PAPER 1

1. The economic problem

The basic economic problem is the allocation of a nation’s scarce resources between
competing uses that represent infinite wants
Scarcity refers to a basic economic problem → the gap between limited resources and
theoretically limitless wants

Economic growth: increase in the level output by a nation

Causes of a positive economic growth:

● New technology
● Improved efficiency
● Education and training
● New resources

Causes of a negative economic growth:

● War
● Natural disasters
● Conflict

2. Economic assumptions
1. Consumers aim to maximise benefit
➔ If a consumer is faced with buying exactly the same product from three
different suppliers, the consumer will buy from the supplier which offers the
cheapest price
➔ If a consumer is faced with buying a product from three different suppliers at
the same price, the consumer will buy the best quality product
2. Businesses aim to maximise their profit
➔ If a business has to buy raw materials, they will buy the products to the
supplier which has the lowest price, but the same quality as the other
products
➔ When setting a price for a product, a business owner will chose the highest
price that the market can stand

Reasons why consumers may not always maximise their benefit:

● Consumers have difficulty in calculating the benefits from consuming a product
● Consumers’ buying habits can prevent rational choices (eg. brand loyalty)
● Consumers may be influenced by others (eg. parents preferences, peer pressure)
● Lack of transparency/knowledge/time

Reasons why producers may not always maximise their profit:

● The performance of some businesses may be influenced by the behaviour of others
in the organisation.
● Some producers have alternative business objectives (eg. customer service)
● Charitable organisations aim to raise awareness and money for a particular cause via
donations (eg. Doctors without Borders, Greenpeace)
 ● Social Enterprises sell a product with the aim to maximise human or environmental
benefit (eg. Humana, TOMS Shoes)
● A producer may not have access to all the information to make a rational decision

3&4. The demand curve

Factors that may shift the demand curve:

Factor Explanation

Advertising Increased advertising, increase in demand

Income Increase in income, increase in demand (more money to buy things)

Fashion & taste Increased popularity of a product, increase in demand

Price of Decrease in price of substitutes, increase in demand

substitutes

Price of Decrease in price of complements, increase in demand

complements

Demographic Increase in population, increase in demand

changes

5&6. The supply curve

Factors that may shift the supply curve:
Factor Explanation

Production costs Increase in production costs, decrease in supply

New technology Increase in technology, increase in supply (lower production costs)

Indirect taxes Increase in indirect taxes, decrease in supply (more costs, harder to produce)

Subsidies Increase in subsidies, increase in supply (money given by the gov to businesses to
produce a specific product)

Natural factors ➔ Natural disasters, decrease in supply

➔ Good growing conditions, increase in supply
7. Market equilibrium
Market Equilibrium: Price & Quantity:
- Equilibrium: A situation in which the price has reached the level
where quantity supplied equals quantity demanded
- Equilibrium Price (PE): The price that balances quantity supplied
and quantity demanded
- Equilibrium Quantity (QE): The quantity supplied and quantity
demanded at the equilibrium price
- The equilibrium is sometimes called the market clearing price

Total revenue:
TR= Price x Quantity

DEMAND SUPPLY EQUILIBRIUM EQUILIBRIUM

PRICE QUANTITY
↓ ↓ indeterminate ↓
↓ ↑ ↓ indeterminate
↑ ↓ ↑ indeterminate
↑ ↑ indeterminate ↑

Market Equilibrium: Excess supply and demand:

Markets not in Equilibrium

- If the price is set above equilibrium price, at $3.50 per cup of hot chocolate, the quantity of
the good supplied (10 cups) exceeds the quantity demanded (4 cups)
- There is a surplus

Surplus
- Suppliers are unable to sell what they want at the going price.
- The suppliers’ response to a surplus is to cut their prices which leads to and increase in
quantity demanded and decrease in quantity supplied
- Prices will continue to fall until the market reaches equilibrium
Markets not in Equilibrium

- If the price is set below equilibrium price, at $1.25 per cup of hot chocolate, the quantity of
the good demanded (10 cups) exceeds the quantity supplied (4 cups)
- There is a shortage

Shortage
- Demanders are unable to buy all they want at the going price
- When a shortage occurs in the hot chocolate market, buyers have to wait in long lines for a
chance to buy one of the few cups that are available
- With too many buyers chasing too few goods, sellers respond to the shortage by raising
their prices without losing sales
- As price rises, quantity demanded falls, quantity supplied rises and the market moves to
equilibrium

8. Price Elasticity of Demand

Calculating PED:

PED Value Elasticity Explanation Example Sketched

Description Products Curve

0 Perfectly Price has no

inelastic effect on
demand at all

-1<0<1 Inelastic Price has a

small effect on
demand
 Exactly -1 or 1 Unitary Changes are
elasticity the same

Greater than 1 Elastic Demand is very

or less than -1 sensitive to
price

(-) Infinity Perfectly Any increase in

elastic price will kill
demand

Factors affecting PED:

Factor Explanation

Availability of ➔ If there are more substitutes available, PED will be more elastic
substitutes ➔ If there are few substitutes available, PED will be more inelastic

Degree of ➔ Necessities - inelastic

necessity ➔ Luxuries - elastic

Proportion of ➔ Inexpensive - inelastic

income spent ➔ Expensive - elastic

Time ➔ Short term - inelastic (takes longer to find substitutes) // Long term - elastic

Branding ➔ Strong brand- inelastic // Store brand- elastic

9. Price Elasticity of Supply

Calculating PES: (same as calculating PED but changing demand by supply)

Factors affecting PES:

Factor Explanation

Factors of ➔ Inelastic: specialised tools, skilled labour, immobile factors

production ➔ Elastic: mobile factors → can be used to produce a variety of products

Availability of ➔ Inelastic: impossible or expensive to hold on stock

stocks ➔ Elastic: easily held in a warehouse

Spare capacity ➔ Inelastic: running at full capacity

➔ Elastic: spare capacity (can produce more)

Time ➔ Inelastic: short-term // Elastic: long-term

 10. Income Elasticity
Calculating YED:

Elasticity and Business:

● Price elasticity:
➔ If firms know the price elasticity of their products, they can predict the effect
on total revenue of any price changes they make.
● Income elasticity:
➔ If firms know the income elasticity of their products, they can respond to
predicted changes in income in an economy (looming recession, expected
boom, etc)

11. The mixed economy

Private sector: provision of goods and services by businesses that are owned by individuals
or groups of individuals
Public sector: government organisations that provide goods and services in the economy

Private sector organisations:

● Ownership and control:
➔ Sole traders: business owned and controlled by one person
➔ Partnerships: business owned by two or more people working together
➔ Companies: where shareholders own the business (shareholders are people
or organisations that owns shares in a company)
Aims:
Aim Explanation

Survival When a firm is set up, they do not usually make profit immediately, it takes time to
establish a business and other businesses often encounter unexpected difficulties. As a
result, the initial aim of a firm is to survive
Profit ➔ All owners want to generate profit for their businesses
maximisation ➔ However, some firms are content to make just enough profit to keep the owner
satisfied

Growth Firms aim to grow as larger firms enjoy a number of advantages

➔ Profit is higher
➔ Also benefits stakeholders, managers, directors as their job is more secure

Social They aim to please a wider range of stakeholders

responsibility

Public sector organisations:

● Ownership and control:
➔ Central government departments
➔ Local authority services: delivered by local councils (libraries, school halls)
➔ Other public sector organisations: BBC, Post office
Aims:
● Improving the quality of services
● Minimising costs: government resources are scarce and it is important that waste is
minimised
● Allow for social costs and benefits: as the government’s aim is not making profit, they
are better replaced to take into account the needs of a wide range of stakeholders

The mixed economy

● What to produce?
➔ Consumer goods: (private sector) so that consumers have choice
➔ Education, street lighting, roads, protection: (public sector) because the
private sector may fail to provide enough of these (called market failure)
● How to produce?
➔ Private sector: produces goods to make profit (maximise quantity and
minimise costs) / competition means consumers have choice
➔ Public sector services provided by the government
➔ Contracting: sometimes the government pays the private sector to produce
public sector goods
● For whom to produce?
➔ Private sector: anyone who can afford them
➔ Public sector: free to everyone and paid from taxes

Market failure and the need for gov intervention:

Market failure Explanation

Externalities ➔ Sometimes firm do not take into account all of the costs of production
➔ E.g a firm producing chemicals may pollute the atmosphere because it has not
taken measures to clean its waste, this is an external cost for people

Lack of ➔ A market may fail if there is no competition and it becomes dominated by one firm
competition

Missing markets ➔ Public goods are not provided by the private sector
 ➔ Merit goods (health and education) are underprovided by the private sector - too
expensive - people are not able to pay them

Lack of ➔ Consumers need to know everything about the nature, price and quality of all
information products
➔ Businesses also need information about the resources and production techniques
used to make a product
➔ A lack of information may result in the wrong goods being purchased or produced,
or the wrong pieces being paid

Factor ➔ Factors of production need to be mobile

immobility ➔ Factors such as labour and capital must be able to move freely from one use to
another

Government intervention:
● Businesses that impose externalities may be heavily regulated or fined
● The gov can use legislation to prevent businesses from dominating markets
● State money can be used to provide public and merit goods
● The government can force firms to provide more information about products
● The gov may be able to make some factors more mobile by retraining workers

12. Privatisation
Privatisation: act of selling a company or activity controlled by the gov to private investors

What is privatisation?
● Sale of nationalised industries
➔ Government sells public sector companies, which become private sector
businesses
➔ ‘Natural monopolies’ are usually not profitable, and it is unwise to privatise
them
● Contracting out
➔ Contractors (private companies) can bid for services previously supplied by
public sector
➔ Examples: school meals, hospital cleaning
● The sale of land and property

Why does privatisation take place?

● To generate income
➔ The sale of state assets generates income for the government
● Public sector organisations were inefficient
➔ Nationalised industries often lack the incentive to make a profit (and often
make losses)
➔ Privatisation often leads to cutting costs, improving services and turning
profits for shareholders.
➔ The private sector is held more accountable (by dissatisfied customers, etc)
● To reduce political interference
➔ In the private sector, the government cannot use these organisations for
political aims
 Arguments in favour of privatisation Arguments against privatisation

➔ Reduces burden on the government - it can ➔ Welfare motive no longer a priority / in

focus on politics existence
➔ Changes and improvements can be made ➔ Important, strategic industries could change
more quickly drastically: this is a risk
➔ More efficient running of organisation due to ➔ Chance of rise of private monopoly
increased motivation ➔ Social cost - restructuring can cause mass
➔ Competition: new incentive to constantly unemployment
improve and innovate ➔ Governments may sell their assets too
➔ Increased research & development; upgrades cheaply and so fail to maximise revenue
in technology
➔ Increased quality of goods and services
➔ Source of revenue to the government

13. Externalities
Externalities: the effects felt by third parties who are external to a transaction

External costs:
● Noise pollution
● Air pollution
● Water pollution
● Overcrowding
● Traffic congestion
● Resource depletion

External benefits of consumption:

● Education: better jobs, earn more money, better quality life
● Health care: better health / benefits third parties as if there is better health in general
people can go to work making contributions to the economy
● Vaccinations: more vaccinations means less people getting ill

Costs:
● Private costs: costs of an economic activity to individuals and firms
● External costs: costs of an economic activity to a third party
● Social cost = private costs + external costs

Benefits:
● Private benefits: rewards to individuals or firms of an economic activity
● External benefits: rewards to a third party of an economic activity
● Social benefit = private benefits + external benefits

Government policies to deal with externalities:

Gov policy Explanation

Taxation Taxation can be used to reduce the external costs of production (to prevent people to
pollute). Taxes can also work to reduce the external costs of consumption (to prevent
people to smoke)
Subsidies The government can offer money to firms as an incentive to reduce external costs (to
produce recycled plastic bottles for example)

Fines To reduce external costs (for example, a fine for someone who damages the environment)

Gov regulations Pressure has grown on governments in recent years to pass more legislation to protect
the environment, so they create laws to protect the environment

Pollution permits Governments can issue pollution permit, letting a company the right to discharge a certain
amount of polluting material

14. The factors of production and sectors of the economy

Factors of production:
Factor Explanation

Capital ➔ Stocks of raw materials and components that will be used in production
➔ Stocks of finished goods waiting to be sold

Enterprise What do entrepreneurs do?

➔ They come up with a business idea
➔ They are business owners (they provide the money; they’re the boss)
➔ Entrepreneurs are risk-takers (they usually invest their own money)
➔ They are responsible for organising the other three factors of production (buy
resources, hire staff, use their business knowledge)

Land ➔ The workforce in the economy

➔ The value of an individual worker to a business is their human capital.
➔ Ex. bus driver, waitress

Labour ➔ The natural resources of the planet – not just the land itself (e.g. seas, forests)

Sectors of the economy:

Sector Explanation

Primary sector ➔ Extracting raw materials from the Earth

➔ Examples: mining- extraction of raw material such as coal, oil, salt

Secondary ➔ Processing raw materials into (semi) finished goods

sector ➔ Metalworking, car production, food processing, construction

Tertiary sector ➔ Production of services into the economy (e.g: Transport- train, taxi)

Why has manufacturing declined in developed countries while services have grown?
● People may prefer to spend more of their income on services than manufactured
goods
● There is competition in the production of manufactured goods from developing
countries
● As countries develop, their public sector grows
● Advances in technology mean that employment in manufacturing falls because
machines replace people
 15. Productivity and Division of labour
Productivity:
● Formula:
➔ Total output / number of workers employed
● Firms want to increase productivity in order to lower costs and earn more profit

Factors affecting productivity - Land:

Factor Explanation

Fertilisers and ➔ Fertilisers are chemicals that help farmers to grow crops and ameliorate their
Pesticides health and their appearance.
➔ Pesticides help farmers to kill bugs that disturb the plants growth and appearance.
➔ These are not healthy for people and other wildlife that don't try to affect the plant.
➔ Therefore the gov imposes some rules of how much you can buy and how much
you can use

Drainage ➔ Used to improve the flow of water off this land and thereby make it more produce
➔ Helps to prevent the flooding of some areas of land that are used to the production

Irrigation ➔ It is a type of system which involves redirecting water to the soil of a plant from
natural sources, such as rivers or lakes
➔ We use it on the land that need more water to make it more productive

Reclamation ➔ If more fertile land can be found to grow crops, the productivity of earth's land will
increase. These lands can be reclaimed

Genetically ➔ Crops are genetically modified to be more productive by transferring DNA from
modified crops one organism to another
(GM crops) ➔ Positive sides: less likely to be affected by disease // produce higher yields
➔ Negative sides: Unpredictable and harm of food chains

Factors affecting productivity - Labour:

Factor Explanation

Training ➔ Involves increasing the knowledge and skills of a worker to improve their efficiency
working, this also motivates to gain more money

Improved ➔ If people are more motivated they will be more productive

motivation ➔ Piece rates help motivate employees, this involves how much employees are paid
depending on their productivity
➔ Not always money works to motivate employees, this is when non-financial
motivation takes place

Improved ➔ The methods and systems of work that employees are expected to follow when
working working
practices ➔ These help improve productivity by making the workers adapt to a new working
practice and following criteria which increases productivity
Migration ➔ Migration can increase productivity and improve the quality of human capital
because:
★ It can attract highly skilled and well trained workers which can increase the
productivity of an economy
★ Immigrants who aren’t skilled can also positively contribute to a society

Factors affecting productivity - Capital:

Factor Explanation

Primary sector ➔ In agriculture, use of machinery such as tractors can help to increase output,
reduce waste and improve working conditions

Secondary ➔ If more capital is employed there can be more technology used to increase the
sector efficiency and productivity of the assembly lines

Tertiary sector ➔ Technological improvements improved equipment efficiency and thus work force’s
efficiency

Division of Labour:
● Division of labour is the breaking down of the production process into small parts with
each worker allocated to a specific task.
● Allows workers to work/perform better at a certain task or skill

Advantages and disadvantages for the worker

Advantages Disadvantages

➔ Focusing on a task allows the worker to ➔ One of the main problems is that the work
become more skilled at doing the task can become boring as it is repetitive. This is
➔ The more highly skilled workers are, the more most likely to occur if a task requires little skill
they are likely to get paid and find ➔ Repetitive tasks can also have health
employment more easily implications for workers, such as joint wear
➔ Another serious problem for workers might be
too specialised is the risk of unemployment

Advantages and disadvantages for the business

Advantages Disadvantages

➔ There is improved efficiency as there is more ➔ Specialised work can become boring and
specialisation within industries, this means repetitive
that the productivity rate increases due to less ➔ Boredom can have an impact on motivation
mistakes ➔ Poor quality of work: reduce productivity
➔ Greater use of specialist tools, machinery and ➔ Interdependence: a stage of production
equipment is possible when worker specialise depends on another stage
➔ Production time is reduced as workers do not ➔ Loss of flexibility: absent specialist =
take time to move from one task to another disrupted production
➔ The organisation is easier as specialist
workers fit more easily into a structured
system
 16. Business costs, Revenues and Profit
Formulae:
● Total Costs (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC)
● Average Costs = Total Cost ÷ Quantity Produced
● Total Revenue = Price x Quantity
● Profit = Total Revenue - Total Costs

Examples:
● Total fixed costs: rent, business rates, advertising
● Total variable costs: raw materials, packaging, fuel and labour

Labour costs are VARIABLE

17. Economies and diseconomies of scale

Economies of scale: (falling average costs due to expansion)

Internal economies of scale: (the cost benefits that an individual firm can enjoy when it
grows)
Internal EoS Explanation

Purchasing Large firms that buy lots of resources get cheaper rates. Suppliers offer discounts to firms
economies that buy raw materials and components in bulk

Marketing A number of marketing economies exist. These costs can spread over more units of
economies output for a larger firm

Technical They occur as larger factories are more efficient than a larger firm than a smaller form
economies

Financial ➔ Large firms can get access to more money cheaply.

economies ➔ They have a wider variety of sources to choose from
➔ Large firms can negotiate price of loans

Managerial As firms expand, they can afford specialist managers

economies

Risk-bearing Large firms are more likely to have a wider product ranges and sell into a wider variety of
economies markets

External economies of scale: (the cost benefits that all firms in an industry can enjoy when
the industry expands)
External EoS Explanation

Skilled labour ➔ If an industry is concentrated in one area, there may be a build-up of labour with
the skills and work experience required by that industry
➔ As a result, training costs will be lower when workers are reduce
Infrastructure If a particular industry dominates a region, the roads, railways, ports, buildings and other
facilities will be shaped to suit that industry’s needs

Access to ➔ An established industry in a region will encourage suppliers in that industry to set
suppliers up close by
➔ All firms in the industry will benefit from their services

Similar When firms in the same industry are located close to each other, they are likely to
businesses in cooperate with each other so that they can all gain
an area

Diseconomies of scale:
● If a firm continues to expand beyond a certain point average costs eventually rise

Reasons for diseconomies of scale:

External EoS Explanation

Bureaucracy ➔ Too many resources are used in administration

➔ If resources are wasted in administration, average costs rise

Communication Too many workers of different languages, hard to communicate

problems

Lack of control Too many employees, offices around the world → more supervision, raise costs

Distance Too many layers of management between chairperson and workers results in a lack of
between senior understanding between them, workers become demotivated, conflicts may occur and
staff and shop resources may be wasted resolving them
floor workers

18. Competitive markets

Competition: rivalry that exists between firms when trying to sell goods and services

Features of a competitive market:

● Large number of buyers and sellers
● The products sold by each firm are close substitutes for each other
● Low barriers to entry (easy to set up a firm in this industry; little capital or technical
knowledge/equipment to required)
● Each firm has almost no control over the price they charge. If they raise their price,
customers go to a rival.
● High level of transparency (free flow of information about the nature of products,
availability of different outlets, prices etc)

Competition and the Firm:

Generally, firms do not welcome competition; theyʼd prefer to have no rivals.
In order to compete with rivals, firms have to offer products that give consumers value for
money.
 This involves:
● Operating efficiently with low production costs
● Providing good quality products with high levels of customer service
● Charging prices that are acceptable to customers
● Innovating by constantly reviewing and improving the product
● Product differentiation: persuading consumers that their product is
different from those of rivals (e.g. they might identify a USP - a
unique selling point)
➔ The main disadvantage of competition to a firm is the amount of profit made will be
limited, because prices are low to stay competitive

Advantages and disadvantages for firms

Advantages Disadvantages

➔ Generally easy to enter the market ➔ Many rivals makes survival and staying in the
➔ Must operate efficiently to survive, which market more difficult
provides an incentive to keep costs low ➔ Profit tends to be low because prices have to
➔ Forced to innovate/differentiate: firms will try be kept low to attract business
to make their product stand out, resulting in ➔ Potentially high costs of product
higher quality products differentiation and innovation in order to
attract customers

Advantages and disadvantages for customers

Advantages Disadvantages

➔ Lower prices ➔ Market uncertainty because unprofitable firms

➔ More choice due to large number of suppliers eventually leave the market, causing
➔ Better quality products due to firmsʼ attempts disruption to supply
at innovation and attracting customers ➔ Lack of innovation due to insufficient profit to
invest in product development

Advantages and disadvantages for the economy

Advantages Disadvantages

➔ Resources are allocated more effectively ➔ Resources might be wasted because some
because firms have to operate more factors of production are immobile
efficiently to survive ➔ When firms exit the market, resources are
➔ Standard of living is raised because firms are available for alternative uses
more innovative, which leads to the ➔ E.g. people are made redundant and
development of new products, production resources like machines and buildings come
techniques, and materials up for sale
➔ It can take time for resources to be reallocated

19. Advantages and disadvantages of large and small firms

How is the size of a firm measured?
The three main ways of measuring firm size are:
● Annual turnover (total revenue)
● Number of employees
● Balance sheet total (amount of money invested in the business by its owners)
 Small firms:
Advantages Disadvantages

➔ Flexibility: small firms can adapt to change ➔ Higher costs: small firms cannot exploit
more quickly. This is as owners are involved economies of scale, as their output is limited.
in the business. Also their average cost will be higher than the
➔ Personal service: as firms get bigger, it often larger rivals
becomes difficult to offer customers an ➔ Lack of finance: small firms often struggle to
individual, personal service. (some prefer to raise finance, so their choice of sources is
deal with the owner of a firm directly and are limited. They are also considered to be more
prepared to pay a higher price for this benefit) risky than larger firms by financial institutions.
➔ Lower wage costs: many workers in small ➔ Difficult attracting quality staff: Small firms
firms do not belong to trade unions. As a may find it difficult to attract highly qualified
result, their negotiating power is weaker, and and experienced staff. One reason for this is
the owners are often able to restrict pay to the because of the lack of resources
legal minimum wage. ➔ Vulnerability: When trading conditions
➔ Better communication: since small firms become challenging, small firms may find it
have fewer employees, communication tends more difficult to survive than their larger
to be informal and more rapid than in larger rivals. This is because they do not have the
organisations. resources to draw on when economic
➔ Innovation: although small firms often lack conditions worsens. Small firms might also be
resources they are innovative, so they can at risk of take-overs
face competitive pressures

Reasons firms stay small:

Reason Explanation

Size of the ➔ Markets are too small to sustain very large companies
market ➔ E.g the market for luxury yachts is limited

Nature of the ➔ The set-up costs are relatively low

market ➔ Fierce competition stops any single firm from growing
➔ In some markets businesses serve a particular market niche (smaller market,
usually within a large market or industry)

Lack of finance ➔ Would like to grow but are not able lo raise the finance needed to expand
➔ Some businesses are not able to convince money lenders

Aims of the ➔ Some business owners do not want to grow their business
entrepreneur ➔ They may be happy running a small business
➔ Making enough profit to satisfy their needs and do not want the responsibility

Diseconomies of ➔ Further growth results in DoS

scale ➔ Average costs start to rise
 Large firms:
Advantages Disadvantages

➔ Economies of scale: the main advantage to ➔ Too bureaucratic: large firms sometimes
large firms is that their average costs are become overwhelmed by their administration
likely to be lower than those smaller rivals. So systems. Too many resources may be used
they can operate in large scale plants and up in administration. Also, communication
exploit economies of scale. channels may be too long and too many
➔ Market domination: they often dominate the managers may be employed
market. They have a higher profile in the ➔ Coordination and control: it may be difficult
public eye than small firms and benefit from to control and coordinate. Thousands of
such recognition. Meaning that they can employees, and a lot of plants all over the
charge higher prices →more profit. world can make running an organisation
➔ Large-scale contracts: there are both small demanding. There may also be a need for
and large firms in the construction industry. more supervision that will raise costs.
However, small firms cannot compete with a ➔ Poor motivation: In very large organisations,
large firm to build a new motorway for the people can become alienated. The
government. Only large firms can compete organisation may become so large that the
with these large-scale companies as small effort made by a single employee is
firms don’t have the materials to do it insignificant. Personal contact between
employees in large organisations may be
lacking and this in result in poor worker
organisation

Factors influencing the growth of firms

Reason Explanation

Gov regulation ➔ Will monitor business activity and ensure that individual markets are not
dominated by one or a small number of firms, causing them to stop growing further

Access to ➔ The business need money to make acquisitions, build new factories, open new
finance stores or develop new products

Economies of ➔ One of the main motives for growth is to reduce average costs; it is possible to
scale exploit EoS
➔ There are few opportunities to exploit EoS; ∴ business growth is limited

The desire to ➔ Risks can be reduced by diversifying

spread risks ➔ Selling into new markets and developing new products means that if one venture
fails, success in others can keep the firm growing

20. Monopoly
Features of a monopoly:
● One business dominates the market
● Unique product (products are highly differentiated - no substitutes)
● Price maker
● Barriers to entry
 Advantages Disadvantages

➔ Efficiency: It is more efficient for one firm to ➔ Higher prices: Monopolies can restrict output
supply all consumers. They exploit internal to force up the price
economies of scale ➔ Restricted choice: With one supplier in the
➔ Innovation: As they make high profits, they market, choice is obviously restricted. If a
have resources to invest in R&D. Consumers consumer is unhappy with the quality of
benefit from new products and new tech service, they are unable to switch providers
➔ Economies of scale: Because they are ➔ Lack of innovation: Monopolists donʼt have
large, they can exploit EoS, lowering average incentive to spend money on product
costs, and supplying products at a lower innovation, since consumers will buy their
price. A monopoly in the domestic market products regardless
could more readily compete with other foreign ➔ Inefficiency: If a firm does not face
companies competition, they have no incentive to keep
costs down // If too big, they could suffer from
DoS → average costs rise → prices rise //
Criticised for poor customer service

21. Oligopoly
Features of an oligopoly:
● Few firms
● Large firms dominate (set prices, small ones copy)
● Different products (similar products with some differentiation)
● Barriers to entry (Set-up costs are high; dominant firms likely discourage entry by
investing in their brands)
● Collusion
a. Dominant firms in the industry set up agreements to restrict competition
➔ i. Firms could share a market geographically
➔ ii. Price fixing: all firms agree to charge the same (higher) price
➔ iii. Firms agree to restrict output
● Non-price competition
➔ Firms compete using advertising and promotions
➔ Branding: firms give products a name, term, sign or symbol so customers can
identify them more easily
➔ Product differentiation is common: firms persuade customers that their brands
are different from those of competitors
● Price competition

Advantages Disadvantages

➔ Choice ➔ Collusion
➔ Quality: ● Price fixing- firms agree on a
● Non-price competition leads to product higher-than-market price (consumers
differentiation, some products may be pay more)
superior
 ➔ Economies of scale: ● Market is shared geographically-
● Dominant firms are usually large, can consumers in certain areas have only
take advantage of EoS one choice
➔ Innovation ➔ Cartel
➔ (Threat of) price wars ● A group of firms or countries formally
● Prices tend to be stable, which join together to agree on pricing and
provides consumers with certainty output in the market → they then act
about the market as a monopoly
● Consumers can benefit from a price
war (lower prices)

22. The labour market

Factors affecting the demand for labour:
Factor Explanation

Demand for ➔ The demand for labour is said to be derived demand (ie. the demand for labour
products depends on the demand for the good/service being produced

Availability of ➔ The demand for labour can be affected by cost and availability of substitutes for
substitutes labour (not for the product) // Usually this is technology and machines

Productivity of ➔ If every worker is able to produce more output, the demand for labour will
labour increase, because production becomes more profitable and efficient

Other ➔ These costs represent a cost to the employer, shifting the demand curve
employment ➔ Eg. National Insurance Contributions; cost of pensions; perks like company cars,
costs free meals, health insurance; training; sick pay; maternity/paternity leave, etc

Factors affecting the supply for labour:

Factor Explanation

Population size ➔ More people → more supply of labour

Migration ➔ More people → more supply of labour

Age distribution ➔ An ʻaging populationʼ means that the number of people over age 65 is increasing
of the population relative to the total population (most developed countries have an aging pop.)
➔ This means the dependency ratio is also increasing (this is the proportion of
dependants, or non-workers, to workers) which can place a financial burden on
the population

Retirement age ➔ Many countries are raising the retirement age (eg. from 65 to 67 years of age),
which means the supply of labour increases

School leaving ➔ If a country increases the school leaving age, this would decrease the supply of
age labour
Female ➔ In the last fifty to seventy years, an increasing number of women have chosen to
participation enter the workforce due to cultural and societal changes and more favourable
labour equality legislation

Skills and ➔ Supply of labour increases if people are more skilled and qualified
qualification

Labour mobility ➔ Geographically mobile: workers can move to a different region to find work (can be
➔ improved by better transport networks in a community/country)
➔ Occupationally mobile: workers can switch job types easily
➔ The more mobile workers are, the higher the supply of labour

The importance of the quantity of labour to business

● A company may not choose to locate a factory in a certain place just because the
labour is cheap, they also have to consider the quality/skills of labour
● If a business did choose to locate their production where workers are cheap and
unskilled, the firm would have to train them, so it will rise costs, which could be
expensive and time-consuming
● When choosing a location, business not only need to consider the quality of labour
but also the quantity, because if they want to expand they will need to hire more
people

The impact of education and training on the quality of human capital

● Quality of human capital, (value of the workforce or an individual), can be improved
by education and training
● Quality labour means workers who can read and write, or have good communication
skills
● Firms provide training to employees, but so do states because it is more productive
● Education and training will improve productivity, but are also beneficial because
workers become multiskilled which will increase flexibility and reduce frustration

23. Trade unions

Trade union: they are a organisation to protect the interest of workers in most countries

Main aims of trade unions:

● Negotiate pay and working conditions with employers
● Provide legal protection for members, such as representation in court if an employee
is fighting a case against an employer
● Put pressure on the government to pass legislation that improves the right of workers
● Provide financial benefit, such as strike pay whenever necessary

What government laws were created for trade unions

● Required trade unions to have a secret ballot before a strike; a strike could only go
ahead if the majority of the members voted in favour
● Allowed businesses to sue for compensation if trade unions did not obey the law
● Banned secondary picketing
● Made closed shops illegal
The effects of trade unions on wages and employment
● If trade unions are powerful, then they may be able to force wages

Job loss can be prevented by:

● If labour productivity rises at the same time
● If employers are able to passion wage, increase to customers in the form of price
rises
● If profit margins are reduced

24. Government intervention

Government regulation of competition - promoting competition
● Encourage the growth of small firms
➔ More firms →more competition
➔ Governments can start up programmes to help small firms by providing funds,
financial advice, advice on running business
➔ Taxes are usually lower for small firms
● Lower barriers to entry
➔ Lower barriers →more firms can join the market → more competition
➔ Gov could remove legal barriers
● Introduce anti - competitive legislation
➔ In many countries, legislation exists that prevents practices that result in
reduced competition

Government regulation of competition - limit monopoly powers

● If monopolies exists, they need to be carefully monitored, because the temptation to
exploit customers may be too great for some companies
● If a monopoly police catches you will be fined

Government regulation of competition - protect consumers interests

Without government intervention, firms may exploit consumers by:
● Increasing prices to higher levels than they would be in a competitive market
● Price fixing; where a number of firms agree to fix the price of a product to avoid price
competition
● Restricting consumer choice by market sharing
● Raising barriers to entry by spending huge amount of money on advertising, which
smaller companies could not match

So gov legalisation is in place to protect customers, issues covered by this legislation

include:
● Prices
● Information about products
● Trading and age restrictions
● Customers payment methods
● Consumer rights
● Promotion of products
● Product quality
● Product safety
Government regulation of competition - control mergers and takeovers
● Gov monitors takeovers and merges to ensure market stays competitive
● Large mergers and takeovers are likely to be investigated by the government bodies
and may be blocked or allowed to go ahead

Government intervention in the labour market: minimum wage

● Reasons for minimum wage
➔ Raise incomes to lower paid workers
➔ minimum wage benefit disadvantages workers and can lessen the gap
between the rich and the poor
➔ Workers who earn more money will no longer have to rely on gov welfare,
saving the government money and workers will pay more tax on that higher
income
➔ Higher wage may motivate workers
➔ Train workers to improve their productivity and/or replace inefficient labour
and invest in capital which makes the firms more productive; both of these
improve productivity of the economy overall
● Impact of minimum wage
➔ Wages may be increased above labour market equilibrium
➔ This leads to a surplus of labour, which means job loss and unemployment
● Does minimum wage cause job loss?
➔ In theory, yes but if economy is growing it might not cause job loss
 PAPER 2
Macroeconomics: study of large economic system such as those of a whole country or area
of the world

What are macroeconomics objectives:

● Reducing unemployment
● Protect the environment
● Balance of payments (current account)
● Economic growth
● Controlling inflation
● Redistribution of income

25. Economic growth

Economic growth: increase in the level output by a nation

What is economic growth?

● This means that national income will rise
● National income is the value of all incomes in the economy added together (e.g.
wages, profits, royalties, dividends, interest, and income generated from abroad)
● National income is also equal to:
➔ The value of all output or production in the economy
➔ The value of all spending in the economy

Economic growth follows a cycle:

If output increases (the economy is producing more):
● Businesses are more profitable and share prices (the value of a company) rise
● This makes it easier for businesses to raise more capital (money) and employ more
workers
● As more jobs are created, incomes rise
● This means that consumers (the employees) will have more money to spend on
goods and services
● Which will drive economic growth even further

How do we measure economic growth?

● GDP = gross domestic product. This is the market value of all final goods and
services produced in a country over a period of time (usually a year) - i.e. it is a
measure of a country’s output.
● GDP is a standard measure used all over the world, so it allows us to make
comparisons between the growth rates of different countries

Limitations of GDP as a measure of growth:

Type Explanation

Inflation ● Price increases can mean growth rates are misleading

● E.g if an economy grows 2.6% and prices also rise 2.6%, the economy has not
 grown
● However, this problem can be solved by using real GDP to measure growth
● This involves adjusting GDP for inflation
● E.g if inflation is 2.3% and money GDP grows 4.4%, real GDP has grown by 2.1%
(4.4-2.3)

Population ● Population growth must be taken into account when analysing growth patterns
changes ● E.g if GDP grows by 2.8% and the population also rises, this increase in population
will offset the growth in GDP
● GDP will therefore be difficult to calculate
● To overcome this problem, changes in GDP per capita can be calculated (GDP /
size of population)

Statistical ● The gov collects millions of documents for firms, individuals, etc…
errors ● Errors are made because the information has been entered inaccurately or left out
● Therefore, the true value of GDP is never really known

The value of ● Some goods and services are not traded and therefore economic activity is not
home produced recorded
goods ● E.g in undeveloped countries, people rely almost on their own produce to live. It is
not traded and therefore not recorded
● As a result, if such activities are not recorded, the value of national income is
underreported

The hidden ● Sometimes paid work goes unrecorded

economy ● People may do a variety of jobs for cash and not record transactions
● E.g a friend may drive a family to an airport for $25. This $25 will not be recorded.
The transaction becomes part of the hidden economy

GDP and living ● GDP is used to measure living standards

standards ● However, just because GDP rises, it does not mean that living standards have risen
● Other factors need to be taken into account:
➔ The amount of leisure time people have
➔ The way extra income is shared between the population
➔ Whether growth has resulted in pollution
➔ The quality of goods and services

External costs ● GDP doesn’t take into account the external costs
● As a result, GDP does not measure how these costs impact on the well-being of
society

The economic cycle:

 Type Explanation

Boom ● During a boom, GDP is growing fast because the economy is performing well
● Existing firms will be expanding and new firms will be entering the market
● Demand will be rising, jobs will be created, wages will be rising and profits made by
firms will be rising
● However, prices may also be rising

Downturn ● The economy is still growing but at a slower rate

● Demand for goods and services will stop increasing or begin to fall
● Unemployment will start to rise and wage increases will slow down
● Many firms will stop expanding, profits may fall and some firms will leave the
market
● Prices will rise more slowly

Recession or ● Demand will start to fall for many goods and services - particularly non-essentials
depression ● Unemployment rises sharply, business confidence is very low, bankruptcies rise
and price become flat
● Prices of some things may even fall

Recovery ● Businesses and consumers regain their confidence and economic activity is on the
increase
● Demand starts to rise, unemployment begins to fall
● Prices start to rise again

The impact of economic growth:

Type Explanation

Employment ● As business produce more, they need more workers

● Consequently, economic growth raises employment levels, reducing unemployment
● Gov also tend to spend more during periods of economic growth
● This helps to create more jobs - in education, healthcare, etc

Standards of ● Increases in GDP mean that on average people have more income - with more
living disposable income, people can buy more goods and services
● Also, as the economy grows, it is possible to spend less time working - because of
improvements in efficiency
● Also, people can live longer - can buy healthier diets

Poverty ● Rapid economic growth reduces poverty (creates new jobs taken by the poor)
● Growing economy means gov collects more tax revenue - gov can spend more on
healthcare, education and provision for poor - reducing poverty

Productive ● Economic growth raises productive potential - meaning a country can produce
potential more goods and services

Inflation ● If economic growth is too fast, the economy may overheat - causing inflation

Environment ● Economic growth leads to more pollution - e.g as economies grow, more cars are
purchased and more flights are taken
● Also, EG uses up non-renewable resources such as oil - once they are used up,
they cannot be replaced - meaning that future generations will have fewer
resources (called unsustainable growth)
26. Inflation
What is inflation?
● Inflation: general and continuing rise in prices, measured as a rate (%)
● Deflation: a fall in prices OR an economic slowdown (a period of time where
aggregate demand is falling)
● Aggregate demand: total demand in the economy from consumers, businesses, the
government and foreign buyers

How do we measure inflation?

CPI (Consumer Price Index): a measure of the general price level (excluding housing costs
such as house prices and council tax)

How is CPI calculated?

● Every month, the government records the prices of about 600 goods and services
purchased by over 7000 families (UK)
● An average monthly price is calculated
● The average monthly price is converted into an index number
● This allows comparisons to be made between two different periods
● CPI is the measure used worldwide

Types of inflation:
Demand-pull inflation:
● Demand-pull inflation: inflation is caused by increased (too much) demand in the
economy

Possible causes of increased aggregate demand:

● Rising consumer spending encouraged by tax cuts or
low interest rates
● Sharp increases in government spending
● Rising demand for resources by firms
● Booming demand for exports (i.e. foreign buyers
purchasing goods and services from the UK)

Cost-push inflation:
● Cost-push inflation: inflation is caused by rising business costs. Businesses put up
their prices to protect their profit margins

Possible causes of rising business costs:

● Rising costs of imported goods, especially oil
● Wage increases
● Increases in taxation (e.g. indirect taxes such as VAT in
the UK or IVA in Spain)

The relationship between interest rates and inflation:

● Interest rates: Price paid to lenders for borrowed money; i.e. the price of money
 ● Monetarists: Economists who believe there is a strong link between growth in the
money supply and inflation
● Money supply: the stock of notes and coins (cash), bank deposits, and other
financial assets in the economy

KEY CONCEPT: Monetarists believe that inflation may be caused when households, firms
and the government borrow money from banks to fund extra spending.
● This adds to the money supply because there are now more bank deposits (the
borrowed money increases bank balances).
● The extra money lent creates more demand and prices are driven up.
● This type of inflation is likely to occur if interest rates are low
● This is because borrowing is likely to increase when interest rates are low

How interest rates can be used to lower inflation:

1. Higher interest rates reduce borrowing because the “price of money” increases
2. Money supply therefore grows less quickly
3. Demand will therefore fall (as people have less money to spend)
4. The pressure on prices is therefore relieved
5. Inflation will therefore fall

The impact of inflation:

Area affected How inflation affects area

Price ● Prices are rising

● Purchasing power of money is reduced (people cannot buy as much goods/services
with their income) → fall in living standards
● ***Not a problem if wages/incomes rise as much as inflation

Wages ● When prices rise, workers will want higher wages to compensate for their loss of
purchasing power
● So inflation may lead to higher wages, but it is not automatic (depends on employer/
time frame)
● Potential spiral: inflation occurs → firm increases wages → firm increases prices
because costs have gone up → higher wages

Exports ● When prices rise domestically, firms will find it harder to sell goods overseas (price of
exports rise) → demand for exports falls → balance of payments is affected
negatively
● Fall in demand for exports could lead to job loss domesticall

Unemployment ● Inflation means aggregate demand is rising → firms want to increase output since
prices are increasing (more revenue!) → more workers are needed to produce these
goods → reduction in unemployment
● There is a tradeoff between inflation and unemployment

Menu costs ● If inflation is rapid, firms increase their prices frequently

● This represents a cost to businesses because customers have to be informed about
new prices (new brochures printed, websites updated, sales staff informed)
● (Called ‘menu costs’ due to the example of a restaurant having to reprint its menu)

Shoe leather ● When prices change frequently consumers & firms spend more time looking for the
costs lowest price/best value → all of this walking around wears out the leather on your
shoes! (metaphorically…)

Uncertainty ● If inflation is high and varying, firms do not know what prices will be in 3 or 6 months
time → making predictions becomes difficult
○ Will investments be wise?
● It’s not ideal for businesses to make long term (financial) decisions, when inflation is
changing prices rapidly in the short term

Business and ● Consumers may feel anxious about high inflation → less willing to borrow money,
consumer more likely to save ‘just-in-case’ (which means less spending!) → lower aggregate
confidence demand→ potentially few jobs/higher unemployment
● Businesses may postpone growth plans or reduce spending → less likely to take
risks → less economic growth
● Hyperinflation: prices spiral out of control, increase by 100s or 1000s of %, can
destabilise a country

Investment ● Investment requires spending large sums in hopes of future returns (earning that
money back and more!)
● Uncertainty leads to low business confidence, which means investment projects are
likely to be postponed/cancelled. → negative impact on economic growth & employ.

27. Unemployment
Unemployment: when those actively seeking work are unable to find a job

Types of unemployment:
Type Explanation

Cyclical ● Unemployment is high during a recession (demand for goods is low → production
Unemployment is low → less need for labour)
● People are often laid off, or ‘fired’ but because of the companies reduced need for
labour, not because of any wrongdoing
● This is the ‘worst’ type of unemployment, and governments try to prevent it

Structural This type of unemployment happens as a result of changes in the structure of an economy
Unemployment ● Sectorial unemployment: an industry is in decline (coal, video rental stores)
● Technological unemployment: when workers are replaced by machines
● Regional unemployment: unemployment rates can differ by region

Seasonal Some workers only work part of the year (usually due to weather
Unemployment

Voluntary Some people simply choose not to or don't need to work

unemployment

Frictional It occurs when people are unemployed as they move from one job to another
unemployment
 Impact of unemployment:
Impact Explanation

Output ● If people are unemployed, the productive potential of a country is not being fully
exploited
● Levels of output are lower than they could be
● This means that the national income and living standard will be lower
● However, if most of the unemployment is a result of new technology being
introduced, output might not fall. Output could actually increase if productivity rises.

Use of scarce People who are out of work do not make any contribution to production, which is a waste of
resources resources and results in lower levels of national income

Poverty ● High unemployment means higher rate of poverty because less people are earning
money and supporting their family
● When people are unemployed their incomes fall as state benefits tend to be lower
than wages

Gov spending ● In most developed countries, when people are unemployed they are entitled to
on benefits receive financial benefit from the state
● If unemployment levels rise, the government has to allocate more money to
unemployment benefits, which incurs an opportunity cost
● Money could be spent on education, healthcare, etc

Tax revenue ● If unemployment rises, tax revenues will fall because most taxes are related to
income and spending
● This means the government has less to spend and may have to cut public services
● Instead, it may borrow more, which will increase national debt or it may have to
increase tax rate

Consumer ● During periods of high unemployment, consumers lose confidence because they
confidence think that they will get laid off or fired
● This will result in consumers spending less money in order to save it
● Also their income falls because state benefits are generally lower than wages.

Business ● When firms lay off workers, they have to pay them redundancy money
confidence ● The remaining workers may be demotivated because they may fear to be the next
● A firm will be left with spare capacity when laying off people and there is likely to be
a fall in demand
● Sales fall when unemployment rises (people have less to spend)
● These events reduce confidence of business decision makers - as a result, they
may cancel investments)

Society ● Mainly local communities workers are employed by a same big firm , if the big firm
closes then it will cause everyone to have less money
● Therefore this will cause the small firms to struggle which means that the
environment will be worse as the economy is poor
○ Individuals might doubt themselves if they get unemployed
○ Unemployment could also lead to crime and raise stress levels

28. Balance of payments on the current account

● Exports: goods and services which are sold overseas.
● Imports: goods and services which are bought from overseas.
● Balance of payments: a record of all transactions related to international trade.
 ● The current account: the part of the balance of payments where all imports and
exports are recorded

● Current account balance: difference between total exports and total imports
● Current account balance= value of exports into a country - value of imports
● Current account surplus: when the value of exports exceeds the value of imports
● Current account deficit: when the value of imports exceeds the value of imports

● Visible trades: trade in physical goods

● Invisible trades: trade in services

The relationship between current account balances and exchange rates:

● Exchange rate: the price of one currency in terms of another
➔ $1 costs 1.06€
➔ 1€ costs $0.94
● We say a currency “gets stronger” or “appreciates” when one unit of currency can
buy more units of another currency
➔ Last month: $1 costs €0.93
➔ Today: $1 costs €0.95
● The US dollar has gotten stronger against the euro / appreciated against the euro
because it now costs less (in dollars) to buy euros.
● This means that the euro has depreciated (lost comparative value) against the dollar

***KEY POINT*** Exchange rates can affect international trade

● If a country's exchange rate gets stronger (their currency appreciates)
● So exports become more expensive for foreign consumers to buy, and imports
become cheaper for people living in that country to buy
● Therefore fewer exports will therefore be sold and more imports will be bought
● This will have a negative impact (negative, as in ‘lower numbers’ not ‘bad’) on the
current account and could increase a country's current account deficit.

Reasons for deficits and surpluses

Reason Explanation

Quality of domestic ➔ If a country has a reputation for high quality domestic products, it is likely to
goods enjoy high/rising sales from overseas. (eg. wine or olive oil from Spain) →
Increasing demand for exports → higher current account balance
➔ This also means people of that country will prefer their own high-quality
products, so imports for that product will be low →high current account balance

Quality of foreign ● If goods and services from overseas are superior to domestic products →
goods Increasing demand for imports → lower current account balance
● ** Less demand for home-produced goods could mean lower domestic output
and higher unemployment rates

Price of domestic If domestic goods and services increase in price (due to inflation perhaps) → demand
goods from overseas buyers will fall → lower current account balance

Price of foreign If foreign goods and services area cheaper than those produced at home → increased
goods demand for imports → lower current account balance

Exchange rates Exchange rates affect prices, which will impact demand for imports and exports, which
between countries affects the current account balance.

Impact of a current account deficit

Impact Explanation

Leakages from ➔ A persistent deficit suggests a reliance on imports

the economy ➔ Therefore money is flowing out of the economy to businesses overseas
➔ This could lead to lower output levels domestically, and higher unemployment
“Sending jobs overseas”

Inflation ● A persistent deficit suggests a reliance on imports

● If the price of imports goes up, this will be added to the CPI
● Therefore, rising import prices would result in higher inflation

Low demand ● A country with a high CA deficit may be struggling to sell their goods abroad, due to
for exports low quality or high prices
● This can lead to slow economic growth and high unemployment
● This may also suggest a structural weakness in the economy, that they may not be
able to effectively compete internationally

Funding the ● Foreign currency is needed to pay for the rising quantity of imports
deficit ● It may be necessary to borrow foreign currency (interest!)
● This can be offset with a surplus in the capital account

29. Protection of the environment

Business activity that damages the environment:
Type Explanation

Mining Minerals are extracted from a large hole in the ground

➔ Commonly mined materials: copper, iron, gold, diamonds, coal
➔ What is being mined is often rare/scarce, so a lot of ground needs to be dug up and
displaced to find the minerals
➔ This process involved crushing rock, which can release harmful materials into the
air and water
➔ During the separation process, waste material called tailings (crushed rock and
liquid) is produced
➔ Mines themselves are located in countrysides, destroying natural habitats
➔ Mining also requires a significant amount of water, and wastewater from mining can
make its way to rivers & seas

Power ● Damages the environment if electricity is produced with fossil fuels (coal/oil)
generation ● Fossil fuel plants release: release of hot/dirty water, solid waste, ash, & result in
noise and visual pollution. Worst effect is releasing greenhouse gases
● Nuclear power stations also represent a danger of radioactive waste

Chemical ● Necessary because: chemicals are used in daily life- fuels, paints, cleaning
processing supplies, pesticides, plastics, glues, adhesives, refrigerants.
● Creating chemicals can harm the environment
○ Refineries & chemical processing plants produce HAPs (hazardous air
 pollutants) → cause cancer/health problems
○ Some chemical processes release VOCs (volatile organic compounds) into
the air → cause asthma, lung & heart problems

Agriculture ● Use of pesticides and fertilisers: helpful for improving crop yields, but with rainwater
they can pollute rivers & seas and A kill aquatic life
● Factory farming is emits huge amounts of greenhouse gases
● Deforestation also results in huge CO2 emissions and destroys wildlife habitats

Construction ● Produces more waste material than any other industry which uses up resources
and causes disposal problems
● Causes of air pollution: land clearing, operation of diesel engines, demolition,
burning/working with toxic materials
○ Also produces lots of dust, which can cause respiratory problems
● Causes of water pollution: Diesel and oil, paint, solvents, cleaners and other
harmful chemicals and construction waste and dirt can be washed into water
systems

Ways businesses damage the environment:

Type Explanation

Visual pollution ➔ Business activity results in something physical that looks unattractive
➔ Eg. Giant office buildings, bright illuminated signed, wind farms, overflowing skips,
litter

Noise pollution ● Business activity results in excessive noise, causes a disturbance to everyday life
● Eg. jet engines, loud music from bars, machinery/tools, commercial traffic sounds

Air pollution ● Burning fossil fuels: emissions from vehicles, airplanes, etc
● Emissions from factories & other business activities: manufacturing & processing
businesses discharge harmful greenhouse gases
● Agricultural activities: pesticides, fertilisers, ammonia are all byproducts of
agricultural activity.

Water pollution ● Most harmful substances find their way into waterways as a result of business
activity:
○ Industrial waste: manufacturing requires water, and waste water is
sometimes dumped into nearby waterways.Most gov's have regulations
forcing businesses to treat the water before dumping it, but it can still be
dangerous
○ Marine and ocean dumping: waste materials from shipping, oil leaks, and
waste from the land can pollute the ocean; waste from some countries is
dumped directly into the sea.
○ Sewerage: sewage in most developed countries is treated before it reaches
the sea, but untreated sewage is harmful (disease, human waste,
pharmaceutical drugs, plastic, etc)
● Marine life is threatened by water pollution. Pollution can also threaten humans'
access to clean drinking water
 Government intervention to protect the environment
Gov Int’ Explanation Advantages / Disadvantages

Taxation Cost imposed on businesses who ➔ Adv: emissions reduced, green jobs created, tax
create externalities revenue goes to the gov (to fund green projects)
➔ Disadv: represents a cost to businesses

Subsidies Gov offers grants, tax allowances, ● Adv: firms respond to financial incentives
financial incentive ● Disadv: opportunity cost for the government,
can lead to complacency (low effort from firms)

Regulation Laws: regulations, guidelines, codes ● Adv: sets clear expectations for all firms
of practice, ‘rules’ ● Disadv: hard to monitor/enforce, opportunity
Gov agencies check on firms cost for gov resources creating & enforcing laws

Fines Financial penalty for firms & ● Adv: firms are usually very responsive to
individuals who break environmental financial penalties because they reduce profit
laws ● Disadv: not effective if they aren’t large enough

Pollution Gov issued doc that allows firms to ● Adv: incentivises firms to reduce emissions in
permit discharge a certain amount of order to profit from sale of the permit
polluting material ● Disadv: pollution is being allowed; variables
include cost and number of permits issued

Park Gov establishes protected ● Adv: wildlife, historical sites, scenery, unique
provision national/state parks to land & water features are protected
preserve/protect nature ● Disadv: opportunity cost of land & gov
resources

30. Redistribution of income

● Income inequality: differences in income that exists between the different groups of
earners in society, that is, the gap between the rich and the poor

Huge differences in income happen for several reasons:

● Workers with natural talent, a good education, valuable work experience or who can
offer labour in a market where there is a shortage of qualified labour, will earn more
● People who don’t work (pensioners) receive less incomes than those in employment
● The extent to which a government redistributes income through taxes and welfare
payments is influential
● People who own assets such as property, shares and capital will enjoy additional
income such as rents, dividends and interest, respectively

Absolute Poverty VS Relative Poverty

Where people do not have enough resources to meet all of Poverty that is defined relative to existing living
the basic human needs standards for the average individual
● People are fighting to survive (no adequate food, ● Those in relative poverty are at the bottom of a
water, shelter, education, sanitation, etc) nation’s income scales (their income falls short
● Often no income, they live in search of of the average standard of living)
food/basic needs ● Calculation of the EU: those living at 60% or
 ● Levels are low in developed countries due to the less of the median national income, so it varies
government providing basic welfare payments between countries
and programmes for the needy ● This is always present, even in developed
● An estimated 702 million people live in absolute societies
poverty (9.6% of world population)

Reasons to reduce poverty and inequality

Reasons Explanation

Meet basic ➔ About 10% of the world population are at risk of starvation, especially those who
needs are children. (3.1 million children died of starvation in 2011).
➔ Malnutrition increases the risks of other diseases, making people more likely to die
of treatable illnesses.
➔ If absolute poverty is eliminated, basic needs are met, which would lead to less
death from starvation and more healthy children

Raise living ● Although relative poverty will always exist (mathematically) the living standards will
standards rise as income rises
● Those in relative poverty are more likely to become ill and have lower life
expectancy, likely due to: poorer housing, less nutritious diets, reduced access to
healthcare. They are also likely to have lower self-confidence and less control over
their lives and less choice.
● Reduce poverty → higher living standards → more educated population → boost
economic growth → more employment, more income, more tax revenue for gov

Ethical reasons ● Many believe people and governments have a moral obligation to reduce poverty
● It’s seen as a moral duty of both people and governments to help reduce poverty →
reduce human suffering, ensuring people have happier healthier lives

Government Intervention to Reduce Poverty and Income Inequality

Progressive Taxation Regressive Taxation

● Income paid in tax rises as the income of the ● Tax the poor more heavily
taxpayer rises ● Income tax falls as income rises
● E.g. If I earn $25,000, I will pay 7% tax ● Taxes on spending e.g. VAT are more
If I earn $75,000, I will pay 25% tax regressive (a flat tax on the same purchase
● In most nations, tax on income is progressive represents a higher percentage of income for
● This can help close the gap between the rich & a poorer individual)
the poor

Redistribution through benefits payments Investment in Education

● Welfare system to boost incomes of those in ● If people are educated, they can develop
poverty skills and become more employable
○ In EU, payments are made to: the ● School also offers children a safe place
unemployed, the disabled, the sick, where they can learn life skills and can help
single-parent families, the elderly, and them prevent disease
those on very low income ● Education can be expensive to invest in and
● This payments can help reduce poverty (and is it can take a long time to see the rewards
often effective, see Ecuador example) ○ In most developing countries, public
● Areas with large absolute poverty do not tend school is not free as you must pay for
to have these welfare systems e.g. developing books, uniforms etc.
 countries (low GDP, low tax revenue) ○ 67 million 5-11 year olds have no
primary education and over 226
Investment in Healthcare million children do not attend
● Health programmes can reduce mortality rates, secondary school
increase life expectancy ● On average, every year in education
● If children are healthier → more days in school increases a person's future income by 10%
● Longer life expectancy → more likely to save ● Several years of education can reduce
for retirement poverty
● Healthier people → more productive in
workplace → increase output

31. Fiscal policy

● Policy instruments: tools governments use to implement their policies, such as
interest rates, rates of taxation, levels of government spending
● Fiscal policy: decisions about government spending, taxation and levels of
borrowing that affect aggregate demand in the economy

Why does the government levy taxes?

● To pay for public sector services
● To discourage certain activities (eg. cigarettes are highly taxed)
● To control aggregate demand
● To redistribute wealth in an economy

Type Explanation (only need to know the type, not the explanation)

Direct taxes Taxes imposed on firms or individuals

(It’s direct because it is paid directly to the government)
Types of direct taxes:
➔ Income Tax: Based on the amount an individual earns. Paid by anyone employed
or self - employed
➔ Social Insurance Tax: A tax on people's income but the money is used for specific
expenditure e.g. pensions & healthcare
➔ Corporation Tax: The money firms pay on their profits made (specifically limited
companies)
➔ Capital Gains Tax: A tax paid on the selling of assets for profit
➔ Inheritance Tax: Tax when money is inherited when someone dies. Usually a
certain amount is tax free

Indirect tax Any tax on spending

(It’s indirect because the consumer pays the seller, who then pays the government)
Types of indirect taxes:
● Sales Tax: Taxes on spending e.g. VAT - a percentage on a product you buy (VAT
rate in Spain is 21%)
● Duties: Large tax rates on particular goods e.g. Alcohol & Cigarettes
● Customs: Taxes put on imports - Brexit will have big effect on this
● Council Tax: Collected by local council or authorities to pay for local services e.g.
grass cutting & bin collections. Higher the value of property, the higher the payment
● Business Rates: Business pay local authorities money to contribute to local
services
● Stamp Duty: Tax paid when buying certain assets
Environmental Tax designed to protect the environment
tax (reduce negative externalities)
● Landfill Tax: Tax paid on disposing waste in landfill sites. Based on weight of waste
● Climate Change Levies: If greenhouse gas limits are not met (usually paid by
business)
● Aggregates Levy: A tax paid on sand, rock & gravel taken from the ground

Government expenditure:
Expenditure is the opposite of revenue; it is money that the government spends
● Mandatory spending: based on political system, these payments are made
automatically and the gov is legally obligated to pay them (pensions, unemployment
payments, etc)
● Discretionary spending: ‘extra’ or ‘new’ spending (eg. money for a new motorway)

Fiscal deficits and surpluses: *don’t confuse with current account*

Type Explanation

Fiscal deficit Government expenditure is greater than government revenue

➔ Gov. will borrow if they are running at a deficit. In future years, the Government
has to spend its revenue paying off its national debt. (*opportunity cost*)
➔ Eventually, future generations may be left with the burden of paying it off

Fiscal surplus Government expenditure is less than government revenue

● A fiscal surplus could be used to lower taxes in the economy or pay off the
national debt

Debt as a % of ● Important to focus on size of fiscal deficit in relation to years GDP

GDP ● The amount that needs to be borrowed to cover the deficit is only a serious
problem if it is a large percentage of the GDP
● So we express the deficit as a percentage of the GDP

Expansionary Fiscal Policy

Goal: stimulate the economy (increase aggregate demand)

Stimulate ➔ Increased gov spending → more jobs in the public sector → lower unemployment
economic rates & higher aggregate demand
growth ➔ Increased gov spending on infrastructure roads, schools, airports) → factors of
production become more mobile → increased productivity
➔ Cut taxes → households have more disposable income → higher aggregate
demand → suppliers produce more to meet demand

Reduce ➔ Increased gov spending → funds to towards hiring more public sector workers or
unemployment funding infrastructure projects that require contracted labour → reduced
unemployment
➔ Increased gov spending or tax cuts - increase aggregate demand → suppliers
boost production to meet demand - additional workers are hired for the increase in
production
Protect the ● Gov subsidies → encourage 'green' economic activity
environment

Contractionary Fiscal Policy

Goal: cool off the economy (decrease aggregate demand)

Reduce ➔ Reduce gov spending → less gov funding for education, healthcare,
inflation infrastructure, etc → fewer public sector jobs → less AD
➔ Raise taxes → consumers have less disposable income → less aggregate
demand → less inflation

Reduce current ➔ Higher taxes or reduced gov spending → reduced aggregate demand → reduce
account deficit demand for imports → lower current account deficit

Protect the ● Higher taxes on polluting businesses → discourage 'non-green' economic activity
environment

32. Monetary policy

● Monetary policy: use of interest rates and the money supply to control aggregate
demand in the economy

Interest rates: (price paid to lenders for borrowed money)

How do interest rates vary?
● Different banks charge different rates to compete
● Higher interest rate if you borrow money without security
● Borrowers pay more than savers
● High rates of interest on credit cards

Reasons for different rates of interest:

● Different banks charge different rates as they compete with each other for business
● Rates are higher if money is borrowed without security
● The amount paid to borrowers is higher than the amount given to savers. This allows
moneylenders such as banks to make a profit
● Some of the highest rates of interest are charged to credit card users

The role of central banks in setting interest rates:

● Implementing the gov’s monetary policy
● Can lend money to banks as last resort
● Controlling inflation and stabilising currency
● Setting interest rates

Impact of interest rate changes on macroeconomic objectives

Impact Explanation

Inflation ➔ Monetarists believe inflation happens due to money supply growing too quickly
➔ To reduce inflation - slow down speed of money supply
 ➔ To do this, you would raise interest - which will mean borrowing levels fall - money
supply stops growing so fast
➔ This will reduce AD(aggregate demand) in economy

Unemployment ● Lowering interest rates will incentivise firms and individuals to take out loans &
take more risks
● Therefore spending increases, so aggregate demand increases
● More workers are hired so that businesses can increase supply to meet high
demand

Economic ● Monetary policy can be used to influence the natural economic cycle
growth ● Eg. interest rates are lowered to encourage spending, stimulate the economy and
lift a country out of recession (most countries did this after the 2008 crash)

The current ● To reduce a CA deficit: increase interest rates → lower aggregate demand → less
balance demand for imports
● However, if interest rates are raised, this may also increase the exchange rate,
making exports more expensive and imports cheaper, resulting in a larger CA
deficit
● So how can we know how the CA will be affected by higher interest rates? Factors
include:
➔ The strength of link between interest rates & exchange rates: If strong link,
higher interest rates will raise exchange rates. Exports become expensive
& imports cheaper - bad for current balance
➔ Income Elasticity of Imports: If demand for imports were income elastic,
higher interest rates would reduce demand, improving the current balance
➔ Price Elasticity of demand for imports & exports: If both are price elastic
and exchange rates rise when interest rates do, imports would be cheaper
and exports would be more expensive. This would worse the current
balance

The mechanism by which interest rates changes affect consumers and firms
Affected Explanation

Consumers If interest rates fall:

➔ Consumers are more likely to borrow for goods - higher aggregate demand
➔ Mortgage payments fall - they have more money to spend - increase AD
➔ If interest rates are lower, the reward to savers is also lower - encourage people to
spend rather to save

If interest rates increase:

● Consumers try to reduce borrowing because it becomes expensive - AD falls
● Mortgage payments rise - household will have less disposable income to spend

Firms If interest rates fall:

➔ Interest payments on current borrowing will fall
➔ Raise levels of business confidence and stimulate more investment
➔ Returns in investment rates are higher - more investment may be undertaken

If interest rates increase:

● Raise costs, lower profits, reduce business confidence and make entrepreneurs
more cautious - investment in the economy may fall
 33. Supply Side Policies and government controls
Supply Side Policies: the goal is to increase aggregate supply; they tend to be ‘business
friendly’ and increase economic growth

Supply Side Policies aim to:

● Increase flexibility in the labour market by removing restrictions
● Restoring the incentive to work by lowering taxes
● Promote competition through privatisation, deregulation, and helping small firms
● Increase investment by improving the flow of capital in a capital market

Impact of Supply Side Policies on Productivity and Total Output

Productivity: Mostly improve productivity. Resources used more efficiently so potential increases

Improve ➔ Previously, it was believed that workers were inflexible. Trade Unions were an
flexibility obstacle to this change. U.K. 1980s, legislation brought in to remove union power
and so workers became more flexible

Training & ➔ Quality of the workforce will increase with more training and education. Labour
Education productivity will increase therefore so will aggregate supply

Competition ➔ Some Supply Side Policies aim to promote competition, giving firms incentive to
innovate and cut costs, raising productivity

Total Output:
● SS policies lead to increased volume of output, → income will rise along with living standards
● Less chance of demand pull inflation if supply is increased → lower unemployment rates

Impact of Supply Side Policies on macroeconomics objectives

Impact Explanation

Privatisation ➔ 👍 Helps to break up state monopolies, reduce inefficiencies and promote

competition → Competitive pressure should improve quality and choice

➔ 👎Sometimes, state monopolies become private monopolies. Consumers can

➔ Some public services were contracted out (e.g. meals in schools)

then be exploited and has led to poor quality services (e.g. cable companies)

Deregulation
➔ 👍
➔ Deregulation relaxes laws and rules the government uses to control the market
This helps reduce: excessive paperwork, obtaining unnecessary licences,
having many committees approve decisions, various ‘trivial’ rules that slow down

➔ 👎
business development
Inadequate or insufficient regulations may cause problems as businesses are
left unchecked (eg. The financial crisis of 2008, food safety recalls)

Education & ➔ 👍Governments and firms invest in education and training → more skilled
Training workers → higher employability
➔ How?
● Gov can invest in schools, unis, etc

➔ 👎● Gov can provide tax incentives to invest in training

Investment in education is very expensive and returns (results) are not seen for
 years; many developing countries have inadequate education programmes due to
the cost

Policies to
boost regions
➔ 👍Supply side policies are very selective so can be used specifically
➔ Spain 2015 unemployment rate was 24.4% - but Andalusia was 34.8%
with high ➔ Spanish gov organised policies to help labour markets - made easier to hire & fire
unemployment ➔ Spain also got money from the EU for job creation in worst hit areas - technology
park in Andalusia

Infrastructure ➔ Gov. invest more in infrastructure to improve economic growth & aggregate supply
spending ● Improve transportation and communication systems → better geographic
mobility; easier distribution of goods
● Improve education & healthcare → improve quality of human capital
➔ E.g. Building roads will allow for trade for many years into the future
➔ Another example is China investing in internet to produce high speed internet for
commerce

Lower business ➔ Economic growth can be accelerated if businesses are encouraged to invest more
taxes to ● About half of all investments are funded by profits; lower taxes on profits
stimulate → more willing investors
investment ● Tax incentives & write-offs: Certain investments (eg. buying a machine for
your business) are ‘tax-deductible’

Lower income ➔ Some argue high taxes on income and profit reduce output because people are
taxes to discouraged from working / setting up their own businesses
encourage
working

34. Relationship between objectives and policies

Inflation policy Current account impact

If inflation is high and … it will lead to higher prices, including prices of exports → decreased
persistent… demand for exports → lower CA balance

If the government uses ..when interest rates are high, demand for domestic currency may rise
monetary policy to reduce due to foreign savers →appreciating exchange rate → exports become
inflation (high interest rates) … relatively more expensive, and imports relatively cheaper→lower CA
balance

Therefore a government trying to reduce inflation by raising interest rates may have to accept that the
current account will worsen for a while…

…However, it depends on the ➔ If imports and exports are price elastic, they will be very
elasticity of demand of imports responsive to changes in prices, thereby impacting the CA
and exports balance more drastically
➔ If imports and exports are price inelastic, the quantity demanded
will be relatively unaffected by changes in price/ exchange rate

… However, the government ➔ By cutting spending/ raising taxes, there will be a fall in demand
could use just fiscal policy… with little impact on the exchange rate → CA balance is less
affected
…. However, the government ➔ SS policy is unlikely to impact the exchange rate and usually
could use supply side help firms → businesses may be able to produce more output at
policy… low prices → boosting exports may benefit the CA account
➔ Supply side policy is often expensive and takes a long time to
see the impact

Macroeconomics objective: Reduce Inflation

Plan: Reduce inflation by using contractionary Why it may be effective:The government can quickly
monetary policy (raising interest rates) raise interest rates to reduce the demand

Negative consequences of raising interest rates:

● Discourage consumers and businesses from borrowing
● Higher mortgage payments for many households
● Higher interest charges, raise their cost to reduce their profits
● Discourage firms from borrowing to invest on new technology and expansion
● May be harder for firms to sell abroad

Plan: Reduce inflation by using contractionary fiscal Why it may be effective: Inflation will be reduced,
policy (raising taxes and cutting spending) since aggregate demand falls and the equilibrium
price falls.

However… Negative consequences of contractionary fiscal policy:

● There will be unemployment, since consumption falls, therefore firms will have to lay off some of their
workers in order to maximise profits.
● Poor people will suffer, since the government cuts spendings which might include benefits for the
poor in the form of money, food or infrastructure.

Trade off summary: If there is an attempt (monetary policy: higher interest)to reduce inflation, it is likely that
unemployment rates will increase and as a result there will be a reduction in aggregate demand.

Any ways to avoid this trade off? Downsides to this alternative?

Supply side policies can increase aggregate demand Supply side policies tend to be slow to impact the
of labour(because they enable more production), economy, therefore multiple measures should be
therefore unemployment will decrease. introduced.

Macroeconomic objective: Promote Economic Growth

Plan: Grow the economy by using expansionary Why it may be effective: By lowering interest rates
monetary policy (lowering interest rates) aggregate demand rises meaning more employees
are needed therefore the economy grows due to an
increase in national income.

Negative consequences of lowering interest rates:

● As a result of increased aggregate demand prices can become unstable which could eventually
cause inflation in the economy.
● Due to Inflation caused aggregate demand stops meeting supply therefore cyclical unemployment
occurs within many firms and businesses which can decrease standards of living and overall
decrease the economic growth of a country.
Plan: Grow the economy by using expansionary Why it may be effective: Lowering taxes: more
fiscal policy (lowering taxes and increasing disposable income, increased aggregate demand
spending) and increased business output. Increasing
spending: more gov. employment, more production
and increased national income

However… Negative consequences of expansionary fiscal policy:

● Increased aggregate demand can cause inflation
● This could then lead to money devaluating

Trade off summary:

Economic growth might be too expansionary so the economy may become ‘overheated’. Firms may not be
able to meet the rising aggregate so they will respond by rising prices instead of producing more. This
causes demand- pull inflation.

Under what conditions is inflation more likely? How can the threat of inflation be mitigated?
Inflation more likely to be caused if - Supply side policies to promote growth
- there is limited capacity in the economy through helping increase supply instead of
- if it’s difficult to find resources such as skilled prices. Businesses can meet rising demand.
labour

Macroeconomic objective: Economic Growth vs The Environment

Examples of how increased economic growth may lead to externalities

● Businesses produce more output → more emissions from power generators, chemical processors
and other manufacturers
● Extra wealth and income coming from economic growth → increasing numbers of people buy cars
and other vehicles → more emissions & increased congestion on roads
● More land taken for business developments → less is available for wildlife
● The earth’s rainforests, swamps, plains, lakes and other habitats disappear as they are cleared to
make way for industrial uses (e.g agriculture, housing, roads)
● Pollution results from rapid business expansion

Economic growth vs Externalities in developing countries Economic growth vs Externalities

in developed countries

● What can increased economic growth provide citizens in a Why might environmental issues be
developing country: more pressing in developed
● Economic growth will provide citizens with more money. This countries?
is because during times of economic growth, businesses tend The more developed a country is,
to expand and therefore make more profits, this means that the bigger the businesses will be,
people will have more income and will be able to buy more meaning they will have a high output
things. However, this will cause more pollution as companies requiring more resources and power,
will expand, and produce more leading to pollution, however, and therefore polluting more. Also,
the government will not care as their goal is to increase the the bigger a business is, the more
living standards of the citizens, and having more money will space it will need which will leave
allow that to happen less space for wildlife and natural
● Is there any evidence of developing countries trying to reduce habitats causing more pollution.
externalities?
● In 2015, India planned to introduce tougher measures to
punish those polluting the environment.
 35. Globalisation
● Globalisation: growing interconnection of the world’s economies

Key features of globalisation:

● Goods and services are traded freely across international borders. (no laws prevent
sales between countries)
● People are free to live and work in any country they choose → societies are more
multicultural
● Capital can flow between countries (eg. a firm in Australia can put savings in a US
bank, or buy shares of a German company).
● Free exchange of technology and intellectual property across borders (eg. patents
granted in the US are recognised in other countries)

Reasons for globalisation:

Reason Explanation

Fewer tariffs & ● Countries used to restrict flow of imports so consumers buy domestic products
quotas ● Trade restrictions can be in place in some countries to stop this
● One way to avoid this is set up production facilities in that country that has trade
restrictions
● Companies are growing in other countries due to this
● Trade barriers dropped recently - more open economies and less protection of
domestic goods

Reduced cost ● Cost of flying has fallen; number of flights increased

of transport ● People can move easily and goods can be transported for cheaper
● Eg. India built roads, transport much better so people can move goods easier

Reduced cost ● Modern computing - data can be sent within seconds

of ● People can work at home or any part of the world
communication ● Easier for firms as many people do not have to be in offices
● Increase in internet has allowed people buy goods and services online easily

Increased ● Multinational Companies dominate markets: these are companies that operate in
significance of other many different countries
MNCs ● Benefit from having international markets for production savings and prices

Impact of globalisation:
Impact Explanation

Individual ●
countries

Governments ●

Producers ●

Consumers ●

Workers ●
The ●
environment

36. MNCs and Foreign Direct Investment (FDI)

What are Multinational Companies (MNCs)?
● Companies that sell goods and services to global markets

Key features of MNCs:

● Huge assets (lands, buildings, machinery, money) and revenue
● Highly qualified and experienced managers
● Powerful advertising and marketing
● Advanced and up-to-date technology
● Strong influence economically and politically
● Efficient at exploiting huge economies of scale

What is Foreign Direct Investment (FDI)?

Occurs when a company makes an investment in a foreign country or purchases shares of a
foreign businesses

Reasons for Emergence of MNCs/FDI

Reason Explanation

Economies of ● Large companies mean large savings

scale ● Can pressure suppliers to lower prices
● Can source factors of production from cheapest providers (across several
countries!)

Access to ● MNCs invest overseas since they buy in big quantities

natural ➔ African states attract FDI as they are rich in natural resources (mining, oil)
resources/ ● Many countries import food from overseas (eg UK) so they use FDI to ease
cheap materials access to these resources

Lower transport ● With globalisation and advanced tech, air travel is cheap, communication is
& comm. costs instant with internet

Access to cust. ● MNCs can sell goods to customers from many countries, instead of just their own,
in different more opportunity for profit
regions

Advantages of MNCs/FDI
Advantage Explanation

Many countries actively seek and encourage FDI from foreign MNCs by:
● Offering tax breaks, subsidies, grants, and low interest loans
● Lifting restrictions and relaxing regulations to facilitate investment
● Investing in their own infrastructure
● Investing in education to improve their domestic human capital

Job creation ● When foreign MNCs set up operations in a country, they hire domestic workers →
 increase in domestic income → extra output and employment leads to economic
growth & higher living standards
● Often MNCs pay better wages than domestic firms

Investment in ● Countries with poor infrastructure struggle to attract FDI, so gov will invest in
infrastructure infrastructure to attract MNCs → better infrastructure → everyone benefits
● Sometimes FDI funds go directly to infrastructure as an investment

Developing ● MNCs provide training and work experience for domestic labour force
skills ● Gov invests in education so workers are better qualified to attract MNCs (eg India
investing in tech ed)
● MNCs may encourage local entrepreneurs to use their skills and motivation
● MNCs may help local suppliers learn new skills, methods, and working practices
(eg: no more siesta…)

Developing ● MNCs often have the funds to build facilities with latest technology (high quality
capital capital)
● Local suppliers may have to ‘up their game’ by improving their own capital in order
to secure orders to supply the MNCs

Contributing to ● Profits made by MNCs are taxed by host nation → host gov has more funds for
taxes future investment/growth

Disadvantages of MNCs/FDI
Disadvantage Explanation

Tax avoidance ● Powerful firms have savvy legal teams to find tax loopholes, many MNCs have
been accused of not paying their fair share

Environmental ● MNCs are heavily involved in coal, oil, and mining industries which are very
damage destructive

Moving profits ● Profits are subject to repatriation (where MNC headquarters are), so less
abroad developed host countries lose out on benefits

37. International Trade

Reasons for international trade:
● Obtaining Goods that Cannot be Produced Domestically
➔ Countries may lack the (natural) resources to produce certain goods (eg.
farming in Iceland)
● Obtaining goods that can be bought more cheaply from overseas
➔ Some countries produce certain goods more efficiently than others, due to
natural resources, specialisation, cheap labour, capital etc.
● Selling off unwanted commodities
➔ Some countries have too much of certain goods, so they export them (eg. oil
in Qatar)

Advantages of international trade

 Advantage Explanation

Lower prices ● Choice: domestic consumers have access to their own products as well as foreign
and increased ones → improved standard of living
choice for ● Competition leads to fairer prices
consumers

Lower input ● Companies may produce more cheaply in other countries (eg. China buying
prices cheap raw ore materials from Australia, who specialise in mining)
● Specialisation and economies of scale within countries allows for lower prices on
the global market

Wider market ● Selling on the global market allows firms to grow/profit, spread risk, and exploit
for businesses economies of scale

Disadvantages of international trade:

Advantage Explanation

Competition for ● Domestic producers may struggle to compete with imports of good quality that are
domestic competitively priced
businesses ● Eg. Manufacturing in the US and Europe has declined since they could not
compete with China’s cheap imports (so the West has shifted focus from the
secondary to the tertiary sector)

Unemployment ● Domestic companies who can’t compete will go out of business and the workers
there will lose their jobs to their overseas competitors.
● Countries that are highly specialised in producing certain goods may be in danger
if demand for those goods drops

38. Protectionism
● Protectionism: approach used by governments to protect domestic producers

Reasons for protectionism:

Reason Explanation

Prevent ● Dumping: where foreign producers sell goods below cost in a domestic market
dumping (sometimes deliberately to destroy overseas competitors)
● Companies that ‘dump’ may afford to do so due to subsidies

Protecting ● Domestic industries may need protection from overseas competition to save jobs
employment

Protecting ● Infant industries: new industries that are yet to become established
infant industries ● They may need protection from overseas competitors until they can develop and
exploit economies of scale

To gain tariff ● Gov can raise revenue if it imposes taxes on imports → more expenditure
revenue
Preventing the ● Eg. EU banned imported beef from cattle raised using growth hormones
entry of harmful
or unwanted
goods

Reduce current ● Trade barriers → reduced demand for imports → increased current account
deficits balance

Retaliation ● Impose trade restrictions on ‘dumped’ goods to maintain fair prices

● Also, if one country imposes trade barriers, the affected country may do the same
(trade war!)

Methods of protectionism:
Method Explanation

Tariffs ● Tax on imports to make them more expensive → decreased demand for imports,
increased demand for domestic products
● Advantages: protect domestic industries, government earns revenue, improved
current account balance
● Disadvantages: imports could stop altogether; consumers pay higher prices

Quotas ● Quota: physical limit on the amount of goods allowed in the country → domestic
producers have a greater market share
● Quotas may result in higher prices (decreased supply)
● Advantages:
➔ physical limit makes it difficult for foreign companies to get around quotas
by adjusting prices
➔ Takes time for the shortage to force the price up, allowing domestic
producers to ‘plug the gap’
● Disadvantages: restricted choice for consumers, loss of incentive to be efficient
for producers

Subsidies ● Involves giving financial support (grants, tax breaks) to exporters/domestic

producers who face competition from imports
● Advantages:
➔ Subsidies to domestic producers reduce production costs→ increased
supply → lower cost to consumer → consumer chooses the domestic
product over imports → boosts employment and current account balance
➔ Subsidies to exporters reduce production costs → these businesses can
more easily break into foreign markets
● Disadvantages:
➔ Subsidies are often disallowed by free trade agreements
➔ Opportunity cost; subsidies are expensive and gov could use the money
elsewhere

Protectionism Summary:
● If gov restricts free trade, consumers end up paying more for products & choice is
limited
● If domestic producers don’t face competition, they have less incentive to innovate
and keep prices low and quality high → lack of innovation slows global growth →
lower living standards → fewer jobs created
 Impact of tariffs, quotas and subsidies on markets:
Tariffs and quotas Subsidies

Shift the supply curve to Shift the supply curve

the left (higher prices, to the right (lower
lower quantity) price, higher quantity
demanded)
★shown as a perfectly
inelastic sup. curve ★

39. Trading Blocs

● Trade bloc: group of countries situated in the same region that join together and
enjoy trade free of tariffs, quotas and other forms of trade barriers

Types of agreements within trading blocs:

Type Explanation

Preferential ● Members agree to remove trade barriers on some goods and services
Trading areas
(PTAs)

Free Trade ● Trade between members is completely free of trade barriers

areas (FTAs) ● Members are allowed to impose trade restrictions on non-members
● Eg: NAFTA (USA, Canada, Mexico)

Customs unions ● Similar to FTAs but members impose a common set of trade barriers on
non-members
● Products imported by one member can be resold and transported to other
members in the union

Common ● Operate like customs unions but allows free movement of labour & capital
markets between member countries

Economic (and ● Most advanced type of trading bloc

monetary) ● Adopt the arrangements of common markets & customs unions but aim for even
unions more integration

Advantages of Trading Bloc membership

Advantage Explanation

Competition & ● Goods become cheaper and more choice available if barriers removed
Growth ● Economies of scale for business and access to larger markets

FDI ● Foreign firms eager to locate to area where no trade barriers

Improved ● Better cooperation between members
relationships ● Reduce border conflicts, promote peace

Disadvantages of Trading Bloc membership

Advantage Explanation

Cost ● Big financial cost to the government (taxpayers!)

Regional ● Firms in trading blocs can merge and lead to monopolies to exploit consumers
monopolies ● Some members benefit more than others

Reliance ● Countries can rely too heavily on trade within the bloc → more vulnerable to
changes in prices and demand patterns within the bloc / and they may miss out
on global trade opportunities
● Inefficient producers may be protected from competition from firms outside of the
trading bloc → consumers may pay more for goods and services in some
industries
● There may be set regulations that some members do not approve but have to
use

40. The World Trade Organisation and World Trade Patterns

● World trade organisations: international organisations that promote free trade by
persuading countries to abolish tariffs and other barriers

Activities of WTO:
Activity Explanation

Trade ● Aim: reduce or eliminate trade barriers (trade liberalisation) via negotiation,
negotiations establish procedures for settling disputes
● How: encourage countries to draw up trading agreements covering matters such
as anti-dumping, subsidies, & produce standards

Implementation ● Employs councils and committees to administer and monitors the application of
and monitoring the WTO’s rules
➔ Ensure trade agreements are clear and well-documented
➔ Conduct regular reviews of trade policies and practices
➔ Countries submit reports to the WTO as part of the monitoring process

Settling trade ● If there is a dispute, and a country thinks that their rights under their trade
disputes agreements have not been preserved → WTO appoints independent experts to
make judgments relating to the dispute after arguments from both sides have
been presented

Building ● Encourages new members to join

membership

Criticism of the WTO:

● Undemocratic
● Favours the right of corporations over those of workers
 ● Destroying the environment
● Favours wealthy nations over poorer ones
● Causing hardships for poorer nations

World Trade Patterns:

Reasons why world trade has increased:
● Better transport and communication
● Relaxing of trade barriers
● Development of multinationals
● Travel and consumer awareness
● Trade agreements

Trade in developed countries:

● Loss of trade in manufacturing
● Secondary sector moving from west to china
○ More air travel
○ Widening the development gap
● Developed countries less poverty
● Trade grows → gap between rich and poor is widening

Trade in developing countries:

● Increase in net migration
○ People leaving developing countries to find work in developed countries
● Increase FDI in Africa
○ More jobs created → increase living standards
● Rising the commodity dependence
● Debt cancellation
○ International monetary fund has encouraged countries to cancel debt owned
by poor countries so they can open their economies and grow
● Reduction of trade barriers
○ Help improve current account balances of developing countries

41. Exchange Rates and their Determination

● Exchange rate: price of one currency in terms of another

How are Exchange Rates Determined?

● Market forces (supply and demand) determine the price of any currency.
● The exchange rate is the equilibrium price

Factors affecting the demand for a currency:

Factor Explanation

Interest rates ● Increased interest rates attract foreign savers (eg. UK increases interest rates →
european savers exchange euros for pounds in order to put them in UK banks
and earn interest → increased demand for GBP)
Currency ● What are they? : Firms, individuals & financial institutions that buy and sell
speculators currencies in hopes of making a profit
● How do they make money? : They buy a particular currency then sell it for a
higher price later as its value can change dramatically
● Eg. when speculators think the pound is going to increase in value, the demand
for the pound increases

The demand for ● Firms selling to other countries expect to be paid in their own currency.
exports ➔ (EX1 Uk firms selling to Australia want to be paid in GBP not AUD, so
Aussie firms must obtain GBP from the bank in order to make the
purchase)
● Therefore, an increase in demand for an export leads to an increase in the
exporter’s currency.
➔ (and a fall in demand for an export can lead to a fall in demand for that
exporter’s domestic currency)
● Movements of investment capital can also affect the demand for currency (inward
FDI increases demand for host country’s currency)
➔ EX2, if a British MNC wants to build a factory in Nigeria, they will need
Nigerian Naira (NGN) to buy the materials, labour, and other resources →
this will increase demand for NGN

Factors affecting the supply for a currency:

Factor Explanation

Interest rates in ● If UK savers see there are higher interest rates in Spain they may convert their
other countries pounds to euros in order to put their savings in Spanish banks. → This increases
the flow of pounds into foreign exchange markets, which increases the supply of
pounds and decreases the exchange rate. (The opposite will happen if overseas
interest rates are lower than the UK)

Currency ● They affect supply and demand of currency

speculators ● If speculators believe the price of the pound is going to fall, they will sell pounds
in exchange for another currency → increasing supply of pounds in the foreign
exchange market and lowering the exchange rate

Demand for ● Imported goods are bought with foreign currency, so if UK importers buy more
imports foreign goods, they also buy foreign currency using their pounds → increase of
flow of pounds onto the FEM (increased supply)
● Outward FDI also affects supply of currency (eg. UK MNC build a supermarket in
 Germany, convert GBP to EUR for investment → increase in flow of GBP in
FEM)

42. Impact of Changing Exchange Rates

Impact of exchange rate appreciation

Impact Explanation

Impact on ● UK firm sells goods worth £2 million to a US firm (US firm pays $3 million at the
exports original exchange rate.
● When the exchange rate rises (GBP becomes more valuable), the dollar price of
the goods also rises and the US firm now must pay $4 million.
● IMPACT: appreciating currency means a fall in demand for exports, because
exports become comparatively more expensive on the global market

Impact on ● UK firm buys goods worth $600,000 from a US supplier, price in pounds at the
imports original exchange rate is £400,000 ($600,000/1.50)
● When the exchange rate rises, the new price for the UK firm is £300,000
($600,000/2)
● IMPACT: appreciating currency means an increase in demand for imports as
imports are comparatively cheaper on the global market

Impact on ● Exchange rate appreciates → demand for exports falls & demand for imports
current account rises → lower current account balance
Impact of exchange rate depreciation
Impact Explanation

Impact on ● UK firm sells goods worth £2 million to a US firm (US firm pays $3 million at the
exports original exchange rate.
● When the exchange rate falls (GBP becomes less valuable), the dollar price of
the goods also decreases and the US firm now must pay $2.4 million.
● IMPACT: depreciating currency means a rise in demand for exports, because
exports become comparatively cheaper on the global market

Impact on ● UK firm buys goods worth $600,000 from a US supplier, price in pounds at the
imports original exchange rate is £400,000 ($600,000/1.50)
● When the exchange rate rises, the new price for the UK firm is £500,000
($600,000/1.2)
 ● IMPACT: depreciating currency means a decrease in demand for imports as
imports are comparatively more expensive on the global market

Impact on ● Exchange rate depreciates → demand for exports rises & demand for imports
current account falls→ increased current account balance

Exchange Rates and Gov Policy:

How can a gov reduce a persistent current account deficit?
● Let the currency depreciate (price of exports fall so demand increases, and price of
imports rises, so demand decreases)
● But how can it depreciate its own currency?
● If interest rates are reduced, exchange rate is likely to fall
● So it’s possible for a country to devalue its currency, but:
○ The gov may not have complete control over the base interest rates (its set by
the central bank and not the legislative or executive branches)
○ Reduced interest rates may counteract other macroeconomic objectives
(such as reducing inflation)
○ Devaluation will only work if the demand for exports and imports is responsive
to price changes (elastic PED!)

Exchange Rate Changes & Price Elasticity:

● Effectiveness of government exchange rate policy will depend on price elasticity of
demand for imports and exports.
● Eg. UK decreases interest rates → GBP depreciates → CA balance deficit will only
be reduced if the demand for imports and the demand for exports are both elastic.
● Countries that import mainly primary goods (foodstuffs, fuel, minerals) will find it
difficult to reduce quantity demanded, as PED for these goods is likely to be inelastic
as they are necessities, so higher prices resulting from the depreciation are not likely
to reduce the quantity demanded.
● Therefore, depreciation may work to reduce the CA deficit if exports are
non-essentials such as tourism or consumer durables