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A Level Economics
Stephen McArdle
The Economic Problem
The Economic Problem
The economic problem arises due to scarcity
...
People
must therefore make choices, and if they act rationally, they choose the choice
which provides the lowest opportunity cost
...
For example: Someone makes a rational choice about going on a holiday
...
g
...
Money is no solution to the economic problem
...
Opportunity cost
Opportunity cost is the next best alternative which people lose when they take
their first choice
...
Opportunity is the real cost of the product
...
The economic units
There are three economic units which are found in every society and engaged
in making economic choices
...
The household - the consumptive unit
...
A need is something essential to man's survival; anything else
qualifies as a want
...
2
...
The organisation involved in the production
of wealth and in our economy it is motivated by the consideration of
profit
...
3
...
Left wing governments believe in greater
government intervention than right wing governments
...
Points on the PPF itself produce the same level of welfare
...
Points inside the curve are wasteful, perhaps
due to unemployment or idle factories
...
PPFs can be used to show opportunity cost
...
PPFs curve usually shift outwards because of the law of diminishing returns
...
2
Factors of Production
Factors of Production
A factor of production is defined as a productive resource
...
The reward for land is
rent
...
The reward for labour is wages
...
The reward for capital is interest
...
Can be considered as a specialised form of labour
...
Classifying industries
The three main sectors of the economy are:
Primary sector - extracting raw materials
Secondary sector - processing, manufacturing and assembling raw materials
into goods
Tertiary sector - aid the production of goods (e
...
lorry driving) and sell
services
In a MEDC such as the UK the majority all economic activity is the tertiary sector
(currently 76%)
...
Example: "A poor coffee harvest will raise coffee prices and
people will drink more tea"
Normative statements are value judgements and opinions
...
Example: "We should redistribute wealth from
the rich to the poor"
Specialisation and Trade
Specialisation is when a factor of production is devoted to a specific job
...
By
specialising and trading, countries can increase overall output
...
The country can produce at a lower factor
cost
...
The
producer with the lowest opportunity cost of production for a particular product
has comparative advantage
...
Compared with Portugal, England is bad at producing cloth, but terrible at
producing wine
...
The Gains from Trade
The most important gain from trade is increased output
...
Other gains include:
4
Economies of scale
Political links may prevent wars
Competition gives greater efficiency and reduces the power of the
monopoly producer
Division of labour
Division of labour is a special type of specialisation
...
There are
three types of division of labour:
1
...
g
...
Specialisation by process (e
...
jam making)
3
...
g
...
Time saving
2
...
Improvement in quality of goods because specialists can perform better
4
...
Reduction in costs because people work faster
6
...
Mental disadvantages on workers of low job satisfaction
2
...
Immobility of labour
Limits to the division of labour
Some trades, such as handmade craft trades, are not suitable for
specialisation
...
The amount that
the consumer benefits
...
Producer surplus is the difference between the minimum price the
producer would be willing to sell for and the market price
...
The yellow area represents the costs to the firm of producing the good
...
Demand Theory
A demand curve
For the vast majority of goods, when a good falls in price more people buy it
...
The market demand consists
of the sum of all effective demand of households
...
Determinates of demand
The following factors may influence demand, shifting the demand curve to the
left if there is less demand and to the right if there is an increase in demand
...
Price
2
...
Changes in the price of relative goods
4
...
Changes in the distribution of income
6
...
Changes in marketing strategy
8
...
Changes in the law
10
...
Introduction of a new product
12
...
An increase in price leads to an increase in supply as the incentive for firms to
produce increases
...
Determinates of supply
The following factors may influence supply, shifting the supply curve to the left if
less is supplied and to the right if there is an increase in supply
...
Price of the goods
2
...
Changes in the price of all other goods
4
...
Changes in the state of technology
6
...
Imposition of a tax or subsidy
8
...
10
...
The market is cleared because consumers
demand what producers have to sell
...
The equilibrium will change when the demand and supply curves move
...
A contraction occurs when the demand/supply decreases
...
8
Elasticity of Demand
Elasticity of demand is the responsiveness of a good to changes in price,
income and the demand for substitutes and complements
...
The value of PED will always be negative because when price increases the
quantity demanded falls (for the same reason the demand curve slopes
downwards)
...
Goods with unit elasticity experience an equally proportionate change in price
to a change in quantity
...
For inelastic goods, a
proportionate change in price leads to a less than proportionate change in
quantity
...
e
...
What is the PED of cinema tickets?
Proportionate change in quantity is
Proportionate change in price is
Therefore
This shows the PED for cinema tickets is somewhat inelastic
...
The demand curve for inelastic goods has a steep gradient
...
Perfectly elastic
goods have horizontal demand curves (looks a bit like a capital E)
The elasticity of demand falls over the length of any given straight-line demand
curve
...
e
...
At high
quantities, the market is almost saturated and a fall in price has little response
(i
...
inelastic)
...
Availability of substitutes
2
...
Bought at short intervals or long intervals
4
...
Incomes
6
...
Market information, transport and communication
Income elasticity of demand
10
Income elasticity of demand (YED) is a measurement of how a good responds
to a change in income
...
g
...
g
...
g
...
g
...
Complements (e
...
fish and chips) have a negative XED
Unrelated goods have a XED of 0
...
g
...
11
Elasticity of Supply
Price elasticity of supply (PES) is measurement of the responsiveness of supply of
a good to a change in price
...
Goods with an inelastic supply will see a less than proportionate increase in
supply when the price increases
...
Many goods, especially agricultural goods, have an inelastic supply in the short
run because producers are unable to increase supply significantly with short
notice
...
Perfectly inelastic PES goods have vertical supply curves (looks like a capital
I)
...
Perfectly elastic PES goods have horizontal supply curves (looks a bit like a
capital E)
...
Spare capacity
2
...
Quantity of stocks
4
...
Rationing - when there is a shortage of a good, the price increases (it is
"bid up"), leaving only those with the willingness/ability to pay to purchase
the product
...
2
...
For example, the price of goods which are scarce will increase
...
e
...
3
...
Advantages of the price mechanism
The great benefit of the price mechanism is the invisible hand of price
described by Adam Smith
...
The idea of consumer sovereignty - consumers have the power to determine
what is bought and sold in the market
...
Prices are as low as possible and resources go to the most efficient use
...
Disadvantages of the price mechanism
Inequality of income and wealth
Without government intervention, there will be under-provision of public and
merit good
Unemployment
Inflation
Wastage on advertising etc
...
Indirect Taxes and Subsidies
The incidence of taxation is who finally pays the tax
...
Taxes
Taxes are designed to limit production of a good
...
The greater the PED or the smaller the PES, the greater the burden upon
producers
...
15
Ad valorem taxes, such as VAT, are a fixed percentage of the price of the good,
so the amount of tax (indicated by the red arrow) increases as the price
increases
...
They encourage greater production
of a good, shifting the supply curve to the right
...
16
Economies of scale
Economies of scale are savings firms achieve from growing larger
...
Internal economies of scale
Internal economies of scale are the savings which occur within a firm,
independent of other firms
...
Technical economies of scale
Large firms have savings in cost during production compared to small firms
...
Linked processes can be used on a larger scale (e
...
a conveyor belt
operation)
...
Increased dimensions
...
This is an
important economy of scale in areas where bulky material must be
transported (e
...
oil tankers)
...
Indivisibility of capital
...
g
...
In this case only large
firms can afford to buy it
...
Specialisation
...
Workers
are able to become more efficient at a particular job when specialisation
occurs
...
17
Managerial economies of scale
Savings from delegation and specialisation
...
Delegation of authority so that accountants do the accountancy
...
Functional specialisation' so that there is a separate sales department
...
Managerial expertise - for example head-hunting the best workers
...
1
...
Specialist buyer
3
...
Specialist transport
5
...
Advertising
Financial economies of scale
Large firms find raising capital easier because large firms are considered a
better risk
...
Diversification
A large firm engaged in many markets is less risky because if one market goes
down, the firm can still make money in the others (e
...
Virgin)
...
g
...
1
...
Transport facilities (e
...
better motorway network in the area)
Information
Firms exchange ideas and publish articles and magazines that promote the
spread of information throughout the industry
...
Trade journals
2
...
Ancillary trades
2
...
These are:
1
...
2
...
19
Market failure
Market failure occurs when the price mechanism fails to produce the goods
consumers want
...
There is no productive or
allocative efficiency
...
To achieve this, firms must exploit economies of scale and minimise
wastage of resources
...
This occurs when the
marginal cost of an item is equal to the market price
...
Such a point is a
Pareto Optimum, named after Vilfredo Pareto
...
Externalities
Externalities are effects of production or consumption of a good on a third party,
who is not directly involved in the activity
...
20
Externalities cause market failure if the cost/benefit to third parties is not taken
into account
...
Negative Externalities
The quantity Q1 to Q2 is overproduction
...
Examples include:
Smoking - passive smoking causes health problems for people who do not
consume cigarettes themselves
...
Alcohol abuse - clean-up costs of fights, vomiting etc
...
Positive Externalities
21
The quantity Q1 to Q2 is underproduction
...
Examples of positive externalities
include public transport, vaccinations and education
...
Taxes
2
...
Subsidies
4
...
State-provided goods
22
Specialisation and Trade
Specialisation is when a factor of production is devoted to a specific job
...
By
specialising and trading, countries can increase overall output
...
The country can produce at a lower factor
cost
...
The
producer with the lowest opportunity cost of production for a particular product
has comparative advantage
...
Compared with Portugal, England is bad at producing cloth, but terrible at
producing wine
...
The Gains from Trade
The most important gain from trade is increased output
...
Other gains include:
Economies of scale
Political links may prevent wars
Competition gives greater efficiency and reduces the power of the
monopoly producer
Division of labour
Division of labour is a special type of specialisation
...
There are
three types of division of labour:
23
1
...
g
...
Specialisation by process (e
...
jam making)
3
...
g
...
Time saving
2
...
Improvement in quality of goods because specialists can perform better
4
...
Reduction in costs because people work faster
6
...
Mental disadvantages on workers of low job satisfaction
2
...
Immobility of labour
Limits to the division of labour
Some trades, such as handmade craft trades, are not suitable for
specialisation
...
In the UK it is measured using the CPI (Consumer Price Index) measure
...
It is often also useful
for governments to consider the RPIX measure of inflation, this is often referred to
as the "underlying rate of inflation"
...
However, there are differing explanations:
1
...
Consumers initially underestimate the average price level, and shocked
by the "excessive" rise in prices cut their consumption in response until
they recognise the higher price levels
...
Buckley (1981): suggests that even if inflation fully anticipated, the savings
ratio will increase as long as anticipated inflation is itself increasing
...
Cuthbertson (1982): suggests that, due to inflation, the real rate of interest
(nominal – inflation) often zero or negative, so real purchasing power of a
given stock of liquid assets (notes/coins/bank deposits & other short-term
assets) falls
...
4
...
Unemployment
6
...
26
7
...
• The unemployment rate is expressed as a percentage of the total
labour force, not the whole population
...
’ people who are not part of the labour
force are those out of the age range, students, parents who stay at home,
retired people, and people who choose not to work
...
9
...
Information is gathered from censuses and surveys,
as well as administrative records such as unemployment insurance records
and social security information
...
10
...
• Geographical • Age • Ethnic • Gender
12
...
• Costs of unemployment to the unemployed people themselves (lower
standard of living because of less income, high levels of stress, depression,
mental health problems, break-downs, suicide levels increase)
14
...
While it would be a simplification to
blame these problems entirely on unemployment, they are not
unconnected
...
• Costs of unemployment to the economy as a whole – a PPF can be
used to illustrate the key problem facing an economy with unemployment
– if actual output is less than potential output due to unemployment of the
factor of production, labour, then the economy is forgoing possible output
and would be operating at a point within its production possibility curve
...
There is an opportunity cost for the
government’s spending on unemployment benefits
...
The
government may have to spend more money to solve the social problems
27
created by unemployment
...
The costs increase the longer a person is
unemployed
...
At any time there will be pool of unemployment
...
This, along
with the demand for labour, will determine the level of unemployment
and employment in an economy
...
Types of unemployment
18
...
Same as minimum price
...
Solutions-reduce the power of trade unions, reduce minimum wage
...
Worsening distribution of income
...
• Demand-deficient
...
Leads to a fall in demand for labour, as firms cut back on production
...
So unemployment is created
...
20
...
Jobs exist, but people are unwilling or
unable to take the jobs that are available
...
• At any given wage rate there will be more people looking for jobs than
those who are actually willing/able to take jobs
...
• The fact that there is no disequilibrium unemployment in the economy
means there are jobs availible, but people just can’t or are unwilling to
take them
...
g
...
Or
perhaps there are jobs for computer programmers, yet unemployed
computer programmers don’t know the jobs are availible
...
• Gap between supply of labour and labour force curve is smaller at
higher wages because at a higher wage more people will be wiling to
work/likely to correct the reason they can’t work
...
• An economy is at the full employment level when the unemployment
that exists is only the natural unemployment
...
• There are a few types
...
• Frictional unemployment-short term unemployment that occurs when
people are in between jobs, or have left education and are ready to take
up their first job
...
Solutions-reduce the unemployment
benefits that are availible whilst looking for a job
...
• Seasonal unemployment-sometimes in an economy people are
employed on a seasonal basis
...
Ski instructors only work in
the winter
...
’
28
...
Occurs as the result of the changing structure of an economy
...
Natural in a growing economy
...
)
29
...
We say
that they lack the occupational mobility to change jobs
...
Causes of structural unemploymenttechnologies make certain types of labour unnecessary, lower cost labour
in foreign countries, changes in consumer taste
...
Solutions-education system that trains people to be educationally flexible
...
Spending on adult retraining programmes
...
Apprentice programmes
...
Or reduce unemployment benefits, and deregulation
...
Market regulations protect workers
...
So although unemployment may fall, there
29
would be a high cost for the workers themselves
...
31
...
Only a problem in the long term
...
Same with interest rates
on spending and investment
...
32
...
33
...
Or an economy could be suffering from different types of
unemployment
...
Demand side to narrow
business cycle fluctuations and reduce output gaps
...
34
...
These are sold as bonds to financial institutions who sell them to people
who want to save money
...
This results in an increased interest rate, and a disincentive
for businesses to invest as they see less return on their investment
...
30
Revision:Limits to growth and development
1- Primary product dependency
• Comparative advantage – means exports one g/s, imports everything else,
so very dependent on one commodity, e
...
Zambia almost 100% dependent
on copper
...
g
...
• Structural distortion Developed countries pose further problems as they will
only import raw materials, and choose to manufacture these themselves
...
g
...
Therefore; developing countries cannot process them (e
...
value added)
and move into secondary sector
...
Primary sector is not very productive (Lewis model)
...
• Prebisch-Singer Hypothesis the terms of trade between primary products
and manufactured goods tend to deteriorate over time because as world
incomes rise we tend to demand more manufactured goods, than say,
food
...
• Price fluctuations deter investment and mean farmers cannot invest and
plan for the future, to get the best of their harvest
...
• Capital-intensive farming – this is to provide for the world market, often
by MNCs
...
Should enforce redistribution of land, and encourage labour intensive
farming to make distribution of income equal
...
Lack of infrastructure – transport, telecommunications, energy, water and
waste
...
Jeffrey Sachs says landlocked countries e
...
S-S Africa at a
disadvantage, e
...
high in mountains, lack of navigable rivers
...
Transport is 14% of exports in
landlocked countries
...
Savings gap –Already in a poverty trap, low GDP per capita means little
saving by individuals– Harrod-Domar suggests this means they cannot
invest, preventing economic growth from occurring
...
Corruption and war – bribery, extortion, diversion of resources by
government – this is an inefficient allocation of resources and restrains
development
...
This will deter aid
...
g
...
War and corruption also deter investment
...
Population growth - rapid population growth in poorest countries e
...
Malawi
...
Malthus said at the end of the
18th C that famine was inevitable because population would increase
geometrically, but food production could only increase arithmetically
...
Poorer countries have
high birth rates and slowing death rates
...
HIV/AIDS – Reduced working population – the working population suffer,
so there is a loss of highly skilled workers
...
In Swaziland, life expectancy is just 31
...
Labour becomes
more expensive, so higher CoP, and can attract less FDI
...
Resources diverted from
growth to treating AIDS
...
Education - a huge investment in human capital through education has
allowed China to shift out its PPF
...
It will mean more FDI in the future as firms will
not have to train workers
...
Debt servicing - LEDCs borrowed in 1980s
...
45
...
46
...
e
...
Conditions for contestable markets:
1
...
2
...
No sunk costs
In contestable markets incumbent firms are forced to act as if they are in
competition, and therefore make only normal profits
...
Hit and run entry can only
occur in barriers to entry and exit are low
...
Barriers to contestability always exist
...
Sunk costs
Sunk costs are costs which are irrecoverable to the owners of the firm if it leaves
the market
...
It is a past
expense that cannot be altered by current/future actions
...
Causes of sunk costs:
No second hand market
Industry specific capital
Future liabilities (e
...
nuclear power plants)
Implications
34
The theory tells us that all markets can be efficient as long as they are
contestable
...
Instead the government's role should be to:
Make the market more competitive by increasing the degree of
contestability
Lower barriers to entry and exit in an industry
Allow take-overs (if they don't prevent competition)
Efficiency
Productive efficiency
Productive efficiency is defined as the production of goods and services using
the least possible scare resources or is achieved when a firm is producing at the
lowest possible average cost
...
Productive efficiency alone does not ensure economic efficiency
...
e the lowest point on the lowest average cost curve of the firm)
The second way of analyzing productive efficiency is through understanding it
on a production possibility frontier or a production possibility curve (PPC)
...
g consumer and capital goods
...
Any production within the
boundary of the PPC would imply inefficient use of resources in production of
goods and services or spare capacity
...
Competition in general ensures that a firm produces goods and services at the
minimum cost to maximize profits
...
Perfect competition
35
epitomizes the concept of productive efficiency as firms produce at the lowest
point on their respective average cost curves at a point where AR=MR=P
...
Allocative efficiency
Allocative efficiency is the concept of producing goods and service using least
possible scare resources that are most wanted or desired by consumers
...
e
...
Allocative efficiency unlike productive efficiency cannot be illustrated on a PPC
as the point of allocative efficiency may be at any point on the PPC and is
entirely dependent on consumer preferences
...
Failure to do so would mean loss of business
opportunities to rival firms and possible bankruptcy
...
Allocative efficiency
Allocative efficiency is achieved when the cost of producing a good is equal to
the price consumers are willing to pay - this is how much the consumer values
the good
...
Pareto optimality is achieved
...
The condition for allocative efficiency is AR = MC (AR is equal to the price by
definition)
...
Long run costs fall due to economies of scale, and
then rise again with diseconomies of scale
...
The envelope curve shows how, when SR costs begin to rise, the firm should
move along the LRAC by increasing the quantity of capital (assuming capital is
the factor kept constant short run)
...
A lack of finance may prevent movement along the LRAC
...
This may be for many
reasons, such as the manager taking the afternoon off to go golfing or workers
playing minesweeper!
38
Revenue
Revenue is the income generated from sales in the market
...
The gradient of marginal revenue is double that or average revenue
...
Revenue with elastic demand
39
Main article: Perfect competition
Under perfect competition, each firm has an elastic PED
...
When AR is horizontal, MR=AR
...
MV = PT
Wrong because not all the
extra money is spent velocity is may slow down
...
Therefore
increasing M increases
prices, output and
employment
...
Reducing the rate of
growth of the money
supply will reduce
inflation without leading
to long-term
unemployment
...
In the long run, higher
AD being expanded for too
demand leads to
long at too fast a rate
...
*Damaging to business
Effects of inflation
...
This
increases output
...
Solutions to
unemployment
Government policy
41
...
Long run, increase
the mobility of labour
through training and a
reduction in
unemployment benefit
...
Control interest rates
and exchange rates to
reduce uncertainty
...
Effect of increased
government spending
Taxation
Thinks the other side is
wrong because
for controlling the money
supply
...
Multiplier
Crowding out
Good
Bad - incentives better
They put too much reliance
on markets - more complex
than they suggest
They cannot explain
stagflation
Monopolistic competition
The model of monopolistic competition lies halfway between perfect
competition and monopoly
...
PD is assisted by advertising, which can steepen the
demand curve
...
Long run equilibrium
Free entry erodes profits
...
The AR and MR of these firms moves to the left, to the point
where MR=MC and AC is tangent to the AR curve
...
43
How to draw the tangency solution point
1
...
Draw the AC, with a tangency point 3/4 of the way up the AR
3
...
Draw in the MC
...
It
should cross the minimum of AC
...
However, the
consumer gains from the choice that product differentiation brings
...
The legal definition of monopoly is a firm which has a market share greater than
25%
...
Barriers to entry and exit
...
Evidence of price discrimination
...
Assumptions of monopoly:
One seller of the good
No substitutes
Barriers to entry
The monopolist is able to raise prices without competitors entering the market
...
The monopolist has a downward sloping demand curve because, unlike in
perfect competition, when the firm raises its prices it will retain some customers
...
It is a price maker and can choose its position
along the curve
...
The output is lower and
the price is higher than under perfect competition
...
Profits are not eroded long run because of the existence of
barriers to entry
...
46
Natural monopolies
Natural monopolies occur in industries where there are no diseconomies of
scale
...
The largest firm can always produce at a lower cost than any potential entrant
...
The government may control natural monopolies
...
Efficiency
Productive efficiency is not achieved - the firm is not producing at the lowest
point of the AC curve
...
The
consumer loses consumer surplus (shaded areas in the diagram)
...
A number of assumptions are
made:
1
...
Many individual buyers (no monopsony power)
3
...
Homogenous products (no product differentiation)
5
...
No externalities
Perfect competition graphically
In perfect competition, firms are price takers
...
Short run
Firm making a profit
If the market price is set above or below the costs of the firm, the firm may make
profits or losses
...
If the
costs are lower than this, the firm makes a profit
...
Productive efficiency is not achieved because AC
does not equal MC at the output solution point
...
Again, allocative efficiency is achieved
...
Long run
If firms in the short run are making profits, there are incentives for new firms to
enter the market
...
This can occur because there
are no barriers to entry
...
This is long run equilibrium with no tendency to change
...
Allocative efficiency is achieved: MC = AR
Evaluation of perfect competition
50
Perfect competition is merely a theoretical ideal
...
It provides a measure against which other market structures can be
compared
Economic analysis can be used to investigate the effects of relaxing
assumptions (e
...
allowing for product differentiation or asymmetric
information)
The model of perfect competition is most applicable in markets such as
Some agricultural markets
o
o
Low barriers to entry
o
Mostly homogenous products
o
Many buyers and sellers
The firms demand curve is almost horizontal (e
...
a firm's PED for
sweetcorn was estimated to be -31353)
...
Currency markets
o
Homogenous product
o
Good knowledge in the market
o
Very low transaction costs
Even these markets do not fit the model perfectly
...
Price discrimination
Price discrimination arises if a firm is able to charge different price to different
groups of people and gain their consumer surplus
...
The firm must be a price maker in the market - price discrimination can
only take place under monopoly or monopolistic competition
...
The firm must be able to identify different groups of customers and know
their different elasticities of demand
...
There can be no resale in the market between consumers
...
Effects of price discrimination
Buyers lose their consumer surplus to the monopolist
Profits rise for the monopolist
Some consumers gain a good or service that they might otherwise not have
been able to have
First degree price discrimination
Also known as perfect price discrimination
...
The firm extracts all the consumer surplus
and turns it into revenue
...
Beyond
this point the price consumers are willing to pay is less than it costs the firm to
make
...
Second degree price discrimination
52
Occurs in markets where there is a fixed capacity so it is in the firms interest to "fill
every seat", and the firm is prepared to sell at cost to achieve this
...
For example, it costs much the same to
fly a Boeing 747 whether there is 1 passenger on it or hundreds
...
However this
leads to spare capacity
...
Examples: theatre tickets, plane tickets (last minute tickets cost less), football
tickets in lower divisions ("kid for a quid" - adds to revenue but adds little to
costs)
...
The
monopolist charges a lower price to a group of people who have more elastic
demand
...
53
Producer and Consumer Surplus
Consumer surplus is the difference between the market price and the maximum
price the consumer would be willing to pay
...
On the diagram is is the top triangle shown in blue
...
It is the triangular area below
the consumer surplus shown in red
...
Together
the yellow and red represent the revenue of the firm
...
When we talk of a firm breaking even, the
firm is making just enough profit to stay in business long term
...
MC is drawn as a tangent to TC
...
55
With downward sloping demand
When an industry has imperfect competition, a firm's demand curve slopes
downwards
...
MR is the tangent of TR
...
Sales and Revenue Maximisation
Firms do not always aim to maximise profit
...
Sales maximisation
Sales are pushed up to the point where the firm just breaks even, where TR = TC
...
56
Revenue maximisation
The point when MR = 0 and the firm is producing at the point where TR is
maximised
...
Output will be larger than under
profit maximisation
...
This
applies to all factors of production - land, labour, capital and enterprise
...
Absolute and comparative advantage
When a country can produce more of a product per unit resource than its rivals
can, it has absolute advantage
...
More important, however, is Ricardo's idea of comparative advantage
...
For example, Portugal can produce more wine
and cloth than England per unit resource (it has absolute advantage in both)
...
Therefore England should specialise in cloth and Portugal in
wine, because the opportunity cost of Portugal producing extra cloth is greater
than producing extra wine
...
This can lead to
increased living standards, greater variety of goods and spread of technology
...
The production of a good is
spilt into many tasks which can be undertaken by different people
...
Specialisation of people in trades or professions (e
...
milkmen)
2
...
g
...
Specialisation by area (e
...
Silicon Fen, Cambridge)
Advantages
1
...
Increase in output due to productivity gains from increased economic
organisation
3
...
Makes the best use of natural abilities
5
...
Automation as the use of machinery takes over repetitive tasks
Disadvantages
1
...
Strikes and absenteeism
3
...
Large scale sales are needed for division of labour
Management may not be efficient
Indirect Taxes and Subsidies
The incidence of taxation is who finally pays the tax
...
Taxes
Taxes are designed to limit production of a good
...
The greater the PED or the smaller the PES, the greater the burden upon
producers
...
59
Ad valorem taxes, such as VAT, are a fixed percentage of the price of the good,
so the amount of tax (indicated by the red arrow) increases as the price
increases
...
They encourage greater production
of a good, shifting the supply curve to the right
...
A2 Economic Rent and Transfer Earnings
60
Transfer earnings are the minimum payment required to keep a factor of
production in its present use
...
Example - a man may decide to work as a shop assistant because they
pay is better than if he was a waiter
...
The opportunity is
seen in terms of this forgone alternative
...
Economic rent is a payment received by a factor of production over and
above what would be needed to keep it in its present value
...
e
...
It is a demand determined
reward to labour and will be earned when labour is to some degree in
inelastic supply
...
To the extent that the demand for
doctors exceeds the supply, they will be able to negotiate higher salaries
than most could earn as research scientists or in other occupations
The factor that determines the level of economic rent in comparison
to transfer earnings is the elasticity of supply of labour
...
Conversely, the more elastic the labour supply is, the more
transfer earnings make up of total earnings, and so the economic
rent is less
...
61
Firstly, surgeons are inelastic in supply, especially in the short run
...
Also, not
everyone has the required abilities to become and surgeon
...
So in this case, a large proportion of surgeons’ total earnings are
made up of economic rent
...
So, the labour supply would be relatively elastic,
meaning economic rent will be relatively less important than in
the case for surgeons
...
Aid
Aid can come in many forms such as:
1
...
help with supplies (such as food and clean water or even medical
supplies)
3
...
e
...
Aid can also be from one country to another (bi-lateral) of from the world bank
or other organisation (unilateral)
...
tied aid may not benefit the country directly due to harsh conditions, an
example of this would be the STRUCTURAL ADJUSTMENT SCHEMES (SAPS,
look it up!)
...
the country may have a corrupt governance which leads to money being
wasted on either white elephant projects or even stolen by the political
elite
...
the aid may not be enough - remember SIZE MATTERS (evaluation marks,
anyone?)
4
...
the recipient country may not have the infrastructure required to make
use of the aid properly - for example if hey want to attract MNCs or foster
a good entrepreneurial spirit, a good infrastructure is required (phone
lines, transport networks, etc)
6
...
I'm sure you people can think of more POST THEM!
Lastly, aid can be very good for the economy due to many factors such as
1
...
conditional aid may have good conditions, such as the money must be
spent on education and training, this by-passes the possibly corrupt
political elite
63
3
...
e
...
key workers such as teachers will have a long lasting effect on those
people they work with - increasing the knowledge in the country and
shifting the LRAS to the right
64
World Bank
This consists of two organisations now, although when it was set up it was an
organisation designed to relieve the short term BoP problems of LDCs
...
The two parts are -
International Bank for reconstruction and development IBRD
This part is responsible for the funding of various projects in cooperation with the
local government
...
International Development Association - IDA
This part lends money to the poorest LDCs to tackle BoP problems and the like
on concessionary terms, ie long repayment periods and very low or zero interest
rates
...
A third organisation called the International financial corporation (IFC) is closely
linked with the world bank and gives a type of aid without going through the
local government - hence less likely to be affected by corrupt government
officials, although more risky financially, since they buy into shares of firms or lend
directly to them if the IFC believes that this will lead to higher levels of
development
...
These are pretty set regardless of the country they're being
used for and are also pretty harsh as they push the economy too hard to
change and try to bypass 'take off'
...
The bad press comes because of these SAPs
making life worse for people, especially since they try to force the economy to
change from LDC to MDC so quickly
...
cut/drop in all subsidies and price controls so that market prices can be
charged
2
...
Reduction in public and rise in private employment
4
...
Lowering in barriers to trade
These policies will open up domestic producers to the low world prices and
often send them out of business
...
In the long run, efficiency will rise however with the
incentive for lower prices
...
Basically, SAPs bone countries like a femur in the short run but usually work out in
the long run - of course, there are exceptions
...
Human rights people that
enforce equality of race etc
...
MNCs have such large amount of capital that their yearly turnover can be
more than some countries' GDP, thus having an MNC present within your
country promotes economics stability
...
MNCs promote good infrastructure, they will do all they can to better
transport links and phone lines - this will benefit the whole country
...
MNCs create jobs in their local area, this can totally revive some parts of
the country, and will lead to higher demand for labour, thus wages will
rise (may cause inflation) and AD will shift right, thus economics growth
will occur
...
the main aim of an MNC is to exploit economies of scale in order to be
competitive in international markets - this means that one of their primary
aims will (indirectly) be to better the current account position
...
When an MNC first arrives to a country it will require buildings, land labour
and capital, the capital aspect (machinery, buildings, etc) will be a
positive on the financial account, better the balance of payments
straight away!
All those are very good points, promoting price stability, low unemployment,
balance of payments on the current account and economic growth (four of the
main macroeconomic objectives)
...
MNCs are driven by producing at the lowest costs, so they usually set up in
places where labour is cheap, they will then exploit workers in LDCs (shell
oil, or Nike, anyone?)
...
MNCs yield a lot of power over the country they are in - once in the
countries governance will do little to regulate them of the fear that they
will leave
...
67
3
...
4
...
FDIs
Everything to do with MNCs pretty much applies to all types of FDI,
Finally the means by which countries attract FDI:
1
...
2
...
this is helped by the use of
*fixed rule* fiscal policies (such as Gordon browns golden rule)
3
...
4
...
5
...
transport links are required to get raw materials
and to distribute goods
...
country links - whether the country is in a free trade area, or customs union
will have an effect on the MNC this is because they can have access to a
market without trade distortion (such as the many forms or protectionism)
68
Formulae
PED
o
PED >1 elastic
o
PED <1 inelastic
o
PED =1 unitary
PES
YED
o
positive = normal good
o
negative = inferior good
o
YED > 1 = luxury good
XED
o
Substitutes: XED > 0
o
Complements: XED <0
Macroeconomics
69
APC: the proportion of income consumed
APS: the proportion of income saved
in a simple closed economy
...
Spending
Bank/credit
o
o
P = price level
o
Q = real GDP
o
70
V = income velocity of circulation
o
M = Money Supply
Monetarists believe:
Standard of Living =
Externalities
Externalities are effects of production or consumption of a good on a third party,
who is not directly involved in the activity
...
Externalities cause market failure if the cost/benefit to third parties is not taken
into account
...
Negative Externalities
The quantity Q1 to Q2 is overproduction
...
Examples include:
Smoking - passive smoking causes health problems for people who do not
consume cigarettes themselves
...
Alcohol abuse - clean-up costs of fights, vomiting etc
...
Positive Externalities
71
The quantity Q1 to Q2 is underproduction
...
Examples of positive externalities
include public transport, vaccinations and education
...
Taxes
2
...
Subsidies
4
...
State-provided goods
72