EconomicsIGSCE

Notes on Specification

Sec A: The Market SystemI) Demand and Supply1. The Market System Markets exist wherever buyers and sellers can communicate and trade goods and/or services in exchange for money. The amount of money needed to be paid for a certain item is its price. Countries where there are many markets operate together to form a Market System, also known as Price Mechanism. This system automatically determine two functions by its daily operations:i Price determination; to determine the price of a product by communication.ii Resource allocation; to allocate available resources to most successful uses. Supply and Demand are two factors that arise in the market system.i Supply refers to amount of a good or service that sellers are prepared to sell at given price over a period of time.ii Demand refers to the amount of a good or service that will be bought at given prices over a period of time.2. The Demand Curve Effective demand; amount of good or service people can afford and willing to buy at given prices over period of time. Price affects the quantity of demand. Price and the quantity of demand are inversely related. That means that if one falls, the other rises. For example, if the price of wheat falls, the quantity of demand for wheat rises. Graphs of the demand curve are used to show the inverse relationship these two factors share. The graphs showing the demand curve are usually similar to either reciprocal functions or functions of (x). 3. Factors that Affect Demand Factors that affect demand, apart from price, include:i Income; generally, as incomes rise, so does demand. With more money, the consumer has greater spending power. However, this principal only applies on normal goods. On inferior goods, an increase in income means a decrease in demand as people will be able to afford better. ii Fashion; demand of goods or services is often subject to mass appeal.iii Advertising; method used to increase appeal and thereby, demand.iv Demographics; as populations rises generally, so does demand. Additionally, several segments of the global population are rising quicker at certain location as compared to others. For example, the population of men may be rising quicker than women, meaning demand of male clothing would probably rise quicker than female clothing. v Complementary or Substitute Goods; the former being goods that are required for functionality of a good. If the price of either rises, the demand for the other product can be affected. A substitute good might be introduced that is cheaper or more efficient at the same price. Would decrease demand for less efficient or more expensive good. vi Interest rates; since loans are often used to purchase goods such as houses or cars, interest rates can play a role. For example, if the interest rates are high, people will be reluctant to take loans and vice-versa. If prices fluctuate, there is a movement along the demand curve. However, if other factors change, the entire demand curve on a Price vs. Quantity graph shifts. For example, if incomes rise, people will have the ability to buy more and therefore, general effective demand will rise. As a result, the demand curve will move right on the Price vs. Quantity graph. This means that people will be able and willing to demand more quantity at every price.4. The Supple Curve Supply is the amount of a good or service sellers are willing to sell at given prices over a period of time. As prices rise, so does the quantity of supply. Generally, there is a direct proportional-like relationship between price and the quantity of supply. The supply curve is straight. If prices change, there is movement along that curve. Sometimes, there is a fixed supply. This means that at any given price, the quantity of supply will remain constant. On a graph, the supply curve will be vertical. For example, the price of seats available at a sports event will not affect quantity of supply.5. Factors that Affect Supply Apart from price, other factors that affect supply include:i Subsidies; these are grants given by the government to a firm to encourage production of a certain good or service in a certain condition. For example, a government may inject some money into a bus company on the condition of providing services to unpopulated areas too that will not be profit-generating activities. As the costs of production are aided with the governments help, quantity of supply will increase.ii Costs of Production; the costs of the factors of production which are land, labor, capital, and enterprise can determine, to a large part, how much a firm can produce, and therefore, quantity of supply.iii Technological Changes; change the costs of production. For example, automated car-making reduces need for manual labor, so costs of labor are reduced. Also, since technology makes production quicker, supply increases. iv Natural Factors; the production of several goods (i.e. fruits, wheat, meat, etc.) is affected by natural factors such as natural disasters, weather, or infestation. Therefore, quantity of supply will be affected.v Indirect Taxes; taxes imposed by government will discourage firms to produce as they represent cost for the firm. vi Prices of Other Goods; suppliers may switch to dealing with services or goods that are more profitable, thereby decreasing quantity of supply for the former good or service. If any of these factors changes in some way, the supply curve shifts on the Price vs. Quantity graph. If price changes, the movement is along the supply curve only. For example, if the cost of production rises, less profit would be yielded out of the revenue. Therefore, quantity supplied would gradually decrease at all given prices. However, if the costs of production lower, selling products would be more profitable. By principal, supply will rise in quantity for every given price. The supply curve on a graph would move right.6. Market Equilibrium The equilibrium price is found when demand and supply are equal. It can be seen on a graph where the demand curve meets the supply curve. The price coordinate of that point is the equilibrium price. The quantity coordinate of that point is the amount of the goods both the supplier and the customer are willing to deal on at the price mentioned. At the equilibrium price, all stock will be bought as all that is supplied is demanded. Therefore, this is known as the market clearing price. By multiplying the x-coordinate and y-coordinate of the point where supply and demand meet, we get total revenue.

Total revenue is the amount of money generated by the sale of total output. It is equal to total expenditure; which is the amount of money spent buying the firms output. Total revenue concerns firms, or the suppliers; whereas total expenditure concerns consumer, or demanders. If demand increases due to factors other than price, then equilibrium prices rise. If demand decreases due to factors other than price, then equilibrium prices fall. On the contrary, if supply increases due to factors other than price, then equilibrium prices fall. If supply decreases due to factors other than price, then equilibrium prices rise. If the price is set lower than the equilibrium price, there is excess demand. This is because at the price, there is not enough supply to meet demand. There is a shortage of goods or services. If the price is set higher than equilibrium price, then there will be excess supply. At this price, there is not enough demand to consume supply. There is excess of goods, or services, which will not be sold. The market has been flooded.7. Price Elasticity of Demand For all items, demand generally slopes downwards when comparing with price. That is, quantities of demand and price have an inverse relationship. However, the degree to which demand slopes can vary. Some items are deeply dependent on the price factor. A slight change in price can cause massive changes in demand. On the other hand, some items are not that easily affected by price. A significant change in price might actually cause a slight change in demand. The relationship that exists between the responsiveness of demand to a change in price is called price elasticity of demand (PED or Ed). The demand of goods or services that have a low response in terms of change of quantity of demand due to change of price are said to be price inelastic. That is, a change in price will cause a proportionally smaller change in demand. When the response of quantity demanded is significant to a change in price, the demand of a good is said to be price elastic. In this case meaning a change in price will cause a proportionally greater change in demand. Additionally, they may be referred to as goods that have inelastic demand or elastic demand, respectively. To judge whether the demand of a good or service is price inelastic, or elastic, the following formula is used (data from demand curve on the Price vs. Quantity graph):

If, for a product, the value of elasticity of demand is less than one, the products demand is said to be inelastic. The demand curve is steep in this case. However, if a good or services elasticity in terms of demand measures more than one, its demand is elastic. This will resemble a flat line.Ed > 1; Demand is price elastic.Ed < 1; Demand is price inelastic. The demand of some products is special. There are three such cases: i Perfect Elasticity; some goods can only be demanded at one price. If the price changes slightly, demand completely diminishes. Since their elasticity is infinite, the graph is horizontal.ii Perfect Inelasticity; the demand of some goods is absolutely immune to change in price, demand always stays constant. Since they have zero elasticity, their graphs are vertical.iii Unitary Elasticity; the demand of some goods respond correspondingly to change in price. That is, a percentage of change in price would result in the same percent change in quantity demanded. Since they are inversely proportional, they resemble reciprocal functions.Ed = ; Demand is perfectly price elastic.Ed = 0; Demand is perfectly price inelastic.Ed = 1; Demand is unitarily price elastic. Several factors affecting price elasticity of demand include:i Availability of Substitutes; if substitute goods can be found for a product, consumers will move to those if prices for that product rise. For instance if price of strawberry jam rises, people will move to other types of jams instead. However, if no or little substitutes are available, the demand for them will not move to other substitute goods. A good or service with substitutes is therefore, elastic; whereas one without substitutes would be inelastic.ii Degree of Necessity; the necessity of a good or service can affect its elasticity. Essential products, like fruit or fuel for instance, will not easily lose demand due to changes in price, making the demand of such inelastic. Luxury goods will have demand elasticity.i Proportion of Income Spent on Product; peoples personal income play a big role too. If a large proportion of them are spent on a certain good or service, it will be price elastic. However, products whose price is insignificant to income will tend to be price inelastic.ii Time Period; in the short term, all goods generally are demand inelastic. That is because new circumstances need time to adapt the effectively as appropriate if prices fall or rise. For instance, it will take time for consumers to find substitutes if prices rise.8. Price Elasticity of Supply For all items, supply generally slopes up with changes in price. That is, quantities of supply and price have a variation relationship. However, the degree to which the demand slopes upwards can vary. The degree of response that price has upon quantity supplied varies with different goods or services. This relationship is known as the price elasticity of supply (PES or Es) The supply of goods or services that have a low response in terms of change of quantity of supply due to change of price are said to be price inelastic. That is, a change in price will cause a proportionally smaller change in supply. When the response of quantity supplied is significant to a change in price, the supply of the good is said to be price elastic. In this case meaning a change in price will cause a proportionally greater change in supply. Additionally, they may be referred to as goods that have inelastic supply or elastic supply, respectively. To judge whether the supply of a good or service is price inelastic, or elastic, the following formula is used (data from supply curve on the Price vs. Quantity graph):

If, for a product, the value of elasticity of supply is less than one, the products supply is said to be inelastic. The supply curve is steep in this case. Additionally, the supply curve would cut the quantity axis. However, if a good or services elasticity in terms of supply measures more than one, its supply is elastic. This will resemble a flat line. In this case, the supply curve cuts the price axis.Ed > 1; Supply is price elastic.Ed < 1; Supply is price inelastic. The supply of some products is special. There are three such cases: i Perfect Elasticity; some goods can only be supplied at one price. If the price changes slightly, supplied completely diminishes. Since their elasticity is infinite, the graph is horizontal.ii Perfect Inelasticity; the supply of some goods is absolutely immune to change in price, supply always stays constant. Since they have zero elasticity, their graphs are vertical.iii Unitary Elasticity; the supply of some goods responds correspondingly to change in price. That is, percentage of change of price equals percentage of change in quantity supplied. The supply curve passes through the origin, making this a directly proportional line.Ed = ; Supply is perfectly price elastic.Ed = 0; Supply is perfectly price inelastic.Ed = 1; Supply is unitarily price elastic. Several factors affecting price elasticity of supply include:iii Time; the speed with which produces can react to changes in price is crucial to determining the elasticity of good or services supply. If a producer can respond quickly, the supply of the goods in that industry are price elastic. If it takes him a long time to respond, the supply is price inelastic. The following factors can influence speed with which producers react: Stock Levels; if there is stored stocks of goods, producers can respond more effectively to market. However, some goods are perishable or dangerous in storage. Production Sped; if it is easy to control speed of production, it would be easy to respond to the changes in market prices. Spare Capacity; firms often are not using the factors of production available at full potential. If they are, it isnt possible to increase production when prices rise. If there is spare capacity, firms will want to fill potential as soon as they can. Barriers to Entry; the ease for producers to enter into markets that have experienced changes in prices will have a big impact on supply too. For example, if there are barriers to entry, supply would be harder to increase as the industry would keep other firms from joining. iv Producer Substitutes and the Mobility of Production Factors; if producers can locate and allocate factors of production appropriately, for instance to use those resources on different uses depending on the situation; the supply will be more flexible and thereby, more elastic. This factor refers to the elasticity of the factors of production themselves.9. Income Elasticity The income has the largest effect on the quantity of demand after price. Income elasticity of demand is the responsiveness of demand due to a change in income. For some products, demand changes drastically as incomes rise or fall, whereas some products demand shifts slightly. The formula to find the income elasticity of the demand of a good or service is:

There are two sets of interpretations available from finding the income elasticity of a products demand:i If the value of the income elasticity of demand is greater than one, the demand is income elastic. That is, if incomes rise, the demand of these goods or services will rise in greater proportion. Conversely, if the value of the income elasticity of demand is less than one, the demand of that good or service is income inelastic. That is, if incomes change, demand changes in a smaller proportion.IED > 1; Demand is income elastic.IED < 1; Demand is income inelastic.ii If the value of income elasticity is positive, the product is said to be a normal good. For all normal goods, as income rises, so does the demand for it. On the other hand, if the income elasticity is negative, the good is an inferior good. With inferior goods, demand falls as income rises.IED > 0; Normal good.IED < 0; Inferior good. The factor that determines whether goods or services are income inelastic or elastic is whether those goods are necessities or luxuries, respectively. i Necessities; include basic goods that are essential. With a decrease in income, demand falls slightly, since people still need those goods. Also in this category are habitable or addictive goods, such as drugs.ii Luxuries; are goods that are not needed for survival, they are bought only if affordable. With an increase in income, demand significantly increases. Spending on these goods is discretionary, meaning it doesnt need to be undertaken. Studies show that imports are also, similar to luxuries, income elastic.10. Applications of Elasticity Information about elasticity is often used by firms and government in various applications:i Firms use info on price elasticity to control and optimize total revenue. For a good whose demand is price inelastic, a rise in price means a rise in total revenue; likewise, a drop in price would mean a drop in total revenue. On the other hand, goods with a demand that is price elastic work different. A rise in price would decrease total revenue; and a drop in price would increase total revenue. This information will supply firm with the knowledge of what a price change will financially mean for the business. Furthermore, it is important to understand that raising the prices on goods with unitary elasticity will lower the quantity demanded by an equally proportionate amount. Therefore, total revenue will always remain constant on such goods no matter how much the price has changed.ii Firms are also interested in the income elasticity of the demand of a product for several reasons. This is because they will be able to respond effectively to predicted changes in income: Production Planning; based on the expected trend of incomes, production can be planned effectively on goods whose demand is income elastic. If incomes are going to rise, stocks can be placed appropriately to be used in production. On the other hand, if incomes are to fall, firms may plan to cut output in order to not flood the market due to falling demand and lose total revenue. However, firms producing inferior goods or services may plan to increase output and productivity if a recession thereby meaning a fall in income is expected. Production Switching; firms obtain resources that are used in multiple ways. Therefore, those factors of production can be adapted to produce goods whose demand factor will work profitably when incomes change. Goods with demand that is income elastic will have increased production if incomes were to rise as total revenue would soar.iii Governments use information on price elasticity of demand for tax purposes. Although extreme necessities such as water and food are avoided, taxes like VAT are placed on products whose demand is price inelastic, since the price added will not affect quantity demanded significantly. This will ensure that the tax will be paid and the items demand wont be significantly affected.II) The Role of the Market in Solving the Economic Problem11. Resolving Scarcity The four factors of production land, labor, capital, and enterprise exist in limited quantities; that is, they are finite resources. This is known as scarcity. In addition to scarcity is the issue of incapability as many developing countries are not able to exploit their own natural resources. Humans have both of the following:i Needs; physical needs such as food, water, or shelter; and psychological or emotional needs such as love and security are essential for survival.ii Wants; further desires which expand as the human imagination does. They can include cars, vacations, computers, jewelry, etc. Wants are infinite, and often need to be replaced frequently. All nations and economies face the basic economic problem. That is, human wants are infinite and ever-expanding, whereas the resources available are scarce and finite. Infinite Wants > Scarce ResourcesDemand > Supply Decisions have to be made to overcome the economic problem and allocate a nations scarce resources between different uses. This is the purpose of economics and economic thought. These decisions include:i What to produce? Which goods and services should the country allocate its scarce resources to?ii How to produce? How to organize the factors of production effectively and efficiently?iii For whom to produce? How to distribute and share produce between members of population? The search for an effective solution has given birth to several different economic systems and ideologies. Because of scarcity, choices have to be made since resources can be used to serve several different purposes and thereby fulfill different wants. These choices are made by individuals, firms, and governments. They have to choose how and where to spend their limited budgets. Due to sacrifices that are made, an opportunity cost arises. This is the benefit of the next best alternative. It is regarded as a cost because it was not pursued; its benefits are not attainable. Production possibility curves (PPC) are curves drawn on a Consumer Goods vs. Capital Goods graph. A measurement of a nations production capacity is taken and plotted on the graph. The PPC shows how consumer and capital production relate to each other and what the different combinations of amounts at which each good can be produced by an economy if all the nations resources are employed are. It shows the opportunity cost of raising the production of either capital or consumer goods. Economies are expected to push production up to aim at the PPC line. As an economy moves along the PPC, an opportunity cost has risen. For instance, if an economy was previously producing 36m units of consumer goods and 9m units of capital goods, a shift to producing 20m consumer goods and 15m capital goods would present the opportunity cost of 16m consumer goods. Therefore, choosing between combinations is important. Higher focus on consumer goods ensures greater prosperity for now, whereas capital goods are investments into the future while they lower quantity of consumer goods supplied. Over time, the PPC shifts outwards. This is called economic growth and refers to the increases in production capacities. This may be due to increasing population, discovery of natural resources, or improved capital goods. As economies are always attempting to push production up to the PPC, production will increase.12. The Mixed Economy Economy is a system of producing, distributing, and consuming while applying the principal in the economic problem. The word economy is usually used in the national context. In any economy, goods and services are produced by two distinct sectors. The power of each sector varies with economic systems and ideologies:i Private Sector; consists of individual or groups of individual who set up businesses with which the supply good and service to anyone willing to buy.ii Public Sector; consists of state-managed organizations that conduct economic activities. Different economies have different approaches on providing goods and services. The type of economy used to choose, produce, and distribute goods and services varies according to the role the public sector is given. There are three main types of economies are:i Market Economy or Free Enterprise Economy; relies least on the public sector for economic activities. The private sector chooses, produces, and distributes goods and services, and allocates resources, based on the market forces of supply and demand. The economic activities of the public sector are minimalized to management of departments and state services like defense in market economies. Additionally, the state ensures healthy competition between businesses.ii Command Economy or Planned Economy; relies entirely on public sector for economic activity. The state chooses, produces, and distributes all goods and services. Consumers buy them from state outlets at fixed prices. Market forces are ineffective in planned economies.iii Mixed Economy; utilizes both sectors and delegates powers and responsibilities. The degree of mixing is different depending on nation. In reality, all economies are mixed economies. The three choices that need to jointly decided upon by the public and the private sector are:i What to produce? Consumer goods and services are often delegated to the private sector in mixed economies because the consumer gets a greater say in in private sectors activities. Additionally, the market forces will allocate all resources available for private sector use. Economic activities such as street lighting, education, or healthcare that the private sector neglects are taken up by the public sector.ii How to produce? Due to the economic factors of profit and competition, the private sector will use any production method that maximizes quality and minimizes costs. Public sector services will be provided in several different ways by different state organizations. Occasionally, the state employs the private sector to carry out its services.iii For whom to produce? The goods or services produced by the private sector are for anybody who can afford them. The public sector is responsible for providing free services and social and financial benefits paid by taxes. Due to scarcity, resources should be utilized as efficiently as possible to get optimal results from factors of production:i Produce at lowest costs possible.ii Minimizing resources required for production.iii Only produce those goods and services that people want. Due to lack of competition in the public sector, efficiency is often lacking in state-run services. Conversely, healthy competition in private sector encourages efficiency as only the most effective producers survive. However, due to market failure, resources are sometimes wasted. This is why the public sector is often used. Market failure is when markets are leading to inefficiency, which can happen for a number of reasons:i Externalities; these are costs of production that a firm may impose onto a surrounding community. These are known as negative externalities. For instance, a factory may release a poisonous gas during production, for which the community will have to pay.ii Lack of Competition; dominating firms and monopolies may charge higher prices and abuse their customer base for self-gains. This, along with lack of competition itself, will cause inefficiency.iii Missing Markets; consists of public goods, which are goods the private sector is unlikely to provide, and merit goods, which the private sector will under-provide. The public sector provides them for free instead.iv Lack of Information; if consumers do not know the nature, quality, and prices of goods and services, they may be over-priced. Efficiency requires a free flow of communication between buyers and sellers.v Factor Immobility; efficiency requires mobility of the factors of production from one market to the other. However, this is usually difficult due to specialized technology being made for any specific purposes. Additionally, the constantly vibrant nature of the market heightens this factor. III) The Labor Market: An Example of a Market in a Mixed Economy13. The Division of Labor The people available to work in a nation represent the working population. There is an overwhelming abundance of labor as all nations, including the G8, have unemployment of the labor factor to a degree. However, that also may be due to inability of the labor to work, for one reason or another. Several notes about characteristics of labor as a resource:i In contrary to machines, people can be inconsistent and reactive. They are difficult to manage.ii Globally, the supply of labor is increasing, even though not all current units are employed.iii They are an expensive resource. They require breaks, vacations, and can only work certain hours. Specialization, the production of a limited range of goods by individuals, firms, regions, or nations, is important in todays business activities. Different firms specialize in the production of different goods and services; for example, McDonalds produces fast food goods. Different nations specialize in the making of different goods; for instance, China makes manufactured goods. Furthermore, in businesses, the production process is broken down into small parts and each is allocated a specific task. This type of specialization known as division of labor. Workers are employed based on their potential in a certain field. For example, in a school, teachers are responsible for the teaching the students, whereas the director is responsible for managing staff. This practice of division of labor has advantages and disadvantages for the worker:i Advantages; Each member of the production process is focused on one aspect of the production process. Constant repetition makes that worker an expert in that field. Practicing and expertise opens opportunities for them. Additionally, satisfaction is high if worker focuses on one task.ii Disadvantages; Repetition and monotony can make it boring for worker. This boredom may affect motivation. In addition, specialized workers risk unemployment if their fields demand decreases, or other similar factors. There are several advantages and disadvantages of division of labor for the firm:i Advantages; Efficiency improves greatly because workers get better at their specialized field. Therefore, productivity will rise as production will be quicker and of higher quality overall. A greater use of specialist machinery or equipment is possible with specialization. Production time is also decreased as each person does their task and moves on the production to the next in line; time is not wasted preparing and moving around the workplace for the next task. Additionally, production is more organized as all workers do not cross out of their place in line.ii Disadvantages; The repetitive nature of specialization may bore a worker and thereby decrease motivation; this may affect productivity and quality of work, both of which impact profitability. Also, this could result in high labor turnover. There is interdependence, which means that although each worker may excel in their field, the production process will halt if one part failed. A skilled workers absence will disrupt production.14. The Labor Market The labor market is like any other market, it has buyers firms and sellers the working population willing to exchange a service for money. However, when observing the demand curve for labor, the price factor institutionalized for other goods is replaced by wage rate, which refers to the payment need to be made to labor for their services over a period of time. The demand curve for labor, as other demand curves, slopes from up to down. Wage rate and quantity of demand for labor are inversely related, which means that as one increases, the other decreases. For instance, the 500 units of labor could be demanded for a wage rate of $600, but only 200 units of labor would be demanded for $1000. There are several reasons for this, including higher wages mean higher production costs for the firm. In this case, production would have cut, reducing amount of workers needed. The following are factors that affect the demand of labor: i Type of Production; since demand of labor is a derived demand, which means labors demand is derived from the demand of the goods it can produce, the goods and services to be produced themselves play a role.ii Substitutes; costs and availability of substitutes for labor can affect demand of labor. A prominent example is machinery, its efficiency and lower cost is causing the demand of labor to decrease.iii Productivity; of labor can increase demand itself. If labor is being productive, profitability is high and therefore, demand is going to increase.iv Additional costs; demand for labor is also affected by all the costs of the other responsibilities that have to be attended to when employing a worker. Pensions and training are examples.Changes in these factors can cause a shift in the demand curve. For instance, cheaper machinery will replace labor due to costs of production. Therefore, the demand curve will shift to the left, meaning at all wage rates, quantity of labor demanded will decrease. The supply curve of labor, as other supply curve, slopes upwards. This is because wage rates and quantity of supply of labor are proportionately relative, meaning that the rise of one will cause a rise in the other. For instance, 500 units of labor could be supplied at a wage rate of $500, but at wage rate of $1000, 2000 units of labor are supplied. The main reason for this is that higher wages give the working popular a higher incentive to work. The following factors, all of which are determinants of the working population, can affect supply of labor:i Age Levels; since labor has boundary age levels, changes in those age limits would make people part of the working population or otherwise, take them out.ii Empowerment of Women; is increasing the supply of labor.iii Age Distribution of Population; can have an effect if the dependency ratio is changing, which refers to the changes of the proportion of those who dont work on those who do work. Aging populations, for instance, are placing greater burdens on society.iv Immigrant Workers; changes in the amount of foreign workers can swell up or deflate the working population.Changes in these factors cause shifts in the supply curve for labor. For instance, greater empowerment of women by matching their worker expectancies to the same level as men is raising the working population. This will move the supply curve to the right; meaning that for all wage rates, more quantity will be supplied. The equilibrium wage rate is found in the same way as the equilibrium price of a good, by graphing the supply and demand curves of it and then observing the point at which they interact. This is where supply and demand is equal to each other. Shifts in either curve can cause a change in the equilibrium wage rate. For instance, the rise of demand for labor will result in a higher equilibrium wage rate. Different occupations have different wage rates. There are several reasons for this:i The supply of labor varies from occupation to occupation due to factors such as requirements, qualifications, level of hazard, unpleasant conditions, training, etc. Lower supply would mean a higher equilibrium wage rate, whereas a high supply would mean a lower one. ii In expanding industries, demand for labor tends to rise, which would mean a higher equilibrium wage rate. Declining industries work in the other way.iii Benefits and perks are sometimes considered to compensate for lower wage rates. An example is with the low wage rates that are usually associated with public sector jobs due to this.iv Workers in trade unions may get higher wages than those who arent in one. The quality of labor also matters when employers are recruiting workers. Usually, workers who have minimum education, are literate, are numerate, and have good communication skills are preferred because educated and trained workers will be more productive generally. Additionally, appropriate specialist skills are desired by firms.15. Interference in the Labor Market One way in which the government interferes in the Labor Market and disrupts market forces is by setting a minimum wage, which is a minimum amount that needs to be paid to workers in a time period, usually per hour. There are several reasons why legislation for minimum wage is passed:i Benefit disadvantaged workers; groups such as ethnic minorities, low income families, and women benefit from minimum wages.ii Reduce poverty; minimum wages moves individuals and families out of poverty.iii Help businesses; with greater equality and fairness among workers will motivate them and raise productivity and reduce absenteeism and staff turnover. If the government imposes a minimum wage that is above the equilibrium wage rate, then the demand will fall short of the supply, resulting in a flooded market. That is, unemployment will ensue as supply of quantity of labor will not be employed. However, evidence shows that, in the UK, the minimum wage act hasnt caused swelling of unemployment. Furthermore, employment in low-pay jobs has increased. Trade unions are organizations that often interfere with forces of the labor market. They exist to protect worker interests. Although specialized ones exist for different occupations, the principal aims of all are:i Negotiate pay and working conditions with employer.ii Provide legal protection for members.iii Act as pressure groups that encourage government to pass legislation in favor of workers.iv Provide financial benefits whenever necessary. Due to growing power of trade unions on the economy, legislation has been passed in UK to weaken them:i Closed shops are illegal. ii Require trade unions to have ballots before a strike, and only have a strike if all members support.iii Secondary picketing is illegal.iv Businesses can sue for compensation if trade unions break law.This has weakened their position and popularity. As a result, membership has decreased. Powerful trade unions can force wages up in an economy by influencing the supply curve. The supply will become less; that is, less quantity of labor will be supplied at every wage rate. Although this will raise wages, the new demand will be lower, which means units of labor will have to be unemployed as they are no longer necessary in the economy. However, this can be combatted:i If labor productivity rises at the same time.ii If the employer can pass increased productions costs onto customers.iii If profit margins are decreased.

Sec B: Business EconomicsI) Production16. Factors of Production and Productivity Production is a process which involves transforming resources into goods or services. There are four different types of resources, known as the factors of production: i Land: This includes both the plot of land required to set up any premises which can facilitate operations, and all natural resources, renewable or non-renewable.ii Labor: This includes the workforce of the economy. Manual or skilled workers and managers are members of a nations workforce. The value of the collective workforce or each workers individual capability in known as human capital, which varies with education and training.iii Capital: This is a man-made resource. It is often divided in two groups: working, or circulating, capital, and fixed capital. The former refers to both the stocks of raw materials or components that will be used up in production, and stocks of finished goods. The latter refers to factories, offices, shops, machines, or any other equipment that aids production.iv Enterprise: This includes the role that entrepreneurs play in an economy. They produce business ideas, own the business, take risks in order to benefit the business, and manage and organize the other factors. The more effective all this can be carried out, the greater the factor of enterprise.To increase production of goods or services, an increase in the factors of production is required. Production is often said to be labor intensive, if it relies relatively heavier on the labor factor than capital, or capital intensive, if more capital is used in relation to labor. This difference can depend on the availability of and the ease of managing either factor. Production also increases by changing productivity, which is the amount of output which can be produced given an amount of resources. It can be measured as output per unit of input. Increasing productivity is desirable as profit will increase and costs will decrease overall. Productivity is influenced by changing working methods, motivating workers, using efficient machinery, and retaining workers to boost skill.17. Sectors of the Economy There are three sectors in the economy:i Primary Sector is the sector of the economy which involves extracting raw materials from the earth. It includes farming, fishing, forestry, and agriculture, for instance.ii Secondary Sector is the sector where all the raw materials from the primary sector are processed into finished or semi-finished goods occurs. Breweries and food processing are examples of secondary sector activities.iii Tertiary Sector is the sector that produces and provides services in an economy. Financial services or professional services are both examples of tertiary sector activities. Different types of nations have different structures in their economies:i Developed countries are going through a phase of de-industrialization. As the industrial revolution shifted the focus of resources onto the secondary sector, employment of resources in that sector is now decreasing. Manufactured goods are instead being imported from developing countries like Brazil, India, and China. Additionally, since demand for manufactured goods is diverting to services instead, the resources are also appropriately shifting. The tertiary sector, conversely, is on the rise and many resources are being pumped into this sector. This may be due to the idea that as nations and populations grow and develop, public services also increase. The primary sector is already significantly lesser in importance in relation to the other two. The reason that these economic activities utilize a tiny percentage of all resources is due to technological advancements that have replaced the need for labor.ii Most developing nations are increasing their secondary sector activities, as was the trend in 19th century Britain. However, many developing nations still allocate a great majority of their resources to the primary sector. Tertiary sector activities are low, if any at all, in these nations.However, this is a general pattern. Many nations, due to various reasons, alternate from this model.18. Production Costs and Revenue Average cost is the cost of producing a single unit of output, on average. Divide total cost by quantity produced.

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

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

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

The productivity of labor can also be increased by improving the quality of human capital. Several ways include:i Education and Training; A higher investment in schools and quality of teaching and education can provide a great return investment. Additionally, training provided in firms can increase productivity of workers.ii Improving Motivation; Workers with high levels of motivation are more productive. Several schemes can drive workers including financial incentives, job rotation, team working, and empowerment. Improving and adapting working conditions for workers will increase productivity. Examples include:i Changing Factory Layout; This can make the factory more easy to use and production smoother.ii Increasing Labor Flexibility; Workers with the capability to switch jobs at short notice can further ease production.iii Applying Lean Production; This involves reducing the waste that is produced in the production process. Improvements in terms of capital and technology can also increase productivity. It has affected the three sectors:i Primary Sector; All over the primary sector of the economy, technological advances have increased output, improved working conditions, and more efficiency. Labor, as a result, has been practically replaced by machines.ii Secondary Sector; Technology, such as computers and computable machines, have taken over large proportion of all manufacturing and production. iii Tertiary Sector; Although this sector of the economy enjoys being labor-intensive, internet banking and shopping has eased the production process. Additionally, healthcare has become very dependent on machines for medical date collecting, carrying out research and development, and performing operations.21. Externalities: Costs and Benefits Externalities are the spillover effects of consumption and production that may impact anyone but the ones responsible for the economic activity. They can be either positive or negative. Positive externalities are known as external benefits and they include job creation, site development, training and education, research and development, and new technology. Negative externalities are known as external costs and include traffic congestion, overcrowding, resource depletion, and noise, air, or water pollution. Producing or consuming products results in imposing private costs and external costs. Combined, they sum up to make the social costs. Such economic activity also provides private benefits and external benefits. Combined, these two factors make social benefits. Governments encourage positive externalities and discourage negative externalities in several ways:i Taxation; Taxes are often used to discourage economic activity that has many negative externalities.ii Subsidies; These can be used to encourage positive externalities and to reduce economic activities that impose negative externalities on the surrounding community. iii Fines; These are enforced on activities that cause negative externalities.iv Government Regulation; Legislation is passed that regulates the economic activities firms partake in.v Other Measures; A range of measures are taken. For instance, intl pacts have formed, such as the Kyoto Protocol.II) Competition22. Competitive Markets Competition is the rivalry that exists between firms when they sell goods or services to the same market. The following are common features for competitive markets:i Large number of buyers and sellers.ii The products sold by each firm are close substitutes of one another.iii Few barriers of entry. That is, there are only a few obstacles that might discourage a firm from entering a market.iv No firm can individually affect the price of the goods or services. v There is a free flow of information about the availability, prices, and methods of production of the goods or services; and the cost and availability of production factors. In a competitive environment, firms need to do several things in order to survive:i Operate efficiently by keeping costs as low as possible.ii Providing good quality products with high levels of customer service.iii Charging prices which are acceptable to customers.iv Innovating by constantly renewing products.As a result of competition, firms of an industry will have lower profits as the competition will drive prices down. Due to that consequence, firms do not usually welcome competition, preferring to dominate the market instead. Innovation, the commercial exploitation of a product based on a distinguishable idea, involves a practice known as product differentiation. This practice encourages customers to associate superiority with that product. This choice and variety can lead certain innovative firms to a higher degree of success than others. There are, however, several advantages of competition for the consumer:i Lower Prices; Due to substitutes, all firms will have to bring the prices down to be appealing to customers. ii More Choice; Competition means that there are many suppliers to choose products from. Constant innovation and differentiation between products emphasizes this idea.iii Better Quality; Firms will be pressurized to address the quality and benefit of the products as a competitive market will empower consumers to be well-informed about the quality of production of all firms. Additionally, there are some disadvantages of competition for the consumer:i Market Uncertainty; Due to the high risk of small and unsuccessful businesses failing in competitive markets, consumers will not find it convenient to have their preferable provider or supplier leaving the market. ii Lack of Innovation; Due to the less profit that firms make in competitive markets, innovation and progressive ideas may be discouraged. Competition also impacts the economy by several factors including:i As an advantage, resources will be allocated more effectively. Fewer resources are wasted. However, competitive markets can also said to be wasting resources as a failed firm may produce resources that are immobile; that is, they are unable to be used for another function.ii Innovation is also beneficial to the economy if effectively utilized by the firms of an industry. As a result of this, people will have a better standard of living and the PPC will move to the right.23. Advantages and Disadvantages of Large and Small Firms Several different methods can be used to measure the size of a firm, including: (All are general concepts)i Turnover; Firms with large amounts of turnover will be larger than firms with small turnover.ii Number of Employees; The more workforce employed, the larger the firm is.iii Amount of Capital Employed; The more money invested in the business, the greater it is. Self-employment is increasingly giving birth to a blossoming generation of small firms, of which there are many. The pros and cons are outlined ahead:Advantages:i Flexibility; As management is actively involved in the business, its quicker to react and adapt to change.ii Personal Service; As the directing bodies are more easily accessible, a more customized service can be offered.iii Lower Wages; Workers of small firms arent involved in unions, which keeps pay less costly and more stable.iv Better Communication; There is less diplomacy and a more trust-filled environment. This encourages motivation.v Innovation; Due to intense competition, there is a greater pressure to innovate. Additionally, small firms are more ready to take a risk in the pursuit of innovation, as they have less to lose than larger firms.Disadvantages:i Higher Costs; Economies of scale cant be exploited, which means average costs will be high.ii Lack of Finance; As they are risky, and due to other factors, they do not have many sources of finance.iii Difficult Attracting Right Staff; Small firms may not be able to advertise vacancies on a large scale or afford highly skilled staff.iv Vulnerability; If the economic circumstances and trading conditions take a turn for the worst, they will be more vulnerable to falling or being taken over than established large firms. Large firms, on the other hand, are sparse, but contribute greatly to the economy. Following are the pros and cons:Advantages:i Economies of Scale; These can be exploited, resulting in much lower average costs.ii Market Denomination; A greater influence on the economic forces and a greater public appeal in the market.iii Large-Scale Contracts; Lucrative contracts can be won, as large firms have enough resources at their disposal.Disadvantagesi Bureaucracy; Decision-making processes are slow and communication channels are often inefficient. Additionally, a large amount of resources are used in administration. This can lead to inefficiency.ii Co-ordination and Control; With a very large amount of resources to manage, supervision take up a lot as costs.iii Poor Motivation; People become alienated and disempowered. This leads to lack of motivation.24. The Growth of Firms Firms grow because of the advantages offered due to expansion. Here are several of those advantages:i Survival; Often, firms that wish to survive need to grow to be able to bear the competition from larger competitors. Also, growth will lower the risk of being taken over from larger firms.ii Economies of Scale; Efficiency and profitability increases as average costs will fall.iii Increase Profits; By having greater production and selling more products, there are higher profits.iv Increase Market Share; As a large firm, a firm will be able to dominate the market and utilize its position.v Reduced Risk; Diversifying into new markets with new products will establish strong roots for a firm. Organic growth refers to internal growth achieved by expanding current business activities in existing or new markets. On the other hands, businesses also expand much faster by joining forces with other businesses. This can be done by takeovers (or acquisitions), which involve the purchase of a business by a larger firm; or by mergers, which is the joining of two businesses, usually to establish a new one. There are several types of integration, as following:i Horizontal Integration; This is when two firms of the same industry and at the same stage of production integrate. As both deal with the same markets also, there is less of a disruption, and thereby, a greater chance of success.ii Vertical Integration; This involves two firms of the same industry, but at different stages in production, joining into one. There are two types of this integration; forward vertical and backward vertical integration, the former referring to joining with a business at a more consumer-based stage, while the latter refers to joining with a business at a more supplier-based stage. Both offer a greater control over the market without much disruption.iii Lateral Integration; The joining of firms at the same stage of production that produce similar goods or services but are not in the same market. However, production techniques and distribution channels may be similar.iv Conglomerate or Diversifying Mergers; This is the integration of firms across different industries, different stages of production, and different markets. Although this will reduce risk as it establishes a larger firm, it will cause disruption due to lack of knowledge and ability to deal with a different type of production. There are several obstacles that prevent a firm from growing. Major ones are outlined following:i Limited Market; If the market of some products is small, then a large firm wont be needed until the market grows.ii Lack of Finance; Growing requires great investment, but sources are few for small firms due to risk involved.iii Aims of the Entrepreneur; Often, the owners are content with the current size and do not wish to expand.iv Low Barriers to Entry; With few barriers to entry, fierce competition prevents any individual firm from expanding.v Diseconomies of Scale; Once the MES has been attained, a firm will not expand, to avoid higher average costs.25. Monopoly Monopoly is a situation when there is one dominant seller in a market, in which it alone drives all market forces at will. A pure monopoly exists when a market is supplied entirely by one firm, not just dominated. Legal limits are set as to how much of a market has to be dominated in order for a firm to be monopolist. In UK, for instance, it is at least 25%. Monopolies may be local, regional, national, or global depending on the range of the market. There are several common features in monopolized markets:i Barriers to Entry; Monopolies often exist because any competition is discouraged, often by the monopoly itself. These are known as barriers to entry. Cost barriers often stop businesses as some markets require massive amounts of financial commitment, which cant be met by most firms. Secondly, firms can use legal means to keep other firms from entering into the market, such as patented licenses which grant permission to operate as sole supplier of a product. Third, if a large business already dominates a market, it can exploit economies of scale to keep costs much lower than any new competitor, thereby disallowing any firm to enter. Lastly, marketing barriers involve the effect that established and trusted brands have as being unable to be easily replaced by newcomers. Additionally, lowering the pricing at extraordinarily low rates, often utilized by such monopolies, is used if the threat of a newcomer exists. This is known as predatory pricing.ii Unique Product; If a product is significantly distinctive, it is a pure monopoly as there is no alternative choice.iii Control Over Market Forces; Monopolies, often known as price makers, usually control factors such as quantity supplied, and thereby price charged. There are several advantages of monopolies:i More Research and Development; Since monopolies are larger and can exploit several factors to increase profitability, they have more resources to invest in research and development. As a result, consumers may benefit.ii Economies of Scale; Since average costs are lower, monopolies can afford to supply goods at lower prices.iii Natural Monopolies; In some markets, it is a more efficient allocation of resources if only one firm supplies all consumers. A natural monopoly is a situation that occurs when one firm in an industry can serve the entire market at a lower cost than would be possible if the industry were composed of many smaller firms.iv International Competitiveness; If a firm is a monopoly in the domestic market, it can effectively deal with multinational competition. This can improve the domestic economy by raising national income and employment. The key disadvantages of monopolies are:i Higher Prices; Monopolists will tend to control output to force up the price. As it is a monopoly, it is able to.ii Restricted Choice; There is little, or in the case of pure monopoly none, choice over the supplier that consumers may choose. This means that if consumers are unhappy with quality or other factors, they cant switch providers.iii Lack of Innovation; Since no competition exists, there is little incentive for monopolists to improve or develop their products. Additionally, consumers are forced to buy from those firms.iv Inefficiency; Since there is no competition, economic activity may become sloppy in terms of wasting unnecessary costs or giving little attention to customer and labor relations. Additionally, they may incur diseconomies of scale.26. Oligopoly A market that is dominated by several, in relative terms, very large firms is known as an oligopoly. Usually, many small firms also exist in oligopolies as they serve market niches segments of the market that are not served by oligopolists. Oligopolies often slightly differ in different circumstances. However, several key features are common:i Interdependence; There are interconnected links between firms in oligopolies. Economic activities of one firm can affect the partner oligopolists.ii Barriers to Entry; Firms in an oligopoly often benefit from the barriers to entering that market. This may be due to factors such as high initial investment required to set up the business, or the marketing roots large and established firms will have in that market; thereby discouraging any other firms to join that particular economic activity.iii Price Rigidity; Prices remain constant for long periods of time because of the reluctance of oligopolists to lower prices causing a price war to follow, which would lower revenue for all. This would involve the initial change in price by a firm, which will result in a chain reaction of price changes among all firms, as the lowest sells the most. iv Non-Price Competition; Firms also cause brand wars. In these corporate battles, revenue is not lost by all the firms, so engaging in this marketing activity is preferable. It involves creating brand loyalty, price differentiation, or any other relevant marketing act that discourages consumers from trading with other firms.v Economies of Sale; Large firms in an oligopoly exploit economies of scale as they participate in large-scale production. Smaller firms tend to avoid direct competition with large firms due to this disadvantage.vi Collusion; This involves informal agreements between firms to restrict competition. It can be done so by sharing a market geographically, hiking up prices to a fixed rate, or to restrict output, forcing up the price. It is often illegal. Due to some, but limited, competition in oligopolistic markets, consumers benefit. The advantages of oligopolies are:i Economies of Scale; Due to lower costs for the firms, because of exploiting economies of scale, consumers may be charged with lower prices.ii Price Stability; Due to the reluctance of firms to engage in a price war, the prices stay stable in oligopolies. If one does occur however, the consumer benefits as the price lowers.iii Choice; Due to intense competition in oligopolies between large firms, new brands and distinctive products are continuously produced. Due to this choice, consumers benefit. Unless there is competition in the market, consumers are unlikely to benefit from oligopolies. Firms are tempted to form cartels, which partake in acts of collusion, and effectively act like monopolists. They reduce choice and cause prices to rise, both harmful for consumers. Additionally, intense competition results in huge advertising costs, which firms replenish by forcing up the market prices of products.III) Public and Private Sectors27. Public and Private Sectors Firms owned and controlled by individuals or groups of individuals are in the private sector. In the UK economy, most consumer goods are provided by this sector. The types of firms in the private sector include:i Sole Traders; owned and controlled by one individual. For example, plumbers.ii Partnerships; owned and controlled by more than two individuals. For example, lawyers.iii Incorporated Companies; owned by shareholders who elect a board of directors. For example, McDonalds.Most of UKs firms are small, but some are large and contribute greatly to the economy. Some are multinationals. Owners, shareholders that is, decide the business aims in the private sector. Here are some key aims:i Survival; This may apply to a business that is starting off new and wishes to survive. Additionally, it also pertains to larger businesses during intense and volatile economic conditions.ii Profit Maximization; This is an important objective as it reflects the wants the shareholders, high dividends. Those come from profit, which firms want to make the most of in the shortest amount of time.iii Profit Satisficing; This refers to aiming to making enough profit to satisfy owners. Generally, higher profits are not aimed for due to lack of interest in growth.iv Growth; Potential benefit for firms as they will be able to enjoy economies of scale and thereby, higher profits.v Sales Revenue Maximization; Increasing sales revenue to the highest possible in the shortest amount of time.vi Social Responsibility; To become responsible corporate citizens and thereby please a wider range of stakeholders. Organizations owned and controlled by the local or central government form the public sector. Main firms of the UK in this sector include:i Central Government Departments; This involves organizations such as the Ministry of Defense, Department of Transport, or Department of Health. They are usually controlled by boards led by a government minister.ii Local Authority Services; Includes recreation such as sports halls, protection such as police and fire services, and housing which provides council housing for homeless. Run by councilors elected by local community.iii Executive Agencies; Provide services and are accountable to a government department. Usually run by boards. The Office of National Statistics is an example, which gathers economic and other data.iv Other Public Sector Organizations; Run by a trust or board led by an experienced expert appointed by a government body. Examples include the BBC Trust or the Post Office.Mostly, funding comes from tax revenue. However, the government may also charge prices on some occasions. Generally, organizations in the public sector do not aim to maximize profit or other likewise ideals as many of those organization provides free services. Although aims are different, common themes prevail in all public sector aims:i Improving the Quality of Services; Generally aim for progress in terms of the quality of the provided services.ii Minimizing Costs; Costs in all areas should be cut in order to improve efficiency.iii Allow for Social Costs and Benefits; Since aim is not to make profit, impacts of their economic activity on stakeholders, externalities, are always an important factor in the firms functionality. 28. Government Regulation Government regulation is to monitor the activities of monopolistic and oligopolistic markets to avoid illegal practices:i Increasing Prices; to levels above what they should be in a competitive market. ii Restricting Consumer Choice; by refusing to supply products unless certain conditions are met.iii Raise Barriers to Entry; Several mechanisms, like marketing campaigns, utilized to keep new firms from entering.iv Market Sharing; Forming cartels by collusion, who collectively exploit consumers. The government of the UK functions in the economy by promoting competition and preventing anti-competitive practices by the following:i Encourage the Growth of Small Firms; Several mechanisms, including lower taxes and business start-up schemes, are available for small firms to encourage growth of small firms. ii Lower Barriers to Entry; Legal barriers are being lowered or removed so that new firms may join markets.iii Introduce Anti-Competitive Legislation; Several instances of legislation exist to protect consumers from exploitation by monopolies, mergers, or restrictive practices: The Office of Fair Trading was set up to protect consumer interests and ensure fair corporate competition in the UK. The key functions of the OFT are competition enforcement, promotes competition and informs firms with legislation; consumer regulation enforcement, protects consumers by encouraging codes of practice and take action against unfair traders; and investigates and recommends, investigating markets, publishing reports, and recommends appropriate action. The Competition Commission (CC) functions by investigating mergers or other markets where consumers risk being exploited. If competition is visibly being restricted, the CC can either stop economic activity by the perpetuators in the corrupted market or enforce the conditions the market must meet. Regulatory bodies are specialized bodies that exist to follow up on the status of competition and prices in markets that were previously under the public sector but were privatized. Examples include Ofwat (Office of Water Services) and Ofgem (Office of Gas and Electricity Markets). Governments also attempt to influence the location of operation of businesses by introducing regional policy which functions as a mechanism to attract firms and associated economic activity to areas suffering from economic issues:i Reducing unemployment by offering incentives such as rent-free space or tax breaks, to encourage firms to locate in areas of high unemployment in order to generate economic activity.ii Reducing congestion by offering firms incentives to relocate away from areas that are over-bursting with economic activity. Such a situation can be observed with high traffic congestions and housing shortages.iii Reducing income inequality across different regions by encouraging firms to invest in areas with lesser development in order to uniform economic prosperity across entire nations.Assisted areas are areas of economic potential, which involves strong skilled and flexible labor. They are helped by regional development agencies, which are government-funded bodies that promote economic development. The European Unions Structural and Cohesion Funds support social and economic structuring across the EU. They are divided into three separate types:i European Regional Development Fund (ERDF) aims to improving human capital and developing human resources. For example, investing in training for skilled workers.ii European Social Fund (ESF) provides money in disadvantaged regions to encourage infrastructure development.iii Cohesion Fund, which provides money to strengthen economic and social cohesion across the EU.29. Privatization Privatization is the transfer of public sector resources to the private sector. This can be carried out in several ways:i Sale of nationalized industries; This involves the process of selling shares of nationalized industries, which were themselves industries brought into the public sector from the private sector, to individuals in the private sector.ii Deregulation; This involves lifting legal restrictions that prevent private sector competition in an industry.iii Contracting out; This involves government or local authority services contracting out to the private sector to supply services that were previously supplied by the private sector. There are several reasons why privatization takes place in the UK:i To generate income; The sale of state assets generates income for the government. ii Inefficiency in nationalized industries; Lack of competition and incentive to make profit decreases efficiency. Due to economic accountability firms have to their employees, theres higher quality productivity in the private sector.iii As a result of degeneration; When legal barriers of entry are eliminated, firms from the private sector rush in.iv To reduce political interference; Firms and their economic activities would not be subject to political agendas. Privatization has impacts on several different aspects of a nations economic system:i Firms; Without government interference and lack of competition, firms change rapidly. The objective of the business moves away from supplying the public a service to making a profit. However, competition lowers the profits reaped. Investments for industries also rise usually following privatization. Additionally, mergers, takeovers, and conglomerates emerge due to the liberty of a firm in the private sector.ii Consumers; Due to the competition usually prevalent in the private sector, consumers have benefited from lower prices and better quality. However, if the market fails in a certain industry, these benefits do not apply. In fact, monopolies and oligopolies, along with other market conditions, could be harmful for consumers. Additionally, any loss-making economic activity, like servicing less-populated areas, will be avoided, to the detriment of a consumer.iii Workers; Due to the importance of economic output and private sector competition, industries pressurize workers to raise productivity levels. Additionally, to lower costs, privatized industries make a lot of workers redundant. However, if a privatized industry results in high competition, more factors of production could be utilized.iv Government; Governments benefit from privatization as they can raise funds in the issuing and selling of shares, although the marketing for such sales can be costly. Additionally, as the government is no longer responsible for these industries, attention can be effectively diverted to governmental operations. As a cost of privatization, governments will no longer have prominent influence in the economic activities of privatized industries, but this can be dealt with by forming regulatory bodies.v The economy; Due to the empowerment of the invisible hand, guided by market forces, increased competition would lead to lower costs, less waste of resources, and better allocation of resources. However, most public corporations exist in the public sectors as monopolists. The privatization of such industries would result in private sector monopolies, which can have numerous unintended side effects.

Sec C: Government and the EconomyI) Macroeconomic Objectives30. Macroeconomic Objectives The study of economics is branched into two:i Microeconomics; the study of the individual and fundamental components of the economy.ii Macroeconomics; the study of the economy as a whole and its more large-scale functions. Often, the political viability of a government depends on the economic performance during their reign. To measure the economy, several indicators are used to show different aspects of economic performance, each with its own degree of importance. These are known as macroeconomic objectives and governments are interested in them as they are often assumed responsible for fulfilling them:i Economic growth; Governments often emphasize the importance of creating institutions and opportunities to sustain economic growth. An internationally recognized indicator of economic growth is the gross domestic product, which is the total value of the nations economic output over a time period. With a greater and more efficient economy, living conditions improve.ii Inflation; Although this always occurs as a side effect of economic growth, governments aim to keep it marginal and under control. If inflation occurs to an abnormal degree, it can have several consequences for the economy and the nation. If it rises quicker than incomes, the power of purchasing drops. Additionally, rampant inflation can make the economy unstable and confusing as it would distort the value of money. Due to these factors, living conditions can fall, which is why it is of concern to the government.iii Unemployment; This involves the issue of a lack of employment of labor resources. As a result, resources are said to be being wasted. In addition, unemployed members of society will face more hardships than those who do work, creating inequality and instability in society. As wasted resources lower the GDP, governments are interested in controlling unemployment rates and encouraging employment opportunities.iv Current account; Governments find it important to address imports and exports and ensure that the value of exports is higher than the value of imports, as that would achieve at least a balance. This is an important source of activity for the national economy. The current account records the values of goods and services traded and a balance of payments shows the total value of international transactions.v Protecting the environment; People are becoming more aware of the environmental harms from economic activity. As a result, governments aim to act to reduce damage to the environment.31. Economic Growth When economies grow, it is said that national incomes rise. This can refer to several equivalent values: all income generated within or abroad; all output or production; all spending in the economy. The most common measure of national income is gross domestic product (GDP). Growth rates refer to the percentage by which GDP may have grown, whereas the total growth shows the actual value, in monetary terms, by which the GDP grew. Although GDP is a common indicator of economic progress, there are some limitations:i Inflation; GDP fails to account for inflation, and thereby, fluctuation in the value of money. Real GDP is then used as a measurement, which is the difference between the inflation rate and the growth in money GDP.ii Population changes; GDP doesnt take into account whether the growth is sufficient to suit population changes. Therefore, GDP per head/capita is used to show the growth of GDP per person in the population.iii Statistical errors; As millions of documents needed to be collected from all firms from all industries and sectors, mistakes are often made when calculating the GDP.iv The value of home produced goods; When home produced goods and services are lived upon rather than traded, they are not recorded as economic output. As a result, they are not included in the GDP.v The hidden economy; Money generated in informal, black, or hidden markets goes unrecorded, therefore not becoming part of the GDP.vi GDP and living standards; Although GDP is used to indicate status of living standards, it alone cant show the entire picture as several other factors also need to be considered to conclude that life has improved. Although GDP is generally expected to grow, the rate of growth fluctuates. This principal is modeled by what is known as the trade, business, or economic cycle. Following are the phases(in consecutive order):i Boom; This is the peak of the cycle as it is the point where GDP is rapidly growing. With businesses expanding and new firms forming, jobs are created, profits will be rising, wages will be increasing, and demand will be high. However, prices will also rise, as a side effect to increased demand.ii Downturn; The economy grows, but at a slower rate. Firms will decrease expansion, and some firms may leave the market; resulting in rising unemployment. Wage increases slow down, and demand flattens out or begins falling, resulting in lower inflation.iii Recession or depression; The lowest point in the cycle, where the GDP becomes flat. Non-essential produce loses its demand. Often, such periods are associated with hardship as unemployment rockets, bankruptcies become rampant, prices become flat or fall, and business activities lose confidence.iv Recovery; GDP begins to rise again as a result of several factors. Consumers and suppliers regain confidence, unemployment decreases, demand rises, and prices increase. There are several benefits of economic growth to living standards, which is why governments prioritize it:i Increased incomes; Higher GDP means people will have more income, which means that citizens of the economy may purchase goods and services in better quantity and quality.ii More leisure time; With economic growth, efficiency of production rises. This leads to less work demanded from labor resources.iii Greater life expectancy; Due to economic growth, people can afford healthier food and better medical procedures, resulting in longer and more healthy lives. iv Better public services; As both incomes and spending are linked with tax revenues, the tax revenues correspondingly increase when the economy grows. This tax collected can be reinvested to develop public services, thereby improving living standards. Economic growth, however, can also impose problems, as outlined below:i Regional differences; Economic growth will not be shared to all members under the economy in equity. On the contrary, it will be shared according to existing discriminatory procedures, which will breed discontent.ii Environmental damage; The economic growth is often damaging to the environment, many environmentalist groups would argue. This is due to several corporate activities that may impose environmental costs, but are condoned because of the economic growth they may reap.iii Unsustainable growth; When non-renewable resources are exploited, they cannot also be utilized for future generations. Therefore, any growth resulting from the exploitation of those resources is unsustainable.iv Inflation; If economic growth is too rapid in relation to its time period, the economy may overheat, resorting to abnormal inflation.32. Inflation Inflation is a general and persistent rise in prices that occurs naturally in all markets as the economy grows. As prices increase across the board, it is said that the cost of living has increased. Deflation also occurs, if the economy slows down; when the aggregate demand total demand in the economy including consumption, investment, government expenditure, and exports minus imports falls. Governments regulate inflation by monitoring the prices of goods and services that are purchased by families. The measurements are portrayed through the consumer price index (CPI) or the retail price index (RPI). The former is a measure of general price level (excluding housing costs), and is used in Europe; whereas the latter measures the general price level, including house prices and council tax. Different economists have different views on the causes of inflation. However, there are three recognized causes that can be significant reasons for initiating inflation:i Demand-pull inflation; This type of inflation occurs due to rises in demand. If demand increases in a market, the prices correspondingly rise; similarly if aggregate demand increases in a market, all prices generally rise. Such inflation can be caused by: rising consumer spending due to tax cuts or low interest rates; sharp increases in government spending; rising demand for resources by firms; and booming demand for exports.ii Cost-push inflation; This types of inflation occurs when costs rise. If the costs of production rise for a firm, they have to pay for the higher costs by selling products at a greater price in order to keep their marginal profit high. The reasons why this type of inflation might ensue include: rising costs of imported goods; wage increases impose greater costs on firms; and increases in taxation.iii Money supply inflation; Monetarists believe that there is a strong link between growth in the money supply and inflation. Their proposition is that when banks supply money more freely, spending powers cause demand to go up, resulting in this type of inflation.33. Consequences of Inflation Inflation can have undesirable effects on households, firms, and the economy in several ways:i Reduces purchasing power; Inflation will always result in a depreciation of the currency as the currency will only be able to buy a portion of the good or service, as its value has risen. The only exception is if incomes rise as quickly as inflation. Otherwise, general living standards will fall as less goods or services can be purchased.ii Reduces the value of savings; If inflation rises higher than interest rates, savings will depreciate over time.iii Increased business costs; Inflation can impose numerous costs on businesses. To start off with, firms will have to pay more for the resources the factors of production. Although raising prices subsequently is an easy fix, it is not always possible in competitive markets. Furthermore, at time of inflation, workers want higher wages to be able to compensate with the loss of purchasing power; presenting another cost to the firm.iv Balance of payments problems; If inflation rises in a particular region, it would make exports from there expensive. As market forces imply, importers from there would rather look elsewhere for those goods; resulting in a fall of demand for the regions international market. As a result, the current account would fall in deficit, further harming the economy. On the other hand, if imports are cheaper than domestically-produced products, then demand for them would rise, furthering the adverse effect on the current account.v Increases in government spending; A lot of government expenditure also rises with inflation. For example, state benefits are index linked, which means that they rise in correspondence with the increase in RPI. Money has quite a few functions in the economy:i Medium of exchange; Money can be used as a medium in trade to be exchanged for goods or services.ii Store of value; Money can be saved and used at a later date as it will still hold a value, whether big or small.iii Unit of account; Money can be used to place values on different items, thereby allowing comparison.iv Standard for deferred payments; Money can be used as credit or to settle a debt.Inflation can have an impact relating to each of these functions of money. Firstly, in cases of extreme inflat