterprise is used or in which occupation
Labour force- people in work and those actively seeking work
Productivity- the output per factor of production in an hour
Output- goods and services produced by the factors of production
Investment-spending on capital goods
Gross investment- total spending on capital goods
Depreciation (capital consumption) - the value of capital goods that have worn out or become obsolete

Net investment- gross investment minus depreciation

Negative net investment- a reduction in the number of capital goods caused by some obsolete and worn-
out capital goods not being replaced
Opportunity cost - the next best alternative forgone while making an economic decision
Production possibility curve- a curve that shows the maximum output of two types of products and
combination of those products that can be produced with existing resources and technology
The Allocation of Resources
Microeconomics- the study of the behaviour and decisions of households and firms and the performance
of individual markets.
Macroeconomics- the study of the whole economy
Market- an arrangement which brings buyers into contact with sellers
Economic agents- those people who undertake economic activities and make economic decisions
Economic systems- the institutions, organisations and mechanisms that influence economic behaviour
and determine how resources are allocated
Planned economic system- an economic system where the government makes the crucial decisions, land
and capital are state-owned and directives allocate resources
Mixed economic system- an economy in which both the private and public sectors play an important role
Market economic system- an economic system where consumers determine what is produced, resources
are allocated by the price mechanism and land and capital are privately owned
Price mechanism- the way the decisions made by households and firms interact to decide the allocation
of resources
Capital-intensive- the use of a high proportion of capital relative to labour

Labour-intensive- the use of a high proportion of labour relative to capital

Market equilibrium- a situation where demand and supply are equal at the current price
Market disequilibrium- a situation where demand and supply are not equal at the current price
Demand- the willingness and ability to buy a product
Market demand - total demand for a product
Aggregation - the addition of individual components to arrive at a total amount
Extension in demand- a rise in the quantity demanded caused by a fall in the product's price.
Contraction in demand- a fall in the quantity demanded caused by a rise in the product's price.
Changes in demand- shifts in the demand curve
increase in demand- a rise in demand at any given price, causing the demand curve to shift to the right

Decrease in demand - a fall in demand at any given price, causing the demand curve to shift to the left
Normal goods- a product whose demand increases when income increases and decreases when income
falls
Inferior goods- a product whose demand decreases when income increases and increases when income
falls
Substitute- a product that can be used in place of another
Complement- a product that is used together with another product
Ageing population- an increase in the average age of the population
Birth rate- the number of live births per thousand of the population in a year
Supply- the willingness and ability to sell a product
Market supply- total supply of a product
Extension in supply- a rise in the quantity supplied caused by a rise in the product's price.

Contraction in supply- a fall in the quantity supplied caused by a fall in the product's price.
Changes in supply- changes in supply conditions causing shifts in the supply curve
Increase in supply- a rise in supply at any given price, causing the supply curve to shift to the right
Decrease in supply- a fall in supply at any given price, causing the supply curve to shift to the left
Unit cost- the average cost of production. It is found by dividing the total cost by the output
Improvements in technology- advances in the quality of capital goods and methods of production
Direct taxes- taxes on the income and wealth of individuals and firms
Indirect taxes- taxes on goods and services
Tax- a payment to the government
Subsidy- a payment by the government to encourage the production or consumption of a product

Equilibrium price- the price where demand and supply are equal
Disequilibrium - a situation where demand and supply are not equal
Excess supply- the amount by which supply is greater than demand
Excess demand- the amount by which demand is greater than supply
Price elasticity of demand (PED) - a measure of the responsiveness of the quantity demanded to a
change in price
Elastic demand - when the quantity demanded changes by a greater percentage than the change in price
Inelastic demand - when the quantity demanded changes by a smaller percentage than the change in
price
Perfectly elastic demand- when a change in price causes a complete change in the quantity demanded
Perfectly inelastic demand - when a change in price has no effect on the quantity demanded
Unit elasticity of demand - when a change in price causes an equal change in the quantity demanded,
leaving total revenue unchanged.

Price elasticity of supply (PES) - a measure of the responsiveness of the quantity supplied to a change in
price
Elastic supply- when the quantity supplied changes by a greater percentage than the change in price
Inelastic supply - when the quantity supplied changes by a smaller percentage than the change in price
Perfectly elastic supply - when a change in price causes a complete change in the quantity supplied
Perfectly inelastic supply- when a change in price has no effect on the quantity supplied
Unit elasticity of supply- when a change in price causes an equal change in the quantity supplied
Public sector- the part of the economy controlled by the government
State-owned enterprises (SOEs) - organisations owned by the government which sell products
Privatisation - the sale of public assets to the private sector
Price mechanism- the system by which the market forces of demand and supply determine prices

Market failure- market forces resulting in an inefficient allocation of resources

Free rider - someone who consumes a good or service without paying for it
Allocative efficiency- when resources are allocated to produce the right products in the right quantities
Productively efficient- when products are produced at the lowest possible cost and make full use of
resources
Dynamic efficiency - efficiency occurring over time as a result of investment and innovation
Third parties- those not directly involved in producing or consuming a product
Social benefits- the total benefits to a society of an economic activity
Social costs- the total costs to a society of an economic activity
Private benefits- benefits received by those directly consuming or producing a product
Private costs - costs made by those directly consuming or producing a product

External benefits- benefits enjoyed by those who are not involved in the consumption and production
activities of others directly
External costs- costs imposed on those who are not involved in the consumption and production
activities of others directly
Socially optimum output- the level of output where social cost equals social benefit, and society's
welfare is maximised
Merit goods- products the government considers consumers do not fully appreciate how beneficial they
are and will be under-consumed if left to market forces. Such goods generate positive externalities.
Demerit goods- products the government considers consumers do not fully appreciate how harmful they
are and will be over-consumed if left to market forces. Such goods generate negative externalities.
Public good - a non-rival and non-excludable product hence needs to be financed by taxation.
Private goods- a product which is both rival and excludable
Monopoly- a single seller
Price fixing- when two or more firms agree to sell a product at the same price
Mixed economic system- an economy in which both the private and public sectors play an essential role

Rationing- a limit on the amount that can be consumed

Lottery- the drawing of tickets to decide who will get the products
Nationalisation- moving the ownership and control of an industry from the private sector to the
government
Public corporation- a business organisation owned by the government which is designed to act in the
public interest
Microeconomic Decision Makers
Money- an item which is generally acceptable as a means of payment
Commercial banks- banks which aim to make a profit by providing a range of banking services to
households and firms
Central bank- a government-owned bank which provides banking services to the government and
commercial banks and operates monetary policy
Liquidity - being able to turn an asset into cash quickly without a loss
Disposable income- income left after income tax has been deducted and state benefits received
Wealth- a stock of assets, including money held in bank accounts, shares in companies, government
bonds, cars and property
Rate of interest- a charge for borrowing money and a payment for lending money
Average propensity to consume (APC) - the proportion of household disposable income which is spent
Consumption- expenditure by households on consumer goods and income
Savings ratio- the proportion of household disposable income that is saved

Average propensity to save (APS)- the proportion of household disposable income that is saved
Mortgage- a loan to help buy a house
Earnings- the total pay received by a worker
Wage rate- a payment which an employer contracts to pay a worker. It is the basic wage a worker
receives per unit of time or unit of output.
National minimum wage (NMW) - a minimum rate of wage for an hour's work, fixed by the government
for the whole economy.
Elasticity of demand for labour- a measure of the responsiveness of demand for labour to a change in
the wage rate
Elasticity of supply of labour- a measure of the responsiveness of the supply of labour to a change in the
wage rate
Specialisation - the concentration on particular products or tasks
Division of labour- workers specialising in particular tasks
Trade union- an association which represents the interests of a group of workers

Collective bargaining- representatives of workers negotiating with employers' associations

Industrial action- when workers disrupt production to put pressure on employers to agree to their
demands
Industry- a group of firms producing the same product
Primary sector- covers industries which extract natural resources
Secondary sector- covers manufacturing and construction industries
Tertiary sector- covers industries which provide services
Quaternary sector- covers knowledge-based service industries
internal growth- an increase in the size of a firm resulting from it enlarging existing plants or opening
new ones
External growth- an increase in the size of a firm resulting from it merging or taking over another firm
Horizontal merger- the merger of firms producing the same product and at the same stage of production

Vertical merger- the merger of firms producing the same product but at a different stage of production
Vertical merger backwards- a merger with a firm at an earlier stage of the supply chain
Vertical merger forwards- a merger with a firm at a later stage of the supply chain
Conglomerate merger- a merger between firms producing different products
Internal economies of scale - lower long-run average costs resulting from a firm growing in size
External economies of scale - lower long-run average costs resulting from an industry growing in size
Internal diseconomies of scale - higher long-run average costs arising from a firm growing too large
External diseconomies of scale - higher long-run average costs arising from an industry growing too large
Total cost- the total amount that has to be spent on the factors of production used to produce a product
Average total cost - total cost divided by output

Fixed costs- costs which do not change with output in the short run
Average fixed cost- total fixed cost divided by output
Variable cost- costs that change with output
Average variable cost- total variable cost divided by output
Price- the amount of money that has to be given to obtain a product
Total revenue- the total amount of money received from selling a product
Average revenue- the total revenue divided by the quantity sold
Profit satisficing - sacrificing some profit to achieve some goals
Profit maximisation - making as much profit as possible
Market structure- the conditions which exist in a market, including the number of firms

Competitive market- a market with a number of firms that compete with each other
Monopoly- a market with a single supplier
Barrier to entry- anything that makes it difficult for a firm to start producing the product
Barrier to exit- anything that makes it difficult for a firm to stop producing the product
Scale of production- the size of production units and the methods of production used
Government and the macroeconomy
Local government- a government organisation with the authority to administer a range of policies within
an area of the country
Natural monopoly- an industry where a single firm can produce at a lower average cost than two or more
firms because of the existence of significant economies of scale
Strategic industries- industries are important for the economic development and safety of the country
National champions- industries that are, or have the potential to be, world leaders
Trade blocs- a regional group of countries that remove trade restrictions between them
Free international trade- the exchange of goods and services between countries without restriction
Economic growth- an increase in the output of an economy in the long run, an increase in the economy's
productive potential
Actual economic growth- an increase in the output of an economy
Potential economic growth- an increase in an economy's productive capacity
Aggregate demand - the total demand for a country's product at a given price level. It consists of
consumer expenditure, investment, government spending and net exports (exports-imports)

Aggregate supply- the total amount of goods and services that domestic firms are willing to supply at a
given price level
Full employment- the lowest level of unemployment possible
Economically active- being a member of the labour force
Unemployment rate- the percentage of the labour force who are willing and able to work but are
without jobs
Price stability- the price level in the economy not changing significantly over time
Inflation rate- the percentage rise in the price level of goods and services over time
Balance of payments- the record of a country's economic transactions with other countries
Budget- the relationship between government revenue and government spending
Budget deficit- government spending is higher than government revenue
Budget surplus- government revenue is higher than government spending

National debt- the total amount the goverment has borrowed over time
Multiplier effect- the final impact on aggregate demand being greater than initial change
Direct taxes- taxes on income and wealth
Indirect taxes- taxes on expenditure
Progressive tax- one which takes a larger percentage of the income or wealth of the rich
Proportional tax- one which takes the same percentage of income or wealth of all taxpayers
Regressive tax- one which takes a larger percentage of the income or wealth of the poor
Automatic stabilisers- forms of government expenditure and taxations that reduce fluctuations in
economic activity, without any change in government policy
Inflation- the rise in the price level of goods and services over time
Informal economy- that part of the economy that is not regulated, protected or taxed by the government

Flat taxes- taxes with a single rate

Fiscal policy- decisions on government spending and taxation designed to influence aggregate demand
Expansionary fiscal policy- rises in government expenditure and/or cuts in taxation designed to increase
aggregate demand
Contractionary fiscal policy - cuts in government expenditure and/or rises in taxation designed to reduce
aggregate demand
Monetary policy- decisions on the money supply, the rate of interest and the exchange rate taken to
influence aggregate demand
Foreign exchange rate- the price of one currency in terms of anther currency or currencies
Expansionary monetary policy- increases in the money supply and/or the reduction in the rate of interest
designed to increase aggregate demand
Contractionary monetary policy- cuts in the money supply or growth of money supply and/or rises in the
rate of interest designed to reduce aggregate demand
Supply-side policy- measures designed to increase aggregate supply
Deregulation- the removal of rules and regulations

Gross domestic product (GDP)- the total output of a country

Circular flow of income- the movement of expenditure, income and output around the economy
Value added- the difference between the sales revenue received and the cost of raw materials used.
Transfer payments- transfers of income from one group to another not in return for providing a good or
service
Nominal GDP- GDP at current market prices and so, not adjusted for inflation
Real GDP- GDP at constant prices and so, adjusted for inflation
Subsistence agriculture - the output agricultural goods for farmers' personal use
Recession - a reduction in real GDP over a period of six months or more
Sustainable economic growth- economic growth that does not endanger the country's ability to grow in
the future
Employment- being involved in a productive activity for which a payment is received

Unemployment - being without a job while willing and able to work

Claimant count- a measure of unemployment which counts as unemployed these in receipt of
unemployment benefits
Labour force survey (ILO) Measure - a measure of unemployment which counts as unemployed people
who identify as such in a survey
Frictional unemployment- temporary unemployment arising from workers being in between jobs
Structural unemployment - unemployment caused by long-term changes in the pattern of demand and
methods of production
Cyclical unemployment - unemployment caused by a lack of aggregate demand
Search unemployment - unemployment arising from workers who have lost their jobs, looking for a job
they are willing to accept
Casual unemployment- unemployment arising from workers regularly being between periods of
employment
Seasonal unemployment- unemployment caused by a fall in demand at particular times of the year
Regional unemployment- unemployment caused by a decline in job opportunities in a particular area of
the country

Technological unemployment- unemployment caused by workers being replaced by capital equipment

Deflation- a sustained fall in the prices of goods and services
Disinflation- a fall in the rate of inflation
Cost-push inflation- rises in the price level caused by higher costs of production
Demand-pull inflation- rises in the price level caused by excess demand
Wage-price spiral- wage rises leading to higher prices, in turn, lead to further wage claims and price rises
Monetary inflation- rises in the price level caused by an excessive growth of the money supply
Hyperinflation- a very rapid and large rise in the price level
Index-linking- changing payments in line with changes in the inflation rate
Menu costs- costs involved in having to change prices as a result of inflation
Shoe-leather costs- costs involved in moving money around to gain higher interest rates
Economic development
Purchasing power parity- an exchange rate based on the ratio of the price of a basket of a products in
different countries
Human development index (HDI) - a measure of living standards which takes into account income,
education and life expectancy
Absolute poverty- a condition where people's income is too low to enable them to meet their basic
needs
Relative poverty - a condition where people are poor in comparison to others in the country. Their
income is too low to enable them to enjoy the average standard of living in their country
Vicious circle of poverty - a situation where people become trapped in poverty
Emigration- the act of leaving the country to live in another country
Birth rate- the number of births in a year per 1000 population in a year
Death rate- the number of deaths in a year per 1000 population in a year
Infant mortality rate- the number of deaths per 1000 live births in a year
Population pyramid- a diagram showing the age and gender structure of a country's population
Optimum population- the size of population which maximizes the country’s output per head
Economic development- an improvement in economic welfare
International trade and globalisation
Globalisation- the process by which the world is becoming increasingly interconnected through trade
and other links
Quota- a limit placed on imports and exports
Embargo- a ban placed on imports and exports
Exchange control- a limit on the amount of foreign currency that can be obtained
Infant industries- new industries with relatively low output and high cost
Declining industries- old industries which are going out of business
Strategic industries- industries that are considered important for the survival or development of the
country
Foreign exchange rate- the price of one currency in terms of another currency or currencies
Fixed exchange rate - an exchange rate whose value is set at a particular value in terms of another
currency or currencies
Devaluation- a fall in the value of a fixed exchange rate

Revaluation- a rise in the value of a fixed exchange rate

Floating exchange rate - an exchange rate which can change frequently as it determined by market forces
Appreciation- a rise in the value of a floating exchange rate
Depreciation- a fall in the value of a floating exchange rate
Trade in goods- the value of exported goods and imported goods
Trade in goods deficit- expenditure on imported goods exceeding revenue from exported goods
Trade in goods surplus - revenue from exported goods exceeding expenditure on imported goods
Trade in services- the value of exported services and imported services
Trade in services deficit- expenditure on imported services exceeding revenue from exported services
Trade in goods surplus - revenue from exported services exceeding expenditure on imported services

Primary income - income earned by people working in different countries and investment income which
comes into and goes out of the country
Secondary income - transfers between residents and non-residents of money, goods or services, not in
return for anything else
Current account balance- a record of the income received and the expenditure made by a country in its
dealings with other countries
Reflecting on your learning progress will help you study more effectively.