IGCSE ECONOMICS SUMMARY

(9 - 1) SYLLABUS

2023

By: ZAID SIDDIQUE

+60 17 876 8460
[email protected]
 Author’s Note

In this comprehensive guide, we aim to provide you with valuable knowledge and strategies to navigate
through your complex IGCSE Economics journey. Whether you are a new student, a teacher, or someone
seeking personal growth, this book is designed to equip you with the tools and insights necessary to thrive
in examinations and your journey to dive into the world of economics.

Chapter by chapter, we will delve into key topics and offer concise summary notes to provide you with a
comprehensive understanding of the subject matter. These summaries will serve as a handy reference,
allowing you to quickly grasp the main ideas and concepts discussed in each chapter.

Moreover, we understand the importance of mastering the examination questions, he to assist you in these
essential skills, we will share valuable answering techniques to help you express your thoughts clearly,
concisely, and persuasively. In addition, we will provide you with sample answers that demonstrate best
practices, offering you a model to follow and adapt to various scenarios.

As we recognize the significance of academic success, we have dedicated a section to offer tips specifically
tailored to smashing the economics exam. These practical strategies will guide you in studying effectively,
understanding complex economic principles, and applying them to real-world scenarios, ensuring your
confidence and success in your examinations.

Beyond economics and academics, we acknowledge the importance of personal growth and fulfillment. In
this book, we will provide life advice, drawing on our experiences and the wisdom of renowned thought
leaders. These insights will inspire you to develop a growth mindset, cultivate resilience, and achieve
balance in your personal and professional life.

Finally, we will explore the future progression in transitioning to the next step in life, keeping you informed
about emerging trends, options available, and university journey. Our goal is to equip you with the
knowledge and foresight necessary to adapt and thrive in an ever-evolving world.

We hope that this book will serve as a valuable resource and guide on your journey towards success,
personal growth, and a fulfilling career. Let's embark on this enlightening adventure together and unlock
the potential that lies within you.
UNIT 1: Market System
Chapter 1: Economic problems
Basic Definitions
1) Needs: the basic necessities to live a life. Eg: Food and shelter
2) Wants: the desires of people. Eg: Luxurious vehicles
3) Scarce resources: insufficient resources
4) Capital intensive production: use of machineries to produce goods and services
5) Labor intensive production: use of labors to produce goods and services
6) Opportunity costs: the value of the next best alternative foregone
7) Capital goods: goods consumed by firms to produce other products Eg: machineries or raw materials
8) Consumer goods: goods consumed by consumers
9) Production Possibility curve: it’s a diagram that illustrates the combination of 2 products an economy
can produce over a period of time by using its resources effectively and efficiently
10) Economic growth: an increase in the productive potential of a country over a period of time
11) Recession/negative economic growth: Fall in the productive potential of a country over a period of
time

The economic Problem

The basic economic problem is the difficult in meeting the unlimited needs and wants of people around the
globe with insufficient (scarce) resources. This problem arises 3 main question for all countries:
What to produce? : Countries may have to pick up some of the most important products that are needed by
the people to satisfy their basic necessities. This is because all products cannot be made due to the lack of
resources.
How to produce? : Governments should decide on how to produce the goods and services either by capital or
labor intensive production techniques.

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Opportunity costs
This is the value of the next best alternative foregone. In simple words, when you have 2 choices with similar
benefits and then you chose one of them, the benefit that may be gained by the unselected (or left out)
option becomes the opportunity cost.
Example: Adam has 3 choices to spend his money on. He has ranked them in an order depending on its benefits:
1) Spending on going to a club
2) Spending on travelling the world 3) Spending on purchasing a ball
He chooses the first option. And the opportunity cost would be the benefit that he would have enjoyed by
travelling the world as that option is the next best option Adam would have chosen in case the option 1 wasn’t
there.

• Governments may experience opportunity costs when spending. For instance, should they spend on
infrastructure or education?

• Consumers. (As given above)

• Firms may have decide between spending on promotion or increasing pay for staff?

Production possibility curve (PPC)

Production possibility curve (definition in the basic definitions) has 3 main points. The concept of opportunity
costs can be experienced in this diagram as well.

P.T.O FOR GRAPH

A = Maximum productive potential of an economy/Fully employed resources

X = Unemployed resources (resources are not utilized effectively)

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Y = Unobtainable. (Economy doesn’t have enough resources to reach that point

Economic growth and decline using a PPC

ECONOMIC GROWTH DECLINE/RECESSION

Causes of Economic Growth

• Introduction of new technology which helps to increase the production of goods and services
More efficient methods of producing products
• Increase in spending on education and training helping to increase the knowledge and
productivity of workers
• Introduction of new resources helping to improve the competitiveness of a country

Causes of Decline/Recession will be the exact opposite of the causes of economic growth

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PPC and the Opportunity cost

For instance, an economy is currently producing 160 Kg of wheat and 400 Kg of cotton. But if it wants to
increase its production of cotton to 480 Kg it may have to forego 80 Kg of wheat. (This is the opportunity cost)

Chapter 2: Economics assumption

Basic Definitions

1) Costs/Benefit analysis: Finding out the benefits and costs of each choice given and then selecting the
choice with the highest benefit and lowest costs.

2) Rational decision: This is a decisions that is taken by consumers or firms after doing a proper
cost/benefit analysis. Consumers and firms make decisions that maximizes their utility.

3) Irrational decision: is when consumers or firms make decisions that doesn’t maximize their welfare or
utility.
4) Utility: Satisfaction.

Consumers and firms always try to maximize their utility. Consumers may want products that are of better
quality and for reasonable prices. Whereas, producers may want to produce the products at lowest possible
cost and charge higher price to maximize their profits.
However, consumers and firms may not maximize their utility at all times. Below are some reasons for this
strange behavior:

Why do consumers not maximize their utility?

There are 5 main reasons for this:

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 • Poor at computation: Consumers may find it difficult to calculate the cost/benefit analysis. Therefore,
they are unable to make proper judgments on which products would bring them the greatest
satisfaction.
• Consumer inertia: This is when consumers are reluctant to shift from one producer to another although
the other producer offers cheaper products due to the fear of risks that may be associated. (Eg; lower
quality products)

• Habitual behavior: This is when consumers are addicted to a certain product that they could not stop
consuming them regardless of the negative consequences it possesses. (Eg: Cigarettes)

• Herding: this is when consumers are influenced by their friends and family and so do not want shift
producers although, costs may be lower.

• Feeling valued: consumers do not want to shift producers as they are emotionally attached to a
particular brand. (Eg: Nike)

Why do firms not maximize their profits?

• As firms are run by managers and directors rather than owners, they may have different objectives in
comparison to the owners and therefore, make decisions to achieve their objectives instead of profit
which is the main objective of an owner.

• Some businesses operate as Charity organization where there main objective is not profit

• Some businesses operate as social businesses where there objectives is to maximize the welfare of the
people rather than earning a higher profit.

• Businesses may have to sacrifice profits to achieve other objectives such as being ethical.

Chapter 3 and 4: Demand curve and Factors affecting the demand curve

Basic Definitions

1. Consumer trends: These are the consumer behaviors or demand patterns.

2. Substitutes: They are products that could replace one another. They are alternatives to each product.
(For example, Tea and Coffee)

3. Complements: These are products that are consumed together. (For instance, Tea and sugar)

Demand is the amount of goods consumers are willing to purchase at a given price over a period of time. It
changes as the price increases or falls and also depends on certain conditions which would increase or reduce
the demand for a particular product.

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 As the price for a product increases, the demand for the product reduces.
As the price for a product reduces, the demand for the product increases.
This is called an inverse relationship.

Movement and shift along a demand curve

Movements along the demand curve Shift in the demand curve

When the price of the product falls from $499 to $449, the quantity demanded increases from 320 units to
460 units. This increase in quantity due to the fall in price is called a movement along the demand curve.
The demand curve shifts to the right when there is an increase in the quantity demanded due to changes in
various factors (as discussed below) OR the demand curve would shift to the left if the quantity demanded
falls due to changes in various factors. This is called the shift in the demand curve.

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The Factors affecting the demand curve
• There are various factors that may increase or decrease the demand for a product:
• Advertising: When business spend more on advertising their products, this will help them to increase
the awareness of the products. As a result, demand for the product would rise significantly.
• Income: When the income level of people increase due to better economic climate, this may increase
the demand for products.
• Changes in fashions, tastes or preferences: Consumer tastes, fashions or preferences may change from
time to time due to changes in consumer trends. This can be from cultural or traditional or modern
changes. For instance, a modern change to use social media has increased the demand for electronic
devices.
• Prices of substitutes: When the prices of substitute decreases, then the demand for products produced
may fall. This is because consumers may shift to the consumption of substitutes.
• Prices of complementary products: When prices of complements are higher then the demand for the
product may fall.
• Demographic changes: these are the changes that occur in the population of the country. For instance:
• Changes in Age distribution (There may be old aged people living in a country)
• Changes in ethnicity (More Muslims living in a country)
• Changes in gender distribution (more female in a particular region)
• Changes in geographical distribution (more people living in urban areas)
Due to these changes consumer demand may increase for various products, especially products that meet this
group’s needs.

Chapter 5 and 6: Supply and the Factors affecting the supply Basic
Definitions
1. Costs of production: This is the total costs incurred by a business to manufacture a product by using
resources and put them into the market for sale
2. Indirect taxes: This is the tax that is imposed on production of goods and services and the consumption
expenditures
3. Subsidies: They are the grants given by the government to business to lower their costs and increase
their production
4. Economies of Scale: the average costs of producing a single unit falls as the production of goods
increases

Supply is the amount of goods or services that suppliers are willing to supply at a given price over a period of
time.

P.T.O FOR GRAPH

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 • When the prices for the products are high
then the suppliers are often
willing to increase their
production as they may earn higher
profits by selling more at higher prices.
• When the prices are lower suppliers may restrict their production as they may earn lower profits by
selling their products at lower prices.
Movements and Shifts along the supply curve

Shift in Supply curve Movement along the Supply curve

When the price of the product increases from $6 to $12, the quantity supplied increases from 6 to 12 units.
The increase quantity supplied is called the movement along the supply curve.
The supply curve shifts to the right when there is an increase in the quantity supply due to changes in various
factors (as discussed below) OR the supply curve would shift to the left if the quantity supplied falls due to
changes in various factors. This is called the shift in the supply curve.

Factors affecting the Supply curve

• Costs of production: When the costs of production for a firm is high, this can reduce the supply as the
firm will not have enough money to fund the day to day operations of the business.
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 • Indirect taxes: These taxes may discourage the firms from producing goods and services due to an
increase in the costs. As a result, supply may fall. These taxes are used by the government to raise tax
revenues and to discourage the production or consumption of harmful products. Eg: tobacco
• Subsidies: When there is an increase in the subsidies provided by the government, this may increase
the supply of goods. This is because as the costs to the firms will lower. Subsidies can be given in
different forms such as cash, subsidized premise (no rent) or tax incentives (Less or no taxes) etc.
• Natural Factors: Some products demand are influenced by natural factors such as season. For example,
a Farmer may have a high yield in the crops at the rainy season and lower yield in a summer season.
• Changes in technology: When better technology is used, the productivity of the firm would rise helping
them to produce more goods and exploit the economies of scale. As a result, supply would rise.

Chapter 7: Market Equilibrium

Basic Definitions
1. Equilibrium Price: This is the price where both, supply and demand of the product is same
2. Total revenues: This is the amount of money generated by the sales of goods and services

The equilibrium price is determined by the market forces. (The supply and demand) When the amount of
goods supplied in the market by the producers is exactly equal to the amount of goods purchased by the
customers at given price, this is known as the equilibrium or market clearing price.
Su pply Demand Price

100 200 $20

Caps
150 150 Caps $30

200 100 $45

Caps
250 50 Caps $50

Example: As per the table above the equilibrium price for the Cap is $30. This is because the quantity
demanded is equal to the quantity supplied. At an equilibrium price there is no buyers left without products
or there are no sellers left with unsold stocks.

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In a graph, the equilibrium price can be presented in this way,

Equilibrium price and the shift in demand and supply curves

As the demand curve shifts to the right and the supply curve shifts to the right, the equilibrium point moves
from the red point to the yellow point. Therefore, the equilibrium price falls from P1 to P2.

Excess Demand and Supply

Excess demand is when the demand is greater than the supply of a product. Therefore, consumers are left
without goods. Whereas, Excess supply is when the supply of a product is greater than the demand and
therefore, the suppliers are left with a lot of unsold stocks. The graph below shows this:

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Let us take the same example of Caps to calculate the excess demand or supply for a product:

Su pply Demand Price

100 200 $20

Caps
150 150 Caps $30

200 100 $45

Caps
250 50 Caps $50

• At the price of $20, the supply was 100 caps and the demand was 200 caps. Therefore, there was an
excess demand of 100 caps (Shortage in supply).
• At the price of $45, the supply was 200 caps and the demand was only 100 caps. Hence, there was an
excess supply of 100 caps. (Shortage in demand)

How to remove the excess demand and supply? To

remove excess demand;
• Increase the prices
• Increase the production capacity to produce more goods

To remove excess supply;

• Reduce the prices
• Increase spending on Advertising which will help to increase demand

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Chapter 8: Price elasticity of Demand
Basic definitions
1. Perfectly elastic demand: Increase in prices will result in 0 demand
2. Perfectly inelastic demand: Change in price will result in no change in demand
3. Unitary elastic demand: The responsiveness of demand is proportionately equal to the change in prices

Price elasticity of demand (PED) in the responsiveness of demand to a change in price of a product. They are
of 2 types:

• Inelastic demand: This is when the change in price results in smaller change in quantity demanded.
The value of PED would be less than 1 for inelastic products.
• Elastic demand: This is when the change in price results in a greater change in quantity demanded.
The value of PED would be more than 1 for inelastic products.
Note: PED value is always negative. But the negative sign should not be taken into account while deciding on
whether the product inelastic or elastic.

Formula of PED
PED = Percentage (%) Change in quantity demanded / Percentage (%) Change in price

Example: The price of a ball increased from $400 to $450. However, the demand for the ball dropped from
20 balls to 15 balls. Find out the PED for the ball.
Answer: Step 1 = Percentage change in Price = ((450 – 400) / 400) x 100 = (+) 12.5%
Step 2 = Percentage change in Demand = ((20 – 15) / 20) x 100 = (-) 25%
Step 3 – PED = (+) 12.5 / (-) 25 (No need to write the percentage sign while calculating PED)
= (-) 0.5 (PED do not have any units)

Diagrams to show the Price elastic and Price inelastic demand

Each value in the PED will have a certain term

➢ Inelastic demand: Less than 1
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 ➢ Elastic demand: More than 1
➢ Unitary elasticity: Equal to 1
➢ Perfectly price inelastic: 0
➢ Perfectly price elastic: Infinity

Perfectly inelastic demand Perfectly elastic demand

All numerical values can be presented in one graph

RED = Infinity
BLUE = More than 1
YELLOW = (-) 1
PURPLE = Less than 1
BLACK = Zero (0)

Factors influencing the PED for a Product

➢ Substitutes: When a product has lot of substitutes then the PED is elastic. This is because consumers
can easily shift from one to another product. Therefore, an increase in price can lead to lower demand.
➢ Degree of Necessity: As the necessity of the product is high, the PED value tends to be inelastic. This
is because an increase in price will result in smaller changes in quantity demanded as consumers may
have to purchase the product regardless of the higher prices.
➢ Percentage of income spend on goods or services: When people spend high amount of money on
products, the PED would be elastic. This means an increase in price of the product will have a greater

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 reduction in the quantity demanded. This is because consumers are already spending a huge amount
on the product so they are reluctant to spend more. This is mostly the case for luxurious products.
➢ Time: In the short –run the demand for a product is inelastic. This is because in the short-run consumers
have no choice but to purchase the product regardless of the price. However, in the long-run they can
find alternatives and also and easily switch.

Total revenues and PED Calculations

Example 1: A ball has a decrease in the price from $8 to $5. The quantity demanded has increased from 100
balls to 200 balls. (This is an elastic product)
Answer: When Price was $8 = 8 x 100 = $800
Therefore, a fall in price for an elastic product will increase the total revenues generated (VICE VERSA FOR
INCREASE IN PRICE)

Example 2: A water bottle has a decrease in the price from $7 to $5. The quantity demanded has increased
from 200 bottles to 210 bottles. (This is a inelastic product)
Answer: When price was $7 = 7 x 200 = $1400
When price was $5 = 5 x 200 = $ 1000
Therefore, fall in price for elastic products would reduce the total revenues generated (VICE VERSA FOR
INCREASE IN PRICE)

Price elasticity Value Price change Effect of TR

Inelastic Less than 1 Price increase Increase
Inelastic Less than 1 Price decrease Decrease
Elastic More than 1 Price increase Decrease
Elastic More than 1 Price decrease Increase

Chapter 9: Price elasticity of Supply

Basic definition
1. Perfectly elastic supply: This is where Producers will supply an infinite amount of products at a given
price. PES = infinity
2. Perfectly inelastic supply: This is where the Supply is fixed at cannot be adjusted whatever the price
is. PES = 0
3. Unitary elastic supply: This is when the quantity supplied and the price change will be equal.
PES = 1

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Price elasticity of supply (PES) is the responsiveness of supply to a change in the price. They are of 2 main
types:

• Inelastic supply: This is when the responsiveness of supply to a change in price is smaller.
• Elastic supply: This is when the responsiveness of supply to a change in price is greater.

Formula of PES
PES = Percentage (%) change in the quantity supplied / Percentage (%) change in the price
Example: The price of a Vanilla pods (Agricultural product) increased from $2 to $3. In the meantime, the
supply of Vanilla pods increased from 250 pods to 275 pods. Calculate the PES for the Vanilla pods.
Answer: Step 1: Percentage change in quantity supplied = ((275 – 250) / 250) x 100
= 10%
Step 2: Percentage change in Price = ((3 – 2) / 2) x 100
= 50%
Step 3: PES = 10 / 50 (No need to write the percentage sign while calculating PES)
= 0.2 (PES do not have any units)

Price elastic and Price inelastic supply Graphical representation

Interpretation of the numerical values of PES

• Perfectly inelastic supply: Exactly 0
• Perfectly elastic supply: Infinity
• Unitary elastic supply: Equal to 1
• Inelastic supply: Less than 1

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 • Elastic supply: More than 1

P.T.O FOR GRAPH

Diagram to show perfectly inelastic, elastic and unitary elastic curves

Factors influencing the PES

• Factors of production: If the factors of production such as raw materials and other materials are easily
available for lower costs, this will make it easier for the producers to easily increase or decrease their
production depending on the price. Therefore, PES is elastic
• Availability of stocks: If the producers are supplying perishable products then stock holding for a long
period would be impossible as the products may perish and if not the costs of maintaining the quality
will be extremely high. Therefore, in this case PES is inelastic.
• Spare capacity: when producers have enough of capacity to produce extra output then supply tends
to be elastic. This is because in case there is a surge in the price due to various factors, this would
help producers to increase their production. As a result, profits can be maximized at this period.
• Time: the longer to produce gods, the lower the PES. (Inelastic) for instance, Agricultural products can
only be harvested on a particular season of the year. Although, there is a price increase in other
seasons, farmers are unable to increase the production of their goods. So, agricultural products are
price inelastic.

PES for manufactured and primary products

As stated above, producers of agricultural products are unable to increase the production of their products
whatsoever the price increase is.(Inelastic) Whereas, producers of FMCG (fast moving consumer goods) can
easily increase their production, perhaps by asking workers to work overtime and increasing the output in the
factory. (Elastic)

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Chapter 10: Income elasticity of Demand (YED) Basic
definitions
1. Indirect taxes: This is tax that is levied on the production of goods and service and consumption
expenditures.
2. Inferior products: these are products for which demand increases when income falls
3. Normal goods: : these are products for which demand increases when income increases
4. Luxurious products: these are products for which demand is optional. High income earners may
purchase these products. Example: Cars, gold etc.
5. Subsides: they are the grants provided by the government to businesses to encourage consumption and
production of beneficial products. (Example: Food)

Income elasticity of demand (YED) is the responsiveness of demand to a change in the income level. They
are of 2 types:

• Inelastic: When the responsiveness of demand to a change in income is less.

• Elastic: When the responsiveness of demand to a change in income is high.

Formula of YED
YED = Percentage (%) change in quantity demanded / Percentage (%) change in the income

Example: The average income per person in USA increased from $5000 to $7500. The quantity of milk
demanded has increased from 4 bottles to 5 bottles. Find out the YED.
Answers: Step 1: Percentage change in Quantity demanded = (5 - 4/4) x 100
= 25%
Step 2: Percentage change in Income = (7500 – 5000 / 5000) x 100

= 50%
Step 3: YED = 25/50 (No need to write the percentage sign while calculating YED)
= 0.5 (YED has no any units)

Interpretation of the YED numerical values

• Luxurious goods: All positive values above 1 (Example: Travel tickets)
• Normal goods: Positive value up to 1 (Example: Balls)
• Inferior goods: below zero (All values with (-) Negative sign) (Example: Supermarket labelled
products)

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Significance of PED and YED For
Businesses
PED could be used by businesses to predict changes in Total revenues in case the prices are to be changed.
This will help businesses be well-prepared for the future events and effective forecasts can be prepared.
Furthermore, YED could be a useful tool for businesses to predict the changes in demand for their products
as income influences the consumption habits. So, manufacturers may be able to switch production from one
product to another which may be profitable in the future due to changes in income. As a result, products can
be maximized.

For government
Government may use the PED for a product when charging taxes because inelastic products may be consumed
regardless of the price increase. So, by charging more tax on inelastic products they are able to main creases
tax revenues generated. On the other hand, government may grant subsides to inelastic product
manufacturers as if their costs are lower they may charge lower prices. As a result, poor people can also
afford the inelastic products such as the basic necessities. Hence, social welfare is improved.

Chapter 11: The Mixed Economy

Basic definitions
1. Economy: a system that attempts to solve all the economic problems
2. Dividends: Payments in return to the shareholders for their investments in the business. (they are not
a must but if the business makes higher profits they should be paid)
3. Nationalize: Process of converting private firms to government owned firms
4. Market failure: this is when private sector firms fails to achieve the objectives of the society
5. External costs: negative consequences caused by production or consumption of a product which may
affect the third party
6. Monopolies: A single firm that produce goods and dominates the entire market and restricts all sort s
of competition

Private and Public sector businesses

Private sector businesses are owned and run by individuals or group of individuals. Whereas, public sector
businesses are owned and funded by the Central or state government.

Private sector Businesses (Ownership, Control and Aims)

Ownership and Control
• Sole traders: Owned and run by one person
• Partnerships: Owned and run by 2 to 20 members

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 • Companies: Owned by shareholders who have a share in the business due to the contribution that they
made. They are run by directors appointed by shareholders in Annual General Meeting.

Aims of Private sector businesses

Private sector firms are generally set-up to earn profits. Some of the main aims of a Private sector firm would
be:
Survival: One of the main objective of many small businesses is survival in the first few years of their trading.
This is because they may be operating in a competitive environment in which they may threatened by trading
conditions such as, competition.
Profit Maximization and Satisficing: Profit maximization is where firms try to get as much as profit that they
possible could to pay their shareholder higher dividends so that they continue to inject capital. While, Profit
satisficing is when the business makes just enough profit to satisfy the owners and meet their daily needs.
Growth: Most business aim to grow. They may do this by expanding their operations and increasing their
revenues further by spending more on advertising. Costs may be lowered to increase the profits and fund
growth.
Social responsibility: Social objectives are designed to improve the well-being of humans. Most public service
business such as government owned businesses aim to provide public services. However, these services may
not be of high quality as they may be produced at lower costs. This is because the products are not charged
for or may be charged a very low price. Examples: Government schools. Some businesses operate as charity
organizations and other non-profit making organization as they may aim to bring positive impacts to the
society such as to eradicate poverty.

Public sector businesses (Ownership, Control and Aims) Ownership

and Control
• Central government: Departments such as Health and transport are managed and controlled usually
by teams and boards led by a minister.
• Public corporations: These are public sector organization which are usually funded by the tax
revenues. Government appoints a team of Board of directors to run the organization.
• Local authority services: Services such as fire and police services are usually run by councilors who
are elected by the residents living in a city. (Local community)
• Other public sector organizations: Central banks and other government bodies are usually run by a
board that is selected by the government of the country.

Aims
Public sector organizations are generally set-up to maximize the social welfare and well-being. Some of the
main aims of a Public sector organization would be:

• Improving the quality of services: Governments may want to improve the quality, quantity and
professionalism of the service that they provide in order to maximize the welfare for the citizens.

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 • Minimize costs: This is when public sector businesses wish to become cost-efficient and reduce
wastages.
• Allow for social costs and benefits: Public sector businesses can take into account the pollution caused
by their production and other negative effects on the environment. This can be one of the important
aim as they don’t aim to increase their profits.
• Sometimes the government nationalize some large businesses that make huge profits. Therefore, in
this case they may aim to make higher profits.

Types of Economy
There are 3 main types of economy. An economy will have to carry out functions such as deciding what to
produce, for whom to produce and how to produce. These questions will be addressed by the public or the
private sector depending on the economy. They are:

• Market/Free enterprise economy: This economy depends almost completely on the private sector
businesses. Allocation of resources are dependent on the supply and demand. Government may play a
role in provide some public services such as Fire services.
• Command economy: This economy is completely relies on the public sector. Everything is state-owned
from the shops to the products sold. Therefore, taxes may be high as revenues have to be generated
to fund all these operations.
• Mixed economy: this economy relies on both, the private and the public sector. Examples: Saudi Arabia

Mixed Economy
In this economy the question of what to produce? Will be determined by both the sectors, private and public.
For instance, goods and services such as travel and Fast moving consumer goods are provided by the public
sector. However, services such education and police services are provided by the public. This ensures that a
market failure is avoided. This is because all goods are provided in the economy, as the services that private
sector firms fails to provide are provided by the public sector firms.
The question of How to produce? May be addressed by the private sector firms. This is because they will be
keen in maintaining the quality and maximizing the profits. While, Public sector will be in charge of making
decisions related to the services such as education, police and fire services.
For whom to produce? Will be addressed by both the sectors. People who have money can afford private
services and who don’t have money can use the public services as they are usually free. However, taxation
may be high as the main source of income to provide these service would the tax receipts.
Different countries may decide on the proportion of mixing the both sectors depending on their requirements.

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Market failure
This is when the private sector firms fails to achieve the objectives of the society. There are various forms in
which this can take place:
External costs: This is where production of goods and services may bring negative consequences to the
environment and the people around. Example: All kinds of pollution, soil erosion, unemployment etc.
Lack of competition: when there is no or less competition consumers may be at a disadvantage due to high
prices, less choices and sometimes lower quality products.
Missing market: this is when some important goods such as education, fire and police services (which are
known as public goods) are not provided by the private sector firms as they are unable to charge a proper
price for their services or they may be expensive to provide.
Information Failure/ Asymmetric information: this is when there is an imbalance of information between
the consumers and the businesses. A lack of information about the quality of the goods and the pricing
strategies may cause wrong goods being bought and higher prices being charged.
Factor immobility: in order to be successful, the mobility of factors of production (land, labor, capital and
enterprise) is important. However, some machineries or other factors cannot be used for more than one
purpose. As a result, there is a lot of wastage.

All the causes that are mentioned above may eventually lead to market failure.

How can the government intervene to reduce or stop the market failure?
• Charge taxes to on business to lower the external costs created.
• Introduce competition regulations such as the (regulating the formation of monopolies) to stimulate
competition in the market
• Government can directly intervene and provide these goods and services that private sector firms fail
to provide
• Government can produce campaigns to inform and educate the customers and business about all
related information such as prices, quality etc.
22
 • Government invest on training to help employees become more flexible

Provision of goods and services by the Private and public sector

Private sector is responsible for producing goods such as clothes, food materials and toys. On the other hand,
the public sector may have to provide the public goods which are known as the merit goods as they do bring
benefits to the economy. Example: education and health care. Public goods are not provided y the private
sector due to some reasons (mentioned below)

Public goods have 2 main characteristics:

• Non – excludability: No one can be excluded from its consumption. This is because they are usually
free of charge.
• Non – rivalry: this means the consumption for the product by one person may not reduce the availability
of products for others. From instance, when one person consumes education, this will not reduce the
availability of education for the consumption of the other citizens.

Why are private sector firms reluctant to supply public goods?

• Free rider problem: everyone can access it and by the consumption of one. So, this may lower their
profits.
• Expensive: these goods and service as are very expensive to produce
• Proper pricing strategies cannot be used as the consumption cannot be measured

Conclusively, it depends on the countries about the role the public sector r has to play. For example, in
countries such as the UAE the public sector play a major role? In contrast, in countries such as USA private
sector play the dominant role? As a result, we cannot accurately say the importance of each sector as they
may vary.

Chapter 12: Privatization

Basic definitions
1. Monopolies: It’s a situation where the business activity is controlled by one company or the government
by not allowing other firms to compete.
2. Nationalize: Process of converting private firms to government owned firms
3. Redundant: laying off workers due to lack of work or finance and it’s not same as dismissal
4. Takeovers: it is an act of taking control of a company by purchasing 50% of its shares
5. Mergers: this is when 2 companies join together and share all the responsibilities and profits/losses

Privatization is an act of selling a state-owned business to the private sector. This can take place in 3 forms:
Sale of Nationalized industries: This is where businesses that nationalized previously due to various reasons
such as inefficient supply of services is now being sold back to the private sector.
• Contracting out: services that were previously supplied by the public sector such as health and
education are now sold to the private sector. Here, businesses or individuals are allowed to bid for the

23
 services and thereby, the highest bidder will be given the opportunity to provide the service to the
citizens.
• Sale of land and property: this s where government sells some of the state-owned properties to the
general public. (Citizens)

Reasons for Privatization

• To generate income: government may need income to fund other public services that they provide.
So, to raise finance they may privatize these industries.
• To make services more efficient: when the public services are privatized, this will make private sector
firms be more efficient due to the competition that they may face. However, when these services were
provided by the government, the quality of the services were low and they had made huge losses.
• To reduce the political interference: the services provided by the government may be subjected to
political interference. Therefore, if these services are privatized, all decisions will be free to be made
by the private sector. As a result, time lags would be prevented and the quality of the services may
also improve.

Effects of Privatization on various groups

Consumers
• Quality services would be provided
• Reasonable prices may be charged
• Efficiency will be improved
• However, tax payers may have to face increased burden due to huge subsidies provided by the
government and sometimes prices may be higher.

Workers
• Redundancy level increases
• Workers are forced to adopt flexible working practices

Business
• Objectives are changed to profit maximizing, so costs may have to be reduced which may mean
the quality may be compromised
• Increasing investments on providing these services
• More takeovers and mergers are taking place
• Firms have diversified themselves to different areas and striving for growth

Government
• It’s an expensive process due to the money spent on advertising
• Privatized businesses are subject to takeovers that they don’t agree for (hostile takeovers)
• However, revenues will be generated and government can focus more on the government businesses,
as a result, efficiency could be improved.

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Chapter 13: Externalities
Externalities are the spillover effects on third parties caused by production and consumption of private
individuals. They are of 2 types:
• Negative externality
• Positive externality

Negative externalities

There are 3 main costs associated with negative externalities:

1) Private cost: costs incurred by producers and consumers for their production and consumption.
Example for producers: Costs of materials
Example for consumers: price of the product

2) External costs: this is the negative spillover effect on third parties caused by production and
consumption of private individuals. Examples: Pollution, congestion etc. 3) Social costs: External costs
+ Private costs

Positive externality
There are 3 main benefits associated with positive externalities:
1) Private benefits: Benefits enjoyed by producers and consumers from production and consumption.
Example for producer: Profits
Example for consumer: Consumers satisfaction

2) External benefits: they are the positive spillover effect on third parties caused by production and
consumption of private individuals. Example: Unemployment, Economic Growth etc. 3) Social benefits:
Private benefits + External benefits

Impact of externalities on various contexts (External costs and External benefits)

Transport sector
Lot of external costs are created in the transport sector. This is because it involves air travel and land travel.
Both of these emit greenhouse gases such as CO2 which increases the air pollution and thereby, causes various
health issues such as asthma. As a result, this can lead to higher government expenditures on health care
sector.

Health sector
In this sector external benefits are being experienced. This is because, when government spends more on
health care, this can result in people getting better treatment. Therefore, they may be healthy and fit to
work. As a consequence, absenteeism rates for businesses may fall drastically which may increase the labor
productivity due to less disruption in the production process.

25
Education sector
External benefits are experienced in this sector. This is because in an educated society, citizens may easily
get employed in different organizations and this can result in innovative ideas and strategies being used by
these educated citizens. As a result, productivity may be improved. Also as the income of citizen’s increases
due to employment, the tax income for government may rise which could be used to spend on other
development based projects which eventually could result in higher economic growth rates. (Other benefits:
Higher property prices, fall in social unrest and increase in social harmony)

Environment
External benefits and cost may be experienced her. The external costs that may be experienced is the
pollution of production of various activities which may deplete natural resources and reduce the sustainable
growth by compromising on the availability of resources for the future generations. External benefits enjoyed
will be that educated people will bring in innovative ideas to reduce the impact on the society such as use of
renewable resources or eco-friendly machineries.

Vaccinations
This is when a vaccination is consumed by a person for an infectious viral diseases (such as the COVID-19) then
the chances of it spreading would be lower. Hence, there is a benefit to the third part of not contracting the
disease. As a result, an external benefit is created.

Government polices to deal with externalities

Taxation
Government can charge higher taxes on firms that pollute the environment. This will increase their costs and
thereby, increasing their costs of production. As a result, their profit margins may fall. Hence, immediate
actions will be taken to reduce the external costs caused by their production (such as using environmental
friendly products) As a result, the external costs can be controlled. Also, the tax revenues generated by the
government could be used to fund the cleaning of the pollution caused

Subsidies
If the governments provides subsides to firms that produce goods that are beneficial to the environment,
(education, health products) this can lower their costs of production. Hence, prices charged may be low as
possible. As a consequence, more people will be able to afford these products. Therefore, the external
benefits could be enjoyed by a larger number of people.

Fines
If fines are implemented on the consumption and production of products that may cause health damages (such
as tobacco) then the consumption and production would be comparatively lower. As a result, the external
costs (such as health issues) created by these products would be controlled. This is because people are fearful
for the fines due to the increased financial burden.

26
Government regulations
The government may impose legislations to ensure that the concerned parties are aware of the punishments
and fines and therefore, reduce or eliminate the activities that may create external costs. Therefore,
government health care expenses would reduce significantly.

Pollution permits

These are permissions that are granted by the government to discharge a fixed amount of pollution. If more
is required permits are to be purchased for extremely higher prices which may discourage firms from
purchasing permits and thereby, reducing the pollution.

External costs
Analysis (Advantages)
➢ Write the type of external costs from the case ➢ Reasons for the creation
of the external costs
➢ Consequences of the external costs on the third parties (consumers,
government and suppliers)
Evaluation (Disadvantages)
➢ External costs cannot be measured
➢ Depends on the magnitude
➢ External benefits are created
➢ Suggestions/Solutions to overcome external costs

Unit 2: Business Economics

Chapter 14: Factors of Production and Sectors of an economy
Basic definitions
1. Human capital: the value of an individual worker or a workforce
2. Labor productivity: it is the amount of goods that can be produced with a given set of input over a
period of time

Production
It is a process that involves converting resources (raw materials) into goods and services.
Factors of productions are the factors that businesses may use to produce a good or service. They are of 4
types:

1) Land
A plot of land is required by a business to locate its premises or operations. Furthermore, land also provides
natural resources such as coal, iron and oil which could be used for production purposes. The resources that
are provided by the land could be divided into 2 types:

27
 ➢ Non – renewable resources: these resources can only be used once. Once used up, they cannot be
used again.
➢ Renewable resources: These resources could be used over and over again. Once used up, they can be
used again.

2) Labor
Labor is the workforce in the economy. They are of different types from skilled, manual and unskilled workers.
They have skills, education, experiences and emotions. The value of the workers are known as human capital
and can be increased by providing more training and education which will help to improve the labor
productivity.

3) Capital
Capital are of 2 types:
➢ Working capital: this is the stock of raw materials and other components that are used in the
production to be converted into final products.
➢ Fixed Capital: These are the furniture and machineries that are used in the production process s but
are not converted into the final product, For instance: Machineries etc.

4) Enterprise/Entrepreneur
In general, enterprise is a business operation. They are run by owners who are known to be as
entrepreneurs. They have crucial role:
➢ They come up with business ideas: they come up with great ideas to start their business. The
ideas may come from different ways, for instance copying a rival’s product, own experience or
from analyzing the market and the needs of consumers. These ideas are then put into a business
model.
➢ They are the owners: they provide the required fund to start up the business and to run its
operations. They are responsible for its direction and are the main decision makers.
➢ They are risk taker: They risk their own money in the venture having no any certainty for the
returns. Therefore, if the business fails they would completely lose all the money that they
invested.
➢ They are responsible for the organization of the other 3 factors of production: they have to
bring all the 3 factor of production to make the product.

Labor intensive and Capital intensive production

Labor intensive production is when a business uses more labor in its production process than capital.
(Machineries) This is widely used in countries such as China, India and Brazil. As these countries have lower
wages for labors, this makes it more affordable than machineries.
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Capital intensive production is when a business uses more machineries that labor. This is widely used in
developed countries such as Saudi Arabia and USA.

Labor intensive production

Advantages Disadvantages
Cheaper for small scale production People are difficult to manage
More flexible than machineries as they can be People needs breaks and holidays
retrained
People are more creative than machineries People can be unreliable as they may take sudden
holidays from work

Capital intensive production

Advantages Disadvantages
Machineries can operate 24/7 Huge set-up costs
Machineries are easier to manage than labor May be inflexible
Machineries are more precise and accurate May leave the workforce facing the redundancy and
effect their morale

Sectors in an economy
The economy is divided into 3 main sectors:
1) Primary sector
This sector is mostly involved with the extraction of natural resources from the earth. Some examples would
be farming, forestry and fishing. 2) Secondary Sector
This secondary is mostly involved in turning the resources or raw materials into finished or semi-finished
goods. They are involved in the manufacturing of the products. Some examples are: textile, chemical and
engineering industries.
3) Tertiary sector
This sector is mostly involved in the provision of services to the economy. For instance, leisure,
accountancy and banking services.

De-industrialization
This is the decline in manufacturing or secondary sector in developed countries due to the emergence and
flourishing of the tertiary sector. Some of the main reasons for this are:
➢ People prefer to spend more of their income on services such as leisure than on manufactured product.
Hence, the demand for the manufactured products are falling.
➢ There are huge competitions for the manufacturing sector from countries such as Brazil, India and
China
➢ As public sector grows, they spend more on public sector businesses which are usually services based
➢ Advancement in technology has replaced labor in the manufacturing sector, hence, this sector is
declining.

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It’s very important to know the proportion of growth in each sector in developed and developing countries:
Developing countries have most of their labor and growth from the primary sector and the least from the
tertiary sector as they mostly import these services The manufacturing sector is not as prosperous as the
primary sector neither are they worse as the tertiary sector.
Developed countries have most of their labor and growth from the tertiary sector and the least from the
primary sector as they import primary products. The manufacturing sector is not as prosperous as the tertiary
sector neither are they worse as the primary sector.
USA = Developed economy Brazil =
Developing economy Nepal =
Underdeveloped economy

Chapter: 15 Productivity and Division

of Labor Basic definitions
1) Bonus: it is a financial method of motivation often given to sales staff for reaching set targets within
a period. They are in addition to the basic salary.
2) Flexible working practices: they are working practices that help employees to cater surges in demand
in a short time period. Eg: Part time working

What is productivity and the factors that affect the productivity?

Productivity is the rate at which goods are being produced and the amount at which they are produced in
relation to the time, money and work that is required to produce them. To increase the productivity the
business can modify the 3 factors of production: Land, Labor and Capital.
1) Land (Only some are mentioned as others are less important as these are examples)
➢ Fertilizers and Pesticides: fertilizers can be used to increase the amount of crops harvested (yield)
and improve their health. Pesticides could be used to kill insects that damage the crops. However,
they may also kill some other animals that are harmless.
➢ Drainage: they could be used to improve the productivity of land as they eliminate the flood of water
in the productive parts of the land.
➢ Irrigation: this system can be used by farmers to increase the productivity in seasons where there is a
shortage of rain. Hence, the yield will continue to improve regardless of the rain.

2) Labor
➢ Training: this is the process of increasing the knowledge and the skills of the workers so that they get
familiarized with their jobs and thereby, do the work more effectively. As a result, they are
wellmotivated leading to higher productivity.
➢ Increasing the motivation: businesses can provide various motivational schemes to encourage
employees to be more efficient and productive. For instance, they can use bonuses as a motivation to

30
 achieve targets. Hence, employees will have a reward to work towards leading to higher labor
productivity.
➢ Improved working practices: businesses can adopt new working practices such as flexible working
practices. This will help them to be more innovative and efficient helping them to work in an organized
manner. As a result, the productivity would rise significantly.
➢ Migration: when a government of a country promotes migration, this would help them to attract foreign
highly skilled workers who may positively contribute to the productivity of an economy by bringing in
innovative ideas that would help to reduce the time consumed and the wastages. As a consequence,
the productivity and the profits for businesses may rise drastically.

3) Capital
Use of technology has helped to improve the productivity in all 3 sectors of an economy:
➢ Primary sector: in this sector drones, tractors, lifting equipment and irrigation systems have been
introduced to reduce the waste and improve the working conditions which has helped to improve the
productivity.
➢ Secondary sector: this sector has been the mostly influenced by the advancement of technology. This
is because of the newly introduced complex machineries such as robotic arms and Computer aided
designing systems which has helped to save more time and labor costs for business. Therefore, the
productivity has also rose.
➢ Tertiary sector: although this sector is not affected by much, there are still slight improvements due
to the advanced technology used in the health care sector. For instance, newly introduced operating
machines has made the job of the doctor easier. Also, the use of internet shopping has grown in
emergence due to various factors, currently the COVID-19.

Division of labor and specialization

Division of labor is the division of workers to do separate tasks of a complete work, so that together the
product could be made faster. It also means to break down the production process into smaller parts, so that
each worker can specialize in their area of expertise. On the other hand, Specialization is production of
limited range of good by a firm, region or a country.

Division of labor – Workers

Advantages Disadvantages
They can become expertise on a particular task Boredom/Monotonous
Workers pay will be higher if they are highly Less chances to get employed in other jobs due to
expertise lack of diversification of jobs
They can concentrate on a narrow range of task –
less stress

Division of labor – Businesses

Advantages Disadvantages
Efficiency is improved as worker waste less time as Due to boredom, motivation suffers causing a fall in
they are familiar with the job productivity
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 Tools could be given to a group of workers rather If production fails to deliver the product on time,
than an individual worker, hence, les tools are then the rest of the production would be delayed
required
No time wasted moving from one job to another Loss of flexibility in the workplace. They are confined
to one job only
Production organizing becomes more easier

CHAPTER 16: COSTS

Basic definitions
1) Costs: expenses that must while running the business
2) Fixed cost: the costs that remain constant
3) Variable costs: the costs that vary with the level of output
4) Total costs: the total of the fixed cost with the variable costs 5) Total revenue: money generated from
the sale of outputs

Fixed costs
Fixed costs do not vary with the level of output. They don’t increase when output increases neither do they
decrease when the output decreases. However, they are to be met even if no output is produced. They form
a straight horizontal line in a graph. Examples: rent, development costs etc.

Variable costs
Variable costs are the costs that vary with the level of output. When output increases they increase and the
vice versa. Examples: raw materials, packaging.
To find total variable costs = Variable cost per unit x number of units

Total costs
This is the addition of the Variable and fixed costs.
Total cost = Fixed cost + Total Variable costs

Average costs
This is the average cost of producing one single unit:
Average costs = Total cost / total quantity produced
The below labelled terms will be explained in the following chapter

32
 Diseconomies
Economies of scale
of scale

Minimum
Efficient Scale

(MES)
Total revenues

The amount of money the firm receives after selling its outputs. Total
revenues = Price x Quantity

Profit
The amount of money that is given to the owner or distributed among the owners or shareholders after the
deduction of all costs is called profit. Profit = Total revenues – Total costs

Chapter 17: Economies and Diseconomies of scale

Basic definitions
1) Bulk purchases: buying in large quantities
2) Product portfolio: this is the range of products that a business is currently marketing (selling)
3) Vocational training: this is a form of training that emphasizes the skills and knowledge of a particular
industry or job.
4) Staff turnover rates: amount of workers leaving the organization
Economies of scale is the fall in the average costs due to expansion of the business. This is because as more
output is produced the costs can be shared among more outputs. Diseconomies of scale is the rise in the
average costs when a firm becomes too large and everything goes out of control.

Economies of scale can be divided into 2 categories:

1) Internal Economies of scale is the costs benefits that an individual can enjoy as they expand. They are
have of 6 types:

33
 ➢ Purchasing economies of scale: This is when firms are given discounts when they buy raw materials
in Bulk. As a result, their average costs falls significantly helping them to maximize their profits.
➢ Marketing economies of scale: This can be experienced as the firm increases in size. For instance,
large firms can find it cheaper to purchase their own delivery vehicles instead of paying a distributor
to carry their orders. As a result, the average costs may reduce.
➢ Technical economies of scale: Large firms may have the opportunity to invest heavily on machineries
that may be more productive and efficient while smaller firms may find difficulties in affording this.
As a result, the sales can be maximized.
➢ Financial economies of scale: financial institutions may find large firms to be less risky and may easily
provide finances for lower interest costs. Therefore, they will find it easier to raise finance to fund
further expansion.
➢ Managerial economies of scale: larger firms may be able to attract highly skilled employees from all
over the world as they are able to provide higher salaries and other benefits while, smaller firms may
find it difficult. So, better decisions may be made by these highly qualified managers helping to
improve the business performance.
➢ Risk-bearing economies of scale: this is when larger firms are able to be spread their risk among more
products due to their diversification. (more product in the product portfolio) So, in case a loss is
incurred in one of their products, then they are able to compensate with other products but small firms
are more vulnerable to changes in the market conditions. (They can easily fail)

2) External economies of scale: costs benefits that all firms can enjoy once the industry they are in
expands. They are of 4 types:
➢ Skilled labor: if an industry is focused on one particular region or area of a country, then the highly
qualified workers who are working in fields that are related to this industry may be attracted, hence,
the costs of training will be much lower for the firms. Also, local schools may provide vocational
training to mold children to the expectation of the industry.
➢ Infrastructure: governments of the country may be keen to invest on roads, railways or ports if a
particular industry dominates the country. As a result, the productivity rates increases as time is saved
due to fast delivery of raw materials caused by the better roads etc.
➢ Access to suppliers: as a particular area is dominated by an industry, this will encourage suppliers to
set up close to those areas to easily attract more business. Therefore, the business in the industry may
find it easier to purchase the components that is required.
➢ Similar business in the area: when the firms in the same industry are located in the same area, they
are likely to corporate well to gain the benefits of external economies of scale.
Diseconomies of scale
There are 4 main types of diseconomies of scale that may be encountered as the business increases in
its size:
➢ Bureaucracy: This is experienced by businesses as they spend more time on administration and get
signs for authorities before a decision is being made. Hence, this red tape (increase in paper work) can
cause a business to spend more time and eventually, lose important opportunities.
➢ Communication and Coordination problems (2 points related to each other): as the business
increases in size, the number of employees and number of machineries may increase. Hence,
coordination problems may arise as managers may not have tighter control with their employees as it
may be impossible to control all of them. Hence, message may be misunderstood causing huge mistakes
to happen which may incur costs to the business.
➢ Distance between top management and shop floor workers: the distance between the top
management and the ground workers such as clerks will worsen. Hence, the needs of these workers

34
 will not be met causing a demotivation at the work place. Hence, staff turnover rates may increase
significantly.

P.T.O FOR GRAPH

➢ Economies of scale: Falling average costs

➢ Diseconomies of scale: Rising average costs
➢ Minimum efficient scale: This is where all business must try to be. They should expand so that they can
enjoy economies of scale but should not overgrow so that they don’t experience diseconomies of scale.

Chapter 18: Competitive Markets Basic

definitions
1. Rivals: competitors
2. Product differentiation: this is when firms have to exploit a unique feature of their product that would
distinguish their products from that of the rivals.
3. Market share; this is the proportion of the market a business or a product holds
4. Competitive edge: this is when a firm has unique feature that completely differentiates its products
from the rivals.
5. Barriers to entry: Obstacles that may discourage firms from entering the market
Competition is the rivalry that exists between 2 or more firms when trying to sell their products to the same
group of customers. The products sold in a competitive market will be similar or identical. Some of the
prominent features of a competitive market are:
✓ Large number of consumers and sellers
✓ Lower barriers to entry
✓ Similar products sold
✓ No firm have control over the prices that they charge
✓ Free flow of information: Nature of the product, availability and the location of outlets etc.

35
Effects of competition on firms
➢ There is a need to innovate new products as to attract customers from the rivals
➢ Product differentiation is encouraged as to attract more consumers and increase market share
➢ Businesses should operate efficiently and keep costs low as possible
➢ Charge prices that are acceptable to customers
➢ Provide better quality products

Advantages of competition to consumers

➢ Lower prices: in competitive markets firms try to charge as low as possible as to attract consumers and
to maximize their revenues
➢ More choices: as the barriers to entry are low, more firms enter the market and consumers have more
products to choose from. They can chose the product with the best quality for reasonable prices.
➢ Better quality: as firms want to increase their profits, they put more effort to improve the quality of
their product hence, consumers get better quality products.
➢ More innovation (Can also be used as a disadvantage): as firms may want to earn a competitive edge
in the market, they may innovate new products and thereby, consumers get the best products.

Disadvantages of competition to consumers

➢ Market uncertainty: due to high competitions, firms may eventually leave the market, thus, reducing
the choices for consumers.
➢ Lack of innovation: as firms have less profit margins, they have less finance to fund the innovation of
new products. Therefore, consumers may not be able to get new products.

Advantages of competition to the economy

➢ Resources will be allocated more effectively as firms’ competition may try to reduce the wastages to
lower their costs.
➢ More innovative products may be introduced which may help to increase the standard of living for the
people in the economy.

Disadvantage of competition to the economy

➢ Resources may be wasted in a competitive market as when a business fails due to high competition.

Chapter 19: Small and Large firms

Basic definitions
1. Turnover: Revenues of the business

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 2. Balance sheet: is a financial document that lists out all the assets and liabilities of the business at the
end of each financial year

The size of the firms can be measured in 3 main ways:

➢ The turnover of the business
➢ The number of employees employed
➢ The total of the balance sheet

Small firms
These firms have limited growth potential and fill up a vast majority of the firms in a country. They can be
either sole traders (single owner businesses) or partnerships. (2-20 owner businesses) Advantages
➢ They are flexible as there is only one decision maker who would adopt to changes quickly. Hence, they
can easily cope up with surge or a fall in demand or to the market conditions. There is no delay in
time.
➢ They are able to offer personal services as most consumers would be prepared to pay higher prices if
they deal directly with the owner.
➢ Lower wage costs as there are trade unions and the employees are unlikely to demand for higher wages.
➢ Better communication as there are less employees. Therefore, messages would be clear and not
misunderstood. Hence, avoiding high costs of mistakes.
➢ Innovative as they face huge pressure to innovate as they compete with larger firms. So, to remain
competitive, they have to continuously bring in new products.

Disadvantages
➢ Higher costs: as they cannot exploit the economies of scale due to less output produced.
➢ Difficulties in raising finance: financial institutions may find it ‘risky’ to provide finance to small firms
as they may be unable to repay them along with interest payments.
➢ Difficulty in attracting quality staff: this is because highly qualified staff may expect higher wages and
more additional benefits (perks) which small firms are incapable of doing.
➢ Vulnerability: small firms are vulnerable to changes in market conditions. For example, in the case of
COVID-19, many small firms have already close down their operations as they have become
unprofitable.
➢ Monopolies: this is when there is one business dominating the whole market.

Large firms
Large firms are global giants known to be as Multinational companies. Some examples are: Nestle, Unileiver
etc.

Advantages
➢ They can easily access the economies of scale as they produce in large quantities
➢ They are also able to dominate the market due to their huge size. They can charge lower prices to
drive out smaller rivals from the market and later on increase the prices to a higher level.

37
 ➢ They can easily attract large scale contracts as they may be more efficient in completing projects on
time and are more recognizable to the public due to their giant size.

Disadvantages
➢ Too bureaucratic: large firms always have more paper work to complete. Decisions cannot be taken
immediately due to the red tape involved in decision making. So, they tend to lose more opportunities
than small firms do.
➢ Communication and Coordination problems: as the business increases in size, the number of employees
and number of machineries may increase. Hence, coordination problems may arise as managers may
not have tighter control with their employees as it may be impossible to control all of them. Hence,
message may be misunderstood causing huge mistakes to happen which may incur costs to the business.
➢ Poor motivation: in large firms employees at the bottom will not be given more importance. Hence,
motivation suffers causing an increase in the staff turnover rates. As a result, business costs may rise
drastically.

Factors influencing the growth of the business

➢ Government regulations: as governments are highly involved in releasing new regulations to protect
the consumers and the economy from being exploited, this may have a great impact on the firms. For
instance, governments may investigate mergers and takeovers to ensure that together the businesses
may not become monopolies and exploit the consumers by charging higher prices. Therefore, this may
prevent the growth of businesses.
➢ Access to finance: Some firms may have the desire to grow but are unable to raise the necessary
finance that is required. This is because financial institutions may be reluctant to provide small firms
with loans as they fear that these firms will not repay the loans alongside the interest payments.
Therefore, this may restrict the growth of certain businesses.
➢ Economies of scale: although some businesses find it easy to exploit the economies of scale due to
higher production, there are some small firms who may find difficulties in exploiting the economies of
scale. Hence, due to higher average costs they tend grow slowly or even not grow.
➢ Desire to spread risks: firms may want to diversify their product portfolio to spread their risk within
all their products. So, this reduce the amount that they may lose in case a single product fails as they
can rely on other products. Therefore, they may want to grow.
➢ Desire to take over competitors: businesses may want to grow so that they can take over their rivals
and increase their market share. Also, by driving off rivals or by taking over them they would be able
to dominate the market and charge higher prices. So, this can be a desire for firms to maximize their
profits.

Reasons for small businesses to stay small

➢ Size of the market: some businesses operate in a market where large businesses are unlikely to exist.
For example, luxurious product market. This is because the demand for these products are limited to
the rich people.
➢ Nature of the market: some businesses are existing in markets where barriers to entry are very low.
So, many firms can enter the market easily and therefore, competition is high. This may prevent small
firms from growing.
➢ Lack of finance: some firms have the desire to grow but unfortunately do not have the required as
they cannot even borrow due to their size and nature. So, this is another barrier for the growth of
small business.
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 ➢ Aim of the entrepreneur: this is usually another reason to restrict the business growth. Some business
owners want to run a business that would make them enough money to fund their lifestyle. They may
not want to shoulder the extra responsibility associated with increasing the size of the business.
➢ Diseconomies of scale: some firms may not like to grow much as they fear that due to diseconomies
of scale their average costs would rise significantly. Hence, this may also reduce the potential for
growth.

Chapter 20: Monopoly

Basic definitions
1. Patents: this is a license that prevents other firms from copying the design of the product made by the
firm. It can exist up to 20 years.
2. Natural monopolies: this is where one its more practical for a single firm to supply the entire market
at a low cost than more may small firms to supply the whole market.
3. National income: income of a country (total)
4. International market: where all country markets compete
Monopoly is a situation where there is one dominant seller in the market. They have almost 25% of the market
share.

Features of Monopoly
✓ One business dominates the market: this is when a product is supplied by only one supplier in the
market. However, there can be a monopoly even when there are other suppliers. For instance, if there
was a single supplier who dominates the market with more than 25%.
✓ Unique product: the product that is supplied by the monopolistic business is unique as they may be
highly differentiated from any other alternatives. So, consumers who may want to purchase the product
may have no any other choices.
✓ Price makers: monopolists can adjust the prices accordingly. For instance, they can increase the prices
by restricting the quantity of outputs. Or they can fix a lower price to sell more quantities.
✓ Barriers to entry: as the barriers to entry are very high and strict, this discourages firms from entering
the market. Hence, monopolies usually dominate the market and at times exploit the consumers.

Some of the common barriers to entry into the monopolistic market:

➢ Legal barriers: this is when the government wants to contract out a particular service to one firm. For
example, the water services. So, once the firms has the government contract, competition is legally
forbidden.
➢ Patents: as some firms have patents for their products, competition can be eliminated. Hence, higher
prices can be charged for the products.
➢ Marketing budgets: Monopolies are highly branded businesses who have already built trust and loyalty
for their brand. New firms may find it difficult to compete with these businesses as consumers may not
be willing to purchase their product as they are loyal to the monopolies and have more trust on them.
They also spend huge amount on advertisements.
➢ Technology: as monopolies are already established in the market and are highly profit making, they
may invest more on complicated machineries which may help to improve the efficiency of their
products. Therefore, small firma are unlikely to be competing with these businesses as they do not
have the required finance to fund the purchase these machineries.

39
 ➢ High start-up costs: setting up a business to compete giant businesses which are the sole producer of
a product can be an expensive process. Therefore, businesses are reluctant to come forward and
compete with these giant leaders.

Advantages of a monopoly
➢ Efficiency: When natural monopolies exist, the efficiency of the production would be improved due to
one supplier supplying the whole market. As there is no duplication of resources, there is no wastage
of resources.
➢ Innovation: as monopolies make huge profits, they spend more on research and development of new
efficient, innovative and low cost products. This would help an economy to improve their living
standards making life much easier with new products.
➢ Economies of scale: as monopolists are huge firms with high products, they are able to exploit the
economies of scale. Therefore, their average costs are lower which means prices may be lower. This
will also help them to be competitive in the international market which will help them to dominate
the international market and thus, increase the national income and employment opportunities.

Disadvantages of monopoly
✓ Higher prices: as there is no competition in the monopolistic market, the prices charged may be
extremely high. This is because consumers may have to purchase the product regardless of the price
charged as there is no any suitable alternative to the product. Therefore, consumers are exploited.
✓ Restricted choices: as there is less or no firms in this market, the choices for consumers are limited.
They have to choose from a restricted amount of choice.
✓ Innovation: as there is no competition in the market, monopolies do not find any incentive to innovate
products. This is because they are already dominating the market and therefore, there is no need for
them to be innovative.
✓ Inefficiency: They may also be inefficient as they may not have the incentive to be cost-efficient.
Therefore, due to their huge size, they may experience, diseconomies of scale and thus, average costs
start to rise. Hence, the services that they may offer will be of lower quality as to reduce the costs.

Chapter 21: Oligopoly

Basic definitions
1. Cartel: is when a group of firms agree to ho together and agree on pricing and output levels 2.
Oligopoly is a market that is dominated by a few large firms.

40
Features of Oligopoly
➢ Few firms: in an oligopolistic market there are few firms that would dominate the market and have
the most market share.
➢ Large firms dominate: the firms with the highest production capacity and the lowest costs would
dominate the entire market as they have higher market shares. Smaller firms would just copy the prices
charged by the large dominating firms.
➢ Different products: products sold in an oligopolistic market are similar but have differences. Firms
put more effort to differentiate their products from their rivals so that they can get higher revenues.
➢ Barriers to entry: they may also be high as the costs of starting up a business in an oligopolistic
environment would definitely be high. Hence, less firms enter the market.
➢ Collusion: this is when dominant firms in an industry decide to charge a fixed price, or supply in a
particular region or restrict the supply to force the prices up. This is illegal in many countries.
➢ Non-price competition: This is where firms use loyalty cards, free gifts etc. to compete instead of
reducing prices and causing disruption in the market where all firms may lose due to one firm’s
decision.
➢ Price competition: This is when firms compete by reducing their prices and offering more generous
discounts. This will force other firms to lower their prices and to maintain the market share and
eventually cause a price war. But this may exist only for a short period of time.

Advantages of Oligopoly
➢ Choice: These businesses compete by launching new brands with different features although they may
be the same product. Therefore, consumers have more choices. Small producers also provide choice
by supplying into a niche market.
➢ Quality: Businesses in this market will spend more money to differentiate their products in terms of
quality. Therefore, consumers get better products due to the non-price competition that puts pressure
on the business to improve the quality.
➢ Economies of scale: as the dominant firms in the m market produce high quantity of products, they
are able to exploit the economies of scale. Hence, due to lower average costs incurred the prices of
the products may be lower.
➢ Innovation: there is a contradiction over here. This is because as oligapolists make higher profits they
are able spend more on research and development of new products. However, due to the high amount
of spending on advertisements, the chance of innovation would fall.
➢ Price wars: consumers may benefit from price wars. This is when the market leader (usually the
business with the highest market share) reduces the price. Hence, the rest of the firms may follow the
leader and reduce their prices. This will provide consumers an opportunity to save money and so on.
However, this may only be for a short-term period.

Disadvantages of Oligopoly
➢ If a collusion takes place between firms, this can exploit consumers as the prices charged would be
high.
➢ In some oligopolistic markets a cartel may exist. Therefore, if output is restricted then the
consumers may have to pay higher prices for the output available. ➢ Lack of innovation as explained
above

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Chapter 22: The labor market Basic
definition
1. Wage rate: This is the amount of money paid to workers for their services over a period of time.
2. Dependency ratio: proportion of the population that are unable to work and are dependent on the
youth workers and the middle aged works. Dependency ratio = Extremely young + Extremely Old (only
for reference)

Demand for labor: Worker’s rewards are the payments that they get for their services. The demand curve
for labor for labor is similar to the normal
demand curve the wages per hour falls. learnt in the first few
chapters. The demand for labor increases as

Factors that affect the demand for labor

Demand for labor means the business’s need for labor. There are several factors that affect the demand for
labor in a country:
➢ Derived demand: This is when the demand for all products increases due to changes in income,
businesses will hire more workers as to cope up with the increased demand.
➢ Availability of substitutes: businesses may also take into consideration the costs and availability of
substitutes for labor such as machineries. If machineries were cheaper than labor then they may prefer
to hire machineries instead.
➢ Productivity of labor: if labor is more productive the business may hire more workers as they become
more profitable.
➢ Other employment costs: if the costs that are related to employment such as insurance and car costs
are increased then the demand for labor may fall.

42
 Increase or decrease in each factor will shift the demand curve to the right or left (same like the
normal demand curve)

Supply of labor: The supply of labor increases as the wages increases. This the number of people willing to
work.

Factors affecting the supply of labor

✓ Population size: As the population grows yearly there will be more people available for work.
✓ Migration: when people migrate to countries they increase the supply of labor in that country as they
are willing to work as to earn a living.
✓ Age distribution of the population: as the population age increases (65+) the dependency ratio
increases which forces the middle and the young aged population to work longer hours.
✓ Retirement age: as the retirement age is increased in some countries the number of people who are
willing to work may also rise. Hence, the supply of labor increases.
✓ School leaving age: this is the minimum age that children have to study until. If this age changes then
the supply for labor would also change accordingly.
✓ Female participation: due to favorable changes in the society and emerging of the equality acts,
females now prefer to work and thus, increase the supply labor in many countries.
✓ Skills and qualifications: this is where employees get more qualifications and they are more
employable. Also, as the number graduates entering the work force increase the supply of labor tends
to increase sharply.
✓ Labor mobility: this is the ease with which labor can move geographically and occupationally between
jobs. Geographically means that they can move from one place to another and occupationally means
they can move from one job to another.

43
Increase or decrease in each factor will shift the supply curve to the right or left (same like the normal
supply curve)

Wage determination
The wage of labors are determined by the supply and the demand for labor. Where the supply and demand
are equal, the equilibrium wage rate will be set. Minimum wage laws can also determine the wage rate. These
are laws which are set by the government above the equilibrium rate to protect the disadvantages working
groups. (Women, black people and minority ethnic groups)

What business have to look for when choosing the premise location?
❖ The quality, skills or qualifications that employees must have to maintain the standards of the business.
❖ The costs of labor
❖ The costs of training – this depends on the level of skills that employees possess.
❖ They should also ensure that there are enough workers in the site.
❖ They should also be convinced that there are enough workers if the business expands in the future.

Impact of education and training on the quality of human capital

Employers may want to employ workers who are professional, well-educated, qualified and responsible for
the job. They may invest on training for the following reasons:
➢ Increase the skills and the knowledge that is needed to do the jobs more effectively
➢ Increase the flexibility of workers
➢ Ensure that are workers are familiar with the company’s polices and health and safety procedures ➢
Make employees familiar to the job so that they don’t feel anxious while doing the job ➢ Improve the
motivation

Chapter 23: Impact of changes in supply and demand of labor and trade union activities in labor
markets
Basic definitions
1. Secondary picketing: when workers in one company strikes in a group at a particular location to support
the striking workers in a different company.
2. Closed shops: where all workers should belong to a particular trade union

P.T.O

44
Graphs for increase in demand for labor

The demand for a caps increased due to an increase in income in the country. Therefore, the demand for
production workers to produce more caps increased. As a result, the wage rate per hour has also rose.

Graphs for increase in supply for labor

The supply of labor in Saudi Arabia has increased due to the

increase I the educational qualifications in the country as more
graduates are emerging from top universities.

Trade unions
They are organizations or group of people who exist in a business or separately out of a business to protect
the rights of the workers. They fight for better pay, better working conditions and working time. Some of the
aims of Trade unions are:

• Negotiate pay and working conditions with employer

• Provide legal protection of members. For instance, represent in a court
• Put pressure on governments to on legislations in favor of labors
• Provide financial benefits when there is a strike (work is stopped due to a fight)

The trade union laws for limiting power is not required. If you want you can refer to the book..

45
Effects of trade unions on employment and wages
Trade unions usually negotiate for higher pay for their members. This can put pressure on the business and
make them to redundant (dismiss) some of their employees to lower the costs. However, this could be avoided
if:
✓ Labor productivity rises at the same time
✓ Employers are able to pass the increase in wage costs to customers in terms of higher prices ✓ If
profit margins are reduced

The diagram above shows the interference if the trade union has increased the wage rate from W1 to W2.
The supply of labor has become perfectly elastic.

Chapter 24: Government intervention

Basic definitions
1. Government intervention: this is where government get involved in a situation to help the
problems to be solved
Government intervention to deal with externalities
Taxation
Taxes are the government charges on certain activities that may create external costs. Taxes would increase
the costs of production for firms and therefore, encourage them to take immediate decisions. The tax
revenues generated by the government can be used to clean up pollution.

Analysis (Advantages)

✓ Generate more revenues which could be used clean up pollution.

✓ Tax system can be adjusted according to the gravity (size) of the problem.

✓ Directly influences on costs of production and therefore, immediate actions may be taken.

46
 ✓ Tax revenues could be used to develop economy.

✓ Can easily control external costs

Evaluation (disadvantages)

✓ Appropriate taxation cannot be charged as external costs cannot be measured.

✓ Impact of taxes depends on the magnitude of tax charged.

✓ Profits may lower, leading to lower investments and therefore, lower economic growth rates.

✓ Depends on elasticity of the product.

✓ It can be regressive – Impact may be more on poor.

✓ It may restrict external benefits

Subsidies
Subsidies are grants provided by government to businesses in order to encourage them to do something.
Subsides will lower the costs of production and would encourage firms to adopt new working practices and
purchase green technologies that would help to reduce the emissions and impact on the environment.

Analysis (Advantages)
✓ Subsidies will encourage producers to produce more merit goods
✓ Lowers the costs of production
✓ Greater efficiency
✓ Can easily control external costs

Evaluation (Disadvantages)

✓ Costs to the government

✓ Opportunity cost

✓ Depends on the magnitude

✓ Only effective in the short-term

✓ Firms become inefficient

✓ No monitoring systems by government

47
Government rules and regulations
The government may impose legislations to ensure that the concerned parties are aware of the punishments
and fines and therefore, reduce or eliminate the activities that may create external costs.

Analysis (Advantages)

✓ Simple and easy to understand

✓ Quick response as people and firms may fear the punishments or fines

✓ Cheaper to enforce

✓ Can easily control external costs

Evaluation (Disadvantages)

✓ Time lag
✓ Monitoring problems
✓ Negligence by firms
✓ Appropriate laws cannot be implemented based on the gravity of problems ✓ It may restrict external
benefits

Pollution permits
These are permissions that are granted by the government to discharge a fixed amount of pollution. If more
is required permits are to be purchased for extremely higher prices which may discourage firms from
purchasing permits and thereby, reducing the pollution.

Analysis (Advantages)
✓ High prices can discourage firms from purchasing extra permits to discharge extra emissions ✓
Marketable or tradable
✓ More revenues
✓ Can easily control external costs

Evaluation

✓ Depends on the elasticity of the product. If inelastic costs can be passed to consumers

✓ It may restrict external benefits

✓ It would be difficult to set appropriate levels of permits for each industry

✓ Lack of monitoring and negligence.

48
Fines
If fines are implemented on the consumption and production of products that may cause health damages (such
as tobacco) then the consumption and production would be comparatively lower. As a result, the external
costs (such as health issues) created by these products would be controlled. This is because people are fearful
for the fines due to the increased financial burden.

Analysis (Advantages)
✓ They can be adjusted according to the gravity of the problem
✓ Producers may fear the fines and may reduce the external costs created ✓ Help
government to control the external costs effectively

Evaluation (Disadvantages)
✓ Depends on the magnitude
✓ In the long-term it may not be effective

Government regulations aiming to increase the competition in the market

➢ Promoting competition: the governments all over the world may take measures to promote and to
prevent anti-competitive practices which may eliminate competition.
Some examples would be:
➢ To encourage the growth of small firms in the market, this will increase the completion and thus,
reduce the prices.
➢ Lowering the barriers to entry which will help firms to easily enter the market. They can do this easing
the legal procedures
➢ Introduce anti-competitive legislations such as protect the interest of consumers and therefore, the
consumers are not exploited.
➢ Limit monopoly power: governments should continuously monitor the monopolies to ensure that they
do not exploit the consumers by restricting the choices and increasing the prices.
➢ Protecting the interest of consumers: Government may have to intervene in the market to ensure
that consumers get the right information, better quality products, fairly priced products and the
products are fit to use. If not firms may exploit the consumers.

49
 ➢ Control mergers and takeovers: governments must regulate the formation of mergers and takeovers
as they may restrict the consumer choices and increase the prices by much.

Government intervention in the labor market

Government may intervene in the labor market by setting up a minimum wage rate. This means no employers
(managers) can pay their workforce (labors) below the minimum wage. If they do pay, they are entitled for
penalties and punishments.

Reasons for minimum wages

➢ It will benefit the disadvantaged workers who are paid based on their ethnicity, religion, gender or
color.
➢ As many low income earners claim for welfare benefits from the government, the expenditure for the
government is high. Therefore, by increasing their income through minimum wage laws this will reduce
the claims and thus, increase the money saved for other expenditures that improve the state of the
country. (Such as education and infrastructure)
➢ Improves the productivity in the economy as higher wages increase the motivation.
➢ This provides an incentive for the managers to invest on training as to get the maximum from the
workers as the paid highly.
➢ It reduces the gap between the rich and the poor.

Advantages and Disadvantages of Minimum wage laws

Advantages Disadvantages
Improves the labor productivity Increase the costs to business
Increase the incentives for people to work Increase unemployment economy (discussed in later
chapters)

Reduces the poverty in the country Could lead to higher prices as firms may pass on the
increase in costs to consumers through higher prices

Reduce the government expenses

50
Minimum wage graph

Unit 3: Government and the Economy

Chapter 25: Economic growth
Basic definitions
1. Macroeconomics: It is a study of a large economic system such as the world or country economic system
2. National income: is the value of all incomes added together in a country.
3. Economic cycle: shows the fluctuation of an economy between growth and decline (recession)
4. Unsustainable growth: growing by using all the resources available (Non-renewable resources) without
sparing anything for the future generations to come.
Economic growth is the increase in a country’s productive potential. It is measured in terms of GDP. When
economic growth is experienced, the national income of a country will rise.

Why do countries experience economic growth?

➢ Higher tax revenues
➢ Higher profits for business
➢ Higher income for citizens therefore, improved living standards
➢ Improved current account balance
➢ Fall in unemployment

GDP (Gross Domestic Product) as a measure of economic growth

GDP is the total value of all goods and services produced in an economy. It is known to be as the national
income of a country and a measure of economic growth. They only include the value of the final products and
not the value of components (raw materials) used to make the product.

Limitations of using GDP to measure economic growth

Factor Boom Downturn Depression Recovery

51
Growth High Growing at a GDP falls sharply GDP starts to rise
slower rate

Employment High Unemployment Unemployment Unemployment

begins to rise increases sharply starts to fall

Inflation Increasing Prices Prices may Prices fall sharply Prices start to rise
increase but at a
slower rate

➢ Inflation: If prices tends to increase then the GDP value may be overstated which means a wrong
figure may be calculated.
➢ Countries may use different accounting conventions to calculate
the national income
➢ The value of home produced goods such as subsistence farming
(farming in the backyard) should be considered
➢ National income figures should be adjusted for the size of
population
➢ National income statistics takes no account of externalities created by different economies
➢ Hidden economy: black market activities which taken place in an individual level and not
registered to taxation is not considered.
➢ External costs: as the economy grows the eternal costs such as pollution may affect the third
parties
➢ The living standards cannot be completely dependent on the GDP as other important factors such
as the amount of leisure time citizens have must also be taken into account. Economic cycle
➢ Red: Boom/Growth
➢ Yellow: Downturn/Recession
➢ Purple: Depression/Slump
➢ Green: Recovery/Upturn

Impact of economic cycle on Growth, Employment and Inflation

Impact of Economic Growth

✓ Economic growth: Employment levels would rise as businesses would need more workers to
produce high levels of output. Also, government will spend more on education and health care
sector which may consequently increase the jobs created.
✓ Standards of living: this would improve as consumers have more income, they may purchase
better quality products helping them to improve their living standards. And the emergence of
new technology has also helped in improving the standard of living during an economic growth.
✓ Poverty: the level of poverty would reduce drastically. This is because as business have high
demand, they may employ more people. As a result, poor people may get employed in
businesses and earn an income which could be used to fund the necessities for life. (Such as
food)

52
 ✓ Productive potential: the productivity of an economy would rise significantly if an economic
growth is experienced. This is because workers are more productive as they have more
incentive to work. (Motivational schemes used by businesses)
✓ Inflation: during a high growth, the prices of products would increase significantly due to high
demand. Businesses may increase the price as they are unable to cope up with the demand
causing a demand-pull inflation. (Discussed later)
✓ Environment: during a peak/economic growth the costs such as pollution and use of
nonrenewable resources can increase the spending for the government. This is because the
government may have to spend more on health care sector to treat the people who have health
issues caused by pollution and so on. Also, unsustainable growth will be experienced.

Chapter 26: Inflation Basic

definitions
1. Aggregate demand: this is the total demand in an economy
2. Interest: they are the costs of borrowing and the rewards for savings
3. Purchasing power: this is the amount of goods and services that can be bought with a fixed amount of
money

Inflation is the general rise in the price level in an economy. Governments may want a lower level of
inflation rates. Typically, between 2% to 4%. On the other hand, Deflation is a general fall in the price level
in an economy.

Reasons

➢ Ensure that costs of production for firms don’t rise

➢ Value of money remains doesn’t deteriorate
➢ Appreciation of currency doesn’t happen and worsen the current account balance

CPI and RPI as a measure of Inflation

Consumer price index (CPI) is the measure of general price level in an economy which excludes the retail costs
such as council taxes. Whereas, the Retail price index is the measure of general price level in an economy
which includes the house costs such as council tax etc.

There are 2 main causes/types of inflation:

➢ Demand–pull inflation: this is caused by the increase in Aggregate demand for a product. As businesses
are unable to cope up with increased demand, they increase their prices. Some reasons for higher
Aggregate demand are lower taxes, increase in income and rising demand for firms.
➢ Cost-push inflation: this is when the costs of materials and other costs for businesses increases. This
would increase the costs and lower the profits. In an effort to increase the profits or maintain the
profits, businesses would increase their prices. This is mainly caused by rising costs of imports, wages
and taxation.

53
Relationship between interest rates and inflation
This can be spoken in 2 ways:
1. When inflation rates are high, the interest rates may be increased. This is because, if the interest rates
are high, borrowing would reduce as it is costly. Therefore, people have less money to spend on goods
and services and thus, reducing the inflation.
2. When inflation rates are high, the interest rates may increase. This will attract people save more
money as the rewards are higher. Therefore, they would spend less which can result in lower spending
on goods and services. As a consequence, inflation rates would fall.

Impact of Inflation
➢ Prices: as the prices increase, the value of the money would fall which means the purchasing power
would reduce. As a result, less goods can be purchased with the same amount of money used last year
to purchase more goods.
➢ Wages: as the inflation level increases, employees may demand for higher wages as they are unable to
fulfil their needs with the same amount of money they earn due to the fall in purchasing power. Hence,
business costs would rise which could further increase the inflation rates.
➢ Exports: inflation may reduce the exports. This is because countries will be reluctant to purchase the
exports of this country as the prices are higher. Hence, the international competitiveness would be
lost. Therefore, the current account balance would worsen. (Discussed in the next few chapters)
➢ Unemployment: they can have 2 types of effects. One effect is the increase in unemployment as
businesses may face higher costs due to the inflation as the costs of raw materials and wages would
rise significantly. Therefore, they may lay off workers in order to cope up with the rise in costs.
However, unemployment levels may fall as inflation is caused by an increase in the aggregate demand.
Therefore, more workers will be employed by businesses to increase the production.
➢ Menu costs: if inflation increases, then the prices may have to be changed continuously. Therefore,
menus will have to be updated and costs of printing would increase.
➢ Shoe leather costs: consumers may spend time walking in and out of stores to find the best deals in
periods of high inflation. It’s a costs as it takes time and wears out the leather in the shoes.
➢ Uncertainty: businesses will not be able to take better decisions regarding the future. This is because
of the uncertainty caused by inflation which cannot ensure that profits may continue to fall or can rise
in the future. As a result, investment decisions may be postponed.
➢ Business and consumer confidence: Inflation may make consumers more anxious and they may not
borrow money rather save money. Also, businesses will postponed all their projects and have no hopes
for the future as the returns would be low. Therefore, growth rates in the country may fall.
➢ Investment: due to high levels of inflation, the investments in the country would reduce drastically.
This is because investors may shift to other countries as they may have less or no returns for their
investments. As a result, growth rates would drop significantly.

Chapter 27: Unemployment

Basic definitions
1. Redundancy payments: they are payments provided by the business for employees who leave after 5 or
more years of service to the organization.

54
Unemployment is the amount of people who are not employed and do not contribute to the national income
of the country. Government may want to reduce the unemployment rates.

Reasons
• Lower government spending
• Increase in social harmony
• Higher income leading to an increase in Aggregate demand
• Higher economic growth

Unemployment rate is measured using the ILO (international Labor organization method):

There are 5 main types of unemployment that can occur in an economy:

1. Cyclical or demand-deficient unemployment: This is an unemployment that is caused due to a fall in
demand which is caused by a downturn or a recession in an economy. This is because, when the AD
(Aggregate demand) in an economy falls, businesses may have to face higher costs as their profits are
lower. Therefore, they may lay off more workers to cope up with the high costs.
2. Structural unemployment: this is caused by the changes in the structure of an economy. They are of
3 main types:
➢ Geographical immobility: this refers to some people finding it difficult to move from one region to
another to get jobs.
➢ Technological changes: Fall in demand for labors as work that was previously done by workers are now
being replaced by machineries.
➢ Structural changes in the economy: decline in an industry for e.g.: Coal mining industry has led to
many coal miners finding it difficult to get job as they only have skills in jobs related to coal mining.

3. Seasonal unemployment: This is when the demand for certain workers may fall as outputs produced
fall in some seasons. For example, farmers may have less revenues at certain time of the year and
therefore, they may lay off some workers.

55
 4. Voluntary unemployment: This is an unemployment that is resulted from people deliberately choosing
not to work. This is because they are not prepared to work for the given salary or they don’t like to
work.
5. Frictional unemployment: This unemployment is caused when people to move between jobs. This is
not necessarily an unemployment because people have already obtained the job.

Impact of Unemployment

✓ Outputs: the productivity if the country would reduce as more people are not working. However, the
outputs can be high as most of the unemployment is caused due to technological developments which
could increase the productivity further.

✓ Use of scarce resources: the amount of resources wasted would be high as people are resources are
they are not maximized. As a result, the growth would be lower hence, the GDP rates would fall.

✓ Poverty: as unemployment increases in a country, the level of poverty would also rise significantly as
people do not have money to fund the necessities of their daily lives such as food and shelter.

✓ Government spending: the government expenditures will also rise drastically as they may have to
spend more on providing welfare benefits to the poor and unemployed. Hence, less amount of money
will be available to spend other parts of the economy.

✓ Tax revenues: the tax revenues may also fall as most of the tax is related to income. If people have
no income then they are not eligible for any tax payments. As a result, less amount of money will be
available to spend other parts of the economy.

✓ Consumer confidence: this may fall as people are unemployed and may suffer to fund the basic needs.
Also, employed people may lose confidence as they may fear their job to be lost. Consumers cannot
purchase whatever they want as the state provision will be less than wages or salaries earned from
employment.

✓ Business confidence: business confidence may also fall as the redundancy payments have to be made
which may increase the costs to the business and also revenues have fallen due to lower income for
citizens. Therefore, they are not likely to invest on projects.

✓ Society: people may be affected psychologically. The social harmony will be disrupted as stealing will
become common for survival. If a company that employs many people in the community closes down,
then the whole community will be affected. Environments may not be taken care and so on.

Chapter: 28 Current account deficit or surplus

Basic definition
1. Balance of payments: they are the record of transactions relating to international trade.
2. Primary income: the money received from the loan of production factors abroad
3. Secondary income: government transfers between countries
4. Balance of trade: the difference between visible exports and imports (tangible goods)

Current account is a part of the balance of payments where all exports and imports are recorded. There can
be a current account deficit which means that the import expenditures are greater than the export earning
56
which is not good for the country. Whereas, there can also be a current account surplus where the export
earnings are greater than the import expenditures.

The international transactions can be of 2 types:

1. Visible trade: trade in tangible products
2. Invisible trade: trade in services

The relationship between current account and interest rates

Exchange rate is the value of a currency in terms of another. The country’s exchange rate can appreciate
which means they may become stronger. Therefore, imports will increase and current account balance will
worsen. (Increase in deficit)
The country’s exchange rate can depreciate which means they may become weaker. Therefore, exports will
increase and current account balance will improve. (Increase in surplus)
(This topic will be explained in detail in the upcoming chapters refer to the last few chapters)

Real world examples of exchange rate

Different countries have different currencies. So, in order to exchange a currency with another we will have
to calculate the value of the currency in terms of another currency. If we want to convert US Dollar to UK
pounds, then the exchange rate at June 2019 is as follows:

$1 = £0.79
Therefore, if we want to calculate how many pounds will we get if we exchange $4 to pounds, We
need to cross multiply it to get £3.16

Reasons for Deficits and Surpluses

➢ Quality of domestic goods: If country produces better quality products then the overseas demand
would rise which would help to increase the exports. Imports would reduce as consumers may purchase
the goods produced in the country as they may be cheaper and of better quality. The current account
balance will improve.
➢ Quality of foreign goods: if the quality of the foreign goods are better, then the imports would rise as
citizens may prefer to purchase better quality products. While, exports will be lower as countries will
purchase the goods that are more superior. As a result, the current account balance would worsen.
➢ Prices of domestic goods: if domestic goods are cheaper, citizens will import less and exports would
rise due to lower prices. Hence, current account balance would improve.
➢ Prices of foreign goods: if foreign goods are priced lower comparative to the domestic products,
citizens may import more. This will worsen the current account balance.

57
 ➢ Exchange rates: if a country’s exchange rate is weak (depreciating) then exports will rise significantly.
Imports may become expensive and thereby, fall. As a consequence, the current account balance will
improve.

Impact of current account deficit

✓ Leakages from the economy: this is when consumers spend money out of the economy. Therefore,
the national income would fall while the unemployment levels would rise, both of which are dangerous
for an economy.
✓ Inflation: due to high demand for imports, prices may be increased. This can have an increase on the
prices of goods and services in the country as resources may be imported which would increase the
costs, consequently increasing the inflation levels.
✓ Lower demand for exports: demand for exports may be lower which can cause many domestic
businesses to fail. As a result, they may lay off workers which would increase the unemployment levels
in an economy. Also, as they no longer contribute to the national income, the economic growth rates
may also fall.
✓ Funding the deficit: there may funding problems that would arise. Therefore, governments may have
borrow an international loan which they may have to pay high interest payments. This may increase
the costs to the government and provide them less money to spend on other parts of the economy.

Chapter 29: Protecting the Environment

Basic definitions
Business activities and the way they damage the environment (The book provides a lot of irrelevant
information. So, the notes below summarizes the main points provided in the book and it combines both of the
subtopics)

✓ Mining: this is the extraction of resources from the earth. They use advanced machineries that produce
huge amount of sound and dust particles get into the air. Therefore, Noise pollution and air pollution
is experienced.
✓ Power generation: This is the burning of fossil fuels such as coal and oil to generate power. It produces
a lot of toxic gases such as carbon monoxide which means Air pollution will be experienced. It may
create noise which means Noise pollution could also be encountered.
✓ Chemical processing: they are produced to cure and prevent diseases and improve the quality of life.
They release hazardous air pollutants which can cause Air pollution. Factories can also cause visual
pollution as they may release the pollutants through pipes which will be unattractive to the eyes.
✓ Agriculture: Pesticides and fertilizers are used to increase the yield of the crops that are planted.
They also kill some aquatic life and continuous exposure to these chemicals can cause various diseases
such as headaches.
✓ Construction: this is the process of building premises with bricks and high use of machineries that
release very dangerous pollutants. Therefore, Air pollution is caused. Water may also be polluted as
some of waste materials may be washed in the rivers or lakes which could contaminate the water
causing water pollution. Noise pollution is also common as more machineries are being used up.

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Government intervention to overcome the problems
Park provision: This is where the government can provide parks which completely makes it illegal for any
business to locate their premises at. This preserves the natural beauty of a country and attracts many
tourists from all over the globe.
For the rest of the intervention methods refer to the Government intervention chapter 24 which has
detailed explanation of all methods that could be used by the government to overcome the above
mentioned problems.

Chapter 30: Income inequality

Basic Definitions
1. Regressive taxation: this is where the amount of tax charged increases as the income fall. (Burden is
higher on the poor than the rich as tax is fixed)
Income inequality is the differences in the income level of the rich and the poor that exists in a country.

Reasons for income inequality (some)

➢ Education, skills and natural talent will help people get into employment easily and therefore, earn
higher income.
➢ People who don’t work such as prisoners will receive lower income than other employed workers.
➢ People who own properties, shares and capital may enjoy higher income in terms of rent, share
dividends or interest payments.

You don’t need to learn the Lorenz curve

Poverty is of 2 types:
➢ Absolute poverty is where people do not have enough finance or the resources to meet the basic needs
of survival. They are also deprived from education, health care and other services.
➢ Relative poverty is where people have enough resources and finance to meet their basic needs but
unable to fund the average lifestyle of a citizen in a country. This may change overtime as the income
of people may increase.

Reasons to reduce the income inequality

✓ To meet basic needs: if people can meet their basic needs for survival, they will be able to come out
from the crisis of hunger and poverty.
✓ Raise living standards: when people are taken out of poverty the global living standards could increase.
This will also increase the level of education and thereby, increase the economic growth
for countries. Government revenues also may be high as they earn more tax revenues from highly
qualified workers.
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 ✓ Ethical reasons: it is a moral duty of everyone to help reduce the poverty. Several charity organizations
are formed to raise funds and provide to people who live in extreme poverty line.

Government intervention to reduce poverty

❖ Progressive taxation: this is where the tax is higher for the people of higher income while the tax is
lower for the people with lower income. In this way, the government can collect a proportion of the
income from the higher income earners and distribute them among the poor people. This will help to
reduce the income inequality gap as the poor will get richer and rich will face a fall in their income.
However, as the income of the rich is increasing year-on-year, this may further widen the gap.
❖ Redistribution through benefit payments: the governments’ can also earn tax revenues by imposing
tax on profitable businesses and using the progressive tax system. The revenues could be used to
provide welfare payments and benefits to the poor people and thereby, helping them to get richer and
meet their basic needs for survival. However, businesses may discouraged form operating in the country
due to higher taxes and thereby, leave the country resulting in a fall in the GDP.
❖ Investment in health and education: investing on education will provide free schooling and other
tuition for poor children. Therefore, they can afford to learn and develop a range of skills from problem
solving, decision making to analytical skills which will help them to become more employable and thus,
assisting them in an earning a steady income. Also, investing on health care will help to provide free
vaccinations to poor children which will aid in reducing the spread of dangerous diseases such as the
COVID -19. As a result, both of which will reduce the rich-poor gap and thereby, help to improve the
state of an economy.

Chapter 31: Fiscal Policy

Basic definitions
1. Debts servicing: this is when government use its revenues to pay the national debt owed to other
countries.

Fiscal policy is the use of government expenditures and taxation to control the aggregate demand in an
economy.

Government revenues
The main source of government revenues are through taxation. Government imposes 3 types of taxes to earn
their revenues:
✓ Direct taxation: these are the taxes that are charged on the income or profits of individuals or firms.
Example: Income taxes are charged on the income of a citizen or a resident and corporation tax is
charged on the profits of firms.
✓ Indirect taxation: these are taxes that are charged on the consumer expenditures. (Spending)
Example: Value Added Tax. (VAT) They can be of various forms such as Business rates that are annually
paid by businesses for operating and council tax paid by households.
✓ Environmental tax: these taxes are charged on businesses (especially) to protect the environment
from harmful substances polluting them. For example, Landfill tax are imposed on the disposal of waste
on landfill sites.
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 The rest of the taxes mentioned in the book are just examples to know. They are not relevant for
study purposes.

Government expenditures
The government will incur expenditures in various forms. One form is when they directly provide some
services which are failed to be provided by the private sector due to some problems. (Refer previous
chapters – Market Failure) For instance, to provide the public transport, police services and fire services.

Fiscal deficit and surpluses

Fiscal deficits are the amount by which the government expenditures exceed the government revenues. On
the other hand, Fiscal surpluses are when the government revenues exceeds the government expenses.

Impact of Fiscal deficits and Fiscal surpluses Fiscal

Deficits
✓ As more money is to be borrowed, the national debt increases which means that most of the
government revenues earned should be used on debt servicing.
✓ Future generations will be overburdened with the debt of the previous generations. Hence,
improvements will be restricted.

Fiscal Surpluses
✓ Money generated could be used to spend on public services and provide subsidies to growing businesses
helping them to expand and improve their international competitiveness.

Fiscal policy and the Macroeconomic objectives

This policy uses 2 policy instruments to control aggregate demand. They are taxation and government
expenditures. Expansionary fiscal policy is when the taxation is recued and the government spending may
be increased. Contraction fiscal policy is when the taxation is increased and therefore, government
spending is reduced.

➢ Economic growth: Expansionary fiscal policy can be used to stimulate the economic growth. This is
because lower taxes will help increase the aggregated demand and thus, increase the profits and
investments which would result in higher growth rates.

➢ Inflation: Contraction fiscal policy should be used. This is because the higher taxes will discourage
buyers from purchasing as their income will be lower due to higher taxes. As a result, the Aggregate
demand fall and thus, prices starts to drop.

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 ➢ Current account deficits: Contraction fiscal policy should be used as the higher taxes will lower the
disposable income for consumers and thereby, discourage them to purchases goods form other
countries. Hence, demand for the imports would reduce helping to reach a current account
equilibrium.

➢ Unemployment: Expansionary fiscal policy should be used as lower taxes would increase the aggregate
demand. Therefore, to cope up with higher demand and increase the production, firms may employ
more workers. Thereby, reducing the unemployment rates.

➢ Fiscal policy and the government: Environmental problems can be solved by Contraction fiscal policy
as the taxes imposed will discourage firms from polluting. Therefore, environment will be protected.
Also, Expansionary fiscal policy can be used to increase competition as the government will increase
their spending on providing subsides to start-up or small firms. As a result, more competition and lower
prices.

Chapter 32: Monetary Policy

Basic Definitions
1. Quantitative easing: purchase of financial assets from the commercial banks by the central banks to
increase the flow of money into the commercial banks from the central banks. Therefore, more loans
can be facilitated.

Monetary policy is the use of interest rates and money supply to control the level of aggregate demand in
an economy. Money supply is the total amount of money that is circulating in the economy. Interest rates
are the rewards for savings and the costs for borrowings.
Important point to remember: Interest rates and Exchange rates are directly proportional.
(I.e. when interest rates increases, the currency becomes stronger (Appreciates))

Differences in interest rates reasons is not included in this book as they are not needed for studies. Just
for reference purposes they can be referred to the IGCSE book.

Functions of Central Banks

✓ Implementation of the monetary policy.
✓ Achieving the inflation target.
✓ Acting as a government’s banker: They handle government department accounts such as preparation
of budgets, provides financing for the government when the government has the short-term deficit, it
represents a country in international conferences and provides financial advice to the governments at
times of financial crisis.
✓ Banker to banks: central banks only provide the license and approval for commercial banks and all
commercial banks are under the supervision of the central bank.
✓ Lender of last resort: when commercial banks face financial issues they will expect the support of
central bank to maintain their liquidity.
✓ Setting the interest rates.

Interest rates are set by the Central bank which involves a Monetary Policy Committee (MPC) who are of 9
economic experts. When setting interest rates the following will be taken into the consideration by the MPC:
➢ Inflation rate
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 ➢ Economic growth
➢ Unemployment

The normal inflation target that is set by most Central Banks all around the world will be around 2%.This is to
ensure that the drawbacks of inflation are avoided and the benefits of deflation are enjoyed.

Impact of changes in Interest rates on Macro-economic variables

➢ Inflation: the increase in price will begin to slow down. This is because due to high interest rates
consumers are reluctant to borrow money as they are costly. Also, they may want to save more as the
rewards are higher. As a result, both of which will reduce the Aggregate demand which is the main
cause for increasing prices.
➢ Economic growth: when interest rates are lower, the growth rates will be higher. This is because
borrowing is cheaper, hence, businesses may borrow more money to expand or invest on projects.
Consumers may also borrow money to purchase more goods. Bot of this will increase the Aggregate
demand and thereby, increase the economic growth rates.
➢ Unemployment: due to higher aggregate demand caused by lower interest rates, businesses are more
willing to employ people as to cope up with the increased demand. Hence, unemployment rates fall.
➢ Current account: as mentioned in the beginning, interest rates are directly proportional to the
exchange rates. Therefore, higher interest rates will appreciate the currency. (Currency is stronger)
Therefore, imports will be increased which will cause a severe current account deficit. However, there
is a contradiction here. When interest rates are increased the Aggregate demand will fall. So, imports
will fall helping to improve the current account.

It depends on:
❖ The income elasticity of the imports: if the demand for the imports were income elastic, then higher
interest rates would reduce the imports.
❖ The strength of the link between the interest rates and exchange rates: if this link is stronger then
higher interest rates will increase the imports.
❖ The price elasticity of demand for imports and exports: if the PED for the exports and imports are
elastic, then increase in interest rates would increase the imports.

How changes in interest rates affect consumers and firms

When interest rates fall,
Consumers

• Demand for Loans increases and better quality products are purchased
• Mortgage payments fall
• However, the rewards for savers will be lower.

Firms
• Interest costs fall, therefore, higher profits
• Increase business confidence and investments will be higher
• Currency appreciates, therefore, importing raw materials will become cheaper
• Investment returns will be higher
• However, the rewards for saving retained profits will be lower.
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 (Vice Versa for increase in interest rates)
Just have an idea of Quantitative easing:
Why is quantitative easing used?
It is used to help an economy to recover from a recession and to help monetary policy committee to achieve
the target inflation rates. (Which may be higher than the current rate)

The process of Quantitative easing in simple words

❖ Step 1: First central bank estimates by how much money is to be increased in the country to stimulate
the aggregate demand.

❖ Step 2: Then central bank creates money (Can be by printing notes) and use this money to purchase
financial assets such as: securities and bonds from financial institutions.(commercial banks)

❖ Step 3: Financial institutions (commercial banks) now have more money.

❖ Step 4: This helps financial institutions (Commercial banks) to lend more money to the general public
for lower interest rates.

❖ Step 5: As a result, borrowing becomes cheaper which would attract individuals, investors and
businesses to borrow more money from these banks.

❖ Step 6: As a consequence, Aggregate demand increases and this helps an economy to recover from a
recession due to higher profits, better living standards and a higher investments as costs of borrowing
reduces.

Chapter 33 Supply side polices

Basic definitions
1. Aggregate supply: this is the total amount of supply in an economy.

Supply side policies are the policies that are used to increase the Aggregate supply in the economy.

Impact of Supply side policies (SSP) on Productivity and Total output

Productivity
This is to increase the productivity of businesses in an economy. They can improve flexibility by reducing
intervention of the government on the labor market such as imposing minimum wage laws and so on. This will
help to reduce the costs for firms. Another approach is to increase investments on training and education.
This will make employees less anxious and be more familiarized with their jobs. As a result, productivity can
be maximized.

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Total Outputs
By using effective supply side policies such as reduction in taxes (discussed below) the productive potential
of the economy could be increased by the government. Therefore, firms starts to increase their production
and produce more outputs. Hence, inflation is likely to be avoided.

Impact of SSP’s on Macroeconomic Objectives

❖ Privatization: this is the transfer of public assist or businesses to private sector businesses. By doing
so, the competition can be increased. Therefore, consumer may get better quality products for
reasonable prices. Also, production may be increased as private firms are more efficient which will
help to reduce the inflation rates in a country.
❖ Deregulation: this involves reducing the paper work and unnecessary licenses to be obtained. This
helps new start-up businesses to easily begin trading which will help to increase the total output in a
country and also promote competition which may provide a wide range of goods and services to
consumers. However, less regulation can also cause serious issues such as the financial crisis of 2008.
❖ Education and Training: By investing on education, governments in various countries can ensure that
their citizens or youth are educated and develop a range of skills from writing to analyzing information.
This will make them more employable and thus, unemployment levels may fall. Training will help to
reduce anxiety at work place and thereby, improve the productivity of the workers. However,
investment on education is expensive and the returns will take a long time to be enjoyed.
❖ Polices to boost regions with high unemployment rates: SSP’s can be targeted specifically to certain
regions of a country. This will help them to ensure that the right treatment is given to the right part
of the country. As a result, the overall performance of the country would boost.
❖ Infrastructure spending: Investment on infrastructure helps a country to improve its transport and
communication. Therefore, private sector firms may find it easier to distribute goods between retail
shops and the warehouses. As a consequence, the delivery and the production process is faster.
❖ Lower taxes to stimulate investments: Investments are the main driving force of economic growth. If
investments are increased then economic growth can be accelerated. Therefore, governments have to
reduce the taxes and make the economic state more favorable for investors, so that they invest more.
They can do this by:
• Reducing the taxes on profits
• Providing tax incentives to encourage people to save more and buy more shares
❖ Lower taxes on income: to encourage working: by reducing the taxes, government can increase the
output levels. This is because more citizens will be encouraged to work due to lower income taxes
which means higher income. As a result, more workers will help to increase the overall productivity.

Government controls were already discussed in Chapter 13 Page 29

Chapter 34: Relationship between objectives and Policies
Conflicts between Macroeconomic objectives
Governments may have to face unexpected conflicts when trying to achieve the macroeconomic objectives.
They are:

1) Inflation and unemployment: when central bank wants to control inflation they may use the
contraction monetary policy. This would increase the interest rates in the country. Therefore, the
costs of borrowing will be higher. Hence, citizens will be reluctant to borrow money and thereby,
reduce their spending. Hence, profits fall for firms and thereby, they may lay off workers to cope up
65
 with increased costs. As a consequence, this can have an impact on the unemployment rates. OR firms’
costs would increases when interest rates increases as they have to pay higher interest payments for
the loans borrowed. To cope up with the increased costs they may lay of some workers, increasing the
unemployment levels in the country.

2) Economic growth and protection of environment: when governments use expansionary fiscal policy
to increase economic growth rates, this may lower taxation and increase the government expenditures.
Therefore, firms will have more profits and they may increase their investments. As a result, more jobs
are created and citizens who were previously unemployed would now be employed. Therefore, their
income would rise which could encourage them to different mode of transport such as Air transport
and Land transport. Hence, more CO2 is emitted which will increase the pollution in the environment.

3) Inflation and equilibrium on current account: when government wants to control inflation they may
use the contraction monetary policy. This would increase the interest rates in the country. As interest
rates and exchange rates have a link (directly proportional) this may appreciate the currency. As a
result, import expenditures would increase as imports become cheaper and export earnings would fall
as exports become expensive and uncompetitive in the international market. Therefore, import
expenditure would exceed the export earning causing a current account deficit.

4) Economic growth and income inequality: when governments use expansionary fiscal policy to increase
economic growth rates, this may lower taxation and increase the government expenditures. Therefore,
when income tax is lower the rich will become richer and poor will become poorer. This is because
reduction in taxation would increase the income earned by rich people and would reduce the income
earned by poor as welfare benefits would be lower due to lower tax revenues.

5) Economic growth and Inflation: When expansionary fiscal policy is used to increase the economic
growth by reducing the taxation, consumers may have more disposable income which will increase
their purchasing power. Hence, they may purchase more goods and services which may increase their
Aggregate demand. As a result, therefore, due to higher aggregate demand, businesses may increase
the prices to cope with limited goods and unlimited demand. Hence, inflation rates may rise.

Evaluation for the Conflicts

➢ Tradeoff between inflation and unemployment: In order ensure that unemployment rates don’t rise
the Governments can spend more infrastructure development of the country which would help attract
more. Foreign direct investment (MNC’s) which would create more job opportunities. Also, subsidies
can be provided for small firms to expand and thereby, create more jobs.

➢ Tradeoff between economic growth and protection of environment: subsidies can be provided to
the firms to invest in green technologies and bring out more environmentally friendly products. E.g.:
electric cars

➢ Tradeoff between inflation and current account balance: Governments can increase the exports by
providing export firms tax incentives and other incentives to increase their export and reduce the
prices of the export products. Hence, this will help them become competitive in the international
market. As a result, current account balance would improve.

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 ➢ Tradeoff between economic growth and income inequality: government can charge progressive
taxation (which involves charging higher tax on rich people incomes and lower on poor people’s income)
to increase their tax revenues and to provide welfare benefits and other benefits to these people who
live in poverty and thereby, narrowing the rich-poor gap OR reducing the income inequality.

➢ Trade-off between economic growth and inflation: government can provide subsidies to firms which
will help them to reduce the costs. As a result, they may increase their supplies which can result in a
fall in prices while the needs of consumers are being met.

Unit 4: Global economy

Chapter 35: Globalization Basic

definitions
1. Interdependence: this is where the action of one country influences the other countries.
2. Tariffs and Quotas: they are trade regulations that restricts the entrance of foreign products
3. Multinational companies (MNC’’s): these are large companies who have their headquarters in one
country and their operations all over the world. (Explained in detail in the next chapters)
4. Offshoring: Practice of getting the work done in another country to save more money as they are
cheaper

Globalization is the growing interconnection of the world’s economies. Some of the main features of
Globalization are:
➢ Goods and services are traded freely across all international borders.
➢ People are free to live and work on the country they chose
➢ There is a high level of interdependence between nations
➢ Capital can flow between different countries
➢ There is a free exchange of technologies and intellectual properties across borders

Reasons for Globalization

Fewer Tariffs and Quotas: these regulations/restrictions restrict the flow of foreign into the country.
Globalization helps firms to set their operations in other countries and thus, they can avoid these trade
barriers and grow drastically.

Reduction in the costs of transports: the transport network has improved over the years and this has helped
to increase the number of destinations and make transport of goods much easier. Hence, the costs has lowered
and this has enabled companies to trade internationally.
Reduction in the costs of communication: over the years the advancement of technology has helped to
improve the communication process. Emails for instance, helps to send messages within fractions of seconds
from one part of the world to another. As a result, the costs and the time that it takes to communicate has
fallen and thereby, increasing the international trade.

Significance of MNC”s: these large giants has helped to increase the international trade as they dominate the
international markets by supplying goods all over the world.

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Impact of Globalization and Global companies

Individual countries
➢ Increase in national income as MNC”s make high profits and invest heavily
➢ Reduce in Unemployment in the country
➢ As outputs may be sold out of the country, the foreign currency reserves will rise
➢ Improvement in current account balance – As exports rises
➢ The facilities of suppliers will be modernized with the assistance of MNC’s
➢ However, the events of one country can affect the events of other countries Eg. Financial crisis 2008

Governments
➢ Tax revenues – helps to increase the spending on other parts of the economy such as infrastructure and
education
➢ New business development – Help increase the national income
➢ Reduce government expenditures on unemployed
➢ However, repatriation of profits and the avoidance of taxation can make the government lose more
form the MNC’s

Producers (MNC’)
➢ Access to huge markets: Higher revenues as the products can be sold globally
➢ Lower costs: EOS can be exploited as they produce in large quantities to serve the global market
➢ Access to labor: MNC’s can gain access to labors from different countries with high qualification and
experience
➢ Reduce taxation: they can do this by locating some of their operations in countries where the tax rates
are lower. Hence, profits can be maximized.

Consumers
➢ Prices will be lower: this is because of EOS
➢ Wider range of goods and services
➢ Better living standards – Better quality products
➢ MNC’s may dominate the market and thereby, charge higher prices

Workers
➢ Creation of new jobs
➢ Labors can move freely between countries in search of better jobs
➢ Minimum wage laws of developed countries has helped to encourage workers to work
➢ Workers learn new skills through the training schemes offered by MNC’s ➢ However, when off shoring
happens some workers are made redundant

Environment
➢ MNC’s are usually involved in extraction of resources which would cause Air pollution
➢ Transport of goods and services can increase the greenhouse gases in the atmosphere
➢ Non-renewable resources may be extracted which will reduce the availability of resources for the
future generations (Unsustainable growth)
➢ However, as MNC’s are giants they can afford to use latest green technologies which will help to reduce
the negative impact on the environment.
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Chapter 36: Multinational companies and foreign direct investments
Basic Definitions
1. Host countries: this is the country that the MNC would enter into.

Multinational companies (MNC’s) are firms that have their Headquarters in one country and their operations
all over the world. Some of their prominent features are:

✓ Huge assets
✓ Highly qualified employees
✓ Powerful economically and politically
✓ Efficient as they can exploit the EOS
✓ Advertisements and marketing capabilities
✓ Highly advanced and up-to-date technology

Foreign direct investments (FDI’s) occurs when a company makes an investment in a foreign country in
expectations of higher returns ion the future. (Examples: MNC’s)

Reasons for the emergence of MNC’s/FDI’s

➢ Economies of scale: as businesses are able to lower their costs when they produce more number of
outputs, this reduces the overall costs. Hence, they begin to trade globally by selling goods out of the
country.

➢ Access to natural resources and cheap resources: businesses may require huge amount of resources
to produce goods and services. As a result, they may locate their firms in countries where these
resources are cheaper. Hence, they are able to lower their costs. Also, countries import the food
materials that they don’t have access to.

➢ Reduction in the costs of transports: the transport network has improved over the years and this has
helped to increase the number of destinations and make transport of goods much easier. Hence, the
costs has lowered and this has enabled companies to trade internationally.

➢ Reduction in the costs of communication: over the years the advancement of technology has helped
to improve the communication process. Emails for instance, helps to send messages within fractions of
seconds from one part of the world to another. As a result, the costs and the time that it takes to
communicate has fallen and thereby, increasing the international trade.

➢ Global reach (larger customer base): businesses locate their firms in different countries as to earn
higher revenues. This is because there a wide number of customers all around the world. Hence, this
increases their profits.

Advantages of MNC’s/FDI’s

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 ❖ Job creation: When these global giants enter a country they create huge number of jobs. This helps a
country to reduce its unemployment rate.

❖ Investment in infrastructure: governments in different countries may want to attract FDI’s who may
bring greater benefits to the country. In order to attract these FDI’s, they may invest heavily on the
building proper transport networks and better premises. Hence, this will benefit all people in an
economy.

❖ Developing skills: Government may spend highly on education and vocational training to attract MNC’s.
This may help enhance the skills of workers and students which will attract more investment into the
country. When MNC’s enter the country they provide the required help and training to the suppliers.

❖ Developing capital: When MNC’s enter a country, they may invest on facilities or factories which may
be updated with installing of new technologies and so on. Also, suppliers may invest on more capital
projects to expand their production capacity which may help them to attract MNC”s orders.

❖ Tax revenues: as MNC’s enter a country, their profits will be taxed by the host country. Hence, there
will be a surge in the tax revenues which may provide the government of the host country a lump sum
of money which could be invested on education or infrastructure which may help to boost the economic
growth rates of the country.

Disadvantages of MNC’s/FDI’s

➢ Repatriation of profits: This is when the profits made by the MNC’s are transferred to the countries
where the MNC is based on. Therefore, host country loses out. This is because there resources are used
to make profits but there are no rewards for using it.

➢ Tax avoidance: this is when powerful MNC’s such as Apple and Google avoid paying their taxes. Hence,
the host country would lose from this as well. As a result, developing countries where the government
is weak or corrupt may lose a massive amount from these powerful giants.

➢ Environmental damages: MNC’s who are usually involved in extraction of natural resources and so on
may damage the environment. This is because they may cause various types of pollution from Air
pollution to noise pollution. This can increase the amount of health issues which may cost the
government and increase their expenditures. .

Chapter 37: International Trade

Basic definitions
1. Free trade: this is when the goods coming into or going out from the country are not taxed.
Reasons for countries to trade internationally (free trade)

➢ Obtain goods that cannot be produced domestically: Due to lack of resources many countries find it
difficult to produce some goods. Therefore, they can easily import these from other countries.
Example: Diamonds cannot be produced in all countries.

➢ Obtain goods that can be bought more cheaply from overseas: this is when countries have the ability
and resources to produce the goods but they can purchase these goods from overseas for cheaper prices

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 as other countries may specialize in the production of these goods therefore, their costs may be lower.
Hence, saving a lot of money.

➢ Selling off unwanted commodities: this is when countries have a lot of resources where they cannot
use it all by themselves. Hence, they can sell it overseas which will help to increase revenues.

Advantages of Free trade

❖ Lower prices and increased choices for consumers: goods purchased from overseas may be of lower
prices as the costs of production may be lower due to lower prices of raw materials. Therefore,
consumer’s living standards may improve. As there are variety of choices, consumers can chose the
best quality product for reasonable prices.

❖ Lower input prices: this is because the raw materials produced in other countries may be of lower
prices. This is as a result of specialization. Therefore, the costs of production for businesses importing
raw materials may be lower. Hence, profits can be maximized.

❖ Wider markets for business: if free trade is enabled, businesses will have a larger consumer base. This
will help them to sell their products and tailor them according to the needs of customers in different
locations. As a result, revenues can be maximized.

Disadvantages of Free trade

o Competition for domestic businesses: due to the free trade (open economy), domestic firms will face
higher competition. This can be damaging to their revenues as they have to compete with larger giants
which may be difficult. As a consequence, their profits margins would lower drastically.

o Unemployment: due to free trade, unemployment rates would rise. This is because as the revenues
for domestic businesses fall and the total costs stats to rise, they may lay off workers to reduce the
costs. As a consequence, the unemployment levels in the economy will begin to rise due to the changes
in demand patterns. (Caused by increased imports of quality products from abroad)

Chapter 38: Protectionism Basic

Definitions
1. Protectionism: it is an approach that is used by governments to protect the domestic producers from
overseas competitions.
2. Trade barriers: they are the methods used to restrict the imports into the country.
3. Dumping: this is where an overseas firms sells a large amount of goods in a country below the costs in
a domestic market
4. Tariff: it is a tax that is paid on exports or imports
5. Quotas: restriction on the quantity of imports
6. Retaliation: this is when the trade barriers will be imposed on countries that impose trade barriers just
to take revenge.

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Reasons for protectionism

❖ Prevent dumping: government may use trade barriers to protect the domestic industries from
dumping. This is when an overseas firm sells a large amount of goods in a country below the costs in a
domestic market. This will make it difficult for domestic businesses to survive in the market and thus,
they may leave the industry which will affect the government’s tax revenues and increase the
unemployment rates.

❖ Protecting employment: governments may use trade barriers to ensure that employment is protected.
Due to free trade, unemployment rates would rise. This is because as the revenues for domestic
businesses fall and the total costs stats to rise, they may lay off workers to reduce the costs. Hence,
ensuring that unemployment rates are low and stable.

❖ Protecting infant industries: Infant industries are small industries that have just begun to grow.
Governments must protect them from large overseas rivals. Therefore, by imposing import restrictions,
this will give these industries a chance to expand and grow.

❖ To gain tariff revenues: imposition of trade restrictions would involve the use of tariff or quotas. This
will help the government to raise huge amount of revenues which could be spent on enhancing public
services or infrastructure of the country which will help to attract more FDI’s and thus, increasing the
economic growth rates.

❖ Prevent entry of harmful or unwanted products: barriers may be used to prevent the selling of
unwanted or harmful products by overseas producers such as Tobacco.

❖ Reducing the current account deficits: by imposing tariffs, the imports will become expensive and
therefore, consumers would prefer purchasing the domestic products. Hence, imports fall which will
help to improve/strengthen the current account.

❖ Retaliation: this is when the trade barriers will be imposed on countries that impose trade barriers
just to take revenge. Hence, both countries will find trading difficulties and have current account
impacts.

Methods of protection

Tariffs or custom duties

They are the taxes on imports to make them more expensive. This reduces the demand for foreign goods and
increases the demand for cheaper domestic products. As a result, foreign firms will be protected and current
account deficits can be avoided.

Advantages
• They raise revenues for the government
• Lower current account deficits
• Protect the domestic producers from facing overseas competition.

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Disadvantages
• If the tariff is set too high, government revenues will be zero due to no imports.
• Less choices for consumers
• Retaliation would reduce the export earnings

Quotas
They are the physical limits of the quantity of imports allowed into the country. This would reduce the
competition that domestic producers may face. And also, increase the prices of these products hence,
discouraging citizens and resident from purchasing these imported goods.

Advantages
• They physically limit the amount of imports entering the country
• In the short-term, the prices may be stable, therefore, people may purchase the imports. This will
provide the domestic producers the opportunity to build up stocks which will be needed when the
prices of imports starts to rise.
• They are used to protect certain industries such as Agriculture

Disadvantages
• Domestic producers may be over protected and thus, fail to improve efficiency
• Restricted choices

Subsidies
This involves giving financial supports such as money, tax breaks or grants. This helps to lower the costs of
domestic producers and therefore, they lower their prices. As a result, they are able to easily compete with
the foreign products as they may seem to be much cheaper. They can also easily break into the international
market and increase the exports.

Advantages
• More domestic firms are encouraged to enter the market
• This helps to increase the employment, export and strengthen the current account

Disadvantages
• Costs to the government
• Opportunity costs: the money spent on export subsidies could be used for education and so on.

Governments are encouraged to promote free trade instead of restricting. This is because they increase the
choices for consumers and reduce the prices for goods and services. If domestic producers are exposed to
competition they may be more competitive, innovative and produce better quality products.

Diagrams to show Tariffs, quotas and subsidies

Tariffs and Quotas

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 P.T.O

These barriers restricts the amount of

supply. Hence, the supply curve moves upwards and increases the prices.

Subsidies

This barrier increases the supply. Hence, the supply curve moves downwards and reduces the prices

Chapter 39: Trading Blocs Basic

Definitions
1. Members: they are the countries inside the trading bloc
2. Non-members: they are countries out of thee trading bloc

Trading blocs are formed when group of countries situated in the same region join together and enjoy trade
with no barriers such as tariffs or quotas. This is where free trade is encouraged as there is no any form of
trade barriers among members. But there may common tariffs or quotas set when importing from non –
members.

They are of different sizes:

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Preferential trading areas (PTA’s)
This where members agree to remove trade barriers on various goods and services although some of the goods
are not covered in this free trade policy.

Free trade areas (FTA’s)

• Completely free of all trade barriers
• Members can impose trade restrictions of non-member countries

Customs unions
• Same like FTA’s
• But they impose a common set of trade barriers for non-member countries
• Goods imported from non-member countries can be transported to member countries

Common markets
• Same like customs unions
• Allow free flow of capital and labor between member countries Member countries
have the same regulations and standards

Economic unions
• Same like common markets and custom unions
• Aims for more integrations

Impact of Trading Blocs on member states

Advantages
• Goods will be cheaper
• More consumer choice
• Higher economic growth
• Increase in quality of goods
• Innovative products
• Larger consumer base
• Attracts FDI
• Closer cooperation between members
• Reduction in cross border conflicts

Disadvantages
• Trading blocs only encourage regional free trade and not world free trade
• There is a higher financial costs and therefore, the tax payer bears the burden
• Regional monopolies may form which may exploit the consumers

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 • Members may become too vulnerable to trade within the bloc and may be highly affected with changes
in demand patterns in the bloc.
• New practice, laws and regulations may be implemented to the member country after joining the
trading bloc.

Impact of Trading Blocs on Non-member countries

Non-member states may find it difficult to trade among other countries due to the barriers and common tariffs
imposed.

Examples of Trading Blocs

NAFTA (North America Free Trade Agreement)
Joining of USA, Canada and Mexico

ASEAN (Association of Southeast Asia nations)

Joining of 10 members including Thailand, Malaysia, Singapore and others

SACU (South African custom unions)

Joining of Botswana, Namibia and others.

Chapter 40: World Trade Organization (WTO) and World Trade patterns Basic
Definitions
1. Trade liberalization: moving to greater free trade with the removal of free trade barriers

World trade organization (WTO) is an internationally recognized body that persuades countries to abolish
trade barriers and promote free trade around the globe.

Roles of WTO
❖ Trade negotiations: This is where WTO bring different countries together and negotiate for a free
trade agreement towards the trade liberalization. They draw trading agreements which addresses
various issues such as dumping, unfair subsidies and quality of the products.
❖ Implementation and Monitoring: A committee is being appointed by the WTO to monitor the trade
in goods, services and intellectual property rights. Countries must submit reports to WTO as a part of
the monitoring process.

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 ❖ Settling disputes: Countries bring about their disputes faced while trading with the other countries
to the WTO. WTO will act as a judge and implement rules and regulation to ensure that trade flows
smoothly between countries.
❖ Building membership: WTO helps and encourages new members to join up.

Criticisms of WTO
These come from some bodies who don’t support globalization:
✓ It is undemocratic: As the rules and regulations are written by the WTO for the corporations, the rights
of consumers, environmentalist and others are not taken into consideration.
✓ It favors the rights of corporations over those of workers: They focus more on the businesses and
least on the workers. E.g.: Child Labor is allowed as per the regulations of WTO.
✓ Destroying the environment: some acts that protect the environment are made illegal by WTO.
✓ It favors wealthy nations over the poor ones: Most of WTO meetings are conducted with the wealthy
nations and sometimes the representatives of the poorer nations are not even invited.
✓ It is causing hardships for poorer nations: the present policies that harm poor farmer’s income and
cause various other hardships.

World trade patterns

Reasons for an increase in the International trade
Travel and consumer awareness: due to trend of travelling, people consume more goods from other
countries. Also, consumers are now aware of the better quality, cheaper and variety of products in the
outside world.
Trade agreements: this is when countries for trading blocs and agree on free trade helping to import
products from all countries in a particular region which exposes customers to a wider variety of choices
and alternatives.
(Rest of the reasons could be referred to page 77)

Trade in developed countries

➢ Loss of trade in manufacturing: this is when developed countries are slowly moving to the provision
of services in the tertiary sector due to the De-industrialization (Discussed previously)
➢ More Air Travel: due to the development of budget airlines who offer cheaper flights to different
destinations, people are increasing travelling to various places around the globe.
➢ Widening of the development gap: despite the fact that developed countries are growing from the
international trade, the income inequality gap continues to rise sue to the disparity in the way the
income is redistributed.

Trade in Developing countries

❖ Increase in net migration: Increased amount of people leaving the country to find work in developed
countries.

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 ❖ Increase FDI in Africa: This country has been benefiting a lot from the FDI’s. This is because FDI’s
improve the living standards of workers in the country by providing more job opportunities, training
and other facilities.
❖ Rise in commodity dependence: Developing are now focusing on raw materials sales (Commodity
sales) for their international trade as they are experts in producing these products. Hence, this helps
to increase their exports.
❖ Debt cancellation: this is when developing countries benefit from cancelation of debt repayment by
developed countries which allows them to send money on their nation’s infrastructure and people and
find ways to improve their performance economically.
❖ Reduction in barriers: Removal trade barriers for developing countries through the WTO will help
them to enjoy free trade. This assists in strengthening their current account, increasing profits for
exporters, creating more job opportunities and wider choices for people, which helps to improve their
living standards.

Chapter 41: Exchange rates and their determination Basic

definitions
1. Currency speculators: they are firms, individual or institutions that buy and sell currencies in
the expectation of higher returns. (Capital gains)
2. Foreign exchange market: this is where currencies are bought and sold Exchange rate is the
value of a currency in terms of another.
Real world examples of exchange rate
Different countries have different currencies. So, in order to exchange a currency with another we will have
to calculate the value of the currency in terms of another currency. If we want to convert US Dollar to UK
pounds, then the exchange rate at June 2019 is as follows:

$1 = £0.79
Therefore, if we want to calculate how many pounds will we get if we exchange $4 to pounds, We
need to cross multiply it to get £3.16

Factors affecting the demand for a currency

✓ Interest rates: When the saving interest rates are high, foreigners may want to save their money in
the banks of those high interest countries. Hence, they may have to purchase more of that currency,
which will consequently result in higher demand for the currency. As a result, Exchange rates would
rise. (Vice Versa)
✓ Currency Speculators: If currency speculators expect an increase in the prices of a currency, for
instance the dollar, they may demand more of the currency as the make a profit in the future by selling
them.

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 ✓ The demand for exports: when export earnings increases, the demand for the currency would rise and
the importers from other countries may have to purchase more the currency. Hence, exchange rates
may rise.
✓ Movement of Capital: this is when the MNC’s set-up their operations in other countries such as the UK,
they may demand for more of the Pounds as to purchases resources to set-up their operations.

Factors affecting the supply of a currency

Interest rates in other countries: For instance, when the interest rates in the USA are higher than the interest
rates of UK, UK citizens may decide to save money in the US banks. Therefore, they may purchase more
dollars, this may increase the flow of pounds the foreign exchange, which will reduce the exchange rate.
Currency Speculators: if speculators believe that the price of pounds is going to fall they will sell the pounds,
this may increase the supply of pounds and thus, reduce the exchange rates.
The demand for imports: when the demand for imports are high, the supply of pounds in the foreign exchange
market will rise causing the currency exchange rates to fall.

Determination of Exchange rates

The exchange rates are determined by the market forces, supply and demand of a currency. They are same
like any other products.

P.T.O FOR GRAPH

Effect of changes in supply and demand on the exchange rates

When the supply of a pound increases, the exchange rate would fall. This may be caused by an increase in
the imports resulting in higher levels of the currency in the foreign exchange market.

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When the demand for currency increases, this can result in a higher exchange rate. This may be caused by
higher exports.

P.T.O FOR GRAPH

Chapter 42: Impact of changing Exchange rates

Appreciation is when the value of a currency increases due to changes in market forces. Whereas,
Depreciation is the fall in the value of a currency due to changes in market forces.
Revaluation is when the currency of a country is deliberately increased by the government. Devaluation is
the when the currency of a country is deliberately reduced by the government.

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Fall in exchange rates (Depreciation)
Changes in the exchange rates could have impacts on the demand for exports and imports and the current
account balance (balance of trade). When the exchange rate falls from £1 = $1.50 to £1=$1.20
➢ Changes in exports: exports become cheaper in UK as the prices fall and demand increases.
➢ Changes in imports: imports become more expensive because the prices increases.
➢ Impact on current accounts: current account balance improves.

Rise in exchange rates (Appreciation)

When the exchange rate rises from £1 = $1.50 to £1=$1.20,
➢ Changes in exports: exports decreases as now they become more expensive for US. ➢
Changes in imports: imports increases as they become cheaper as prices are lowered ➢
Impact on current accounts: current account balance worsens.

Exchange rates and Government policy

The government can influence the exchange rates to strengthen the current account by reducing the
deficits. They can do this by making changes to interest rates as the interest rates have a directly
proportional relationship with the Exchange rates. Therefore, the interest rates can be reduced which will
depreciate the currency and thus, make imports expensive which will reduce the deficit.
However, this may be ineffective due to the following reasons:
➢ The government might not have complete control over the interest rates.
➢ Reducing the interest rates will conflict with other policies
➢ Devaluation will only work if demand for exports and imports are responsive to price change

Exchange rates and Price elasticity

The effectiveness of the exchange rates will depend on the PED. For instance, fall in interest rates will
reduce the exchange rates, which may cause a deficit in the current account only if the demand for exports
and imports are elastic.

Please refer to the Economics guide book that is published for Economics which includes
Answering techniques, Sample answers, Tips to smash the Economics paper, Life advices,
Pieces of Advice on progressing to the future, Universities and Jobs related to both streams

THE END

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