1.1 The Market System

The basic economic problem, demand & supply, elasticity, the mixed economy, privatisation and externalities.

Ch 1 The Economic Problem

Chapter 1: The Economic Problem

The whole of economics starts here: wants are unlimited but resources are finite (scarce), so choices must be made. Every choice involves a trade-off — the thing you give up is the opportunity cost. Economists use the production possibility curve (PPC) to show the maximum an economy can produce and the trade-offs involved, and to show economic growth (positive or negative).

LEARNING OBJECTIVES

Understand the problem of scarcity.
Understand opportunity cost.
Understand production possibility curves.
Understand causes of positive and negative economic growth.

GETTING STARTED — RESOURCES AND NEEDS

The planet contains many resources (oil, minerals, water, soil, plants, animals, people) used to produce the goods we like to consume.
The problem: there is only a finite amount of these resources, but people seem to want an endless amount of goods.
SUBJECT VOCABULARY:
goods — things that are produced in order to be sold.
services — things that people do for others in exchange for payment (e.g. a haircut, a train journey, health care).
finite — having an end or a limit.
infinite — without limits.

THE PROBLEM OF SCARCITY

FINITE RESOURCES

All countries have resources, but in any country the quantity is finite (limited) → economists say resources are scarce.
These scarce resources are the four factors of production: land, labour, capital and enterprise (covered in detail in Chapter 14).
GENERAL VOCABULARY — fertile soil: ground that is capable of producing crops.
Resources are scarcer in some countries than others. Example from the book: some African countries have serious shortages of fertile soil and water, so food production is inadequate. Ethiopia struggles to produce enough food because only about 4% of its fertile land is irrigated — the problem is not a shortage of water (it has huge rivers like the Awash and the Blue Nile) but a failure to exploit them (it lacks the financial resources to invest in irrigation projects).
Key idea for essays: scarcity exists everywhere; it is just more visible in poorer countries. Even a rich country has scarcity — no country has enough resources to satisfy all wants.

UNLIMITED WANTS

needs — the basic requirements for human survival: water, food, warmth, shelter, clothing. If needs cannot be satisfied, humans would cease to exist (in some countries people do die because needs cannot be met).
wants — people's desires for goods and services beyond basic needs: more holidays abroad, a better house, more meals out, a bigger car, new golf clubs, a better education, improved health care, a cleaner environment.
Wants are unlimited / infinite — people always want more whatever their circumstances; it is human nature.
The problem is made worse because many things people want have to be replaced — consumers regularly replace cars, computers, shoes, clothes and furniture, either because they stop working or because better/more fashionable versions appear.

THE ECONOMIC PROBLEM (the basic economic problem)

basic economic problem — the allocation of a nation's scarce resources between competing uses that represent infinite wants.
It occurs because: scarce (finite) resources + infinite wants → demand for resources is greater than supply → decisions must be made about how to allocate scarce resources between different uses.
GENERAL VOCABULARY — allocate: to decide officially that a particular amount of money, time, etc. should be used for a particular purpose.
The three key questions every society must answer (the basic economic problem in the book's Figure 1.4): 1. What to produce? — which goods/services to make. 2. How to produce? — which methods/resources (e.g. labour-intensive vs capital-intensive). 3. For whom to produce? — how to distribute output among the population.
These choices must be made by individuals, firms/producers and governments alike:
Individuals: have to choose how to spend their limited budgets. Book example: a university student with £50 left after living costs must choose between getting the train home (£30), a meal with friends (£30), new software (£20), designer jeans (£50) — all together would cost £150, so a choice is unavoidable.
Producers: may choose between spending £100 000 on advertising or on new machinery.
Government: may decide whether to spend £5 000 million on a new motorway or on more hospitals/schools.

OPPORTUNITY COST

opportunity cost — the next best alternative given up when a choice is made.
The book's example: if the government spends the £5 000 million on the new motorway, the opportunity cost is the next best alternative it could have funded (e.g. hospitals). The motorway is the preferred choice; the next-best alternative given up is the opportunity cost.
Individuals, producers AND governments all face opportunity cost — every decision has one.
KEY FACTS: opportunity cost arises only because resources are scarce; if there were no scarcity there would be no opportunity cost.
Case study (Figure 1.5): spending on health care vs military goods in different regions (SIPRI data — global military spending was US$1 676 000 million). Choosing more of one good means giving up the other.

PRODUCTION POSSIBILITY CURVES (PPC)

production possibility curve (PPC) — a curve showing the maximum possible output of two goods that an economy can produce when all its resources are fully and efficiently employed, in a given time period.
The book's Figure 1.6 shows a PPC for a country producing consumer goods (on the vertical axis) and capital goods (on the horizontal axis):
Point A: 16 million units of consumer goods, zero capital goods.
Point D: 8 million units of capital goods, zero consumer goods.
Point B: a combination of 14 million consumer goods + 4 million capital goods.
Point C: 8 million consumer goods + 7 million capital goods.
On the curve = full employment of resources (efficient).
Inside the curve (e.g. point F: 8 million consumer + 4 million capital) = resources are not fully used (unemployment of resources / inefficiency).
Outside the curve = unattainable with current resources and technology.
Moving along the curve (B → C): producing more capital goods means producing fewer consumer goods — the amount given up is the opportunity cost. The PPC is concave (bowed outwards) because resources are not perfectly adaptable between the two goods — the first resources switched are the least suited, so the opportunity cost rises as you produce more of one good.
GENERAL VOCABULARY — efficient: working well and without waste.

WHAT HAPPENS WHEN AN ECONOMY MOVES FROM ONE POINT ON THE PPC TO ANOTHER

Any movement along the PPC = a reallocation of resources (more of one good, less of the other) with opportunity cost.
A movement inside the curve (toward the origin) = resources idle / inefficient (e.g. unemployment rises, factories unused).

CAUSES OF POSITIVE AND NEGATIVE ECONOMIC GROWTH

Positive economic growth = the PPC shifts outward (Figure 1.7, PPC₁ → PPC₂): the economy can now produce more of both goods. Causes:
Improved efficiency / better technology — new machines (robots, computers) enable more production using fewer resources.
More/better resources — some countries find new resources (oil discovered, new land farmed).
More labour (population growth) or better educated/healthier workers.
Increased investment in capital goods.
Example: the USA has raised its productivity in recent years through new technology.
Negative economic growth = the PPC shifts inward: the economy can produce less of both goods. Causes:
Loss of resources — war, natural disasters, depletion of resources.
Reduced efficiency — e.g. poor management, breakdown of infrastructure.
Weather patterns — e.g. dry weather (drought) destroys crops and reduces the country's productive capacity.
A fall in the quantity or quality of the labour force.
💡 Exam tip: Be able to draw the PPC and label: a point on the curve (efficient/full employment), a point inside (inefficient), a point outside (unattainable), an outward shift (growth) and an inward shift (negative growth). Always explain the opportunity cost when moving along the curve.

ECONOMICS IN PRACTICE — CASE STUDY: PRODUCTION POSSIBILITY CURVES (Figure 1.8)

Figure 1.8 shows the PPC of a country producing agricultural and non-agricultural goods.
Use it to practise: identifying full/under employment, and what happens to one good when more of the other is produced.

📊 KEY DIAGRAM — Production Possibility Curve

Production Possibility Curve

✅ Quick check

Define the basic economic problem. (Scarce/finite resources vs unlimited wants → choices about what/how/for whom to produce.)
What is opportunity cost? Give a real example. (Next best alternative given up; e.g. student spending £50 on jeans gives up the train home.)
What does a point INSIDE the PPC show? (Resources not fully employed — inefficiency.)
List two causes of positive and two of negative economic growth. (Positive: new technology, new resources, more labour, investment. Negative: war/disasters, drought, resource depletion.)
Why is the PPC bowed outwards? (Resources not perfectly adaptable; increasing opportunity cost.)

Ch 2 Economic Assumptions

Chapter 2: Economic Assumptions

Economists build models by assuming people behave in predictable ways: consumers aim to maximise their own benefit (satisfaction/utility) and producers aim to maximise profit. This chapter explains those two key assumptions, why they are useful, and the real-world reasons why people and firms sometimes do not behave that way.

LEARNING OBJECTIVES

Understand the underlying assumptions economists make about the behaviour of individuals and businesses.
Understand why consumers are assumed to maximise their benefit (satisfaction), and why they may not.
Understand why producers are assumed to maximise their profit, and why they may not.

GETTING STARTED — CASE STUDY: MAKING CHOICES

A young student, Anita, is given Rs 5000 to spend on anything she chooses up to that value.
Her possible purchases (Options A–D in Figure 2.1) are ranked: Option A is her most preferred, Option D her least preferred.
Economists assume Anita will choose the option that gives her the greatest satisfaction/benefit for her Rs 5000 — this is the idea of rational choice.
GENERAL VOCABULARY (from this section): assumptions economists make are simplifications used to build models of behaviour.

UNDERLYING ASSUMPTIONS IN ECONOMICS

Economists assume how individuals and firms will behave so they can build models and predict behaviour.
Two central assumptions (the ones on the specification): 1. Consumers always try to maximise their benefit (satisfaction/utility). 2. Producers always try to maximise their profit.

CONSUMERS ALWAYS MAXIMISE THEIR BENEFIT

Rational behaviour: consumers make choices that give them the most satisfaction (utility) from their limited income — they compare options and pick the one they value most.
SUBJECT VOCABULARY — utility/satisfaction: the benefit or enjoyment a consumer gains from consuming a good or service.
Two further examples of consumer rationality from the book:
Consumers compare prices before buying (e.g. choosing the cheaper of two identical products).
Consumers respond logically to incentives (e.g. buying more when price falls).

REASONS WHY CONSUMERS MAY NOT ALWAYS MAXIMISE THEIR BENEFIT

Habit: many people buy the same newspaper or brand every day out of habit, without comparing alternatives.
Loyalty / brand loyalty: consumers stick to brands they trust even if cheaper equivalents exist.
Lack of information: consumers may not know the best price or best quality available (imperfect information) — e.g. paying €1.14 for a litre of petrol at one station when a nearby station is cheaper, simply because they didn't know.
Persuasion/advertising: consumers are influenced by advertising and marketing rather than pure value.
Copying others (influence of parents/friends): young people often copy the buying habits of their parents.
Altruism / other motives: some purchases are made to help others (fair trade, charity goods), not to maximise own benefit.
Time/effort costs: comparing every option takes time and effort; people settle for "good enough".

PRODUCERS ALWAYS MAXIMISE THEIR PROFIT

SUBJECT VOCABULARY — profit: total revenue minus total costs (money left over after all costs are paid).
Economists assume producers set prices and output to make the highest profit possible — e.g. a business owner will charge the highest price the market can stand and keep costs as low as possible.
Producers also aim to sell as much as possible at the most profitable price.

REASONS WHY PRODUCERS MAY NOT ALWAYS MAXIMISE THEIR PROFIT

Not-for-profit organisations: charities (e.g. Médecins Sans Frontières — MSF, a not-for-profit medical humanitarian organisation) aim to meet needs, not make profit.
Public-sector firms: government-owned businesses may prioritise public service, low prices or job protection over profit.
Other goals: firms may sacrifice short-term profit for market share, survival, growth, improving reputation, or social/environmental responsibility.
Lack of information: managers may not know the true cost/revenue data needed to maximise profit.
Satisficing: managers may aim for a "satisfactory" profit rather than maximum profit (easier than pursuing full maximum).
Difficulty measuring satisfaction: the benefit from consumption is hard to measure in numbers, so consumers' choices can't be perfectly predicted.

ECONOMICS IN PRACTICE — CASE STUDY: ANNA'S SWIMWEAR

A business (Anna's swimwear — with a hire fee involved, i.e. she hires out swimwear) showing how a producer sets prices/output to try to maximise profit.
Illustrates the producer assumption in practice — and the trade-off between price and quantity sold.

✅ Quick check

State the two key assumptions economists make. (Consumers maximise benefit/satisfaction; producers maximise profit.)
Give three reasons consumers may NOT maximise their benefit. (Habit, brand loyalty, lack of information, advertising, copying others, altruism.)
What is meant by "rational" in economics? (Choosing the option that gives the greatest satisfaction given limited income.)
Give two types of producer that do not aim to maximise profit. (Charities/not-for-profits, government-owned firms.)

Ch 3 The Demand Curve

Chapter 3: The Demand Curve

Demand is the amount consumers are willing AND able to buy at each price. The demand curve slopes down from left to right because price and quantity demanded move in opposite directions. A change in price causes a movement along the curve; a change in any other factor causes a shift of the whole curve.

LEARNING OBJECTIVES

Understand how demand is defined (effective demand).
Understand how a change in price causes a movement along the demand curve.
Understand how other factors cause a shift of the demand curve.

GETTING STARTED — CASE STUDY: CARPET STALL

A carpet seller (a market stall) records how many carpets are bought at different prices each week (a weekly purchases / price (MAD) table — MAD = Moroccan dirhams).
As the price falls, more carpets are bought — this relationship is the basis of the demand curve.

EFFECTIVE DEMAND

demand — the amount of a good that consumers are willing and able to buy at a given price over a given period of time.
It is effective demand that matters: wanting a good is not enough — the consumer must have the money (ability) to buy it.
Wanting a luxury car without the money is not demand in economics — it is just a want.

THE DEMAND CURVE

demand curve — a graph showing the relationship between the price of a good and the quantity demanded at each price (other things held constant).
Price is on the vertical (y) axis; quantity demanded on the horizontal (x) axis.
The demand curve slopes downwards from left to right: as price falls, quantity demanded rises; as price rises, quantity demanded falls. This is the law of demand.
Book example (Figure 3.1 — demand for circuit boards by a South Korean company): when the price is US$1, the quantity demanded is 40 million units; when the price falls to US$0.50, the quantity demanded rises to 70 million units (an increase of 30 million units).
Why does demand rise as price falls? (Reasons to know for essays):
Income effect: a lower price means consumers' money goes further — they can afford more (real purchasing power rises).
Substitution effect: a cheaper good becomes more attractive relative to substitutes, so consumers switch to it.
New consumers: a low price brings in buyers who couldn't afford the good before.

MOVEMENT ALONG THE DEMAND CURVE

A movement along the demand curve happens only when the price of the good itself changes (all other factors unchanged).
In Figure 3.1, when the price falls from US$1 to US$0.50 we move down the demand curve from a higher point to a lower point (quantity demanded rises from 40 to 70 million).
A rise in price → contraction of demand (movement up the curve, quantity demanded falls).
A fall in price → extension of demand (movement down the curve, quantity demanded rises).

STRAIGHT-LINE DEMAND CURVES

Demand curves can be drawn as straight lines for simplicity (e.g. Figure 3.3 — demand for parking spaces at a city-centre car park: when the hourly parking price rises from 60 pence, the number of spaces demanded falls).
A straight-line demand curve still obeys the law of demand: quantity demanded falls as price rises.

ACTIVITY 1 — CASE STUDY: DEMAND FOR CRICKET TICKETS

An Indian cricket stadium has a capacity of 30 000. Figure 3.2 shows the demand for tickets at different prices.
Use it to read off: how many tickets are demanded at a given price, and how demand changes as price changes.

A SHIFT IN THE DEMAND CURVE

SUBJECT VOCABULARY — shift of the demand curve: a change in demand caused by a change in any factor other than price — the whole curve moves left or right.
Rightward shift (D₁ → D₂): demand increases at every price (more bought at the same price).
Leftward shift (D₁ → D₃): demand decreases at every price (less bought at the same price).
Book example (Figure 3.4): the demand curve for holidays to the Maldives — a rise in incomes shifts demand to the right; the factors that shift the curve are covered in detail in Chapter 4.
KEY DIFFERENCE for exams: a price change → movement along the curve; a non-price change → shift of the curve.

ECONOMICS IN PRACTICE — CASE STUDY: AL'S BIG BURGER

Al runs a burger stand and has a weekly demand table for his giant burgers.
Example question: Al currently charges US$3 for his giant burgers — how many burgers would be demanded at that price (read off the demand schedule/curve), and what happens to demand if he lowers or raises the price.

📊 KEY DIAGRAM — The Demand Curve

The Demand Curve

✅ Quick check

What is meant by effective demand? (Willing AND able to buy — wants backed by money.)
Why does the demand curve slope downwards? (As price falls, quantity demanded rises — income effect, substitution effect, new consumers.)
What causes a movement along the demand curve? (A change in the price of the good itself.)
What causes a shift of the demand curve? (Any factor other than price — income, tastes, substitutes, complements, population — see Ch 4.)
In Figure 3.1, what happens to quantity demanded when price falls from US$1 to US$0.50? (It rises from 40 to 70 million units.)

Ch 4 Factors That May Shift the Demand Curve

Chapter 4: Factors That May Shift the Demand Curve

A shift of the demand curve happens when anything other than the price of the good itself changes. The big six factors: advertising, income, fashion/tastes, the price of substitutes, the price of complements, and demographic/population changes. Each is explained here with the book's real-world case studies.

LEARNING OBJECTIVE

Understand the main factors that may shift the demand curve (and in which direction).

GETTING STARTED — CASE STUDY: HOLIDAY TREAT

A consumer deciding on a "holiday treat" shows how wants change with circumstances — e.g. the same person demands different holidays when their income, tastes or the price of alternatives change.

THE DEMAND CURVE — FACTORS THAT MAY SHIFT IT

KEY IDEA: A shift happens when consumers decide to buy more or less at every price (the whole curve moves). Figure 4.1 summarises the main factors; Figure 4.2 shows the shifts:
Rightward shift (D₁ → D₂): demand increases at every price (a rise in demand).
Leftward shift (D₁ → D₃): demand decreases at every price (a fall in demand).

1. ADVERTISING

Effective advertising and other promotion (sponsorship, social media, in-store displays) increases demand → the demand curve shifts right.
Book example (Figure 4.3 — global adspend 2014–20): in the highly competitive soft-drinks industry, Coca-Cola spent US$3 499 million on advertising in 2014 to keep demand high.
💡 Exam tip: advertising shifts demand; it does NOT move you along the curve.

2. INCOME

Normal goods: when incomes (wages/salaries) rise, demand for normal goods rises → curve shifts right. Most goods are normal goods (restaurant meals, holidays, new cars).
Inferior goods: goods whose demand falls when income rises (consumers switch away from them to better alternatives). Examples from the book: relatively cheap supermarket 'own label' brands and public transport.
For inferior goods, a rise in income → demand falls → curve shifts left; a fall in income → demand rises → shifts right.
SUBJECT VOCABULARY:
normal good — a good whose demand rises when incomes rise.
inferior good — a good whose demand falls when incomes rise.
💡 Exam tip: "income rises → demand for inferior goods falls" is a classic exam trap — state the direction clearly.

3. FASHION AND TASTES

Changes in consumer tastes and fashion change demand. If a good becomes more fashionable, demand rises (curve shifts right); if it goes out of fashion, demand falls (curve shifts left).
Tastes are influenced by social changes — e.g. the book notes a rise in demand for Vietnamese, Malayan, Thai and Indonesian meals as Western tastes for Asian food grew; also health trends (demand for organic/sugar-free foods).

4. PRICE OF SUBSTITUTES

SUBJECT VOCABULARY — substitute goods: goods that are alternatives to each other, used in place of each other (e.g. tea and coffee, butter and margarine, train and bus travel).
If the price of a substitute rises, consumers switch towards our good → our demand rises (curve shifts right). If the substitute's price falls, our demand falls (curve shifts left).
If a good has many close substitutes, its demand is very sensitive to changes in the substitute's price (links to Chapter 8 — elasticity).

5. PRICE OF COMPLEMENTS

SUBJECT VOCABULARY — complementary goods: goods that are used together with each other (e.g. cornflakes and milk, cars and car insurance).
If the price of a complement rises, demand for the good falls (curve shifts left) because using the goods together becomes more expensive. Book example: if the price of milk were to rise, the demand for cornflakes would fall.
If the price of a complement falls, demand for the good rises (curve shifts right).

6. DEMOGRAPHIC CHANGES AND POPULATION

SUBJECT VOCABULARY — demographics: the characteristics of a population, such as age structure, gender and income distribution.
Population size and growth: a larger population (or more households) → more consumers → demand for most goods rises.
Age structure: different age groups demand different goods. As the population ages, demand for healthcare, retirement services and age-related goods rises; a young population raises demand for education and toys. A growing number of women in the workforce increases demand for women's workwear.
Birth rate changes: e.g. if the birth rate falls, demand for baby goods falls.
Immigration/migration: changes the size and mix of the population.

CASE STUDIES IN THIS CHAPTER

ACTIVITY 1 — DEMAND AND ADVERTISING: use the global adspend data (Figure 4.3) to explain how advertising shifts demand curves for firms in competitive markets.
ACTIVITY 2 — DEMAND AND POPULATION (the UAE): the UAE population has grown rapidly (Figure 4.5, 1980–2020), driven by immigration — more than half of the population was born overseas (Figure 4.4 shows the origins of the UAE's immigrant population). The UAE government invested revenues from oil sales to build the infrastructure (transport, communication) that makes this economic activity possible. Larger, younger, immigrant-rich populations shift demand for housing, transport, food and services to the right.
ECONOMICS IN PRACTICE — GLOBAL DEMAND FOR CARS (Figure 4.6):
Global car demand has continued to increase; in 2016 it was predicted that 76.5 million new cars would be sold that year.
Electric vehicles (EVs): total sales of EVs reached 1 million by 2015; it is estimated that by 2040 EVs will be a major share of the market.
A key reason: oil prices — when oil was US$140 a barrel (pre-2014), the incentive to buy an EV rose (petrol cheaper than fuel? — actually running costs of petrol cars rose, making EVs attractive); lower oil prices reduce that incentive.
This shows how income, tastes, the price of complements (petrol) and substitutes (EVs vs petrol cars) and technology all shift demand.

✅ Quick check

List the six main factors that can shift the demand curve. (Advertising, income, fashion/tastes, price of substitutes, price of complements, demographic/population changes.)
What happens to demand for an inferior good when incomes rise? (It falls — curve shifts left.)
Cars and petrol are examples of what type of goods? (Complements — used together.)
If the price of coffee rises, what happens to demand for tea (a substitute)? (Demand for tea rises — curve shifts right.)
A shift RIGHT means demand has ______ at every price. (Increased / risen.)

Ch 5 The Supply Curve

Chapter 5: The Supply Curve

This chapter introduces supply — the amount of a good that sellers are prepared to offer for sale at different prices. It explains why the supply curve slopes upwards from left to right, the difference between a movement along the supply curve (caused by a price change) and a shift of the supply curve (caused by any other factor), and the special case of fixed supply. The reason sellers behave this way is the profit motive: higher prices mean more profit, so more is supplied.

LEARNING OBJECTIVES

Understand how supply is defined.
Understand how changes in price cause movements along the supply curve.
Understand what causes the supply curve to shift.

GETTING STARTED

Sellers (or producers) are responsible for meeting the needs of consumers. They provide goods and services that they hope people or other businesses will buy.
There is a strong link between the price of a good and the quantity provided:
If prices are too low, sellers may not be interested in supplying the market because they may not be able to make enough profit.

📚 CASE STUDY: CHICKEN FARMING (Tom Chang, rural China)

Tom Chang is a chicken farmer in rural China who has reared chickens for 35 years and sells them to his local community.
Twice weekly he takes chickens to a market about 15 km away in order to boost his sales.
Table 5.1 shows the number of chickens he is prepared to offer for sale per week at different prices:
At a very low price, he is not prepared to sell any at all because he cannot make a profit at that price.
As the price rises, the number of chickens he offers for sale increases (e.g. at a price of CNY 30 he would offer 50 chickens per week — this figure is confirmed in the chapter text; the OCR of the full table is partly scrambled, but the direction is clear: higher price → higher quantity supplied).
Questions the book asks: (1) How many chickens at CNY30? → 50. (2) What happens to quantity supplied as price rises? → It increases. (3) Why do sellers offer more at higher prices? → Because they can make more profit.

SUPPLY AND THE SUPPLY CURVE

supply — the amount of a good that producers are willing to offer for sale at different prices in a given period of time.
Example: if the market price for chickens is CNY30, Tom Chang would sell 50 chickens during a week — so the supply of chickens by Tom Chang at CNY30 during that week was 50.
The supply of any product can be expressed graphically — the relationship between price and quantity supplied can be drawn on a graph.
A supply schedule is a table showing how much of a good sellers are willing to supply at different prices.

📚 CASE STUDY: M. CRAMMER AND SON (handmade golf shoes, Florida)

Table 5.2 is a supply schedule for handmade golf shoes made by M. Crammer and Son, a family business in Florida.
As the price rises from US$50 to US$350, the quantity supplied per annum rises from 300 to 2100 pairs.
GENERAL VOCABULARY — per annum (p.a.) — for or in each year. So "pairs per annum" means pairs supplied in each year.

📊 KEY DIAGRAM: Figure 5.1 — Supply curve for golf shoes made by M. Crammer and Son

Drawn exactly like a demand curve graph: price on the vertical axis, quantity on the horizontal axis.
The points from the supply schedule are plotted and joined together to form the supply curve.
It is a straight-line supply curve (here shown as a straight line).
It slopes up from left to right, showing a proportionate relationship between price and quantity supplied:
when the price goes up, the quantity supplied also goes up;
when the price goes down, the quantity supplied also goes down.
Example from the diagram: when the price of golf shoes is US$200, M. Crammer and Son will supply 1200 pairs per annum. If the price rises from US$200 to US$300, the quantity supplied increases from 1200 to 1800 pairs.

Price (US$)
  400 │
      │                                                      Supply
  300 │────────────────────────────────────────────────•──
      │                                            •
  200 │──────────────────────────────────•────────────
      │                             •
  100 │──────────────•───────────────
      │        •
    0 └───•───────────────────────────────────────────
      0     500    1000    1500    2000    2500
                 Quantity of golf shoes (p.a.)
(Curve slopes up: higher price → larger quantity supplied.)

Why does the supply curve slope upwards? The main reason is that businesses are motivated by profit:
If prices are rising, existing businesses are willing to supply increasing amounts of a good because they may make more profit.
Or, new businesses will join the market in the belief that they too can make a profit, so supply in the market increases.
This applies to the vast majority of goods, but there are exceptions — one is discussed at the end of this chapter (fixed supply, see below).

MOVEMENT ALONG THE SUPPLY CURVE

As with demand, when there is a price change there is a movement along the supply curve.
Example (Figure 5.1): when the price rises from US$200 to US$300, we move along the supply curve from point A to point B to identify the new level of supply — the quantity supplied increases from 1200 to 1800 pairs of golf shoes.
This movement only happens when there is a price change.
If there are changes in any other factor influencing supply, the effect on the supply curve is different — it is a shift (discussed below).

A SHIFT IN THE SUPPLY CURVE

If the price of a good changes, there is a movement along the supply curve.
A change in any other factor — such as production costs — is shown by a shift in the supply curve.
shift in the supply curve — the movement of the entire supply curve to the left or right when there is any change in the conditions of supply except the price.

📊 KEY DIAGRAM: Figure 5.2 — Shift in the supply curve for a product

The original curve is S1; for any product, at price p1 sellers offer quantity q1 for sale.
Rise in production costs → the quantity supplied falls at every given price → the whole curve shifts left, from S1 to S2. At the price p1, the quantity offered falls from q1 to q2.
Fall in production costs → the quantity supplied rises at every given price → the whole curve shifts right, from S1 to S3. At the price p1, the quantity offered rises from q1 to q3.

Price
  │      S2    S1    S3
  │        \     \     \
p1│─────────\─────\─────\──────  (horizontal line at price p1)
  │          \     \     \
  └─────────────────────────────────
        q2    q1    q3      Quantity
  (shift left  = S1→S2, quantity q1→q2, e.g. costs rise)
  (shift right = S1→S3, quantity q1→q3, e.g. costs fall)

The range of factors likely to cause the supply curve to shift is discussed in detail in Chapter 6 (pages 34–39).

📚 ACTIVITY 1: CASE STUDY — STEEL SUPPLY IN A COUNTRY

Figure 5.3 shows the annual supply curve for steel in a country: price (US$ per tonne) is plotted against quantity (tonnes, million).
The curve slopes up: at US$500 per tonne around 10 million tonnes is supplied; at US$750 per tonne the quantity supplied is higher (around 15 million tonnes, read from the curve).
Questions the book asks: (1) What happens to the supply of steel if the price rises from US$500 to US$750 per tonne? → The quantity supplied rises (a movement along the curve). (2) Why are steel suppliers likely to offer more for sale at higher prices? → Because higher prices mean more profit.

FIXED SUPPLY

In some circumstances the supply of a product or service may be fixed: it is impossible for sellers to increase supply even when prices rise.
If this is the case, the supply curve is vertical.
GENERAL VOCABULARY — capacity — the maximum amount that can be held or produced (e.g. the maximum number of seats in a stadium).

📊 KEY DIAGRAM: Figure 5.4 — Fixed supply: the capacity of Wimbledon's Centre Court

Centre Court at Wimbledon (the main stadium at the venue) has a capacity of 15 000 seats.
It is impossible to offer more than 15 000 seats for tennis matches at this venue.
Even if the ticket price were to rise from, say, £100 to £150, no more seats could be supplied — the quantity supplied stays at 15 000.
The supply curve is therefore a vertical line at 15 000 seats.

Price (£)
 150 │───────────────────────────────●──── Supply (vertical)
 100 │───────────────────────────────●────
  50 │───────────────────────────────●────
   0 └────────────────────────────────────
      0     5000   10000  15000  20000
                    Quantity of seats
(Vertical supply curve: quantity cannot rise above 15 000 seats.)

ECONOMICS IN PRACTICE: CASE STUDY — FOTHERGILL & SONS (park benches)

Fothergill & Sons manufacture a range of wooden products — mainly heavy furniture such as large tables, benches and beds.
One of its profitable lines is park benches, often sold to local governments; many are found in local council parks.
Table 5.3 gives the supply schedule — the number of park benches offered for sale at different prices in a year:

Price (£)	Number of benches p.a.
20	0
40	200
60	400
80	600
100	800
120	1000
140	1200
160	1400

Why is supply 0 at a price of £20? Because at such a low price Fothergill & Sons cannot make a profit (or any worthwhile profit) from producing benches — so they supply none.

📊 KEY DIAGRAM — The Supply Curve

The Supply Curve

✅ Quick check

Define supply. → The amount of a good that producers are willing to offer for sale at different prices in a given period of time.
Why does the supply curve slope upwards? → Because of the profit motive: higher prices mean more profit, so firms supply more (and new firms enter the market).
What causes a movement along the supply curve? → A change in the price of the good itself.
What causes a shift in the supply curve? → A change in any other condition of supply (e.g. production costs) — the whole curve moves left or right.
What does a vertical supply curve show? → Fixed supply — the quantity supplied cannot increase even if price rises (e.g. Wimbledon Centre Court's 15 000 seats).

Ch 6 Factors That May Shift the Supply Curve

Chapter 6: Factors That May Shift the Supply Curve

Price is the main factor affecting supply, but many other factors can shift the whole supply curve. This chapter looks at five of them: costs of production, indirect taxes, subsidies, new technology, and natural factors (weather, disasters, pests). It uses real case studies — Nigerian fish farmers, Sri Lankan fertiliser subsidies, El Niño squid shortages, and Kenyan house building — to show each factor in action. A rise in costs (or taxes, or poor weather) shifts supply left; falling costs, subsidies, and new technology shift supply right.

LEARNING OBJECTIVE

Understand the factors that may cause a shift in the supply curve: costs of production, changes in technology, indirect taxes, subsidies and natural factors (such as natural disasters and the weather).

GETTING STARTED

Chapter 5 established that supply is influenced by price, and that as price rises sellers are willing to supply more.
However, there are other factors that could affect the supply of goods.

📚 CASE STUDY: NIGERIAN FARMING (2016)

In 2016, growing numbers of Nigerian chicken and fish farmers were reducing production rates; some were even abandoning their farms to pursue other business ventures.
This was a response to volatile and rapidly rising feed costs.
GENERAL VOCABULARY — volatile — changing quickly and suddenly; for example, a volatile market rises and falls without much warning.
Nigerian politicians begged young people who had left the countryside for the cities to return to their family farms.
The rising cost of feed caused the problems with supply:
In Lagos state, fish farmers complained that feed prices had risen by as much as 80 to 100 per cent.
Locally produced catfish feed rose from NGN 6000 to NGN 9000.
Imported feed went up from NGN 6000 to NGN 11 000 for a 15 kilogram bag (a rise of about 83%).
Questions the book asks: (1) Describe the main factor affecting supply → rising production costs (feed). (2) Calculate the percentage increase in the price of imported fish feed per 15 kg bag → (11 000 − 6 000) ÷ 6 000 × 100 ≈ 83.3%. (3) Why does quantity supplied fall when production costs rise? → Because profits are squeezed, so producers supply less (and some leave the market).

FACTORS THAT MAY SHIFT THE SUPPLY CURVE

Price is the main factor that affects supply; a change in price results in a movement along the supply curve.
A range of other factors can cause the supply curve to shift. These are summarised in Figure 6.1:

Figure 6.1 (summary diagram): Five boxes pointing into the centre "Factors that cause the supply curve to shift" — Production costs, New technology, Indirect taxes, Subsidies, Natural factors.

COSTS OF PRODUCTION

The quantity supplied of any product is influenced by its costs of production, such as wages, raw materials, energy, rent and machinery.
Assuming the price is fixed:
If production costs rise, sellers are likely to reduce supply, because their profits will be reduced. This is what happened in the Nigerian farming case — rising fish-feed costs drove some fish farmers to leave the industry, causing the quantity supplied to fall.
A rise in costs causes the supply curve to shift to the left.
If costs fall, the quantity supplied would increase because production becomes more profitable — the supply curve shifts to the right.

📊 KEY DIAGRAM: Figure 6.2 — Shift in the supply curve

Original curve S1. When costs rise, the whole curve shifts left from S1 to S2; at a price of p1, the amount supplied in the market falls from q1 to q2.
When costs fall, the curve shifts right from S1 to S3; more is supplied at every price, and at p1 the amount supplied rises from q1 to q3.

Price
  │      S2    S1    S3
  │        \     \     \
p1│─────────\─────\─────\──────
  │          \     \     \
  └─────────────────────────────────
        q2    q1    q3      Quantity
  costs rise  → S1→S2 (left)  → q1→q2  (supply falls)
  costs fall  → S1→S3 (right) → q1→q3  (supply rises)
  (This same diagram is reused for taxes and subsidies below.)

KEY FACTS: PRODUCTIVITY (box)

productivity — the rate at which goods are produced, and the amount produced in relation to the work, time and money needed to produce them.
In recent years, the UK has tried to increase productivity in manufacturing.
However, in a recent survey 73 per cent of industry leaders said they had found it difficult to recruit skilled workers; both the quantity and quality of candidates were lacking.
Sixty-seven per cent of bosses said they were regularly forced to deal with a lack of technical skills; 64 per cent said there were too few people applying; and 61 per cent said candidates lacked relevant experience.
The availability of resources also affects supply: if there is a shortage in some of the factors of production (e.g. land, labour or capital), it becomes difficult for producers to supply the market because their costs are likely to rise.

INDIRECT TAXES

indirect taxes — taxes levied on spending, such as VAT.
VAT (value-added tax) and duties (such as those on petrol and cigarettes) are examples of indirect taxes.
consumption — the amount of goods, services, energy, or natural materials used in a particular period of time.
Indirect taxes have an effect on supply because they represent a cost to firms:
When they are imposed or increased, the supply curve shifts to the left (Figure 6.2: from S1 to S2), so the quantity supplied falls from q1 to q2.
If indirect taxes are reduced, costs are lower, so the supply curve shifts to the right (from S1 to S3), and the quantity supplied rises from q1 to q3.
Why do governments use indirect taxes?
To raise revenue for government expenditure.
To discourage the consumption of harmful products, such as cigarettes and alcohol.
To protect the environment — for example, taxes might be imposed on producers if their production methods damage the environment (discussed further in Chapter 29, pages 228–239).

SUBSIDIES

subsidy — money that is paid by a government or organisation to make prices lower, reduce the cost of producing goods or providing a service, usually to encourage the production of a certain good.
Sometimes the government gives money to businesses in the form of a grant — this is called a subsidy.
Subsidies may be given to firms to try to encourage them to produce a particular product. For example, in the EU, subsidies have been given to farmers to encourage them to produce certain agricultural products.
If the government grants a subsidy on a good, the effect is to increase its supply, because subsidies help to reduce production costs. The supply curve shifts to the right (Figure 6.2: from S1 to S3), so the amount supplied at p1 rises from q1 to q3.

DID YOU KNOW? — Negative effects of subsidies

Government subsidies to producers may have negative effects:
Producers may lack the incentive to improve efficiency (they don't have to cut costs to survive).
There is an opportunity cost: the money spent on subsidies might have been used on other items of government expenditure, such as education.

📚 ACTIVITY 1: CASE STUDY — SUPPLY AND SUBSIDIES (Sri Lanka, 2016)

In 2016 the Sri Lankan government announced it would provide an Rs37 000 million fertiliser subsidy to the nation's paddy farmers (farmers growing rice).
The Ministry of Agriculture said paddy farmers would receive an annual payment of Rs25 000 for every two hectares of farmland used to grow rice.
Vegetable farmers growing crops such as green gram, cow pea, soya bean, Bombay onion would also receive a fertiliser subsidy of Rs10 000 per hectare.
Fertiliser subsidies have been an important feature of Sri Lankan agricultural policy since 2005, accounting for between 2 and 2.5 per cent of total government expenditure over the years.
The subsidies have helped to increase paddy production, stabilise the price of rice, and helped Sri Lanka to become self-sufficient in rice production.
Questions the book asks: (1) Why is the government offering subsidies? → To reduce farmers' costs, boost rice/paddy production, stabilise prices and achieve self-sufficiency. (2) Using a diagram, show the effect on the supply of rice → the supply curve for rice shifts right (from S1 to S3).

CHANGES IN TECHNOLOGY

Over a period of time, new technology becomes available that many businesses use in their production processes.
New technology is more efficient and can therefore reduce the costs of production.
GENERAL VOCABULARY — yield — the amount of something that is produced, such as crops or oil extracted.
Real-world example (oil, 2014): when the price of oil fell sharply in 2014, many oil companies began to use new technology to lower their costs:
Some companies began to use lasers and other hi-tech data-analysis equipment to help measure the potential yield from new oil wells.
Others used new techniques to help them produce more oil from both old and new wells.
Since new technology helps to lower production costs, firms are likely to offer more for sale, so there is a shift in the supply curve to the right (Figure 6.2: from S1 to S3).

NATURAL FACTORS

The production of some goods is influenced by natural factors, such as the weather, natural disasters, or the presence of pests (for example, rats or mice) or diseases. This is true of many agricultural products.
Good growing conditions can help improve crop yields, which increases supply → the supply curve shifts right (from S1 to S3).
Poor growing conditions can cause severe shortages and the quantity supplied may be cut → the supply curve shifts left (from S1 to S2).

📚 CASE STUDY: EL NIÑO AND THE SQUID SHORTAGE (2016)

In 2016 there was a shortage of squid due to the effect of El Niño.
El Niño is a natural but irregular climatic event responsible for raising the temperature of the sea along the coast of Ecuador and Peru; it can have far-reaching effects:
It reduces the amount of nutrients in the sea that are essential to support marine life.
It can cause a change in wind patterns across the Pacific Ocean.
It causes drought (long periods of unusually dry weather) in Australasia and heavy rain in South America.
El Niño caused a shortfall in the supply of squid, which forced prices up from around US$1.80 to US$2.20 per prepared squid in the USA.
Catch totals of squid for the 2015/16 season were 37 000 tonnes, only 35 per cent of the seasonal catch limit of 107 000 tonnes.
Key lesson: a natural factor (El Niño) cut supply, shifting the supply curve left, raising price.

📚 ACTIVITY 2: CASE STUDY — SUPPLY AND THE WEATHER (water shortages)

A number of countries in recent years have faced severe water shortages:
São Paulo, Brazil (2015): people in the city once known as the "city of drizzle" started to dig through basement floors and car parks to gain access to underground water.
California: the state was suffering its fourth year of drought in a row, with January 2015 becoming the driest month ever recorded.
Middle East: overconsumption and reduced rainfall have reduced large areas of the countryside to desert and devastated agricultural production.
Cause: changing weather patterns and melting snow and ice caused by global warming are having a severe impact on the world's water systems; around 1000 million people in the world do not have access to safe drinking water, and the situation is expected to get worse.
UAE response: the government is investing in desalination plants to convert seawater into drinking water and in wastewater treatment units. Crown Prince General Sheikh Mohammed bin Zayed al-Nahyan said: "For us, water is [now] more important than oil."
Questions the book asks: (1) Give at least two causes of the water shortages → overconsumption, reduced rainfall, global warming / changing weather patterns. (2) What measures is the UAE taking? → desalination plants and wastewater treatment units.

ECONOMICS IN PRACTICE: CASE STUDY — HOUSING SUPPLY IN KENYA

Like many countries, Kenya suffers from a housing shortage. People moving into towns and cities from rural areas looking for a better life have created housing shortages in the cities of Nairobi, Mombasa, Kisumu and Eldoret.
The high cost of traditional house-building methods reduced the ability of the government and private constructors to build new houses.
However, new technologies are now being used to help resolve the problem:
House builders are now using newly developed expanded polystyrene Styrofoam (EPS) panels and aluminium moulds in their construction plans.
GENERAL VOCABULARY — formwork — temporary or permanent moulds into which concrete or similar materials are poured or injected.
Benefits of the new materials (superior to concrete, stone and mortar):
Strong, lightweight, fireproof and long lasting.
EPS keeps properties warm effectively; aluminium formwork makes for better quality walls that can be painted easily.
House builders save money: the lightweight technologies do not require builders to lay deep foundations; the amount of concrete used on walls and flooring is reduced — EPS only requires a 5 cm layer of concrete on walls and floors instead of the 20 cm needed with conventional building methods.
Houses can be constructed more quickly, because housing units are assembled from sections that are manufactured off-site — this reduces labour costs and improves business cash flow.
Housing has become more affordable — new housing units are now accessible to the lower middle-class and low-income earners.

💡 Exam tip

Learn the one-sentence rule: a price change = movement along the supply curve; anything else (costs, taxes, subsidies, technology, natural factors, availability of resources) = shift of the whole curve. In exams, always state the direction of the shift (left = less supplied at every price; right = more supplied at every price) and back it with a labelled diagram like Figure 6.2.

✅ Quick check

List the five factors that can shift the supply curve. → Costs of production, new technology, indirect taxes, subsidies, natural factors (plus the availability of resources).
What happens to the supply curve when indirect taxes rise, and why? → It shifts left, because taxes are a cost to firms, so less is supplied at every price.
Why does a subsidy increase supply? → Because it reduces producers' production costs, so the supply curve shifts right.
How did El Niño affect the squid market in 2016? → It reduced marine nutrients and cut the squid catch (37 000 tonnes, only 35% of the 107 000-tonne limit), shifting supply left and pushing the price up from US$1.80 to US$2.20.
What are two possible negative effects of subsidies? → Producers may lose the incentive to improve efficiency; and there is an opportunity cost to government spending (the money could have been spent elsewhere, e.g. education).

Ch 7 Market Equilibrium

Chapter 7: Market Equilibrium

This chapter brings supply and demand together to show how prices are actually set in a market. The equilibrium price (also called the market clearing price) is where the quantity demanded exactly equals the quantity supplied. The chapter explains how shifts in demand or supply change the equilibrium, what excess demand and excess supply are, and how market forces (changing prices or adjusting supply) remove them. Real cases include the global lithium price surge and FA Cup Final tickets at Wembley.

LEARNING OBJECTIVES

Understand how equilibrium price and quantity are determined.
Understand how shifts in the supply and demand curves affect equilibrium price.
Understand excess supply and excess demand.
Understand how market forces can remove excess supply and excess demand.

GETTING STARTED

In any market (unless there is government intervention), the forces of supply and demand set the prices.
GENERAL VOCABULARY — government intervention — a situation where the government becomes involved in a problem in order to help deal with it.
The price consumers pay for goods and services is the price where supply and demand are exactly the same.

📚 CASE STUDY: PRICE, SUPPLY AND DEMAND (Table 7.1)

Table 7.1 shows the quantities of a product that producers will offer for sale, and that consumers will purchase, at different prices (in a given year).
Example given in the text: when the price is CNY 20, producers will offer 40 000 units for sale and consumers will want to buy 70 000 units. At this price demand is greater than supply (excess demand) — so this is not the price that will be charged in the market. (Note: the full OCR of Table 7.1 is scrambled, but the principle is clear: at low prices demand exceeds supply; at high prices supply exceeds demand; the market price settles where they are equal.)
Questions the book asks: (1) What price will be charged? → The price where supply and demand are equal (the equilibrium price). (2) How much is supplied and demanded at CNY40? → Values read from the table. (3) What will happen if producers set the price at CNY40? → There will be a surplus/excess supply or shortage depending on whether 40 is above or below equilibrium.

EQUILIBRIUM PRICE

The way in which the forces of supply and demand determine prices in a market can be shown on a graph.
In any market, the price is set where the wishes of consumers are matched exactly with those of producers.
equilibrium price — the price at which supply and demand are equal.
In Figure 7.1 the equilibrium price is £30: at this price consumers want to buy 3000 units and producers want to sell 3000 units — the wishes of buyers and sellers are matched. There is no other price where this happens.
Example: if the price were £40, sellers would want to supply 4000 units, but at this price buyers only demand 1500 units because the price is too high.
market clearing price — the price at which the amount supplied in a market matches exactly the amount demanded. The equilibrium price is also known as the market clearing price, because the amount supplied in the market is completely bought up by consumers: there are no buyers left without goods and no sellers left with unsold stock — the market is cleared.

📊 KEY DIAGRAM: Figure 7.1 — Market equilibrium

Standard diagram: Supply curve slopes up, Demand curve slopes down; price on the vertical axis, quantity on the horizontal axis.
The two curves cross at the equilibrium: price £30, quantity 3000 units.
The shaded rectangle under the equilibrium point (from price £0 up to £30, and quantity 0 to 3000) shows total revenue.

Price (£)
 50 │
 40 │              Supply
 30 │───────────•(equilibrium)
    │         ██│
 20 │       ██  │    (shaded area = total revenue)
 10 │     ██    │
    │   ██      │
  0 └──█────────┴───────────────
    0    1000   2000   3000 ...
                 Demand
Quantity (units)
(Equilibrium where Supply = Demand: P = £30, Q = 3000.)

TOTAL REVENUE

Figure 7.1 also shows the total revenue (or total expenditure) at the equilibrium price.
total revenue — the amount of money generated from the sale of goods; it is calculated by multiplying price by quantity.
Formula: Total revenue = Price × Quantity, or TR = P × Q
In this example the shaded area in the diagram shows the total revenue:
TR = P × Q = £30 × 3000 = £90 000

📚 ACTIVITY 1: CASE STUDY — EQUILIBRIUM PRICE (woollen hats)

The market for woollen hats in a country is represented by the supply and demand curves in Figure 7.2 (price from £1.00 to £5.00; quantity from 0 to 10 million units; demand slopes down, supply slopes up).
Questions the book asks: (1) What is the equilibrium price and quantity? → Read where the curves cross (around £3.00 and 6 million units from the diagram). (2) What is meant by equilibrium price? → The price where quantity supplied equals quantity demanded. (3) What is the value of total revenue at the equilibrium price? → TR = P × Q (equilibrium price × equilibrium quantity).

SHIFTS IN DEMAND

The equilibrium price will change if there are changes in supply or demand.
If demand increases, price will rise.

📊 KEY DIAGRAM: Figure 7.3 — Effect of a shift in demand for a product

An increase in demand is shown by a shift in the demand curve to the right, from D1 to D2.
This changes the equilibrium price because supply and demand are now equal at a different point: the price is forced up from p1 to p2 and the amount sold in the market goes up from q1 to q2.
If demand were to fall, the opposite would happen: the demand curve would shift left and the price would fall (not shown in the diagram).

Price
  │            Supply
p2│──────────────•────────────
  │           /  |\
p1│─────────•────|──\─────────
  │        /     |   \   D2
  │       /      |    \
  │      /    D1 |     \
  └───────────────────────────
        q1   q2        Quantity
(D1→D2 right: price p1→p2 up, quantity q1→q2 up.)

SHIFTS IN SUPPLY

A change in supply will also affect equilibrium price. If supply increases, the price will fall.

📊 KEY DIAGRAM: Figure 7.4 — Effect of a shift in supply for a product

An increase in supply is shown by a shift in the supply curve to the right, from S1 to S2.
This changes the equilibrium price because supply and demand are now equal at a different point: the price is forced down from p1 to p2 and the amount sold on the market goes up from q1 to q2.
If supply were to fall, the opposite would happen: the supply curve would shift left and price would rise (not shown in the diagram).

Price
  │       S1  S2
  │        \    \
p1│─────────•────\──────────
  │       /  \    \     Demand
p2│──────•────\────\─────────
  │     /      \    \
  └───────────────────────────
        q1   q2       Quantity
(S1→S2 right: price p1→p2 down, quantity q1→q2 up.)

📚 ACTIVITY 2: CASE STUDY — THE GLOBAL LITHIUM MARKET (2015)

In 2015, the global price of the metal lithium rose sharply, from US$6000 per tonne to about US$14 000 per tonne in just a few months.
Why? The quantity of lithium demanded has increased due to its growing use in car batteries for electric vehicles and devices such as smartphones, laptops and power tools.
Main lithium-ion battery-makers: Samsung and LG (South Korea), Panasonic and Sony (Japan), and ATL (Hong Kong); China also has many battery-makers.
The Chinese government is promoting the use of lithium-ion batteries and electric vehicles (EVs) — buses in particular; sales of "new energy" vehicles in China increased by almost three times in the first 10 months of 2015 compared with the same period in 2014.
Tesla Motors, a US EV-maker, is starting large-scale battery production in Nevada; it hopes to supply lithium-ion batteries for 500 000 cars a year within five years.
Toyota has begun using lithium-ion batteries instead of heavier nickel-metal hydride batteries in its Prius model.
Why didn't the higher price automatically increase supply? Although the Earth contains plenty of lithium, extracting it is expensive and time consuming — so higher prices may not automatically increase the supply of lithium (Figure 7.5 shows the global lithium price rising steeply from 2008 to 2015, with the sharp jump around 2015).
Questions the book asks: (1) Calculate the percentage increase in the price of lithium in 2015 → (14 000 − 6 000) ÷ 6 000 × 100 = 133.3%. (2) Why has the price increased? → Demand shifted right (EVs, batteries) while supply was slow to respond, so equilibrium price rose. (3) What impact would a government subsidy paid to lithium producers have? → It would cut production costs, shift supply right, and lower the equilibrium price.

SHIFTS IN SUPPLY AND DEMAND

It is possible for both supply and demand to change at the same time in a market. For example, demand might increase and supply decrease at the same time.

📊 KEY DIAGRAM: Figure 7.6 — Shift in supply and demand for a product

The original equilibrium price is p1, where S1 = D1.
The increase in demand is represented by a shift right from D1 to D2; the decrease in supply is represented by a shift left from S1 to S2.
The new equilibrium price, where D2 = S2, is p2 — the price is higher and the amount sold in the market has fallen from q1 to q2.
Important note: in Figure 7.6 the increase in demand is smaller than the decrease in supply, so quantity sold falls.
It would be possible to redraw the diagram so that, although price is higher, the quantity sold is also higher — this requires making the increase in demand greater than the decrease in supply.
Key conclusion: when there is a change in both supply and demand, it is not possible to show exactly what will happen to price and quantity unless we know precisely how much supply and demand shift.

Price
  │    S2  S1
  │      \   \
p2│───────•────\─────
  │    /  |\    \     D2
p1│───•───|──\───\────
  │ /     |   \   \   D1
  └────────────────────────
      q2  q1          Quantity
(D1→D2 right AND S1→S2 left: price p1→p2 up, quantity q1→q2 down.)

EXCESS DEMAND

If the price charged in a market is below the equilibrium price, supply and demand will not be equal.
excess demand — where demand is greater than supply and there are shortages in the market.
In Figure 7.7 the equilibrium price is £60: at this price the quantity supplied and the quantity demanded are both 6 million units.
However, if the price is set lower, say at £40, the market is not in equilibrium: the quantity demanded is 9 million units and the quantity supplied is only 4 million units.
There is excess demand — a shortage of 5 million units (9 million − 4 million) at the price of £40.

EXCESS SUPPLY

If the price charged is set above the equilibrium price, again supply and demand are not equal.
excess supply — where supply is greater than demand and there are unsold goods in the market.
In Figure 7.7, if the price is set higher, say at £80, the quantity demanded is only 3 million units while the quantity supplied is 8 million units.
This time there is excess supply — goods would remain unsold. The quantity of goods that would be unsold at a price of £80 is 5 million units (8 million − 3 million).

📊 KEY DIAGRAM: Figure 7.7 — Excess demand and excess supply

Supply curve slopes up, demand curve slopes down; price from £20 to £100, quantity from 0 to 12 million units.
Equilibrium at £60 / 6 million units.
Above equilibrium (e.g. £80): the gap between supply (8m) and demand (3m) is labelled "Excess supply".
Below equilibrium (e.g. £40): the gap between demand (9m) and supply (4m) is labelled "Excess demand".

Price (£)
100 │              Supply
 80 │─────────── Excess supply ██   (8m − 3m unsold)
 60 │───────────• equilibrium
 40 │   ██████████ Excess demand      (9m − 4m shortage)
 20 │
    └──────────────────────────────────
      0  2  4  6  8  10 12   Quantity (millions)

REMOVING EXCESS SUPPLY AND EXCESS DEMAND

If there is disequilibrium in a market, producers can restore equilibrium by changing the price or adjusting supply.
If there is excess demand (e.g. at £40 in Figure 7.7):
Producers could raise the price. If producers raised the price to £60, the market would clear, since both the quantity supplied and the quantity demanded would be 6 million units.
Alternatively, producers could employ more resources and increase supply to 9 million units — if this action were taken, equilibrium would be restored at a price of £40.
If there is excess supply (e.g. at £80 in Figure 7.7, where producers wanted to sell 8 million units but consumers only wanted to buy 3 million):
Producers could lower their prices. If producers lowered prices to £60, the excess supply would be removed since both the quantity supplied and the quantity demanded would be 6 million units at this price.
Alternatively, producers could store the excess supply and release it onto the market at a later date. However, this might not be practical because storing goods costs money and some stocks, such as fresh food, need to be consumed quickly.

DID YOU KNOW? — Uber and "surge pricing"

The private taxi firm Uber uses something called "surge pricing" to deal with excess demand.
During very busy periods — such as New Year's Eve or at the end of a major event when thousands of people are looking for a cab home — the fares charged by Uber drivers can rise very sharply: perhaps by two or three times or even more.
The purpose is to remove excess demand:
The higher prices discourage some consumers from ordering a taxi, so demand falls.
The higher fares also act as an incentive for dormant drivers (those who have gone home, perhaps) to get back on the road, so supply increases.
When the supply and demand for taxis is more evenly matched, the fares charged are restored to "normal" levels.

ECONOMICS IN PRACTICE: CASE STUDY — THE MARKET FOR FA CUP FINAL TICKETS AT WEMBLEY

Every year, the FA Cup Final is played at Wembley Stadium, London, the UK's national stadium. Unfortunately, there are never enough tickets for all the supporters who would like to go — there is always a shortage.
The English Football Association (FA) is aware of this but says it would prefer to keep the tickets "reasonably priced" so that genuine football supporters can afford to go to the match, rather than only the wealthy or those using corporate hospitality.
DID YOU KNOW? — The "black market" is an illegal market. The black market for FA Cup Final tickets means that "touts" (illegal traders) sell tickets above their face value.
Evidence of ticket shortages is presented by the price of tickets on "unofficial markets": sellers on the Edinburgh-based website FootballTicketPad were charging supporters up to £21 230 for a pair of £120 category 1 tickets, including a £1930 booking fee — for the 2015 final between Arsenal and Aston Villa.

📊 KEY DIAGRAM: Figure 7.8 — Market for FA Cup Final tickets at Wembley Stadium

The supply curve is vertical because supply is fixed: the capacity of Wembley Stadium is 90 000.
The demand curve slopes down, and at the face-value price p1 the quantity demanded (Q2) is far greater than the fixed quantity supplied (Q1) — a large excess demand / shortage.
The market-clearing price is p2 (where the demand curve meets the vertical supply curve) — much higher than p1.
Because the FA charges p1 (below equilibrium), the shortage persists, which is why touts can resell tickets well above face value.

Price
      │    Supply (vertical, fixed at 90 000)
p2────│──────• (market-clearing price)
      │   /   |
p1────│──•────|────────── (face value price)
      │ /     |    Demand
      └────────────────────────
           Q1  Q2    Quantity
(Q1 = 90 000 seats supplied; Q2 = tickets demanded at p1 → excess demand.)

💡 Exam tip

For equilibrium questions, always draw and label the diagram (axes, Supply, Demand, equilibrium P and Q) and then show the shift and the new equilibrium. State the outcome in words: demand up → price up and quantity up; supply up → price down and quantity up. Remember that when both curves move you can only be certain about one of the two outcomes (price or quantity) unless you know the relative sizes of the shifts — the book makes this exact point with Figure 7.6.

📊 KEY DIAGRAM — Market Equilibrium

Market Equilibrium

✅ Quick check

What is the equilibrium price? → The price at which quantity supplied equals quantity demanded (also called the market clearing price).
Why is it called the market clearing price? → Because at that price all goods supplied are bought — no unsold stock, no unsatisfied buyers; the market is cleared.
Define excess demand and excess supply. → Excess demand: demand greater than supply (shortage), occurs below the equilibrium price. Excess supply: supply greater than demand (unsold goods), occurs above the equilibrium price.
If demand for a product increases and supply stays the same, what happens to price and quantity? → Both rise (Figure 7.3).
How can producers remove excess supply? → Lower the price, or store the surplus and release it later (though storage costs money and fresh goods spoil).
In the lithium case, why did price rise despite plenty of lithium on Earth? → Extraction is expensive and time-consuming, so supply couldn't increase quickly while demand surged — equilibrium price rose.

Ch 8 Price Elasticity of Demand

Chapter 8: Price Elasticity of Demand (PED)

Price elasticity of demand measures how strongly quantity demanded responds to a change in price. It tells a business whether a price cut will raise or lower its total revenue, and tells the government how taxes and subsidies will behave. The key formula is PED = % change in quantity demanded ÷ % change in price.

LEARNING OBJECTIVES

Understand what price elasticity of demand is.
Be able to calculate PED and interpret the numerical value.
Understand the factors that affect PED.
Understand the relationship between PED and total revenue.

GETTING STARTED — CASE STUDY: ELECTRICITY / CHINESE TAKE-AWAY

Electricity: when the price of electricity changed (it rose to US$164 and later fell back only slightly to US$159), consumers used almost the same amount — electricity demand barely changed with price.
Chinese take-away: Anne predicted a local take-away's price rise would make her switch to a rival — and when the price change happened she was proved right, saving over US$10.
The point: some products respond a lot to price changes, others barely respond at all — this is what PED measures.

WHAT IS PRICE ELASTICITY OF DEMAND?

price elasticity of demand (PED) — the responsiveness of the quantity demanded of a good to a change in its price.
Figure 8.1 shows two demand curves, A and B. At a price of £10 both have quantity demanded of 100 units. When price falls to £8:
Product A: quantity demanded rises only a little (110 units) — a small response.
Product B: quantity demanded rises a lot (150 units) — a significant response.
SUBJECT VOCABULARY:
price inelastic demand — when a change in price leads to a proportionally smaller change in quantity demanded (e.g. product A).
price elastic demand — when a change in price leads to a proportionally larger change in quantity demanded (e.g. product B).
GENERAL VOCABULARY — proportionate: corresponding in size to something else.

CALCULATING PRICE ELASTICITY OF DEMAND

PED = % change in quantity demanded
      ÷ % change in price

Product A: price falls 20% (from £10 to £8); quantity demanded rises 10% (100 → 110 units).
PED = 10% ÷ −20% = −0.5 → demand is price inelastic (ignore the minus sign; the absolute value 0.5 < 1).
Product B: price falls 20%; quantity demanded rises 50% (100 → 150 units).
PED = 50% ÷ −20% = −2.5 → demand is price elastic (2.5 > 1).
IMPORTANT — the minus sign: PED is normally negative because price and quantity demanded move in opposite directions. In exams you usually ignore the minus sign and use the absolute value.

INTERPRETING THE NUMERICAL VALUE OF PED

|PED| > 1 (e.g. −2.5) → elastic: quantity demanded changes proportionally more than price.
|PED| < 1 (e.g. −0.5) → inelastic: quantity demanded changes proportionally less than price.
|PED| = 1 → unitary elasticity: quantity demanded changes by exactly the same percentage as price.
PED = 0 → perfectly inelastic: quantity demanded does not change at all when price changes.
PED = ∞ (infinity) → perfectly elastic: at a given price consumers will buy any amount, but any price rise causes quantity demanded to fall to zero.

PRICE ELASTICITY AND THE SLOPE OF THE DEMAND CURVE

Steep (nearly vertical) demand curve → inelastic demand (Figure 8.3, PED = 0 — perfectly inelastic: e.g. a life-saving drug — raising price from P₁ doesn't change quantity demanded).
Flat (nearly horizontal) demand curve → elastic demand (Figure 8.4, PED = ∞ — perfectly elastic: e.g. a farmer's wheat in a perfectly competitive market — charge more than the market price and sell nothing).
Figure 8.5 shows the shape of a demand curve with unitary elasticity.
KEY DIAGRAMS (draw these):

Price ↑ |             Price ↑ |___________
   P₁ ──|──      vs        ──|P          (PED = ∞, perfectly elastic)
        |                    |
        └───────── Q         └────────── Q
   PED = 0 (perfectly inelastic, vertical)

ACTIVITY 2 — CASE STUDY: THE HEPTON TENNIS CLUB

Membership fees were slashed from US$500 p.a. to US$300 p.a. for 2016.
As a result, membership grew from 400 to 600 members.
Total revenue: 400 × $500 = $200 000 → 600 × $300 = $180 000 → TR fell, so over this range demand was price inelastic.
💡 Exam tip: always show the TR arithmetic (£ = P × Q) — that is what gains the method marks.

FACTORS AFFECTING PRICE ELASTICITY OF DEMAND

1. AVAILABILITY OF SUBSTITUTES

The more (and closer) the substitutes, the more elastic the demand — consumers can easily switch (e.g. strawberry jam — switch to other jams/margarines).
With few or no substitutes, demand is inelastic (e.g. electricity, insulin, salt).

2. DEGREE OF NECESSITY

Necessities (food staples, medicines) → inelastic demand (people must buy them).
Luxuries / non-essentials (boats, sports cars, expensive holidays) → elastic demand (people can delay or cancel).

3. PROPORTION OF INCOME SPENT ON THE PRODUCT

If the good takes a large share of income (e.g. a £400 flat-screen TV, a car), demand is elastic — consumers notice and react to the price.
If it takes a tiny share (stamps, pencils, matches), demand is inelastic — consumers don't bother to react.

4. TIME PERIOD (bonus point examiners reward)

In the long run, demand becomes more elastic because consumers have time to find substitutes and change habits; in the short run demand is more inelastic.

THE RELATIONSHIP BETWEEN PED AND TOTAL REVENUE (TR)

total revenue (TR) = price × quantity sold (P × Q).
If demand is INELASTIC (|PED|<1):
A price rise → TR rises (quantity falls only a little).
A price cut → TR falls (quantity rises only a little). Example (product A): P = £10, TR = £10 × 100 = £1000; P = £8, TR = £8 × 110 = £880 → TR fell by £120.
If demand is ELASTIC (|PED|>1):
A price cut → TR rises (quantity rises by more than price falls).
A price rise → TR falls.
If demand is UNITARY elastic: TR stays the same when price changes.
Table to memorise: | | Price rise | Price cut | |---|---|---| | Elastic demand | TR falls | TR rises | | Inelastic demand | TR rises | TR falls |

ECONOMICS IN PRACTICE — CASE STUDY: NG CHOCOLATES

Ng Chocolates considers changing the price of its chocolates and uses the PED of its product to work out whether total revenue will rise or fall.
The lesson: know your PED before changing price — a business that cuts price on an inelastic product actually loses revenue.

📊 KEY DIAGRAM — Elastic vs Inelastic Demand

Elastic vs Inelastic Demand

✅ Quick check

Write the PED formula. (%ΔQD ÷ %ΔP)
If PED = −0.5, is demand elastic or inelastic? (Inelastic — |0.5| < 1.)
List three factors affecting PED. (Availability of substitutes, degree of necessity, proportion of income spent; + time period.)
If demand is elastic, what happens to total revenue when price is cut? (TR rises.)
Draw the demand curve for a perfectly inelastic good. (Vertical line, PED = 0.)

Ch 9 Price Elasticity of Supply

Chapter 9: Price Elasticity of Supply

Price elasticity of supply (PES) measures how much the quantity supplied of a good responds when its price changes. Some goods (like houses and farm produce) can only increase output slowly, so their supply is inelastic; others (like factory-made crisps) can be produced quickly, so their supply is elastic. This chapter shows how to calculate PES, how to read its numerical value, how to draw and interpret supply-curve diagrams, and which factors — including time — decide whether supply is elastic or inelastic.

What is price elasticity of supply?

When the price of a good changes, the amount supplied will also change. However, the size of the change in supply is not the same for all products.
Example used in the book: two products, A and B. At a price of £4, both have a quantity supplied of 20 000 units.
Price rises by 25% to £5.
Product A: quantity supplied rises by only 12.5% (from 20 000 to 22 500 units) — the % rise in supply is smaller than the % rise in price.
Product B: quantity supplied rises by 100% (from 20 000 to 40 000 units) — the % rise in supply is much larger than the % rise in price.
Product B's supply is much more responsive to the price increase than product A's.
This relationship between the responsiveness of supply and a change in price is called price elasticity of supply (PES).

Term — price elasticity of supply (PES) — the responsiveness of supply to a change in price. In plain English: "how strongly does the amount producers are willing to sell change when the price changes?" For example, if the price of strawberries doubles but farmers can't grow more until next year, supply is not very responsive.

Elastic and inelastic supply

Inelastic supply — when a % change in price results in a proportionately smaller % change in the quantity supplied (alternative term: price inelastic).
Product A in the example above has inelastic supply (PES = 0.5).
The supply of houses in the 'Getting started' case is very price inelastic.
Many agricultural goods have price inelastic supply because farmers cannot increase supply at short notice — it takes time to grow farm produce.
Elastic supply — when a % change in price results in a proportionately greater % change in the quantity supplied (alternative term: price elastic).
Product B in the example above has elastic supply (PES = 4).
Provided firms have spare capacity, the supply of many manufactured goods (like crisps in 'Getting started') tends to be elastic.

Term — fast-moving consumer good (FMCG) — goods, especially food, that sell very quickly and in large amounts. Crisps are an example: Lays, one of the biggest crisp manufacturers worldwide, mass-produces millions of packets every year in a number of factories around the world. Because output can be stepped up quickly, FMCGs usually have elastic supply.

Term — raw materials — substances used to make a product (e.g. flour for bread, plastic for bottles). Easy access to raw materials helps producers raise output, making supply more elastic.

Calculating the value of price elasticity of supply

Like price elasticity of demand, PES can be presented numerically using a formula.

📊 Key formula — Price elasticity of supply

PES = Percentage change in quantity supplied ÷ Percentage change in price

For product A in Figure 9.1: PES = 12.5% ÷ 25% = 0.5
For product B in Figure 9.1: PES = 100% ÷ 25% = 4

Interpreting the value of price elasticity of supply

The values calculated show whether supply is price elastic or price inelastic:
PES less than 1 (a fraction or decimal) → supply is inelastic. Product A has inelastic supply because PES = 0.5.
PES greater than 1 → supply is elastic. Product B is price elastic because PES = 4.
PES = 0 → supply is perfectly inelastic.
PES = ∞ (infinity) → supply is perfectly elastic.
PES = 1 → supply has unitary elasticity.

Term — perfectly elastic (supply) — where PES = ∞: producers will supply an infinite amount at the given price (shown by a horizontal supply curve).

Term — perfectly inelastic (supply) — where PES = 0: the quantity supplied is fixed and cannot be adjusted whatever the price (shown by a vertical supply curve).

Term — unitary elasticity (with regard to supply) — where PES = 1: a change in price is matched by an identical % change in the quantity supplied.

Price elasticity and the slope of the supply curve

The supply curves in Figure 9.1 have different slopes:
Product A's curve is steep → generally shows supply is price inelastic.
Product B's curve is flatter → generally shows supply is price elastic.
However, whether supply is elastic or inelastic really depends on whether the supply curve cuts the price axis or the quantity axis:
Straight-line supply curves that cut the price axis are elastic.
Straight-line supply curves that cut the quantity axis are inelastic.

📊 Key diagram — Figure 9.3: Supply curves — special cases (three special cases of straight-line supply curves):

Price
  ^
  |  S1 (vertical) = perfectly inelastic supply (PES = 0)
  |
  |   \ S3 (through origin) = unitary elasticity (PES = 1)
  |    \
  |     \
  |---------------------- S2 (horizontal) = perfectly elastic supply (PES = ∞)
  |
  +----------------------------------> Quantity

S1 — perfectly inelastic (vertical): a price change will not affect the quantity supplied at all; the quantity supplied is fixed and PES = 0. Example: the supply of tickets to a tennis match was fixed at 15 000 because the capacity of the stadium was fixed (fixed supply was first shown in Chapter 5).
S2 — perfectly elastic (horizontal): producers are prepared to supply any amount at a given price; the value of price elasticity is infinite.
S3 — any straight-line supply curve that passes through the origin has a price elasticity equal to 1 — the % change in price is always the same as the % change in the quantity supplied.
In Figure 9.1, the supply curve labelled Sa shows a relatively inelastic supply curve, while the curve Se is relatively elastic.

💡 Exam tip — When asked to classify supply, always quote the PES value AND state what it means (e.g. "PES = 0.5, which is less than 1, so supply is inelastic — the % rise in quantity supplied (12.5%) is smaller than the % rise in price (25%)"). Also practise the three special cases: vertical = PES 0, horizontal = PES ∞, through-the-origin = PES 1.

Worked activity: Ampat Holdings (replica sports shirts)

Ampat Holdings manufactures replica sports shirts in a large factory in Chittagong, Bangladesh, sold to retailers and wholesalers all over the sub-continent.
In 2016 the price of the shirts fell from BDT 800 to BDT 640; as a result, Ampat reduced supply from 1.6 million to 1.2 million shirts.
% change in price: (640 − 800)/800 = −160/800 = −20%; % change in quantity supplied: (1.2 − 1.6)/1.6 = −0.4/1.6 = −25%.
PES = −25% ÷ −20% = 1.25 (greater than 1 → elastic supply).

Term — wholesaler — a person or company that sells goods in large quantities to businesses (retailers and wholesalers), rather than to the general public. Ampat sells its shirts to retailers and wholesalers.

Factors influencing PES

Generally, PES is influenced by whether producers can increase supply easily, or not:
If producers can increase the quantity supplied easily → supply tends to be elastic.
If there are barriers that prevent producers from increasing the quantity supplied → supply is more inelastic.

Availability of the factors of production

If producers have easy access to the factors of production — labour, raw materials, energy, tools and machinery — they can boost production if necessary → supply is elastic.
Example: if the price of training shoes rises, producers should be able to boost production fairly easily, because there is no reason why the resources needed to produce them should not be available.
Supply is more elastic if production factors are mobile — labour and materials can be switched to other uses easily.
However, if specialised resources are needed (such as skilled labour), those resources are less mobile (it may take time to train workers in new skills) → supply is more inelastic.

Availability of stocks

Producers that can hold stocks of goods can respond quickly to price changes → supply is elastic.
Where it is impossible or expensive to hold stocks → supply is inelastic.
The supply of some perishable goods, such as fruit and vegetables, is inelastic because they cannot be stored for very long.

Spare capacity

Supply is more elastic if producers have spare capacity — the ability to produce more with existing resources.
If firms are running at full capacity, supply is inelastic, because output cannot be increased at short notice.
Given more time, even firms running at full capacity can increase supply — they can build a bigger factory or buy more machinery, for example.

Time

The speed with which producers can react to price changes in the market can affect PES.
Generally, all producers can adjust output if they are given time. The more time producers have to react to price changes, the more elastic supply will be.
Where it is not possible to increase supply quickly (due to production limitations), supply is inelastic.
Example: it will take nearly a year to increase the supply of many agricultural products in many countries because growing seasons are so long.

PES for manufactured and primary products

Manufactured goods — producers can be quite flexible and adjust production levels at short notice → elastic supply.
Example: a car engine manufacturer could increase production quickly by stepping up the rate of output in the factory — asking employees to work overtime and keeping the factory open for longer. More raw materials and components will be required, but this should not be a problem.
Primary products — producers (e.g. of agricultural goods) are not able to react quickly to price changes → inelastic supply.
Example: a strawberry producer cannot increase supply until more strawberries can be grown — and this might not be possible until next year.
The supply of other primary goods, such as gold and diamonds, is likely to be inelastic (they cannot be produced quickly at all).

Case study: Housing (Getting started) — why housing supply is slow

Many countries around the world have housing shortages; growing populations (internal migration from rural areas and external immigration from other countries) may cause shortages, especially in areas with high immigration.
But it is not just rising demand that causes problems — the supply of new houses is often slow to increase, particularly affordable houses.
In the UK the National Housing Federation estimated 974 000 homes were needed between 2011 and 2014, but information provided by 326 regional councils showed that only 457 490 were built.
One report suggested there were ten buyers for every house on the market in parts of the UK.
One problem: obtaining planning permission for house building can take significantly longer and cause long delays in the UK. Finding suitable land and constructing houses takes several months.
Result: the average house price rose from £154 452 in March 2009 to £218 255 in January 2017.

Economics in practice: The global supply of coconuts

There has been a sharp increase in the global demand for coconuts (and products made from them) in recent years:
Supermarkets sell coconut milk in cartons with ring-pull opening devices so it can be drunk like a soft drink.
Reports suggest coconut sugar is a much healthier alternative to traditional sugar, and celebrities have been observed consuming coconut products (e.g. actress Gwyneth Paltrow claimed she uses coconut oil as a mouthwash for oral health and whitening her teeth).
The rising demand has resulted in higher prices for coconuts (Figure 9.4 shows the price of coconut oil between September 2015 and September 2016).
Unfortunately, suppliers have not been able to react to the rising prices by increasing the quantity supplied — globally, the supply of coconuts is falling. Reasons: 1. Age of the industry: most coconut trees are grown in India and Southeast Asia and are simply past their best — today's trees were planted more than 50 years ago (according to Hiroyuki Konoma, a representative for the UN Food and Agriculture Organization), putting them more than 20 years past their peak production time. 2. The Philippines is still recovering from the damage caused by typhoon Haiyan in 2013, which wiped out about 15% of its trees; it will take at least another year for new trees to bear fruit. 3. Indonesia, the world's top producer of coconuts, has failed to replace old low-yielding coconut trees, meaning estates are less productive; the government is encouraging more production of corn and soya instead.
It is reckoned that production growth is currently 8% behind demand growth — supply is very inelastic because new coconut trees take years to bear fruit.

✅ Quick check

Q: What does price elasticity of supply measure? A: The responsiveness of supply to a change in price — the % change in quantity supplied divided by the % change in price.
Q: If a 10% price rise causes a 5% rise in quantity supplied, what is PES and what type of supply is it? A: PES = 5 ÷ 10 = 0.5; less than 1, so supply is inelastic (product A in the chapter had PES 0.5).
Q: State the four special PES values and what they mean. A: PES = 0 → perfectly inelastic (vertical curve, fixed supply, e.g. stadium seats); PES = ∞ → perfectly elastic (horizontal curve, any amount at the given price); PES = 1 → unitary elasticity (curve through the origin); PES < 1 → inelastic; PES > 1 → elastic.
Q: Give three factors that make supply elastic. A: Easy access to factors of production (mobile labour/materials), ability to hold stocks, spare capacity, and plenty of time to react.
Q: Why is the supply of agricultural goods (e.g. strawberries) more inelastic than the supply of manufactured goods (e.g. crisps)? A: Farmers cannot increase supply at short notice because crops take a growing season (nearly a year) to produce, whereas manufacturers can raise output quickly using overtime, spare capacity and extra raw materials.

📊 KEY DIAGRAM — Elastic vs Inelastic Supply

Elastic vs Inelastic Supply

Ch 10 Income Elasticity

Chapter 10: Income Elasticity

Income elasticity of demand (YED) measures how much the quantity demanded of a good changes when consumers' incomes change. Demand for necessities (like milk and electricity) barely changes with income (income inelastic), while demand for luxuries (like new cars and designer clothing) changes a lot (income elastic). The sign of YED also tells us whether a good is normal (positive YED) or inferior (negative YED). This chapter covers the formula, how to interpret the values, and why price and income elasticities matter to businesses and to government decisions about taxes and subsidies.

What is income elasticity of demand?

After price, income is one of the most important factors that can affect the demand for products.
For most products, a change in income will result in a change in the quantity demanded — but the change in demand may vary according to the nature of the product.
Income elasticity of demand measures the responsiveness of demand to a change in income.
Example from the chapter: two products, A and B. If incomes rise by 10%:
Quantity demanded for product A rises by 25% → demand for A is very responsive → economists say demand for product A is income elastic.
Quantity demanded for product B rises by only 5% → the % increase in quantity demanded is less than the % increase in income → demand for product B is income inelastic.

Term — income elasticity of demand — the responsiveness of demand to a change in income. In plain English: "if people earn more (or less) money, how much more (or less) of a good will they buy?" If a family's income rises and they immediately buy a new car, car demand is income elastic; if they still buy the same amount of milk, milk demand is income inelastic.

Calculating income elasticity of demand

It is possible to calculate the income elasticity of demand for a good using the formula below.

📊 Key formula — Income elasticity of demand

Income elasticity of demand = Percentage change in quantity demanded ÷ Percentage change in income

For product A in the example above: YED = 25% ÷ 10% = 2.5
For product B in the example above: YED = 5% ÷ 10% = 0.5

Interpreting the value of income elasticity of demand

The values calculated show whether demand is income elastic or income inelastic, and something about the nature of the goods in relation to how demand changes in response to changes in income.

Necessities

Necessities are 'basic goods' that consumers need to buy. Examples include food in general, electricity and water; another example is petrol.
Demand for these types of goods is income inelastic (people buy roughly the same amount whether incomes rise or fall).
If the value of income elasticity of demand is between +1 and −1, demand is said to be income inelastic. Demand for product B is income inelastic because income elasticity is 0.5.

Luxury goods

Luxuries are goods that consumers like to buy if they can afford them. Examples include air travel, satellite television, designer clothing, and many goods and services in the leisure and tourism industry. It is also argued that demand for imported goods is income elastic.
Spending on these types of goods is called discretionary expenditure — this means it is optional and not automatic.
Demand for these goods is income elastic.
If the value of income elasticity is greater than 1 or less than −1, demand is said to be income elastic. Demand for product A is income elastic because income elasticity is 2.5.

Term — discretionary expenditure — non-essential spending, or spending that is not automatic — i.e. optional. Examples: holidays, satellite TV, designer clothes. When incomes rise, spending on discretionary items rises faster than income; when incomes fall, it is often cut back first.

Normal goods

The value of income elasticity can also show whether goods are normal or inferior (see Chapter 4, pages 23–28).
For normal goods, an increase in income results in an increase in the quantity demanded → the value of income elasticity will be positive.
Products A and B above are both normal goods because income elasticity is positive in both cases (2.5 and 0.5).

Inferior goods

For inferior goods, an increase in income results in a decrease in the quantity demanded → the value of income elasticity will be negative.
This shows that the quantity demanded and income have an inverse relationship (they move in opposite directions).
Examples of inferior goods might include those bought at 'Pound' or 'Dollar' shops, where everything sold is either £1 or US$1.

💡 Exam tip — Memorise the sign rule: positive YED = normal good; negative YED = inferior good. And the size rule: YED between +1 and −1 = income inelastic (necessities); YED greater than 1 or less than −1 = income elastic (luxuries). In calculations, always show the formula, substitute the numbers, and give the answer with its classification.

Worked activity: Calculating income elasticity of demand

In 2016, average incomes in a country rose from €30 000 to €32 400 (% change = 2400/30 000 = 8%).
Product X: total annual quantity demanded rose from 24 million to 30 million units (% change = 6/24 = 25%). YED = 25% ÷ 8% = 3.125 → income elastic (greater than 1) → normal good.
Product Y: quantity demanded fell from 10 million to 9 million units (% change = −1/10 = −10%). YED = −10% ÷ 8% = −1.25 → income elastic (less than −1) → inferior good (negative sign).

Did you know? As developing nations become better off, their demand for imports rises significantly. (This is because many imports are luxuries or goods with income-elastic demand.)

Price elasticity and businesses

Price elasticity can provide useful information for businesses: it can help firms predict the effect of a price change on total revenue.
When a firm changes its price, there will be a change in the quantity demanded and therefore a change in total revenue. Knowing the value of price elasticity helps the firm work out the effect in advance.

Effect on total revenue of a price increase when demand is inelastic

If a business has inelastic demand for one of its products, it knows that a price increase will increase revenue.
Example: if PED = −0.8 and current demand is 2 million units, a 5% price increase from US$20 to US$21 will increase revenue. Proof:
PED = % change in demand ÷ % change in price → −0.8 = % change in demand ÷ 5% → % change in demand = −4%.
New level of demand = previous demand − 4% = 2 million − (4% × 2 million) = 2 million − 80 000 = 1 920 000.
At price US$20: TR = US$20 × 2 million = US$40 million.
At price US$21: TR = US$21 × 1.92 million = US$40.32 million.
Therefore the price increase has resulted in a rise in total revenue of US$320 000.
(The full relationship between price elasticity and the effect of price changes on total revenue is summarised in Chapter 8, pages 48–55.)
Conclusion for firms: if firms know the value of price elasticity for their products, they can predict the effect on total revenue of any price changes they make:
If demand is elastic, a price reduction will increase total revenue.
This helps explain why many rail companies charge much-reduced prices for 'off-peak' rail travel — by lowering the price, more travellers are attracted and revenue rises, meaning demand during the 'off-peak' period must be price elastic.

Income elasticity and businesses

Many firms are interested in income elasticity of demand, because changes in income in the economy may affect demand for their products.
If firms know the income elasticity of demand for their products, they can respond to predicted changes in incomes.
Some manufacturers have flexible resources and can switch from the production of one good to another. Example: a manufacturer of plastic products may be able to switch from making plastic buckets to plastic toys if demand for toys was income elastic — a predicted rise in incomes may encourage such a firm to make more plastic toys.
Firms that produce goods that are income elastic will expect changes in income to affect demand:
If incomes are expected to rise in the future, they can plan ahead, making sure they have enough capacity, for example.
If a recession were expected, such firms would plan to cut output — because incomes are likely to fall during a recession. In 2008, as a result of the global recession, car manufacturers started to cut their output.
However, producers of inferior goods might start to build capacity if they believed a recession was coming — when incomes fall, the quantity demanded for inferior goods, such as those sold by low-cost supermarkets, starts to rise.

Price elasticity and the government: indirect taxes

Governments often raise revenue by imposing indirect taxes such as value-added tax (VAT) and excise duty on products.
It is important for governments to select products that have inelastic demand, because consumers will avoid heavily taxed products if demand for them is elastic.
Therefore governments target goods that are either necessities or have few substitutes.
However, most governments do not target goods, such as food and water, which are essential to human survival.
Popular targets for governments when imposing taxes are cigarettes, alcohol and petrol — demand for these products is very price inelastic.

Term — excise duty — government tax on certain goods, such as cigarettes, alcoholic drinks and petrol, that are sold in the country.

Term — value-added tax (VAT) — tax on some goods and services: businesses pay value-added tax on most goods and services they buy, and if they are VAT-registered, charge value-added tax on the goods and services they sell. (VAT is a tax on spending, collected at each stage of production and sale.)

Subsidies

The effect of a subsidy is to move the supply curve to the right (i.e. to increase supply).
Governments might also consider PED when granting a subsidy to producers. If the subsidy is designed to help the poor by making the good cheaper, it is important that demand is price inelastic — if demand is not price inelastic, an increase in supply will only reduce the price slightly.
This might explain why subsidies are often given to farmers: since demand for many food products is inelastic, a subsidy to farmers will help to keep food prices lower.

Case study: Petrol tax and PED (Activity 2)

One of the products chosen by many governments for indirect taxes is petrol.
In December 2016, the average price of a litre of petrol in the UK was around £1.13. Of this, 57.95 pence is fuel duty that goes to the government.
In addition, VAT is charged on petrol at 20%.
UK drivers pay some of the highest prices for petrol in the world due to taxation.
Worked figures: a driver buying 50 litres per week pays 50 × 57.95p = £28.975 ≈ £28.98 fuel duty per week. If it costs £60 to fill up, the price before VAT is £60 ÷ 1.2 = £50, so VAT = £10.
Governments choose products like petrol for heavy duties because demand for petrol is very price inelastic (it is a necessity with few substitutes), so heavy taxation does not greatly reduce the quantity sold — meaning the government raises large amounts of revenue.

Economics in practice: Income elasticity for red meat in a developing country

The income per capita (per head) for a developing country between 2001 and 2017 is shown in Figure 10.1, and the consumption of red meats (such as beef or lamb) in the same country is shown in Figure 10.2.
Figure 10.1 (income per capita, US$000s): rising over time — approximately 12.0 (2001), 12.4, 12.9, 13.5, 14.2, 15.0, 16.4, 18.0, and around 21.5 by 2017 (values rising steadily across the years).
Figure 10.2 (annual red meat consumption, tonnes): also rising — approximately 540, 580, 600, 620, 700, 740, 830, 1000 (2009), 1200, 1400 by 2017 (values rising from 2001 to 2017*, where * = prediction).
Both income and red-meat consumption rise together over the period, so red meat is a normal good; because consumption grows faster than income (income inelastic vs. luxury question), the data is used to test whether red meat behaves like a luxury good in this developing country.

✅ Quick check

Q: What is the formula for income elasticity of demand? A: YED = Percentage change in quantity demanded ÷ Percentage change in income.
Q: If incomes rise by 10% and demand for a good rises by 25%, what is YED and what kind of good is it? A: YED = 25 ÷ 10 = 2.5; greater than 1, so demand is income elastic and it is a normal/luxury good (product A in the chapter).
Q: What does a negative YED tell you? A: The good is inferior — an increase in income causes a decrease in quantity demanded (inverse relationship), e.g. goods from 'Pound' or 'Dollar' shops.
Q: Why do governments put high taxes on cigarettes, alcohol and petrol? A: Demand for them is very price inelastic (necessities with few substitutes), so raising the price via tax does not cut the quantity sold much — the government raises lots of revenue.
Q: Why might a rail company cut 'off-peak' fares? A: Because off-peak demand is price elastic — a lower price attracts many more travellers so total revenue rises.

Ch 11 The Mixed Economy

Chapter 11: The Mixed Economy

Most economies are "mixed": some goods and services are produced by privately owned businesses in the private sector (which aim mainly for profit), and others are provided by the state in the public sector (funded by taxes, aiming to serve everyone). This chapter explains the difference between the two sectors, their ownership, control and aims, the three basic questions (what/how/for whom to produce), and why the market can fail — through externalities, lack of competition, missing markets (public and merit goods), lack of information and factor immobility — so that government intervention is needed.

The public and private sectors

An economy is a system that attempts to solve the basic economic problem — decision makers in an economy have to decide what to produce, how to produce and for whom to produce.
In any economy, goods and services may be provided by the public sector or the private sector.

Term — economy — system that attempts to solve the basic economic problem (what, how and for whom to produce).

Term — private sector — provision of goods and services by businesses that are owned by individuals or groups of individuals.

Term — public sector — government organisations that provide goods and services in the economy.

Term — durables — products that are intended to have a life of more than 3 years from when they are made or bought (e.g. cars, fridges, TVs).

Term — groceries — food and other goods that are sold by a grocer or a supermarket.

In the private sector, individuals or groups of individuals are free to set up businesses and supply goods and services to anyone who wants to buy them.
In the public sector, a range of organisations — government departments, public corporations and other agencies — provide services that are often supplied inefficiently by the private sector. Examples include health care, education and defence.
Most public sector services are provided free by the state and are paid for from tax revenue or borrowing.

Private sector organisations

Ownership and control

Goods and services in this sector are provided by businesses that are owned and controlled by individuals or groups of individuals.
In many countries, most consumer goods — such as groceries and consumer durables like those shown in 'Getting started' (Figure 11.1) — are provided by the private sector.
Private sector enterprises can vary in size and type of ownership. They may be:
Sole traders — the business is owned and controlled by one person (often retailers, and tradesmen such as plumbers, electricians or taxi drivers).
Partnerships — owned and controlled by two or more people working together; often found in the professions and may operate as accountants, solicitors, estate agents and architects.
Companies — shareholders own the business; they elect a board of directors to run the business on their behalf. These vary in size and can be found in a number of different business sectors, such as manufacturing, construction, public transport, media, financial services, oil and gas, pharmaceuticals and engineering.
In most countries, private sector businesses are relatively small and include only sole traders, partnerships and small companies. A minority of businesses are large but contribute enormously to the provision of goods and services. Some are multinationals — they have factories and other operations all over the world.

Term — shareholders — people or organisations that own shares in a company.

Term — professions — careers that need a high level of education and training in order to work in them, traditionally including medicine, law and teaching.

Term — provision — the act of providing something that someone needs.

Aims

In the private sector, the aims of firms are likely to be determined by their owners. The main aim of most owners is to make a profit — but a number of other aims need to be considered:
Survival — when a firm is first set up, many owners will not expect to make a profit immediately (it takes time to establish a business and new owners often encounter unexpected difficulties), so the initial aim might simply be to survive. Survival is also important when trading conditions are difficult: in 2008 and 2009, because of global financial difficulties and recession, many firms struggled due to falling sales and difficulties in raising finance, and many were happy just to survive.
Profit maximisation — the owners of most firms are in business to make a profit. Economic theory assumes that firms will aim to maximise profits (see Chapter 2, pages 12–17) — making as much profit as it possibly can in a period of time. Companies pay their shareholders a share of the profit through a dividend; many shareholders want dividends to be as high as possible, so profit maximisation is an important objective. However, some firms are content to make just enough profit to keep the owners satisfied: in a small firm, this might mean an owner does not want to take on the extra responsibility of growth and is content to make a satisfactory profit; in a large company, it might mean the managers who run the firm make enough profit to satisfy shareholders.
Growth — many firms aim to grow because bigger businesses enjoy a number of advantages: large firms can reduce average costs by exploiting economies of scale (see Chapter 17, pages 124–131); growth also means profits will be higher in the future; and growth benefits other stakeholders such as workers, managers and directors (e.g. their jobs will be more secure). However, one problem with growth is that profit is often used to finance it — shareholders may not like this because dividends may be lower.
Social responsibility — an increasing number of firms aim to be good corporate citizens: they aim to please a wider range of stakeholders. Owing to pressure from the government, the media, environmentalists, local residents, consumers, workers and other interested parties, some firms are aiming to become more socially responsible.

Term — dividend — part of a company's profit that is divided among the people with shares in the company.

Public sector organisations

Ownership and control

Public sector organisations are owned and controlled by local or central government. Some of the main examples:
Central government departments — e.g. in the UK, the Ministry of Health (responsible for the National Health Service), the Department of Defence (responsible for the armed forces) and the Department for Transport (aims to manage the provision of a reliable and safe transport system). These departments are usually controlled by teams or boards led by a government minister.
Public corporations or state-owned enterprises (SOEs) — owned by the government: the government selects the people who run the organisation, often a board of directors, and is also responsible for its key policies. Public corporations are usually incorporated businesses, meaning they have a separate legal identity — they can sue, be sued and enter into contracts under their own name. They are state-funded (the government provides their capital, with the money coming mainly from taxation), and all the assets and liabilities of public corporations belong to the state. However, they can also borrow money and are free to re-use revenue from the sale of any goods or services. The nature and number of public corporations varies by country: although many exist to provide a public service, there are many that operate commercially with the aim of making a profit — in the Middle East, Russia and India, for example.
Local authority services — delivered by local councils, include recreation (libraries, sports halls and swimming pools), emergency services (fire and police services) and housing (council housing and facilities for the homeless). Councillors elected by residents in the local community run local authorities.
Other public sector organisations — such as the BBC, the Post Office, the Bank of England and Network Rail (all in the UK) — run by a trust or a board led by an experienced expert selected by a government body, or the Queen, following government advice.

Term — assets — things or resources belonging to an individual or a business that have value or the power to earn money.

Term — liabilities — amount of debt that is owed or must be paid.

Term — sue — to make a legal claim against someone, especially for an amount of money, because you have been harmed in some way.

Aims

Public sector organisations have different aims from those in the private sector. Without aims, they are likely to deliver poor-quality services and waste resources. Each organisation has its own specific aims, but there are some common themes:
Improving the quality of services — public sector organisations generally aim to improve the standard of their services. Performance indicators may be used to monitor quality: in the railway industry, targets might be set for reliability and punctuality; in the education system, league tables may be published to show student success rates in exams at individual schools. In general, performance indicators might focus on reliability, professionalism, levels of customer service and speed of service.
Minimising costs — government resources are scarce and it is important that waste is minimised. In the past, public sector organisations have been criticised for being inefficient, so the government is regularly looking for ways to cut costs in all areas.
Allow for social costs and benefits — since their aim is not to make a profit, public sector organisations are better placed to take into account the needs of a wide range of stakeholders. When making decisions they can take into account externalities (see Chapter 13, pages 89–96).
Profit — in some countries, the government owns a number of large businesses that aim to make a profit. In the UAE, Emirates Airline and Dubai World (an investment company that manages and supervises a range of businesses and projects for the Government of Dubai) are examples.

Term — stakeholders — individuals or groups who are considered to be an important part of an organisation or of society, because they have responsibility within it and receive advantages from it.

Did you know? Some large, public corporations are part owned by the private sector. For example, the 'Indian' government owns about 60 per cent of the State Bank of India, while private individuals, financial institutions and foreign institutions own the rest.

Case study: Ugandan water supply (Activity 1)

Water and sewerage services in Uganda, like in many other countries in the world, are supplied by a government-owned organisation: the Ugandan government owns 100 per cent of The Ugandan National and Water Sewerage Corporation (NWSC).
Its mission: "To sustainably and equitably provide cost effective quality water and sewerage services to the delight of all stakeholders while conserving the environment." A board of directors, accountable to a government minister, runs the organisation.
NWSC has enjoyed much success in recent years:
Revenue increased from UGX 21 000 million to UGX 220 000 million between 1998 and 2016.
Account holders increased from 58 260 (1998) to 450 000 (2016).
Active in 162 towns (up from 27 towns in 2013).
Employs over 2800 people.
Productivity improvements: in 1998 it took 36 staff to make 1000 connections; in 2016 this was reduced to six staff per 1000 connections.
NWSC aims to supply everyone with clean safe water within a 200 metre distance of all towns and urban centres (supply in these areas is currently 78 per cent).
It links up with customers and local communities through NWSC Water Communication Clubs; its website states "The customer is the reason we exist. We do everything to the delight of our customer." Annual surveys show 90 per cent of customers are satisfied with the service provided.
Key point: governments get involved in business ownership to ensure essential services (like water) are provided to everyone, even where a profit-driven private firm would not.

Types of economy

Different economies have different approaches to providing goods and services. The type of economy used to choose, produce and distribute goods varies according to the role played by the public sector. Historically, a country's type of economy was shaped by its political ideology: capitalist countries adopted a market economy and communist countries a command economy. There are three types of economy:
A market (or free enterprise) economy relies least on the public sector for the provision of goods and services — the vast majority are provided by private businesses. Market forces (supply and demand) determine the allocation of resources. The role of the public sector is limited to providing a legal system, a monetary system, key state services like defence and policing, and ensuring that competition exists between businesses. The most economically free countries in the world are often considered to be Singapore, Australia and the USA.
A command (or planned) economy relies entirely on the public sector to choose, produce and distribute goods. All resources in planned economies belong to the government, and the state is responsible for planning, organising and coordinating the whole production process. Goods are distributed from state-owned shops where they are sold to consumers at prices set by the state. There are few, if any, examples of planned economies in the world today — Cuba, Myanmar and North Korea are the closest examples.
A mixed economy relies on both the public sector and the private sector to provide goods and services. Currently, the majority of countries have mixed economies.

Term — monetary system — the system of money in a particular country or the world as a whole, and the way that it is controlled by governments and central banks.

The mixed economy

In reality, no economy is entirely planned or free market. Most countries in the world have a mixed economy, and the decisions about what to produce, how to produce and for whom to produce are made by both consumers and the state.

Term — mixed economy — economy where goods and services are provided by both the private and the public sectors.

Term — market failure — where markets lead to inefficiency.

What to produce?

A mixed economy recognises that some goods, such as consumer goods, are best provided by the private sector. Goods such as food, clothes, leisure and entertainment, and household services are best chosen by consumers.
The market system ensures that businesses produce the consumer goods that people want.
Other goods, such as education, street lighting, roads and protection, are more likely to be provided by the state.
The public sector tends to provide goods that the private sector might fail to provide in sufficient quantities — this is often caused by market failure.

How to produce?

In the private sector, individuals or groups of individuals who set up businesses with the aim of making a profit provide goods. Competition exists between these firms, and this provides choice and variety for consumers. To meet consumers' needs, firms will use production methods that help them to maximise quality and minimise costs.
Public sector services will be provided by the government organisations outlined above; they will decide how these services should be provided and attempt to supply them efficiently.
However, some public sector goods are produced by the private sector: for example, governments are usually responsible for the provision of roads and motorways, but they may pay private sector businesses to carry out the actual work of construction and maintenance.

For whom to produce?

The goods produced in the private sector are sold to anyone who can afford them — the market system is responsible for their allocation.
In contrast, most public sector goods are provided free to everyone and paid for from taxes.
In some mixed economies, the state also makes provision for people who cannot work due to illness or disability, for example. A system of financial benefits exists to make sure that people have enough money to survive.

The 'degree of mixing'

Different governments around the world will decide on the 'degree of mixing' in this type of economy.
Some countries, like France, allow the government to play a greater role in the economy: government expenditure in France is around 57 per cent of its national income. In such countries, social provision is greater but taxes are higher.

📊 Key diagram — Figure 11.3: General government spending as a proportion of national income in Singapore, Ireland and France: - France: 57% (highest of the three — the state plays the biggest role). - Ireland: middle value. - Singapore: lowest value (the state plays the smallest role — most goods provided by the private sector).

Market failure and the need for government intervention

Although markets may have a reputation for using resources efficiently, because of market failure, resources are sometimes wasted. Market failure is where markets lead to inefficiency. It can occur for a number of reasons:

Externalities

Sometimes firms do not take into account all the costs of production. For example, a firm producing chemicals may pollute the atmosphere because it has not taken measures to clean its waste. This imposes a cost on society, such as poor air quality or ill health.
Any damage done to people or things outside the business as a result of this activity is called an external cost (see Chapter 13, pages 89–96).
The market system has resulted in the chemical firm failing to meet any cost imposed on those affected by the pollution.

Lack of competition

A market may fail if there is no competition and it becomes dominated by one or a small number of firms.
When this happens, the dominant firm(s) may exploit consumers — by charging higher prices and limiting choice, for example.

Term — dominant — more powerful, important, or noticeable than other people or things.

Missing markets

Some goods and services, called public goods, are not provided by the private sector. Examples include national defence, policing and street lighting.
Other goods, called merit goods, such as education and health care, are underprovided by the private sector — this is because they are so expensive that many people would not be able to afford them.

Term — public goods — goods that are not likely to be provided by the private sector.

Term — merit goods — goods that are under-provided by the private sector.

Lack of information

Markets will only be efficient if there is a free flow of information to all buyers and sellers. Consumers need to know everything about the nature, price and quality of all products; businesses also need information about the resources and production techniques used to make a product.
However, this is not always possible. A lack of information may result in the wrong goods being purchased or produced, or the wrong prices being paid.

Factor immobility

For markets to work efficiently, factors of production need to be mobile — factors such as labour and capital must be able to move freely from one use to another.
In practice, though, factors can be quite immobile. For example, a specialised laser machine designed specifically to cut sheet glass may not have any further use if the glass-making factory has to close down — the machine may have to be destroyed, which is wasteful.

Term — legislation — law or set of laws.

Term — merger — occasion when two or more companies or organisations join together to form a larger company.

How the government intervenes

Owing to the threat of market failure, the government often has to intervene in markets. Some examples:
Businesses that impose externalities may be heavily regulated or fined for polluting the atmosphere, for example.
The government can use legislation to prevent businesses from dominating markets — for example, it can investigate whether a merger is in the interests of consumers and block them if they are not.
State money can be used to provide public goods and merit goods. Since these goods and services are important to the well-being of everyone, the public sector can provide them free of charge.
To overcome the problem of poor information, the government can help by passing legislation forcing firms to provide more information about products. (In recent years the internet has improved the flow of information about products.)
The government may be able to help to make some factors more mobile, such as retraining workers when their previous jobs become redundant — but it can do little to avoid the waste of the specialised machine in the example above.

Key facts: Lack of competition — In many countries, most people have to buy their water supply from one provider: they have no choice and have to pay the prices charged by the water company. The role of the government in this case is to monitor and control the prices charged by dominant firms, or pass legislation to ensure that competition exists.

Role of the private and public sectors in the production of goods and services

In most countries, the private sector is responsible for providing the everyday goods and services bought by people: food, clothes, consumer durables (such as electrical goods and cars), personal and household services, financial services, entertainment and holidays. It would also include raw materials, components, machinery and commercial services (such as cleaning, maintenance, IT and insurance) which businesses buy. Very few governments would get involved in the provision of these goods and services.
However, the public sector tends to provide public services. In particular, it focuses on the provision of public and merit goods — goods that would not be provided in sufficient quantities by the private sector. For example, public goods would not be provided at all, because it is virtually impossible for private firms to charge users for their consumption. This is because public goods have two particular characteristics:

Non-excludability

Once a public good is provided in the market, any individual consumer cannot be prevented or excluded from its consumption. Also, an individual consumer cannot refuse consumption of the good even if they wanted to.
Example: it is argued that the protection given by the police service is a public good — an individual cannot be excluded from the protection provided in a community by the police force, and neither can an individual living in that community refuse to benefit from that protection.

Non-rivalry

Consumption of a public good by one individual cannot reduce the amount available to others.
Example: someone benefitting from the protection provided by the police does not prevent others benefitting from the same protection.

The free-rider problem

Governments have to provide public goods because of market failure. If the private sector were to provide public goods there would be a free rider problem.
Since it is impossible to exclude the consumption of a public good by an individual consumer, there is little reason for people to pay for it — so no private firm would bother producing it.
Public goods like defence, policing, the judiciary system, prisons and street lighting will significantly increase the standard of living in a country (assuming there is enough money to pay for them). Consequently, the government takes responsibility for their provision.

Term — free rider — an individual who enjoys the benefit of a good but allows others to pay for it. In plain English: someone who "gets a free ride" — benefiting from something without paying, e.g. benefiting from street lighting or police protection without contributing to its cost.

Case study: Public goods in Bangladesh (Activity 2)

Bangladesh has serious annual flooding problems. The country lies in the Ganges Delta, where many tributaries flow into the River Ganges on its route to the Bay of Bengal.
Flooding usually occurs during the monsoon season between June and September.
To help protect large numbers of the population, flood defences are built in the country.
Flood defence systems are classified as a public good because they are non-excludable (everyone benefits from flood protection whether or not they pay) and non-rivalrous (one person's protection does not reduce protection for others) — so the private sector would not provide them and government intervention is needed when there is market failure.

The public sector and private sector in different economies

The balance between public sector activity and private sector activity will vary in different countries.
In some countries, governments play a key role in the provision of key public services, such as education, health care, security services and infrastructure. At the same time, they also own significant stakes in large commercial organisations — examples include China, Hungary, Russia, Sweden and the UAE, where the public sector plays a dominant role.
In contrast, some governments believe that a greater quantity of goods and services should be provided by the private sector. In countries such as the USA, Singapore and Australia, the state has much less involvement in the provision of goods and services.
Different countries vary their commitment to government involvement: for example, France plays a much bigger role in the provision of goods and services than Singapore.
Finally, in recent years, many economies have become more market orientated. In many countries, the number of public corporations has been reduced — in some countries, industries such as water provision, electricity generation and distribution, and telecommunications have been transferred to the private sector. Many Eastern European countries have also transferred a lot of government-run businesses into the private sector following the break-up of the Soviet Union. This process of transferring public sector resources to the private sector is called privatisation and is discussed in Chapter 12 (pages 81–88).

Economics in practice: Mixed economies

General government spending, as a percentage of GDP, provides an indication of the size of government involvement in the provision of goods and services. The variation in this indicator shows the variety of countries' approaches to delivering public goods and services and providing social protection.

📊 Key diagram — Figure 11.4: Government expenditure as a percentage of GDP for a selection of countries (all of which have mixed economies). Values shown in the text, from lowest to highest: South Korea 32%, Australia 36.2%, Japan 38.1%, Spain 42.1%, Hungary 44.7%, Austria 49.6%, Finland 52.8%, and one further country at 58.1% (the OCR of the final country label is unclear, but it is the highest of all). - The country where the public sector plays the greatest role is the one with the highest percentage of government expenditure as a share of GDP. - You would expect taxes to be highest in the country with the greatest government expenditure — because that spending must be financed out of tax revenue.

✅ Quick check

Q: What is the difference between the private and public sectors? A: The private sector provides goods and services through businesses owned by individuals or groups of individuals, aiming mainly for profit; the public sector provides goods and services through government organisations (departments, public corporations, local authorities), funded mainly from tax revenue and aiming to serve everyone.
Q: Name three aims of private sector firms and three aims of public sector organisations. A: Private: profit maximisation, survival, growth, social responsibility. Public: improving the quality of services, minimising costs, allowing for social costs and benefits (and profit in some countries, e.g. Emirates).
Q: What are the three types of economy? A: Market/free enterprise economy (mostly private, e.g. Singapore, Australia, USA); command/planned economy (all state-run, e.g. Cuba, Myanmar, North Korea); and mixed economy (both sectors — the majority of countries).
Q: List five causes of market failure. A: Externalities (e.g. pollution); lack of competition (dominant firms exploiting consumers); missing markets (public and merit goods not provided); lack of information; factor immobility.
Q: What are the two characteristics of a public good? Give an example. A: Non-excludability (nobody can be prevented from consuming it) and non-rivalry (one person's consumption does not reduce availability for others) — e.g. police protection, defence, street lighting, flood defences. Because of the free-rider problem, private firms will not supply them, so the government must.

Ch 12 Privatisation

Chapter 12: Privatisation

Privatisation is the transfer of assets or businesses from the public (government) sector to the private sector. This chapter looks at why governments privatise, the effects on consumers, workers, firms and the government, and real-world case studies (Greece, the UK railways and water, China) — including where privatisation has failed.

LEARNING OBJECTIVES

Understand what privatisation is.
Understand why privatisation takes place (the motives).
Understand the effects of privatisation on consumers, workers, firms and the government.

GETTING STARTED — FROM THE SOVIET UNION TO MARKETS

After the collapse of the Soviet Union, many formerly state-run economies began selling off government-owned businesses to private owners — a huge wave of privatisation.
GENERAL VOCABULARY — state assets: things owned by the government (state), such as state-owned companies, land and buildings.

WHAT IS PRIVATISATION?

SUBJECT VOCABULARY — privatisation: the transfer of state assets from the public sector to the private sector.
Example from the book: in 1987, British Airways was privatised (sold by the UK government to private shareholders).
Note the related term — nationalisation: the opposite — the transfer of a business from the private sector to government ownership (the book's related vocabulary box).
Governments often privatise monopolies:
SUBJECT VOCABULARY — monopoly: a market in which the supply of a good or service is controlled by only one firm (e.g. a single water or rail company).
Why governments originally owned some industries: it was felt the state should supply essential services that private firms might not provide to everyone at fair prices (e.g. school meals, hospital cleaning, water, rail).

WHY DOES PRIVATISATION TAKE PLACE? (MOTIVES)

To raise money (revenue) for the government — selling state assets raises large one-off sums. Figure 12.1 shows global revenue from privatisation, 2000–15 (hundreds of billions of dollars). For example, Greece, because of its economic crisis, sold airports to raise cash (see below).
To improve efficiency — private firms, driven by the profit motive, have incentives to cut costs and improve service; state firms often had no such pressure.
To increase competition (in some markets) — private ownership can open markets to competition.
To reduce government involvement / reduce the burden on taxpayers — the state no longer subsidises or manages the industry.
To create wider share ownership — encouraging ordinary people to buy shares.

CASE STUDY: GREEK AIRPORT PRIVATISATION

During Greece's economic crisis, Greece received a package of loans worth €86 000 million and was required (by its creditors) to privatise state assets.
The deal to sell regional airports (including Santorini) raised €1230 million for the Greek government.
The buyer pays an operating fee of €22.9 million a year and agreed to invest €330 million in the airports.

EFFECTS OF PRIVATISATION

1. Effects on CONSUMERS

KEY FACTS (CONSUMERS): privatisation has mixed results for consumers:
Possible benefits: more choice, better customer service, lower prices where competition exists (private firms must meet customer needs or lose business).
Possible drawbacks: prices can rise sharply where the privatised firm is a monopoly with no competition.
UK example — the railways: government subsidies to the rail industry rose from just over £1000 million in the late 1980s to more than £6000 million in 2006/07; even in 2014/15 the subsidy was still £4000 million — taxpayers felt this was unfair. UK passengers pay some of the highest fares in the world — a season pass from Chelmsford to London cost £357.90 a month, compared with £37 in Italy, £56 in Spain and £95 in Germany. Rail firms have been fined (e.g. £1.7 million for missing performance targets, and one firm was threatened in 2014 with a £176 million fine).

2. Effects on WORKERS

Workers often face more flexible working practices (changes to hours, contracts and conditions) after privatisation.
Supporters argue privatised firms are more efficient and pay for it with higher wages; critics argue jobs are lost and working conditions worsen.

3. Effects on FIRMS (the privatised companies)

Higher profits: e.g. the profits of British Telecom increased after privatisation.
More investment: many firms increased investment following privatisation (new equipment, networks).
Diversification: many privatised businesses moved into new areas (e.g. Hanson bought Eastern Electricity and diversified).

4. Effects on the GOVERNMENT

One-off revenue from the sale.
No longer has to subsidise the industry.
Loses a source of control/income over the industry.

ACTIVITY 2 — CASE STUDY: PRIVATISATION IN CHINA

China saw an acceleration in privatisation; many local governments sold or restructured state-owned enterprises (SOEs).
Figure 12.2 compares the performance of state-owned enterprises with the private sector — private firms generally showed better efficiency and returns (up to 200% differences in some measures).

ECONOMICS IN PRACTICE — CASE STUDY: WATER PRIVATISATION

Manila, the Philippines: a 25-year concession to private water companies is said to have failed — the private firms could not deliver reliable water to the poor at affordable prices, and the deal had to be renegotiated/cancelled.
UK water companies: since privatisation, UK water companies' profits have risen dramatically — e.g. Northumbrian Water's operating profit jumped from £165.3 million to nearly £3170 million in 2016. Critics say profits are too high while bills rise; supporters say investment in infrastructure improved.
Lesson: privatisation works best where there is competition and effective regulation; it can fail where a natural monopoly (water, rail) simply changes from a public to a private monopoly.

💡 Exam tip: the "for and against" answer

For privatisation: raises government revenue; increases efficiency (profit motive); can increase competition and choice; reduces the taxpayer burden; widens share ownership.
Against privatisation: consumers can face higher prices and worse service if a public monopoly becomes a private monopoly; possible job losses and worse conditions for workers; "selling the family silver" (losing a long-term income stream for a one-off gain); essential services may be cut to raise profit; needs heavy regulation.

✅ Quick check

Define privatisation. (Transfer of state assets/businesses from the public to the private sector.)
Give three motives for privatisation. (Raise revenue, improve efficiency, increase competition, reduce taxpayer burden, widen share ownership.)
Give one benefit and one drawback for consumers. (Benefit: better service/choice where competitive. Drawback: higher prices if it becomes a private monopoly — e.g. UK rail fares.)
What happened to water company profits in the UK after privatisation? (They rose sharply — e.g. Northumbrian Water from £165.3m to ~£3170m.)
Why can privatisation "fail"? (Where the industry is a natural monopoly with no competition — e.g. Manila water — prices/service problems persist without regulation.)

Ch 13 Externalities

Chapter 13: Externalities

Externalities are the spill-over costs or benefits of an economic activity that affect third parties — people not directly involved in buying or selling. They are a form of market failure: the market price does not reflect the true cost or benefit to society. This chapter covers external costs and benefits of both production and consumption, the idea of social cost/social benefit, and the government policies used to deal with them.

LEARNING OBJECTIVES

Understand how external costs are defined, with examples.
Understand how external benefits are defined, with examples.
Understand social cost and social benefit.
Understand government policies to deal with externalities.

GETTING STARTED — PRODUCTION AND CONSUMPTION

Economic activity — building a factory, transporting goods, driving a car — affects people other than the buyer and seller.
These spill-over effects can be negative (external costs, e.g. pollution) or positive (external benefits, e.g. a well-educated workforce).

EXTERNAL COSTS OF PRODUCTION

external cost of production — a cost of production that is incurred by third parties (people other than the producer or consumer).
Example from the book: in 2016, a European waste management company was fined €1.4 million for breaking emissions limits in an urban area — the emissions (a by-product of the firm's production) harmed local residents.
SUBJECT VOCABULARY (summary box): external costs arise when the production of a good damages the welfare of third parties.
Figure 13.1 shows examples of external costs: air pollution, noise pollution (aircraft, road traffic), water pollution, congestion, litter.

ACTIVITY 1 — CASE STUDY: EXTERNALITIES IN FACTORY FARMING

Factory farming (intensive rearing of animals) can create external costs: water pollution from fertilisers and animal waste, smells, and impacts on local communities — costs borne by third parties, not by the farm's customers.

EXTERNAL COSTS OF CONSUMPTION

external cost of consumption — a cost borne by third parties that results from the consumption of a good or service.
Classic example: smoking — the smoker's private cost is the price of cigarettes (e.g. US$100 per month), but the external cost is the harm to others from second-hand smoke (and the health-care burden on society).
Other examples: driving a car (congestion and pollution caused to others), loud music, drinking (costs to others from anti-social behaviour).

EXTERNAL BENEFITS OF PRODUCTION

external benefit of production — a benefit to third parties that results from the production of a good or service.
Example: a firm builds a new factory and trains its workers — the trained workers benefit other employers and the wider economy. Christmas lights example from the book: a shop's festive lights benefit the shop (private benefit) and the fact that others come to see the lights is an external benefit.

EXTERNAL BENEFITS OF CONSUMPTION

external benefit of consumption — a benefit to third parties that results from the consumption of a good or service.
Example: health care — if people are healthier, they are able to work more effectively, are less of a burden on the health service, and society benefits. Vaccinations (protecting others from disease) are another example.
Education is the classic example: an educated person benefits society (a more productive workforce, less crime).

SOCIAL COST AND SOCIAL BENEFIT

SUBJECT VOCABULARY — private cost: the cost of an economic activity to individuals and firms (e.g. to a smoker, the price of the cigarettes).
SUBJECT VOCABULARY — social cost: the cost of an economic activity to society as a whole, i.e.:
social cost = private cost + external cost
Example: the social cost of smoking = smoker's own cost (cigarettes, health) + the cost imposed on others (second-hand smoke, NHS bills).
SUBJECT VOCABULARY — private benefit: the benefit of an economic activity to individuals and firms.
SUBJECT VOCABULARY — social benefit: the benefit of an economic activity to society as a whole, i.e.:
social benefit = private benefit + external benefit
Example: the social benefit of a vaccination = benefit to the vaccinated person + benefit to everyone else (herd immunity).

ACTIVITY 2 — CASE STUDY: COSTS AND BENEFITS OF CAR OWNERSHIP

Sofia took out a US$12 000 loan to buy a new car, then had to pay US$3300 for a year's insurance.
Her private costs = the loan, insurance, fuel, maintenance.
The social cost of her driving = private costs + external costs (congestion, air pollution, road accidents borne by others).
The social benefit = private benefit (her convenience) + external benefits (e.g. her driving to work makes her more productive).
Another example: a regeneration project whose financial cost is US$220 million — the private cost — while the external costs/benefits affect the community.

GOVERNMENT POLICIES TO DEAL WITH EXTERNALITIES

1. TAXATION (KEY FACTS: TAXATION)

Indirect taxes on goods with external costs (cigarettes, petrol, alcohol) reduce supply and raise price, so less is consumed — internalising the external cost.
Example: high taxes on cigarettes raise their price and discourage smoking.
Pollution taxes / carbon taxes: firms pay for the pollution they create → incentive to reduce emissions.
Subsidies and rewards: governments can subsidise goods with external benefits (education, healthcare, renewable energy) to encourage more production/consumption — e.g. grants to firms that install pollution-reducing equipment.

2. GOVERNMENT REGULATION

Laws and fines to control activities with external costs: e.g. vehicle owners caught dumping litter in the streets would be fined.
In the UK, the Environment Act 1995 set up bodies to monitor and regulate pollution.
Bans/standards: e.g. emission limits, noise limits, banning single-use plastics.

3. POLLUTION PERMITS (tradeable permits)

The government sets a total cap on pollution and issues permits allowing firms to pollute up to a limit.
Firms that pollute less can sell their unused permits to firms that pollute more — so there is a financial incentive to cut pollution.
The total amount of pollution is controlled (the cap).

ECONOMICS IN PRACTICE — CASE STUDY: POLLUTION IN CHINA

Air pollution: China's rapid industrial growth created serious pollution. In 2010, a report found severe air pollution in many cities; the China National Petroleum Corporation agreed to pay CNY 100 million for polluting the environment by discharging waste chemicals, and total fines for these separate offences were worth CNY 330 million (one firm was fined US$26 million).
Water pollution: around 60% of monitored rivers/lakes were polluted (from fertilisers, pesticides and industrial activity); a 2012 report found that up to 200 million rural Chinese had no access to safe drinking water.
Car growth: the number of cars in China is expected to grow from 90 million to 400 million — threatening to worsen air pollution unless policies (taxes, fuel standards, EV subsidies, permits) are used.
Government intervention: the Chinese government responded with regulation, fines, and investment in clean energy — showing the role of government in correcting externalities.

💡 Exam tips

Always define external cost/benefit with an example (pollution for cost; education/vaccination for benefit).
Write the equations: social cost = private cost + external cost; social benefit = private benefit + external benefit.
For policy questions, link each policy to whether it reduces the external cost (tax, regulation, permits) or increases the external benefit (subsidy).

📊 KEY DIAGRAM — Negative Externality of Production

Negative Externality of Production

✅ Quick check

Define an external cost. (A cost of production or consumption borne by third parties.)
Give one example of an external benefit of consumption. (Education or healthcare — society benefits.)
What is social cost? (Private cost + external cost.)
Name three government policies to deal with externalities. (Taxation, regulation/fines, pollution permits; also subsidies.)
How do pollution permits reduce pollution? (Cap on total pollution + firms trade permits → financial incentive to pollute less.)

1.2 Business Economics

Factors of production, costs/revenues/profit, economies of scale, market structures, the labour market and government intervention.

Ch 14 The Factors of Production and Sectors of the Economy

Chapter 14: The Factors of Production and Sectors of the Economy

Production needs resources — the four factors of production: land, labour, capital and enterprise. Businesses are also classified into three sectors (primary, secondary, tertiary), and as economies develop the importance of each sector changes — the service sector grows while agriculture and manufacturing shrink (de-industrialisation).

LEARNING OBJECTIVE

Understand the four factors of production and the three sectors of the economy.

GETTING STARTED — CASE STUDY: LG ELECTRONICS

LG Electronics is a large manufacturer. In 2015 it enjoyed revenue of US$48 800 million.
To produce, LG uses a range of resources: raw materials, components, buildings, machinery and people — all of which are the factors of production.
SUBJECT VOCABULARY — production: the transformation of resources (factors of production) into goods and services to satisfy the wants of people.

THE FOUR FACTORS OF PRODUCTION (Figure 14.1)

1. LAND

SUBJECT VOCABULARY — land: all natural resources — everything provided by nature used in production.
Examples: agricultural land, forests, water, minerals, oil, fish stocks.
Example from the book: a large supermarket may require one or more hectares of land for its premises.

2. LABOUR

SUBJECT VOCABULARY — labour: the human effort (physical and mental) used in production.
Examples: workers, managers, the workforce's skills and effort.

3. CAPITAL

SUBJECT VOCABULARY — capital: man-made goods used to produce other goods and services.
Examples: factories, machinery, tools, computers, vehicles.
KEY POINT: capital goods are non-renewable in use — once used they cannot be replaced (they wear out / get used up), so firms must invest to replace them.
Example: a business's delivery vans, ovens, and shop fittings.

4. ENTERPRISE

SUBJECT VOCABULARY — enterprise: the risk-taking and decision-making ability of entrepreneurs who bring the other factors together.
Entrepreneurs set up businesses and are responsible for their direction. Example: an entrepreneur might open a new restaurant — providing the idea, taking the risk, and organising land, labour and capital.
Entrepreneurs are risk-takers: they risk their own money (and reputation) — if the business fails they lose their investment.

LABOUR- AND CAPITAL-INTENSIVE PRODUCTION

SUBJECT VOCABULARY — labour-intensive: production that relies more heavily on labour than on capital/machinery.
SUBJECT VOCABULARY — capital-intensive: production that relies more heavily on capital (machinery) relative to labour.
Example: a hand-carving business is labour-intensive; an automated car factory is capital-intensive.

ACTIVITY 1 — CASE STUDY: ALONSO CORTEZ

Alonso is starting a business (a coffee plantation/farm). Task: suggest two examples of capital he will use (e.g. irrigation equipment, roasting machines, trucks).

THE THREE SECTORS OF THE ECONOMY

PRIMARY SECTOR

SUBJECT VOCABULARY — primary sector: business activity that involves extracting raw materials from the earth.
Examples: farming/agriculture, fishing, forestry, mining, oil extraction.
Saudi Aramco (the world's largest oil company) is a primary-sector business because it extracts oil.
Most agriculture is concerned with food production, but it also includes decorative flowers/plants, etc.

SECONDARY SECTOR

SUBJECT VOCABULARY — secondary sector: business activity that involves converting raw materials into goods.
Examples: manufacturing, construction, food processing, energy generation.
Semi-finished goods are goods used to make other goods (e.g. the parts that go into a car) — produced in the secondary sector.

TERTIARY SECTOR

SUBJECT VOCABULARY — tertiary sector: business activity that provides services to consumers and businesses.
Examples: retailing, banking, insurance, transport, tourism, education, health care, hairdressing.

CHANGES IN THE IMPORTANCE OF DIFFERENT SECTORS

SUBJECT VOCABULARY — de-industrialisation: the decline in the importance of the secondary (manufacturing) sector in an economy.
As countries develop, employment typically moves: primary falls → secondary rises then falls → tertiary rises.
Figure 14.2 — Germany, 1950 vs 2015: a dramatic fall in primary and secondary employment and a large rise in tertiary (services) employment over 65 years.
Activity 2 — Spain (Figure 14.3): Spanish employment in agriculture fell from a high percentage to a small one as the country developed.
Figure 14.4 — Tanzania vs Japan: Tanzania still has a large share of employment in agriculture (primary); Japan has a very small primary sector and a huge tertiary sector — showing the link between development level and sector structure.
Many developing countries in Asia are now beginning to manufacture (their secondary sectors are growing).

ECONOMICS IN PRACTICE — CASE STUDY: HISENSE (China)

Hisense, a Chinese electronics maker, illustrates how China's economy changed over time.
Figure 14.5 — employment by sector in China, 1990 and 2015: the share of employment in agriculture fell sharply (e.g. from around 60% to under 30%) while industry and services rose — China moved from a primarily agricultural economy to a manufacturing and service economy.
Migration also matters: during the 2000s, large numbers of Eastern Europeans moved (an example of labour mobility affecting sector employment).

💡 Exam tip

For "explain the sectors" questions: define each sector with examples, and use a real country (Germany, China, Tanzania vs Japan) to show how sector importance changes with development.

✅ Quick check

Name the four factors of production. (Land, labour, capital, enterprise.)
Define capital and give an example. (Man-made goods used to produce other goods — e.g. machinery.)
What is the primary sector? (Extraction of raw materials — farming, mining, oil.)
What is de-industrialisation? (The decline of the manufacturing/secondary sector's importance.)
Which sector grows most as an economy develops? (Tertiary/services.)

Ch 15 Productivity and Division of Labour

Chapter 15: Productivity and Division of Labour

Productivity is output per unit of input — the most important driver of a country's standard of living. It is raised by training, motivation, technology and working practices. Division of labour (specialisation) — splitting work into separate tasks — massively raises productivity, but it has costs for both workers and businesses.

LEARNING OBJECTIVE

Understand what productivity is, the factors affecting it, and the advantages and disadvantages of the division of labour.

GETTING STARTED — CASE STUDY: RED CARNATION HOTELS

A hotel group employs many specialist workers: chefs, housekeepers, front-desk staff, accountants, managers.
Each worker does one job well instead of everyone doing everything — this is specialisation / the division of labour.
Task: suggest two examples of specialist workers at the hotels (e.g. head chef, receptionist).

WHAT IS PRODUCTIVITY?

SUBJECT VOCABULARY — productivity: the output per unit of input (per worker, per machine, per hour) in a given time period.
Labour productivity = output ÷ number of workers.
Example from the book (Pentangle Plastics): a company produced 25 million units with a workforce of 50; in 2015 output fell to 24 million units with the same workforce → productivity FELL (24m ÷ 50 < 25m ÷ 50).
Why productivity matters: higher productivity = more output from the same resources = higher incomes and living standards, lower costs, and a more internationally competitive economy.
Figure 15.1 shows EU productivity levels, 2006–16.

FACTORS AFFECTING PRODUCTIVITY

1. TRAINING AND SKILLS

A well-trained, skilled workforce is more productive. The book cites a company committed to the training of its workers as a productivity booster.

2. MOTIVATION

Motivated workers work harder and better. Non-financial incentives may be needed because money alone is not enough — e.g. praise, promotion, job satisfaction, better working conditions.

3. WORKING PRACTICES / ORGANISATION

Improving how work is organised raises output — e.g. changing the factory layout so workers and materials don't have to move around as much.

4. TECHNOLOGY AND CAPITAL

Better machinery and equipment raise output per worker. Examples: in agriculture, machinery (tractors, harvesters) hugely increased productivity; computer-aided design (CAD) and computers speed up design and admin.

5. LABOUR MOBILITY AND MIGRATION

Many countries openly attract large numbers of overseas workers to fill skill gaps (Figure 15.3 — immigrant levels in a selection of countries, 2015). Migrant workers can raise productivity where there are labour shortages.

6. LAND IMPROVEMENT

Improving land raises its productivity — e.g. draining wetlands or reclaiming land. Figure 15.2 shows land reclaimed by the top seven countries (China leads in land reclamation).

ACTIVITY 1 — CASE STUDY: PRODUCTIVITY IN COFFEE GROWING

Coffee growers can raise productivity by using better seeds, fertiliser, irrigation, and machinery — each input decision affects output per worker.

THE DIVISION OF LABOUR (SPECIALISATION)

SUBJECT VOCABULARY — division of labour: the breaking down of the production of a good or service into a series of separate tasks, each performed by a specialist worker.
Workers specialise in the task they are best at: e.g. in house construction, specialists (bricklayers, electricians, plumbers) each do their own trade; on a production line, each worker does one small task; CAD specialists handle design.

ADVANTAGES AND DISADVANTAGES OF THE DIVISION OF LABOUR

For the WORKER

Advantages: - Workers become expert and fast at their task → higher productivity. - Less time wasted switching between tasks. - Repetition builds skill and speed.

Disadvantages: - Work can become boring, repetitive and demotivating (the book notes production-line jobs that were "boring and demotivating"). - Loss of flexibility — a worker who only knows one task can't easily do others. - Loss of craft skills — workers no longer make a whole product. - If a task requires little skill, the worker may earn less and be easily replaced.

For the BUSINESS

Advantages: - Higher output and efficiency — more goods produced in less time → lower unit costs. - Workers need less training for a single task. - Specialised machinery can be used for each task.

Disadvantages: - Over-dependence on specialists: if a specialist worker is absent (sick, leaves) or a specialist supplier of parts stops, production can halt. - Loss of flexibility in the workplace — reallocating workers is hard. - Quality control issues — workers may not care about the final product. - Demotivation/boredom can reduce productivity and raise staff turnover. - Workers' skills can become outdated (e.g. an IT worker must keep updating skills as technology changes).

ACTIVITY 2 — CASE STUDY: PINTERS LTD

A manufacturer using division of labour on its production line — use it to identify the advantages (speed, output, lower costs) and disadvantages (monotony, dependence on each worker).

ECONOMICS IN PRACTICE — CASE STUDY: PENTANGLE PLASTICS

Pentangle Plastics produced 25 million units with a workforce of 50; in 2015 output fell to 24 million units with the same workforce → labour productivity fell from 500 000 to 480 000 units per worker.
Questions to consider: what could the firm do to raise productivity (training, motivation, new machinery, better layout, incentives)?

✅ Quick check

Define productivity. (Output per unit of input — e.g. output per worker.)
List four factors that affect productivity. (Training, motivation, working practices, technology, labour mobility, land improvement.)
What is the division of labour? (Breaking production into separate tasks done by specialist workers.)
Give one advantage and one disadvantage of division of labour for a worker. (Adv: expert/fast, higher productivity. Disadv: boring/repetitive, loss of flexibility.)
For a business, why is over-specialisation risky? (Dependence on specialist workers/suppliers — production can halt if one fails.)

Ch 16 Business Costs, Revenues and Profit

Chapter 16: Business Costs, Revenues and Profit

Every business must manage its costs (fixed and variable), understand its average costs, and know how to calculate revenue and profit. The core relationships: TC = FC + VC, AC = TC ÷ output, TR = price × quantity, and profit = TR − TC. These feed directly into the next chapter (economies of scale).

LEARNING OBJECTIVE

Understand business costs (fixed, variable, total, average), total revenue and profit.

GETTING STARTED — CASE STUDY: GREENWAY CONSTRUCTION

A construction company has many costs (materials, wages, rent of equipment) and earned total revenue from selling houses of US$64 340 700 (with costs of US$56 450 200) — profit = revenue − costs.
Different costs behave differently when output changes — some stay the same, some rise.

TOTAL FIXED COSTS (TFC)

SUBJECT VOCABULARY — fixed costs: costs that do not change when output changes.
Examples: rent, business rates, insurance, salaries of permanent staff, loan interest.
Fixed costs must be paid even if the business produces nothing.
Figure 16.1 (Frampton Training): total fixed costs are US$40 000 p.a. — whether the firm provides 100 or 150 training places, fixed costs stay US$40 000 (drawn as a horizontal line on a graph).

TOTAL VARIABLE COSTS (TVC)

SUBJECT VOCABULARY — variable costs: costs that change (rise/fall) in proportion to output.
Examples: raw materials, wages of part-time/hourly workers, electricity used in production.
If output is cut, variable costs fall.
Figure 16.2 (Frampton Training): variable cost is US$500 per course. At 100 courses, TVC = US$50 000; at 150 courses, TVC = US$75 000 (drawn as a rising line from the origin).

TOTAL COSTS (TC)

SUBJECT VOCABULARY — total cost: total fixed cost + total variable cost.
TC = TFC + TVC
Figure 16.3 (Frampton Training): when courses rise from 100 to 150, total cost rises from US$90 000 to US$115 000.
At 100 courses: TC = US$40 000 + (100 × US$500) = US$40 000 + US$50 000 = US$90 000.

ACTIVITY 1 — CASE STUDY: KANDASAN CRICKET BATS

A cricket bat maker: identify which of its costs are fixed (rent, machinery, permanent staff) and which are variable (wood, wages of bat-makers paid per bat).

AVERAGE COSTS (AC) — THE AVERAGE COST CURVE

SUBJECT VOCABULARY — average cost (unit cost): the cost of producing one unit of output.
AC = Total cost ÷ Output (quantity produced)
Frampton Training: AC at 100 courses = US$90 000 ÷ 100 = US$900 per course.
The average cost curve is U-SHAPED (Figure 16.4):
At low output, average cost is high.
As output rises, AC falls — e.g. at 100 units AC = £20; at 300 units AC falls to £7.50 (economies of scale — spreading fixed costs over more units).
Beyond a certain output, AC rises again (e.g. £10 at very high output) — diseconomies of scale.
The bottom of the U = the minimum average cost (the most efficient output level).

TOTAL REVENUE (TR)

SUBJECT VOCABULARY — total revenue: the money a business receives from selling its output.
TR = Price × Quantity sold
Frampton Training charges US$1500 for its HGV training course: TR = US$1500 × 100 = US$150 000.

CALCULATING PROFIT

SUBJECT VOCABULARY — profit: total revenue minus total costs.
Profit = TR − TC
Frampton Training: profit = US$150 000 − (US$40 000 + US$50 000) = US$150 000 − US$90 000 = US$60 000.
If TC > TR, the business makes a loss (negative profit).

ACTIVITY 2 — CASE STUDY: JENKINS LTD

A manufacturer: use its fixed costs, variable costs per unit, price and output to calculate TC, AC, TR and profit. (Practice the exact method: TC = FC + (VC per unit × output); profit = TR − TC.)

ECONOMICS IN PRACTICE — CASE STUDY: MAHABIR METALS

A sign-making business works out its variable costs per sign and decides the price to charge to cover costs and make a profit — linking unit costs to pricing decisions.

💡 Exam tip — the calculation method examiners want

TC = Fixed costs + (Variable cost per unit × output)
AC = TC ÷ output
TR = Price × quantity
Profit = TR − TC Always show your working and put the correct units (US$ / £) on the answer.

✅ Quick check

Define a fixed cost and give an example. (A cost that doesn't change with output — rent.)
Write the formula for total cost. (TC = TFC + TVC.)
If TC = US$90 000 and output = 100, what is the average cost? (US$900.)
If a firm sells 200 units at US$10 each, what is TR? (US$2 000.)
TR = US$150 000 and TC = US$90 000 → profit? (US$60 000.)

Ch 17 Economies and Diseconomies of Scale

Chapter 17: Economies and Diseconomies of Scale

As a firm grows, its average (unit) costs fall — that's economies of scale — but beyond a certain size they start to rise again: diseconomies of scale. This explains the shape of the long-run average cost curve and why firms want to get big (and why too big is bad).

LEARNING OBJECTIVE

Understand the internal and external economies of scale and the diseconomies of scale.

GETTING STARTED — TWO FOOD BUSINESSES

Gilly's Snack Shack (small): buys about 20 loaves of bread a day from a local baker — no bargaining power.
GF Foods (large): buys from farmers and manufacturers in huge quantities (e.g. tomatoes from local growers) — it gets much lower prices per unit because it buys so much.
The difference in unit costs between big and small firms is the heart of this chapter.

ECONOMIES OF SCALE

SUBJECT VOCABULARY — economies of scale: the fall in average (unit) costs that a firm enjoys when it increases its scale of production (grows larger).
Figure 17.1 shows average cost falling as output rises to 20 000 units and beyond — then rising (diseconomies).
Why costs fall is summarised in Figure 17.2 (the sources of internal economies of scale).

INTERNAL ECONOMIES OF SCALE (arise from the firm's OWN growth)

1. PURCHASING ECONOMIES

Bulk buying: large firms buy raw materials in huge quantities → lower prices per unit (suppliers offer discounts).
Example: IKEA buys furniture components in massive volumes worldwide → much lower unit costs than a small furniture shop.
GENERAL VOCABULARY — bulk buying: buying goods in large quantities, which is usually cheaper per unit.

2. MARKETING ECONOMIES

Advertising and marketing costs are spread over more units — a big firm can afford a national TV campaign; the cost per product sold is tiny.
A large firm may find it cost-effective to advertise because the fixed cost of the campaign is shared across millions of units.

3. TECHNICAL ECONOMIES

Large firms can afford expensive, more efficient machinery and use it fully (e.g. a car plant's robotic production line).
Indivisibility: some machines only pay off at high output — a small firm can't use them efficiently.
Specialised equipment and processes (containers, pipelines, large furnaces) lower cost per unit.

4. FINANCIAL ECONOMIES

Large firms can borrow more easily and cheaply: banks trust them, so they get lower interest rates on loans and can raise money from many sources (e.g. issuing shares as a large limited company).

5. MANAGERIAL ECONOMIES

Large firms can afford to hire specialist managers (accountants, HR experts, marketing directors) — each expert does one job well, raising efficiency and lowering cost per unit.

6. RISK-BEARING ECONOMIES

Large firms spread risk across a wider variety of markets/products — if one product fails, others keep the firm going (diversification). A one-product small firm is much riskier.

ACTIVITY 1 — CASE STUDY: IKEA

Use IKEA to identify which internal economies of scale it enjoys: purchasing (bulk buying), marketing (global advertising), technical (automated flat-pack production), financial and managerial.

EXTERNAL ECONOMIES OF SCALE (arise from the firm's LOCATION/INDUSTRY)

SUBJECT VOCABULARY — external economies of scale: falls in average cost that benefit a firm because of the growth of the whole industry or the advantages of its location — outside the firm's own control.
SKILLED LABOUR: a firm located where there is a pool of skilled workers (e.g. Silicon Valley for tech) can recruit trained staff easily and cheaply.
ACCESS TO SUPPLIERS: being near suppliers cuts transport costs and delivery delays (e.g. component firms near a car plant).
SIMILAR BUSINESSES IN THE AREA (clustering): firms benefit from shared infrastructure, training providers, and specialist services. Example: the car industry in the Midlands in England — firms cooperate, share facilities, and attract suppliers together.
Support services and other facilities are shaped to suit that industry's needs.

DISECONOMIES OF SCALE

SUBJECT VOCABULARY — diseconomies of scale: the rise in average costs that a firm suffers when it grows too large.
Figure 17.1 shows average cost rising again beyond the efficient output level.
Causes:
COMMUNICATION PROBLEMS: messages get distorted as they pass through many management layers → delays and mistakes.
LACK OF CONTROL: managers find it hard to monitor and coordinate a huge workforce → inefficiency, wasted resources, low motivation.
DISTANCE BETWEEN SENIOR STAFF AND SHOP-FLOOR WORKERS: senior managers become remote from what actually happens on the ground → decisions are slower and less informed.
Poor motivation and "them and us" attitudes can also raise costs.

ACTIVITY 2 — CASE STUDY: VOLKSWAGEN (the diesel-emissions scandal)

VW grew into one of the world's largest car makers, but size brought control/communication problems: engineers fitted software to cheat emissions tests without senior management knowing — the CEO of VW said he did not know about this activity.
When discovered, the value of the company suffered badly (huge fines, compensation, lost sales).
Lesson: in a giant firm, poor communication and lack of control (diseconomies of scale) led to catastrophic decisions.

ECONOMICS IN PRACTICE — CASE STUDY: FLAMBOYANCE

A fashion retailer that grows — consider which economies of scale it gains (bulk buying, marketing, financial) and, if it grows too fast, which diseconomies could hit it (control, communication).

💡 Exam tip — the 6 internal economies mnemonic: P M T F M R

Purchasing, Marketing, Technical, Financial, Managerial, Risk-bearing. Know one real example for each (IKEA = purchasing; VW = diseconomy; Silicon Valley = external/skilled labour).

✅ Quick check

Define economies of scale. (Falling average costs as the firm grows.)
Name three internal economies of scale. (Purchasing, marketing, technical, financial, managerial, risk-bearing.)
Give an example of an external economy of scale. (A pool of skilled labour in the area, access to suppliers, clustering of similar businesses.)
What are diseconomies of scale? (Rising average costs when a firm gets too big — communication problems, lack of control.)
Which VW example shows diseconomies of scale? (The diesel-emissions scandal — senior managers didn't know what engineers were doing.)

Ch 18 Competitive Markets

Chapter 18: Competitive Markets

A competitive market has many buyers and sellers, free entry for new firms, and firms that have almost no control over price. Competition is good for consumers (lower prices, more choice, better quality), good for firms (pressure to be efficient), and good for the economy as a whole. This chapter contrasts competitive markets with those where firms face little competition.

LEARNING OBJECTIVE

Understand the characteristics of competitive markets and the effects of competition on the firm, the consumer and the economy.

GETTING STARTED — TWO EXTREMES

CASE STUDY: ONATEL — a national telecommunications company that faced very little competition (often a monopoly or near-monopoly in fixed-line telecoms).
CASE STUDY: MILK PRODUCTION IN AUSTRALIA — thousands of dairy farmers supplying milk; no single farmer can influence the price of milk.
The number of competitors in a market is its market structure — competition ranges from "very competitive" to "no competition at all".

CHARACTERISTICS OF A COMPETITIVE MARKET

SUBJECT VOCABULARY — competitive market: a market in which there is strong competition between many firms.
Main features (all on the specification): 1. Many buyers and many sellers — no single firm dominates. 2. Freedom of entry and exit — new firms can easily enter the market (it is not technically difficult and does not require too much capital); firms can also leave. 3. Each firm has almost no control over the price — firms are price takers: if a farmer tries to charge above the market price, buyers simply go elsewhere. 4. Products are similar/close substitutes — so consumers can easily switch. 5. Perfect information (in theory) — buyers know prices and quality.
GENERAL VOCABULARY — barrier to entry: something that makes it difficult or costly for a new firm to enter a particular business activity.
Contrast: where barriers to entry are high, there is little competition (e.g. telecoms needing a huge network).

ACTIVITY 1 — CASE STUDY: THE MARKET FOR CURRENCY

The foreign-exchange market is very competitive: many dealers buy and sell currencies, prices (exchange rates) are set by market forces, and anyone can buy foreign currency — even over the internet. No single dealer controls the price.

COMPETITION AND THE FIRM

Firms in competitive markets must:
Keep costs down and be efficient, or they will be undercut by rivals.
Innovate (improve products and processes) to stay ahead — the book notes that small firms face competitive pressure to innovate or lose customers.
Provide good value and quality to keep customers.
Because they are price takers, competitive firms focus on cost control and efficiency rather than price-setting.

COMPETITION AND THE CONSUMER

Benefits to consumers:
Lower prices — firms compete on price.
More choice — many firms offer different products.
Better quality and service — firms compete on quality to win customers.
Greater value for money.
Competition is one of the main forces that keeps prices down for consumers.

COMPETITION AND THE ECONOMY

Competitive markets improve the efficiency of the whole economy:
Inefficient firms go out of business → resources move to efficient firms.
Resources are used where they are valued most (allocative efficiency).
Lower prices and better quality raise living standards.
Pressure to innovate drives economic growth.
This is one reason governments try to promote competition and prevent monopolies (see Chapter 24).

ECONOMICS IN PRACTICE — CASE STUDY: COMPETITION IN THE USA

US CORPORATE PROFITS (Figure 18.1, 1950–2016): US corporate profits look very impressive — between 2000 and 2015 corporate profits were US$1 575 400 million. But some of these profits come from firms facing little competition.
US AIRLINE INDUSTRY: after consolidation (mergers), US airlines made an annual profit of US$24 000 million — less competition allowed higher prices and profits.
US PHARMACEUTICALS INDUSTRY: Mylan raised the price of EpiPen (used for potentially fatal allergic reactions) by 550% — from US$94 to US$608 since getting the selling rights in 2007. Mylan also struck deals with potential rivals to keep them out of the market. With little competition, a firm can raise prices far above cost — bad for consumers and a reason for government regulation.

💡 Exam tip

"Explain why competition is good" → three paragraphs: firm (efficiency), consumer (lower price/better quality/choice), economy (efficiency/growth). Use a real example (EpiPen/Mylan shows what happens WITHOUT competition).

✅ Quick check

List three features of a competitive market. (Many buyers and sellers, free entry/exit, firms have no control over price.)
Why are firms in competitive markets described as price takers? (They must accept the market price — charging more means losing all customers.)
Give two benefits of competition for consumers. (Lower prices; more choice; better quality.)
What does Mylan's EpiPen price rise (550%) show? (That without competition a firm can exploit consumers with high prices.)
Why is competition good for the economy? (Forces efficiency, innovation and lower prices — raises living standards.)

Ch 19 Advantages and Disadvantages of Large and Small Firms

Chapter 19: Advantages and Disadvantages of Large and Small Firms

Firm size is measured by employees, turnover and balance-sheet total. Small firms are flexible and innovative but short of finance; large firms enjoy economies of scale but suffer slow decisions and diseconomies. This chapter covers what makes firms grow, what makes firms stay small, and why governments regulate the growth of firms.

LEARNING OBJECTIVE

Understand how firm size is measured, and the advantages and disadvantages of large and small firms (plus why firms grow or stay small).

GETTING STARTED — CASE STUDY: THE ROLE OF SMEs IN MALAYSIA

SMEs (small and medium-sized enterprises) are vital: there were an estimated 5 million private businesses in Malaysia, and SMEs make a huge contribution to GDP and exports.
Figure 19.1 shows GDP contributions by SMEs and large firms (SMEs contribute roughly half — around 48.6% / 47.9% of GDP/employment in the figures). Malaysia's GDP was US$338 100 million in 2014.
Point: small firms matter — an economy needs both large and small firms.

HOW IS THE SIZE OF A FIRM MEASURED?

Three common measures (Table 19.1 in the book): 1. NUMBER OF EMPLOYEES — how many people the firm employs. 2. TURNOVER (total revenue / sales) — the money the firm earns from sales. Example: in 2015 BP had a turnover of US$225 900 million. 3. BALANCE SHEET TOTAL (value of assets) — the total value of what the firm owns. Example: in 2015 the balance-sheet total for BP was US$98 300 million. - (Market value/capitalisation and output are also used.)

SMALL FIRMS — ADVANTAGES AND DISADVANTAGES

Advantages of being small: - Flexible and quick to react to change — a small baker can quickly change its products to meet customer demand. - Direct contact with customers — owners know their customers personally. - Competitive pressure to innovate — small firms must innovate to survive and stand out. - Personal service and motivation — the owner's own money and reputation are at stake, so they work hard. - Lower overheads and simple decision-making. - Example: Bolt (the ride-hailing/Estonian transport business) grew from a small start-up backed by family and friends — around 16 million two-wheelers... (small firms can scale fast with the right idea).

Disadvantages of being small: - Lack of finance — the number of sources is limited; a sole trader cannot sell shares to raise capital. - Lack of resources — may not be able to afford the wages of specialist staff or expensive equipment. - No economies of scale — small firms pay more per unit (no bulk-buying discounts). - High dependence on one owner and higher risk of failure.

LARGE FIRMS — ADVANTAGES AND DISADVANTAGES

Advantages of being large: - Economies of scale — large-scale plants and bulk buying lower unit costs (see Chapter 17). - Access to finance — can borrow cheaply and raise money by selling shares. - Market power and the ability to invest in R&D, advertising and new technology.

Disadvantages of being large: - Slow decision-making — large administration systems mean decisions can be very slow. - Excessive administration/bureaucracy — too much time spent filling in forms. - Diseconomies of scale — communication and control problems (see Chapter 17). - Workers may feel remote from owners → low motivation.

THE GROWTH OF FIRMS — FACTORS INFLUENCING GROWTH

THE DESIRE TO TAKE OVER COMPETITORS (mergers & acquisitions, M&A): firms buy rivals to grow. Globally, M&A deals totalled US$4.7 trillion during 2015 — e.g. AB InBev's US$100 000 million-plus takeover of SABMiller in beverages. The amount of M&A varies with the economy — after a downturn, global M&A fell to US$2.2 trillion.
ACCESS TO FINANCE: firms need money to build new factories, open new stores or develop new products — better access to cheap finance → faster growth.
ECONOMIES OF SCALE: the desire to cut unit costs pushes firms to grow bigger.
THE DESIRE TO SPREAD RISK: diversification into new markets/products reduces risk.
GOVERNMENT REGULATION: governments monitor business activity to ensure individual firms don't get too powerful — blocking mergers that threaten to reduce competition can slow growth.

ACTIVITY 2 — CASE STUDY: BT (merger)

BT confirmed it would buy mobile operator EE for £12 500 million.
Expected benefits: BT could save about £360 million a year in operating costs (economies of scale), and the combined two businesses an extra £1600 million a year could be generated.
Costs/constraints: BT would have to raise about £1000 million by selling some assets/operations, and the deal was subject to approval by BT shareholders and examination by the regulators (competition authorities).

REASONS FIRMS STAY SMALL

SIZE OF THE MARKET: some markets are too small to sustain very large companies (a niche market can only support small firms).
NATURE OF THE MARKET: in markets needing personal service (hairdressing, restaurants, repairs), big firms have no advantage; customers want local, personal attention.
LACK OF FINANCE: without finance, firms cannot expand or borrow more.
AIMS OF THE ENTREPRENEUR: many owners simply want to stay small — they value independence and control over growth and profits.
DISECONOMIES OF SCALE: some owners know that getting bigger would raise their average costs, so they stay at the efficient size.

ECONOMICS IN PRACTICE — CASE STUDY: STARBUCKS AND THE COFFEE LOUNGE

Starbucks (large chain): economies of scale, global branding, cheap finance — but standardised, slow to adapt locally.
The Coffee Lounge (small independent café): personal service, flexibility, local loyalty — but limited finance and no bulk-buying power.
Use both to contrast large vs small firm advantages.

✅ Quick check

Name three ways to measure the size of a firm. (Number of employees, turnover, balance-sheet total.)
Give two advantages of small firms. (Flexibility, personal service, innovation pressure.)
Give one disadvantage of large firms. (Slow decision-making, bureaucracy, diseconomies of scale.)
List two reasons firms grow. (Take over competitors/M&A, exploit economies of scale, spread risk, access finance.)
List two reasons firms stay small. (Small market size, nature of the market, lack of finance, owner's aims, diseconomies of scale.)
Why might a government block a merger? (To protect competition.)

Ch 20 Monopoly

Chapter 20: Monopoly

A monopoly is a market dominated by one firm (in the real world, "near-monopolies" with one dominant firm). Monopolies exist because of barriers to entry. They can bring benefits (economies of scale, big R&D) but also real costs to consumers (higher prices, restricted choice, less innovation) — which is why governments regulate or control them.

LEARNING OBJECTIVE

Understand the features of a monopoly, its advantages and its disadvantages.

GETTING STARTED — CASE STUDY: THE US MARKET FOR SEARCH ENGINES

Google dominates US desktop search (Figure 20.1 shows Google with roughly a 79.88% share; rivals such as Bing at 8.34% etc.).
In 2015 Google generated US$74 500 million in revenue and made a profit of US$16 300 million.
Google has been criticised for avoiding tax: in 2014 the company transferred €11 700 million to Bermuda to minimise tax, paying just €2.8 million in taxes (0.024% of €11 700 million revenue) — while many people pay up to 25% tax on their own personal income. Google was also fined US$22.5 million (by the EU for anti-competitive practices around its Android/ads business).
Monopolies dominate their markets — but not always purely by being best.

FEATURES OF MONOPOLY

SUBJECT VOCABULARY — monopoly: a market in which the supply of a good or service is controlled by only one firm (a pure monopoly). In practice, a firm with a dominant share (like Google) is treated as a monopoly.
Pure monopolies are rare, but they do exist (e.g. some state-owned railways, postal services).

1. ONE BUSINESS DOMINATES THE MARKET

In markets dominated by one seller, a monopoly is said to exist. There may be tiny firms operating alongside, but one firm has almost the whole market.

2. UNIQUE PRODUCT

No close substitutes — there is not another product exactly like it (a pure monopoly sells a unique product).

3. BARRIERS TO ENTRY

SUBJECT VOCABULARY — barriers to entry: obstacles that make it difficult or impossible for new firms to enter a market. The main barriers (Figure 20.2):
Economies of scale of the existing firm: the incumbent's huge size gives it such low unit costs that new entrants can't compete (e.g. markets with very high fixed costs, like rail and water).
Brand names and reputation: e.g. Coca-Cola, which dominates the soft-drinks market — new firms can't easily match brand loyalty.
High R&D/technology requirements: e.g. Rolls-Royce spent over £800 million on R&D in 2016 — new competitors cannot match such spending; Google spent US$12 280 million on R&D in 2015.
High advertising spending: e.g. one firm spent US$2800 million on advertising in 2014 — a barrier because new firms can't match it.
Legal barriers / licences: where government gives exclusive rights to provide a particular service — two common examples are rail and water provision (franchises).
Natural monopoly: where one firm can supply the whole market at lower cost than several could (e.g. a water network) — competition would be wasteful (duplicated pipes).
GENERAL VOCABULARY — brand: the name, term, sign or symbol that identifies a firm's products.

THE ADVANTAGES OF MONOPOLY

ECONOMIES OF SCALE: a monopoly can produce on a huge scale, giving very low unit costs — which can mean lower prices than several small firms could offer (especially for natural monopolies like water/rail networks).
INVESTMENT AND INNOVATION: monopolists earn large profits, which can be reinvested in R&D and new technologies that benefit consumers. Example: Google spent US$12 280 million on R&D in 2015 and has a reputation for being an innovator.

ACTIVITY 1 — CASE STUDY: THE UK WATER INDUSTRY

Water is supplied by regional monopolies (one company per region). Figure 20.3 shows the services provided by water companies (supplying clean water, sewage treatment).
Advantages of the monopoly: the huge water network is a natural monopoly — duplicating it would be enormously wasteful; one firm can exploit economies of scale and invest in infrastructure.

THE DISADVANTAGES OF MONOPOLY

HIGHER PRICES: a monopolist will tend to restrict output to force up the price — consumers pay more than they would under competition (no rivals to undercut).
RESTRICTED CHOICE: consumers can't switch — e.g. 2.9 million households and businesses in the north-west of England must use their regional water company for the entire water network; they have no alternative supplier.
LACK OF INNOVATION: with no competitive pressure, monopolists may not bother to innovate or improve quality.
POOR SERVICE: because customers cannot switch, service quality can suffer — e.g. in 2015, Air Namibia (a near-monopolist on some routes) gave poor service to passengers in Katima Mulilo (delays, cancellations) — there was no alternative airline on that route.
Monopolists may also exploit workers/suppliers and use their power politically (avoiding tax, blocking rivals).

ACTIVITY 2 — CASE STUDY: AIR NAMIBIA

Use the airline case to identify features of monopoly (dominance of routes, unique service, barriers to entry) and its disadvantages (poor service, high prices, restricted choice for passengers).

ECONOMICS IN PRACTICE — CASE STUDY: PFIZER AND FLYNN PHARMA

Pfizer had a 75.84% share of the market for a drug treating a life-threatening condition — and, with Flynn Pharma, raised its price dramatically: from £2 million in 2012 to £50 million the following year.
The Competition Authority (CA) fined the two firms a total of £90 million for "unfair" pricing — the price rise (up to 2600%) was not justified by costs.
Figure 20.4 shows Pfizer's R&D expenditure, 2010–15 — a reminder that monopoly profits don't always go into innovation; they can go into higher prices instead.
Lesson: when a monopoly (or dominant firm) has no competition, it can exploit consumers — this is why regulators exist (see Chapter 24: government intervention).

💡 Exam tip — the balanced answer

For: economies of scale → lower unit costs; large profits fund R&D/innovation; natural monopolies are more efficient than competition.
Against: restricts output and raises prices; restricted choice; lack of innovation; poor service; can exploit consumers (Pfizer example).
The examiner wants BOTH sides plus a judgement.

✅ Quick check

Define a monopoly. (A market where one firm controls supply — no close substitutes, high barriers to entry.)
List three barriers to entry. (Economies of scale, brand names, high R&D costs, high advertising spend, legal barriers/licences.)
Give two advantages of monopoly. (Economies of scale; big profits fund R&D/innovation.)
Give two disadvantages. (Higher prices (restricted output), restricted choice, lack of innovation, poor service.)
What did Pfizer/Flynn Pharma do, and what was the result? (Raised a drug's price from £2m to £50m in a year; fined £90 million for unfair pricing.)

Ch 21 Oligopoly

Chapter 21: Oligopoly

An oligopoly is a market dominated by a few large firms — the most common market structure in the real world (cars, airlines, film, banking). Firms are interdependent: each firm's actions affect the others. They compete mainly through non-price competition (branding, advertising, product differences), but may also collude (fix prices) — which is illegal and bad for consumers.

LEARNING OBJECTIVE

Understand the features of oligopoly, and its advantages and disadvantages.

GETTING STARTED — CASE STUDY: GLOBAL CAR SALES

Just six producers dominate the global car industry — the "Big Six" (Figure 21.1 shows global car sales and market shares, 2015).
The Big Six compete fiercely: GM and Ford spent US$3500 million and US$2680 million respectively on advertising.
A few huge firms, intense rivalry, big marketing budgets — that is oligopoly.

FEATURES OF OLIGOPOLY

SUBJECT VOCABULARY — oligopoly: a market dominated by a few large firms.
There are many examples in most countries: e.g. in many countries just three firms dominate banking or supermarkets.

1. FEW FIRMS

Only a small number of firms (three, four, five or six, for example) supply most of the market.

2. LARGE FIRMS DOMINATE

Each of the few firms has a large proportion of the market to itself and is highly influential in the market (e.g. the global car market).

3. DIFFERENT PRODUCTS (product differentiation)

Although the big six car manufacturers all produce cars, their products have real differences — design, features, quality, image (e.g. there is a real difference between a sports car and a family saloon).
GENERAL VOCABULARY — product differentiation: making a product different from rivals' so it stands out; differences may be real or imaginary (e.g. two similar colas can be made to seem different through branding).
Firms give products a name, term, sign or symbol (a brand) so consumers can tell them apart.

4. BARRIERS TO ENTRY

New firms find it very hard to enter because of high set-up costs (as in the motor-car industry), brand loyalty, advertising spending and economies of scale of existing firms.

5. INTERDEPENDENCE

SUBJECT VOCABULARY — interdependence: the idea that the actions of one firm affect the others — each firm must consider rivals' reactions.
Example: if one firm decides to cut its price, rivals must respond (or lose customers) → price wars.

COMPETITION IN OLIGOPOLY

NON-PRICE COMPETITION

SUBJECT VOCABULARY — non-price competition: competing on factors other than price — branding, advertising, product quality, design, features, service, guarantees, loyalty schemes.
Advertising is central: e.g. Warner Bros. spent US$727 million on television advertising; in the film industry, big releases like Finding Dory (Buena Vista's most successful film of 2016) rely on massive marketing.
Product differences may be real or imaginary — branding makes similar products seem different.

PRICE COMPETITION

Price wars: if one firm cuts price, others follow, and profits fall for everyone — so oligopolists often avoid price competition (preferring non-price competition).
GENERAL VOCABULARY — price war: a period when rival firms repeatedly cut prices to steal customers from each other.

COLLUSION (the danger)

Firms may agree to restrict competition — e.g. price fixing (all charging the same high price) or sharing a market geographically (each firm gets its own territory).
SUBJECT VOCABULARY — collusion: an agreement between firms to restrict competition (e.g. fixing prices or sharing markets). Collusion is usually illegal (anti-competitive practice) because it harms consumers.

ACTIVITY 1 — CASE STUDY: THE US FILM INDUSTRY

The film industry is an oligopoly: a few major studios (Buena Vista/Disney, Warner Bros., etc.) dominate; they spend enormous sums on television advertising and rely on product differentiation (franchises, stars) and market share battles.

ADVANTAGES OF OLIGOPOLY

ECONOMIES OF SCALE: large firms produce on a massive scale → low unit costs → competitive prices.
PRICE WARS CAN BENEFIT CONSUMERS: when oligopolists do compete on price, consumers get lower prices in the short run.
CHOICE AND QUALITY: firms differentiate products, giving consumers more choice — e.g. in the car industry there are niche markets (e.g. specialist sports cars — Malvern in England (Morgan) is one such example) supplied by firms choosing a niche.
INNOVATION: rivalry drives research and product development; product quality in some markets may be superior because firms compete on quality.
GENERAL VOCABULARY — niche market: a small, specialised segment of a market.

DISADVANTAGES OF OLIGOPOLY

LITTLE REAL CHOICE: in some markets there may be little real choice — a few giant firms all offering similar products (e.g. in many countries a handful of banks or supermarkets).
COLLUSION / PRICE FIXING: firms may agree to restrict competition (price fixing, sharing markets) → higher prices and restricted output for consumers (see the cartel case below).
HIGH PRICES IN THE LONG RUN: avoiding price wars keeps prices above competitive levels.
BARRIERS TO ENTRY protect the incumbents and keep new competition out.

ACTIVITY 2 — CASE STUDY: A CARTEL

A cartel is a formal agreement between firms to fix prices or share markets (collusion). Cartels raise prices above competitive levels and restrict output — which is why they are illegal and regulators fine them heavily.

ECONOMICS IN PRACTICE — CASE STUDY: DOMESTIC AIR TRAVEL IN INDIA

Indian domestic air travel is an oligopoly: a few large airlines (e.g. IndiGo, Air India, Jet Airways, SpiceJet) dominate.
They compete via non-price competition (schedules, service, loyalty programmes) and occasionally price wars (offering very cheap fares).
Watch for: interdependence (one airline's fare cut forces others to react), barriers to entry (huge capital for aircraft), and the risk of collusion.

💡 Exam tip

Define oligopoly → give the features (few firms, large, differentiated products, barriers, interdependence) → advantages (economies of scale, choice, price wars) → disadvantages (collusion, little real choice). Use cars or airlines as your example.

✅ Quick check

Define oligopoly. (A market dominated by a few large firms.)
What is interdependence in an oligopoly? (One firm's actions affect rivals, so each must consider their reactions.)
Give two examples of non-price competition. (Advertising, branding, quality, design, service.)
What is collusion? (An agreement between firms to restrict competition — e.g. price fixing; usually illegal.)
Give one advantage and one disadvantage of oligopoly. (Adv: economies of scale / consumer choice / price wars. Disadv: collusion raises prices, little real choice.)

Ch 22 The Labour Market

Chapter 22: The Labour Market

The labour market is where workers sell their labour and firms buy it. Demand for labour is a derived demand (depends on demand for the product). The wage is the price of labour, set where the demand for labour equals the supply of labour. Many factors shift the demand and supply of labour — technology, product demand, population, retirement age, female participation, migration and skills.

LEARNING OBJECTIVE

Understand the demand and supply of labour, wage determination, and the importance of the quantity and quality of labour to businesses.

GETTING STARTED — TWO CONTRASTING CASES

CASE STUDY: ROBOTS AT FOXCONN: the electronics manufacturer introduced robots to replace workers on assembly lines → demand for (some) labour falls (machines are substitutes for workers).
CASE STUDY: EMPLOYMENT IN US SOLAR POWER: the growing solar industry employs more and more workers → demand for labour rises (growing product demand raises derived demand).
In both cases the demand for labour changed — but in opposite directions.

THE DEMAND CURVE FOR LABOUR

SUBJECT VOCABULARY — derived demand: demand for a factor of production (like labour) that results from (is derived from) the demand for the product it helps to produce.
Example: demand for cabin crew is derived from the demand for air travel.
SUBJECT VOCABULARY — demand for labour: the quantity of workers that firms are willing and able to employ at a given wage rate.
The demand curve for labour slopes downwards (Figure 22.1): the higher the wage, the fewer workers firms employ (labour is more expensive).
Example: at a wage of US$600 per week, 100 workers are required; if the wage rises to US$800, demand falls to 80 workers.

FACTORS AFFECTING THE DEMAND FOR LABOUR

DEMAND FOR THE PRODUCT (derived demand): if demand for the product rises, demand for labour rises — e.g. an increase in the demand for air travel shifts the demand curve for cabin crew workers to the right (Figure 22.2).
AVAILABILITY OF SUBSTITUTES (capital/machinery): if machines can replace workers, demand for labour falls — e.g. Fukoku Mutual Life Insurance bought IBM's Watson Explorer AI system for JPY 200 million to replace insurance workers, saving the company about JPY 140 million per year.
PRODUCTIVITY OF LABOUR: more productive workers are more valuable → demand for their labour rises.
OTHER EMPLOYMENT COSTS: the total cost of employing someone (wages plus national insurance, pension, training) affects how many workers firms hire.

ACTIVITY 1 — CASE STUDY: FUKOKU MUTUAL LIFE INSURANCE

The Japanese insurer bought an AI system for JPY 200 million to take over work done by human workers, saving about JPY 140 million per year — a real example of capital substituting for labour, reducing the demand for certain workers.

THE SUPPLY CURVE FOR LABOUR

SUBJECT VOCABULARY — supply of labour: the number of people willing and able to work at a given wage rate.
The supply curve of labour slopes upwards (Figure 22.3): the higher the wage, the more people want to work (work becomes more attractive relative to leisure/other options).
Example: at US$600 per week, 40 workers would want to work; at higher wages, more workers make themselves available.

FACTORS AFFECTING THE SUPPLY OF LABOUR

POPULATION SIZE: a larger population → a larger supply of labour. (The book notes world population was 7400 million in 2016, predicted to rise to 9700 million — more potential workers.)
AGE DISTRIBUTION OF THE POPULATION: the age structure affects how many are of working age.
RETIREMENT AGE: if the retirement age rises, people work longer → supply of labour rises (e.g. in Canada the state pension age was raised; Ireland announced it would raise its retirement age).
SCHOOL LEAVING AGE: a higher school leaving age removes young people from the labour market → supply falls (until they finish education).
FEMALE PARTICIPATION: more women entering the workforce increases supply — in Canada, new technologies (e.g. electrical appliances) changed gender roles and boosted female participation (Figure 22.5 shows participation rates for men and women aged 25–54).
SKILLS AND QUALIFICATIONS: the supply of skilled labour depends on the education and training system.
LABOUR MOBILITY: SUBJECT VOCABULARY — labour mobility: the ease with which workers can move (geographically or between jobs) to find work. If workers are geographically mobile, supply can respond to demand.
IMMIGRATION: an increase in immigration increases the supply of labour — the supply curve shifts right (Figure 22.4). Many countries in the Middle East have a history of welcoming migrant workers.

ACTIVITY 2 — CASE STUDY: WOMEN AT WORK IN CANADA

Female labour-force participation in Canada rose dramatically over recent decades as social attitudes and technology changed — an example of a shift in the supply of labour.

WAGE DETERMINATION

SUBJECT VOCABULARY — wage: the price of labour — the payment a worker receives for their work.
Equilibrium wage: the wage where the demand for labour equals the supply of labour (where the two curves cross — Figure 22.6).
Example from the book: the equilibrium wage is US$800 per week, and at this wage both firms and workers are satisfied (quantity of labour demanded = quantity supplied).
If the wage is set above equilibrium (e.g. by a minimum wage or a trade union), there is a surplus of labour (unemployment). If set below equilibrium, there is a shortage of labour.
💡 Exam tip: draw supply and demand for labour, label the equilibrium wage (W) and employment (Q), then shift a curve and show the new W and Q.

THE IMPORTANCE OF THE QUANTITY AND QUALITY OF LABOUR TO BUSINESSES

Quantity: businesses need enough workers. Some businesses are beginning to find recruitment difficult in China (e.g. Jenlo Apparel) because of demographic change and rising wages elsewhere.
Quality: the skills, education, health and motivation of workers (human capital) determine productivity. A high-quality workforce makes businesses competitive; a poor-quality one raises costs.
SUBJECT VOCABULARY — human capital: the skills, knowledge and experience of the workforce (their value as a productive asset).

IMPACT OF EDUCATION AND TRAINING ON THE QUALITY OF HUMAN CAPITAL

Education and training raise the quality of human capital → higher productivity → higher wages and economic growth.
Workers will need training if changes affect their jobs (new technology, new processes).
Education institutions adjust their curriculums to meet the needs of businesses (e.g. more STEM subjects, vocational training).
GENERAL VOCABULARY — curriculum: the subjects taught in a school or college.

ECONOMICS IN PRACTICE — CASE STUDY: LABOUR SHORTAGE IN NEW ZEALAND

New Zealand faced labour shortages in boom times. Figure 22.6 shows New Zealand's migration gains (losses), 2006–16: migration helps fill labour shortages — when business activity booms and demand for labour rises, immigration shifts the supply of labour right, helping to meet the shortage.

✅ Quick check

What is meant by derived demand for labour? (Demand for workers derived from demand for the product they make — e.g. cabin crew from air travel.)
Why does the demand curve for labour slope downwards? (Higher wages make workers more expensive — fewer employed.)
List four factors affecting the supply of labour. (Population size, age distribution, retirement age, school leaving age, female participation, skills, mobility, immigration.)
How is the equilibrium wage determined? (Where demand for labour = supply of labour.)
How do education and training affect human capital? (Raise skills/quality → higher productivity and wages.)

Ch 23 The Impact of Changes in Supply & Demand for Labour and Trade Union Activity

Chapter 23: The Impact of Changes in Supply & Demand for Labour and Trade Union Activity

Wages and employment change when the demand for labour or the supply of labour shifts. This chapter applies that analysis to real markets (cleaners, Chinese factory workers, declining industries like coal) and examines trade unions — what they do, their power, why membership is falling, and how union pressure affects wages and employment.

LEARNING OBJECTIVE

Understand the effects of changes in the demand for and supply of labour, and the impact of trade union activity in labour markets.

GETTING STARTED — CASE STUDY: WAGE RATES FOR CLEANERS

Figure 23.1 shows the market for cleaners in a particular country (supply and demand for cleaners).
An increase in the supply of cleaners (more people wanting cleaning jobs, e.g. as a means of earning income) lowers the equilibrium wage and raises employment.

CHANGES IN THE DEMAND FOR LABOUR

Since demand for labour is a derived demand, anything that raises demand for the product raises demand for labour → wage and employment rise.
Example: in China, the demand for factory workers has grown rapidly in recent years. The demand curve for labour shifts right from D₁ to D₂ (Figure 23.2). The effect: both wages and employment rise.
Figure 23.3 (a bar chart of rising wages in Chinese manufacturing) supports the view that the rising demand for labour pushed wages up.

CHANGES IN THE SUPPLY OF LABOUR

Example: raising the retirement age increases the supply of labour (older workers keep working).
Figure 23.4 shows the effect: the supply curve shifts right → the equilibrium wage falls and employment rises (from Q₁ to Q₂).
General rule to memorise:
Demand for labour ↑ → wage ↑ and employment ↑.
Demand for labour ↓ → wage ↓ and employment ↓.
Supply of labour ↑ → wage ↓ and employment ↑.
Supply of labour ↓ → wage ↑ and employment ↓.

ACTIVITY 1 — CASE STUDY: WAGE DETERMINATION IN A DECLINING INDUSTRY

In a declining industry, e.g. coal mining in many countries, the demand for labour falls over a long period (demand for coal falls as cleaner/cheaper energy replaces it).
Effect: falling wages and falling employment — workers must retrain and move to other industries.

TRADE UNIONS

GENERAL VOCABULARY — trade union: an organisation that represents workers and protects their interests (wages, conditions, job security).
SUBJECT VOCABULARY — collective bargaining: negotiations between trade unions (workers) and employers over pay and conditions.
THE POWER OF TRADE UNIONS depends on:
Membership size — more members = more bargaining power.
The importance of the workers (e.g. can they disrupt production?).
The law — new laws can strengthen or weaken unions (e.g. rules on strikes).
The state of the economy — unions are stronger in booms (labour scarce), weaker in recessions (jobs scarce).

KEY FACTS: EXAMPLES OF SOME TRADE UNIONS IN THE UK

Examples include Unite, Unison, GMB, the National Education Union and the RMT (rail workers) — each covering different industries and occupations.

THE DECLINE IN TRADE UNION MEMBERSHIP

Union membership has fallen in many countries (weakening their position):
In 1980 UK union membership was high; it has since fallen sharply.
Figure 23.6 shows the decline in Australian trade union membership, 1990–2014.
Reasons for the decline: changes in the structure of the economy (decline of manufacturing — a union stronghold — and growth of services), new employment laws, greater workplace flexibility, and negative publicity about strikes.

EFFECTS OF TRADE UNIONS ON WAGES AND EMPLOYMENT

Figure 23.7 shows the effect of trade union interference in the labour market:
Without unions, the equilibrium wage is where demand = supply.
A union negotiates a wage above the equilibrium (W₁ → W₂).
The higher wage attracts more workers (supply extends) but firms demand fewer workers → employment falls (from Q to Q₂) — some workers lose their jobs (a wage differential creates unemployment).
💡 Exam tip: unions can raise wages above equilibrium, but at the cost of lower employment — draw Figure 23.7 (W₂ above W₁, employment falls) and explain.
Note the counter-argument: unions can also raise productivity (better trained, more motivated workers) and reduce labour turnover, which can benefit firms too.

ACTIVITY 2 — CASE STUDY: IG METALL

IG Metall is a large German metalworkers' trade union. It negotiates pay and conditions for millions of German engineering workers.
Describe the main purpose of a trade union using this case: to protect and improve members' wages, working conditions, and job security through collective bargaining.

ECONOMICS IN PRACTICE — CASE STUDY: AGING POPULATION IN THE USA

A rising proportion of the US population is over retirement age (Figure 23.8: more than 22% of the population is over retirement age).
This reduces the supply of labour (fewer people of working age), and Figure 23.9 shows the growth in the number of workers staying in the workforce (older workers).
Implications: labour shortages in some sectors, pressure to raise the retirement age and attract immigrant workers — all shifts in the supply of labour.

✅ Quick check

What happens to wages and employment if the demand for labour rises? (Both rise.)
What happens if the supply of labour rises? (Wage falls, employment rises.)
What is a trade union? (An organisation representing workers to protect pay and conditions.)
What is collective bargaining? (Negotiation between unions and employers over pay and conditions.)
What is the effect of a union forcing wages above equilibrium? (Employment falls — some workers priced out of jobs.)
Why has union membership fallen? (Decline of manufacturing, new laws, workplace flexibility, negative publicity.)

Ch 24 Government Intervention

Chapter 24: Government Intervention

Governments intervene in markets to correct market failure and protect consumers, workers and the environment — dealing with externalities, promoting competition, limiting monopoly power, controlling mergers, and setting a minimum wage in the labour market. This chapter pulls together the regulatory toolkit and the effects of the minimum wage.

LEARNING OBJECTIVE

Understand the reasons for, and methods of, government intervention in markets.

GETTING STARTED — CASE STUDY: DU PONT

DuPont, one of the world's largest chemical companies, was fined over US$1 million in 2014 for eight chemical leaks (and ordered to improve emergency response systems), and US$531 000 in 2015 for alleged Clean Air Act violations (with penalties worth US$97 million in total across cases).
Lesson: even giant firms must obey environmental and safety law — governments intervene when markets would otherwise ignore external costs.

THE NEED FOR GOVERNMENT INTERVENTION

Markets fail when they ignore the interests of certain stakeholders and third parties:
The environment may be damaged (external costs) — e.g. a business clearing woodlands or polluting (a negative externality, see Chapter 13).
Consumers may be exploited (monopoly power, unsafe products, unfair terms).
Workers may be paid unfairly (exploitation) — hence minimum wages and employment law.
Competition may be destroyed by monopolies and cartels.
Government intervention aims to make business activity fair and to correct these failures.

GOVERNMENT INTERVENTION TO DEAL WITH EXTERNALITIES (recap of Chapter 13)

Taxes on goods with external costs (pollution, cigarettes, fuel) → raise price, cut consumption.
Subsidies for goods with external benefits (education, healthcare, renewables, waste recycling — e.g. a business setting up a waste-recycling operation benefits third parties).
Regulation and fines (e.g. the Environment Act 1995, emissions limits).

GOVERNMENT REGULATION OF BUSINESS ACTIVITY — PROMOTING COMPETITION

SUBJECT VOCABULARY — competition policy: government action to promote competition and prevent anti-competitive practices.
SUBJECT VOCABULARY — anti-competitive practices (or restrictive trade practices): attempts by firms to prevent or restrict competition (e.g. price-fixing, cartels, abusing monopoly power).
Methods: 1. Remove legal barriers to entry — e.g. business start-up schemes providing funds for new firms; some governments have removed legal barriers that blocked new entrants (e.g. deregulating markets so new firms can compete). 2. Prevent anti-competitive practices — e.g. in India, laws against practices that result in reduced competition. 3. Set up competition authorities / regulators to oversee monopolies:
- In China, the National Commission (for markets and competition) supervises monopolies.
- In the UK, Ofwat (the Office of Water Services) regulates the water monopolies; similar regulators exist for energy, telecoms and rail.

LIMIT MONOPOLY POWER / CONTROL MERGERS AND TAKEOVERS

Governments block or attach conditions to mergers that would reduce competition.
Example (UK, 2016): the £10 300 million deal by the owner of Three (a mobile network) to take over another operator was ruled to be allowed to go ahead only if certain conditions were met (to protect competition in the mobile market).
Regulators examine big deals (see the Bayer–Monsanto merger below) and can stop them or impose remedies (e.g. selling off parts of the business).

PROTECT CONSUMER INTERESTS (consumer protection legislation)

GENERAL VOCABULARY — consumer legislation: laws that protect consumers' rights.
Figure 24.1 shows fair trade issues covered by legislation (fair pricing, honest advertising, product safety, accurate weights/labels, refunds).
Examples of UK consumer legislation:
Goods must be of appropriate quality and fit for purpose — customers cannot be sold faulty or unsuitable goods.
Products must be safe and comply with safety standards — a business should not sell dangerous items.
This protects consumers from being misled, overcharged, or injured by unsafe products.

ACTIVITY 1 — CASE STUDY: THE NATIONAL COMMISSION OF MARKETS AND COMPETITION (SPAIN)

The Spanish competition authority fined car parts firms €171 million for anti-competitive practices — a cartel that shared activities/markets in car parts to avoid competition.
GM and Ford were hit hardest with fines of €22.8 million and €20.2 million; other firms were fined €18.2 million, €15.7 million and €14.8 million respectively.
What is meant by an anti-competitive practice? An agreement or action by firms to restrict competition (e.g. a cartel fixing prices or sharing markets) — illegal because it raises prices and reduces choice for consumers.

GOVERNMENT INTERVENTION IN THE LABOUR MARKET — THE MINIMUM WAGE

SUBJECT VOCABULARY — minimum wage: the lowest legal wage that employers may pay their workers.
KEY FACTS — REASONS FOR A MINIMUM WAGE:
To give low-paid workers a fair wage and reduce poverty.
To prevent exploitation of workers (especially the low-skilled).
To reduce inequality and raise living standards of the lowest paid.
To reduce the need for welfare benefits (taxpayers save).
(In 2016, UK minimum wage rates applied at different levels for adults, younger workers and apprentices.)

THE IMPACT OF A MINIMUM WAGE ON WAGES AND EMPLOYMENT

Figure 24.2 shows a labour market: if the minimum wage is set above the equilibrium wage, the quantity of labour demanded falls (QL₂ → QL₁) → unemployment (more people want jobs at the higher wage than firms will hire).
BUT the evidence is mixed: Figure 24.3 shows UK employment rates since the introduction of the minimum wage in 1999 (1999–2016) — employment actually grew and the labour market performed better than it had in many years (lower unemployment).
Why the minimum wage may NOT cause unemployment:
It raises productivity and motivation (workers are better paid and more committed).
Firms may absorb the cost or raise prices slightly.
It pulls workers out of poverty → higher spending → more demand for labour.
Activity 2 (Figure 24.4): a country imposes a minimum wage of US$10 per hour — evaluate the impact on wages, employment, poverty and firms' costs.

ECONOMICS IN PRACTICE — THE MINIMUM WAGE AND THE BAYER–MONSANTO MERGER

Bayer (known for pharmaceuticals) proposed a US$66 000 million (US$37 000 million deal) takeover of Monsanto (agrochemicals/seeds).
The merged firm planned to spend about US$16 000 million on R&D.
Regulators were concerned the merger would reduce competition; the companies responded that the deal would actually benefit consumers (efficiency, innovation, lower prices).
This case shows how governments weigh the benefits of scale/R&D against the loss of competition when controlling mergers.

💡 Exam tips

Know the four intervention goals: deal with externalities, promote competition, protect consumers, protect workers (minimum wage).
For the minimum wage diagram: wage floor above equilibrium → excess supply of labour (unemployment); but evaluate with the UK evidence.

✅ Quick check

Give three reasons for government intervention. (Correct externalities, promote competition, protect consumers, protect workers/fair pay.)
What is an anti-competitive practice? (An agreement/action by firms to restrict competition — e.g. cartels, price-fixing.)
Name two UK regulators. (Ofwat (water); also Ofcom (telecoms), Ofgem (energy).)
What is the minimum wage? (The lowest legal wage employers may pay.)
What does the theory say about a minimum wage set above equilibrium? (It creates unemployment — excess supply of labour.) What does UK evidence show? (Employment rose after 1999.)*
Why might regulators block or condition a merger? (To protect competition — e.g. Bayer–Monsanto.)

2.1 Government & the Economy

Economic growth, inflation, unemployment, balance of payments, environment, income redistribution, fiscal/monetary/supply-side policy.

Ch 25 Economic Growth

Chapter 25: Economic Growth

Economic growth is an increase in a country's output (GDP). It is the central macroeconomic objective. This chapter covers the macroeconomic objectives, how growth is measured (GDP and real GDP), the limitations of GDP as a measure, the economic cycle (boom, recession, recovery), and the impact of growth on living standards, productive potential and the environment.

LEARNING OBJECTIVES

Understand what macroeconomic objectives are.
Understand how economic growth is measured, and the limitations of GDP.
Understand the economic cycle and its impact on growth, employment and inflation.
Understand the impact of economic growth.

GETTING STARTED — CASE STUDY: CANADA

Governments manage the economy to achieve goals that help citizens — e.g. Canada's child benefit supports middle-class parents. If the economy is managed well, living standards rise and a government might be re-elected.

WHAT ARE MACROECONOMIC OBJECTIVES?

SUBJECT VOCABULARY — macroeconomics: the study of the whole economy — analysing patterns in the economy as a whole (growth, inflation, unemployment, trade).
The main macroeconomic objectives (Figure 25.1 — on the specification): 1. Economic growth — steady, sustainable growth in output. 2. Low inflation (price stability) — keeping price rises low and stable. 3. Low unemployment (full employment) — everyone who wants a job can find one. 4. A healthy balance of payments — exports broadly matching imports (not running huge deficits). 5. Redistribution of income — reducing inequality. 6. Protection of the environment — sustainable growth that doesn't destroy the planet.
💡 Exam tip: "macro" = whole economy; "micro" = individual markets/firms. Macro objectives are the six above.

MEASURING ECONOMIC GROWTH

SUBJECT VOCABULARY — economic growth: an increase in the total output (GDP) of a country over time.
SUBJECT VOCABULARY — GDP (gross domestic product): the total value of all goods and services produced in a country in a given time period (usually a year).
REAL vs NOMINAL GDP: price increases (inflation) can make growth rates misleading. Real GDP adjusts for inflation — e.g. if inflation is 2.3% and nominal GDP rose 5%, real growth is about 2.7%. Figure 25.2 shows economic growth in the EU, 1996–2016 (real GDP growth).
GDP PER CAPITA: GDP divided by the population — a better measure of average living standards (e.g. GDP per capita in the EU was US$35 079 versus US$1133 in Kenya).

LIMITATIONS OF GDP AS A MEASURE OF GROWTH (why GDP can mislead)

POPULATION CHANGES: if GDP rises but population rises faster, GDP per capita falls — people aren't better off.
STATISTICAL ERRORS: official statistics can be inaccurate (sampling errors, revisions, misreporting).
THE VALUE OF HOME-PRODUCED GOODS: some goods/services are not traded and so are not recorded — e.g. people growing their own produce; GDP understates true output.
THE HIDDEN (UNDERGROUND) ECONOMY: some paid work goes unrecorded — e.g. a friend driving a taxi for cash, undeclared work — GDP misses it.
GDP AND LIVING STANDARDS: GDP counts money value, but living standards depend on many things GDP ignores (leisure, health, environment, distribution of income).
EXTERNAL COSTS: GDP ignores damage done — e.g. the price of plastic is cheap because it does not include the cost of the pollution it creates; growth that pollutes may not improve true welfare.

ACTIVITY 1 — CASE STUDY: ECONOMIC GROWTH IN THE USA, EU AND EAST ASIA & PACIFIC

Compare growth rates across regions: East Asia & Pacific typically grow fastest (catch-up growth), the EU/USA grow more slowly but from a high base. Use real GDP (inflation-adjusted) to compare properly.

THE ECONOMIC CYCLE (trade cycle)

SUBJECT VOCABULARY — economic cycle: the recurring pattern of growth and decline in an economy (booms and recessions) over several years.
The cycle has four phases: 1. BOOM: rapid growth, high employment, high demand — but rising inflation (demand-pull pressure) and possible balance-of-payments problems. 2. DOWNTURN / SLOWDOWN: growth slows. 3. RECESSION or DEPRESSION: negative growth (falling GDP) for two or more consecutive quarters; unemployment rises; a deep/prolonged recession is a depression. 4. RECOVERY: output starts rising again; unemployment begins to fall.
THE IMPACT OF THE ECONOMIC CYCLE ON GROWTH, EMPLOYMENT AND INFLATION:
Boom: high growth, low unemployment, rising inflation.
Recession: falling/negative growth, rising unemployment, low inflation (or deflation).
💡 Exam tip: draw the cycle as a wavy line around an upward trend; label boom, recession, recovery; state what happens to growth, employment and inflation in each phase.

THE IMPACT OF ECONOMIC GROWTH (costs and benefits)

Benefits: - Higher standards of living — more goods/services per person; higher incomes. - Higher employment — growing output needs more workers. - More tax revenue for the government → better public services (health, education). - Increased productive potential — growth funds investment in capital and skills.

Costs/drawbacks: - THE ENVIRONMENT: growth often means more pollution, resource depletion and congestion (external costs). - Inflation if growth is too fast (demand outruns supply). - Inequality — growth's benefits may go mainly to the rich. - Balance of payments problems — booming demand sucks in imports.

ACTIVITY 2 — CASE STUDY: ECONOMIC GROWTH AND UNEMPLOYMENT IN BRAZIL

When Brazil's economy grew strongly, unemployment fell; when growth slowed/contracted, unemployment rose sharply — showing the close link between the economic cycle, growth and employment.

ECONOMICS IN PRACTICE — CASE STUDY: ECONOMIC GROWTH IN INDIA

India has grown rapidly (high GDP growth rates), lifting millions out of poverty, but faces the costs of growth: pollution (e.g. Delhi air), congestion, inequality and pressure on resources. Balanced growth that protects the environment is the challenge.

📊 KEY DIAGRAM — The Economic Cycle

The Economic Cycle

✅ Quick check

List the main macroeconomic objectives. (Growth, low inflation, low unemployment, healthy balance of payments, redistribution of income, protection of the environment.)
Define GDP and real GDP. (GDP = total value of all goods/services produced. Real GDP = adjusted for inflation.)
Give three limitations of GDP. (Population changes, statistical errors, home-produced goods, hidden economy, ignores external costs/quality of life.)
What are the four phases of the economic cycle? (Boom, downturn, recession/depression, recovery.)
Give one benefit and one cost of economic growth. (Benefit: higher living standards/employment/tax revenue. Cost: environmental damage, inflation, inequality.)

Ch 26 Inflation

Chapter 26: Inflation

Inflation is a sustained rise in the general price level (measured by the CPI). It is caused by demand-pull forces (too much spending) or cost-push forces (rising costs of production). Inflation has real costs — menu costs, shoe-leather costs, lost confidence — and is linked to interest rates. Extreme inflation (hyperinflation, as in Venezuela) destroys money's value.

LEARNING OBJECTIVES

Understand what inflation is and how it is measured.
Understand the demand-pull and cost-push causes of inflation.
Understand the relationship between inflation and interest rates.
Understand the impact of inflation.

GETTING STARTED — CASE STUDY: THE SAMUELSEN HOUSEHOLD

Over a year, many prices rise — e.g. the annual gas bill had risen. When the general level of prices rises over time, inflation exists.

WHAT IS INFLATION?

SUBJECT VOCABULARY — inflation: a sustained rise in the general level of prices over time.
It is measured by the percentage change in the Consumer Price Index (CPI) — a basket of goods/services that typical households buy. (Figure 26.1 shows inflation in Peru, 2007–16.)
Disinflation: inflation is still positive but falling. Deflation: the general price level falls (negative inflation).

ACTIVITY 1 — CASE STUDY: EU INFLATION

Figure 26.2 shows the EU inflation rate between 2006 and 2016 (percentage change in the CPI).
Some countries experienced negative inflation (deflation) — e.g. Bulgaria and Ireland where rates were −0.5%.

TYPES OF INFLATION

1. DEMAND-PULL INFLATION

SUBJECT VOCABULARY — demand-pull inflation: inflation caused by aggregate demand rising faster than aggregate supply — "too much money chasing too few goods".
Happens when consumers, firms, government or foreigners spend more while the economy can't raise output quickly (e.g. during a boom, or after tax cuts / lower interest rates).
Activity 2 example — zinc: rising global demand pushed the price of zinc up from around US$1500 per tonne in January 2016 to US$2600 per tonne in April 2017 — demand growing faster than supply pulled the price up.

2. COST-PUSH INFLATION

SUBJECT VOCABULARY — cost-push inflation: inflation caused by rising costs of production, which firms pass on as higher prices.
Sources of rising costs:
Imported goods — e.g. rising oil prices (early 1970s oil shocks).
Wage increases above productivity growth.
Increases in taxation — e.g. in 2010, a rise in indirect tax (VAT) pushed up prices.
Worked example (retailer): a retailer buys goods for £10 per unit and adds 10% to get the selling price £11. If the supplier's cost rises to £12, the new price is £12 × 1.10 = £13.20 — the price rose from £11 to £13.20 because costs have risen → cost-push inflation.

THE RELATIONSHIP BETWEEN INFLATION AND INTEREST RATES

SUBJECT VOCABULARY — interest rate: the price of borrowing money / the reward for saving (a percentage).
High inflation → higher interest rates: central banks raise interest rates to cool demand (borrowing becomes more expensive → spending falls → inflation falls).
Low inflation → lower interest rates: to encourage borrowing and spending.
There is a close, inverse relationship: governments raise rates to fight inflation; cut rates to stimulate growth.

THE IMPACT OF INFLATION

MENU COSTS: the costs of changing prices (printing new menus/price lists, retagging goods, reprogramming tills) — rises with inflation.
SHOE-LEATHER COSTS: the time and effort spent managing money during inflation (frequent trips to the bank to avoid holding depreciating cash).
BUSINESS AND CONSUMER CONFIDENCE: high/unpredictable inflation creates uncertainty — consumers may save more (building reserves for unforeseen price rises), businesses delay investment → lower growth.
LOSS OF MONEY'S VALUE: savers and people on fixed incomes lose purchasing power; money loses value.
Redistribution: borrowers gain (repay with cheaper money), lenders lose.
Very high inflation (hyperinflation): when prices rise by several hundred or thousand per cent a year, money may not be accepted as payment and loses almost all value.

ECONOMICS IN PRACTICE — CASE STUDY: INFLATION IN VENEZUELA

Venezuela suffered sky-high inflation — it was predicted inflation would reach 1600% in 2017 (Figure 26.4 shows inflation 2012–16).
Problems: a backpack full of cash is needed for everyday shopping; prices change constantly; saving is impossible.
Cause: heavy reliance on oil sales — nearly 90% of export revenue — so when oil prices crashed, the government printed money to cover spending → massive demand-pull inflation.

💡 Exam tips

Definition + measure (CPI) + two causes (demand-pull with "too much money chasing too few goods"; cost-push with rising costs) + impacts (menu, shoe-leather, confidence, savers lose).
Know one real example: Venezuela (hyperinflation) and zinc (demand-pull).

📊 KEY DIAGRAM — Demand-Pull Inflation (AD/AS)

Demand-Pull Inflation (AD/AS)

✅ Quick check

Define inflation. (A sustained rise in the general level of prices.)
What is demand-pull inflation? (AD rising faster than AS — too much spending chasing too few goods.)
What is cost-push inflation? (Rising production costs passed on as higher prices — oil, wages, taxes.)
How do interest rates relate to inflation? (High inflation → higher rates to cool demand; low inflation → lower rates.)
Give two costs of inflation. (Menu costs, shoe-leather costs, lost confidence, savers lose purchasing power.)

Ch 27 Unemployment

Chapter 27: Unemployment

Unemployment is when people who are able and willing to work cannot find a job. It is measured (by the ILO measure or the claimant count), classified into five types (cyclical, structural, seasonal, voluntary, frictional), and it imposes heavy costs — lost output, higher benefit spending, lower tax revenue and damaged confidence.

LEARNING OBJECTIVES

Understand how unemployment is defined and measured.
Understand the types of unemployment.
Understand the impact of unemployment on individuals, firms and the economy.

GETTING STARTED — TWO UNEMPLOYED PEOPLE

Kostas Mantalos and Maureen Conte are out of work — people can be without jobs for a number of reasons (lost a job, can't find one, between jobs, choosing not to work).

HOW IS UNEMPLOYMENT MEASURED?

SUBJECT VOCABULARY — unemployment: people who are able, available and actively seeking work but who cannot find a job.
In employment: includes people temporarily away from a job (e.g. on holiday).
Economically inactive: people not seeking work (e.g. students, retirees, stay-at-home parents, long-term sick). Figure 27.2 gives examples of individuals' employment status.
Two measures (KEY FACTS): 1. ILO measure (International Labour Organization): counts everyone who is out of work, available for work and actively seeking work — the more comprehensive international standard. 2. Claimant count: counts only those claiming unemployment benefits — lower than the ILO count because it excludes some groups (e.g. those not eligible for benefits).
Example (Portugal, 2016): population just over 10 million; the number of people able to work was just over 5 million — unemployment is measured as a percentage of the labour force.

TYPES OF UNEMPLOYMENT

1. CYCLICAL (DEMAND-DEFICIENT) UNEMPLOYMENT

SUBJECT VOCABULARY — cyclical/demand-deficient unemployment: unemployment caused by a fall in aggregate demand during a downturn/recession — firms lay off staff as demand for their products falls.
Figure 27.3 links the economic cycle and unemployment: in booms unemployment is low; in recessions it rises and worsens.
This is the type governments fight with expansionary policy (see Chapters 31–33).

2. STRUCTURAL UNEMPLOYMENT

SUBJECT VOCABULARY — structural unemployment: unemployment caused by changes in the structure of the economy — the decline of whole industries and the loss of jobs that cannot easily be replaced.
Causes:
Decline of industries (e.g. coal mining, shipbuilding) as the economy changes.
Technology replacing labour — e.g. banks have cut branches/jobs as online banking replaces staff.
Regional impact: unemployment is not the same in all regions — e.g. in the UK, the north-east has suffered owing to the decline of its traditional industries.
Structural unemployment is long-term and needs retraining/regional policy to fix.

3. SEASONAL UNEMPLOYMENT

SUBJECT VOCABULARY — seasonal unemployment: unemployment caused by seasonal changes in demand — e.g. in holiday resorts, hotels, restaurants and tourist attractions that take on staff for the summer and lay them off in winter (and vice versa).

4. VOLUNTARY UNEMPLOYMENT

SUBJECT VOCABULARY — voluntary unemployment: when people choose not to work at the going wage rate — e.g. some people deliberately take an extended break from work, or prefer not to take available jobs.

5. FRICTIONAL UNEMPLOYMENT

SUBJECT VOCABULARY — frictional unemployment: short-term unemployment while workers are between jobs — it takes time to move from one job to another (searching, interviews, notice periods).
It exists even in a healthy economy.

ACTIVITY 1 — CASE STUDY: MARINE D'ARCY

Marine is between jobs after resigning/moving — a classic case of frictional unemployment (short-term, searching for the right job).

THE IMPACT OF UNEMPLOYMENT

On the economy: - USE OF SCARCE RESOURCES (lost output): unemployed workers are idle resources — the economy produces less than its potential (opportunity cost of lost output). - GOVERNMENT SPENDING ON BENEFITS: the government must pay unemployment benefits — this expenditure has an opportunity cost (the money could be better spent on education or health care). - TAX REVENUE: with fewer people working, income tax, national insurance and corporation tax revenue falls — so taxes on incomes, corporate profits and spending may have to rise (or services be cut).

On individuals and society: - Loss of income and poverty — in some towns and villages a large proportion of the population may be jobless. - CONSUMER CONFIDENCE falls → less spending → firms' revenue falls → further job losses (a vicious circle). - BUSINESS CONFIDENCE falls → firms delay investment and hiring. - Wider social costs: losing a job damages self-esteem, health and family life; can lead to crime and social problems.

ACTIVITY 2 — CASE STUDY: UNEMPLOYMENT IN SOUTH AFRICA

South Africa has persistently high unemployment (Figure 27.4 shows unemployment rates 2006–16). Firms respond to weak demand by laying off workers — e.g. FNB, a South African bank, laid off 589 workers.

ECONOMICS IN PRACTICE — CASE STUDY: UNEMPLOYMENT IN GREECE

The Greek debt crisis caused a huge increase in unemployment (Figure 27.5, 2006–16) alongside a deep recession (Figure 27.6 shows GDP falling) — a textbook example of cyclical (demand-deficient) unemployment: falling GDP → firms lay off workers → unemployment soared (over 25%).

✅ Quick check

Define unemployment. (People able, available and actively seeking work who can't find a job.)
Distinguish the ILO measure from the claimant count. (ILO = all those seeking work; claimant count = only those claiming benefits — lower.)
List the five types of unemployment. (Cyclical, structural, seasonal, voluntary, frictional.)
Which type rises in a recession? (Cyclical/demand-deficient.)
Give three impacts of unemployment. (Lost output, higher benefit spending, lower tax revenue, lower confidence, social costs.)
What type of unemployment is being between jobs? (Frictional.)

Ch 28 Balance of Payments Account on the Current Account

Chapter 28: The Balance of Payments Account (the Current Account)

The balance of payments records all the money flowing into and out of a country. The current account — the part on the specification — records trade in goods (visible), services (invisible), plus income and transfers. A country runs a deficit if money flows out faster than it flows in, and a surplus if the opposite. Deficits/surpluses are driven by the quality and price of goods at home and abroad, and by exchange rates.

LEARNING OBJECTIVES

Understand the current account on the balance of payments.
Understand visible and invisible trade.
Understand the relationship between the current account and exchange rates.
Understand reasons for, and the impact of, current account deficits and surpluses.

GETTING STARTED — CASE STUDY: TRADE IN SOUTH KOREA

South Korea exports semiconductors and many other goods (Figure 28.1: value of goods sold abroad, January–December 2016) and imports crude oil/petroleum products and other goods (Figure 28.2).
If the value of goods bought exceeds the value sold, the country imports more than it exports.

THE CURRENT ACCOUNT ON THE BALANCE OF PAYMENTS

SUBJECT VOCABULARY — current account: that part of the balance of payments that records the flows of money from trade in goods and services, income and transfers.
It has four parts: 1. Visible trade — trade in physical goods (exports − imports = the balance of trade / visible balance). Figure 28.3 shows a visible balance for a country in 2016 (−US$69 181 million — a deficit). 2. Invisible trade — trade in services: banking, insurance, tourism, transport, shipping (e.g. the UK's strength). GENERAL VOCABULARY — invisible trade: the exchange of services (as opposed to physical goods). 3. Income flows — interest, profits and rents from the ownership of assets overseas (and the same paid to foreigners owning domestic assets). 4. Transfers — money flowing between governments and organisations (e.g. foreign aid, EU budget payments).
Balancing it up: the current balance = visible balance + invisible balance + income + transfers. Figure 28.4 shows a current balance of −US$22 332 million → a current account deficit.
SUBJECT VOCABULARY — deficit: when money flows out of the economy exceeds the money flowing in (spending on imports etc. exceeds earnings from exports). Surplus: the opposite (more flowing in than out).

VISIBLE AND INVISIBLE TRADE

Visible: physical, tangible goods (cars, electronics, oil, food).
Invisible: services (tourism, banking, insurance, shipping, education) and income/transfer flows.
KEY FACTS: the balance of trade (visible balance) is exports of goods − imports of goods; the current account balance is the broader measure including invisible items.

ACTIVITY 1 — CASE STUDY: NIGERIA'S BALANCE OF TRADE

Figure 28.5 shows Nigeria's balance of trade for 2015/16. Nigeria imported more than it exported (its trade deficit was around US$69 000 million — US$96 732 m − US$165 913 m), largely because oil exports fell in value.

THE RELATIONSHIP BETWEEN THE CURRENT ACCOUNT AND EXCHANGE RATES

A current account surplus tends to strengthen the currency (more foreigners need your currency to buy your exports); a deficit tends to weaken it.
Example: when the UK voted to leave the EU in June 2016, the value of the pound fell quite sharply — from £1 = US$1.50 to around £1 = US$1.24 in January 2017, a fall of about 17% (Figure 28.6). Sharp changes like this affect trade and the current account.
EXAMPLES OF REAL-WORLD EXCHANGE RATES: the book gives real £/US$ (and other) rates — know that exchange rates change constantly with supply and demand (and speculation).

REASONS FOR CURRENT ACCOUNT DEFICITS AND SURPLUSES

QUALITY OF DOMESTIC GOODS: if domestic goods are poor quality, consumers and foreigners buy imports instead → deficit. (Conversely, high quality → surplus — e.g. the UK's strong services reputation.)
QUALITY OF FOREIGN GOODS: high-quality foreign goods attract domestic buyers → imports rise → deficit.
PRICE OF DOMESTIC GOODS: if domestic goods are expensive (e.g. owing to rapid inflation), demand from abroad falls and imports look cheap → deficit gets bigger.
PRICE OF FOREIGN GOODS: cheap imports → higher import spending → deficit.
EXCHANGE RATES BETWEEN COUNTRIES: a strong currency makes exports expensive and imports cheap → deficit; a weak currency does the opposite → surplus. (E.g. after the pound fell post-Brexit, UK exports became cheaper and imports more expensive — improving the current account.)

ACTIVITY 2 — CASE STUDY: FERRARI

Ferrari's total revenue in 2015 was €2854 million; only 285 of the cars it sold were in its domestic market — most sales are overseas.
Why does Ferrari sell so well abroad? Product quality, brand and exclusivity → strong demand for exports → contributes to Italy's export earnings.
Discuss the importance of product quality for a country's current account: quality products command high prices and strong export demand.

THE IMPACT OF A CURRENT ACCOUNT DEFICIT

LEAKAGES FROM THE ECONOMY: money spent on imports leaks out of the domestic economy — reducing the circular flow of income and demand for domestic goods/services.
LOW DEMAND FOR EXPORTS: a persistent deficit often reflects weak international competitiveness — fewer jobs in export industries.
FUNDING THE DEFICIT: the deficit must be financed — by borrowing from abroad, selling assets, or attracting flows of foreign currency (e.g. via higher interest rates or foreign investment). GENERAL VOCABULARY — flows of foreign currency can be attracted by a country if it offers high returns.
Analogy from the book: someone earning £25 000 a year but spending £25 005 has overspent by £5 — they must borrow/fund the difference, just like a country with a current account deficit.
Some countries, like China and Japan, have persistent surpluses — they export far more than they import, building up foreign currency reserves.

ECONOMICS IN PRACTICE — CASE STUDY: THE MOROCCAN CURRENT ACCOUNT

Morocco runs deficits on its current account (Figure 28.7 — the Moroccan current account balance). In November 2016, Morocco's balance of trade was MAD −13 866 million — it imported far more goods than it exported, financed by services (tourism), remittances and foreign investment.

💡 Exam tips

Definitions: current account, visible/invisible trade, deficit/surplus.
Reasons for a deficit: poor quality/price competitiveness, strong currency, high domestic inflation, weak export demand.
Impact of a deficit: leakages, lost jobs in exporting industries, need to borrow/fund the deficit.

✅ Quick check

What does the current account record? (Money flows from trade in goods and services, income and transfers.)
What is visible trade? (Trade in physical goods — exports minus imports = balance of trade.)
Give two examples of invisible trade. (Banking/insurance/tourism services, income from overseas assets.)
Give three reasons for a current account deficit. (Poor quality or expensive domestic goods, attractive imports, strong exchange rate.)
How does a weak currency affect the current account? (Exports cheaper, imports dearer → improves the balance.)
What must a country do to fund a current account deficit? (Borrow from abroad, sell assets, attract foreign currency flows.)

Ch 29 Protection of the Environment

Chapter 29: Protection of the Environment

Business activity can damage the environment in many ways — visual, noise, air and water pollution, and waste. Because this damage is an external cost (see Chapter 13), governments intervene to protect the environment using taxes, subsidies, regulation, pollution permits and national parks.

LEARNING OBJECTIVES

Understand the business activity that damages the environment.
Understand how governments intervene to protect the environment.

GETTING STARTED — CASE STUDY: GLOBAL WARMING

The Earth's temperature is subject to natural variation over hundreds of millions of years, but Figure 29.1 shows global temperatures, 1974–2016, rising sharply in recent decades — widely attributed to human (business) activity, especially burning fossil fuels.
Environmental damage is a classic negative externality — the market price of goods doesn't include the cost to the environment.

BUSINESS ACTIVITY THAT DAMAGES THE ENVIRONMENT

A wide range of business activity has the potential to damage the environment:
POWER GENERATION: burning fossil fuels (coal, oil, gas) releases CO₂ and pollutants; nuclear power carries radiation risks and waste problems.
CHEMICAL PROCESSING: petrochemical plants use benzene (a chemical known to cause cancer); chemicals are used in countless products and processes; spills and emissions harm health and the environment.
AGRICULTURE: nitrogen (a key ingredient in fertilisers) washes into rivers, lakes and the sea where it can kill aquatic life; clearing woodland or rainforest to grow crops destroys habitats.
CONSTRUCTION: in the UK the construction industry produces 109 million tonnes of waste a year.

ACTIVITY 1 — CASE STUDY: ENVIRONMENTAL DAMAGE

Identify the ways different businesses damage the environment (emissions, waste, habitat destruction) — every type of production has some negative environmental impact.

WAYS BUSINESSES DAMAGE THE ENVIRONMENT

1. VISUAL POLLUTION

Business activity that results in something physical that looks very unattractive — giant office blocks, advertising hoardings, derelict sites, transmission pylons.

2. NOISE POLLUTION

Excessive noise from business activity (aircraft, road traffic, factories, construction) — a problem for people, reducing their quality of life; can damage eardrums and lead to loss of hearing, and disturb wildlife.

3. AIR POLLUTION

Emissions of smoke, gases and particles. Figure 29.2 shows levels of pollution in some of the most polluted cities in the world (many in the Western Pacific/Asia). The main causes of air pollution differ around the world — industrial emissions in some, vehicle exhaust in others, burning of waste in others.

4. WATER POLLUTION

SUBJECT VOCABULARY — water pollution: the contamination of rivers, lakes and seas, making water dirty and dangerous for people and wildlife.
Causes: industrial discharges, fertiliser run-off (nitrogen), oil spills (see the Hachiuma Steamship case below), untreated sewage.
Some waste is very persistent — e.g. foam and Styrofoam can take 50 and 80 years, respectively, to decompose.

ACTIVITY 2 — CASE STUDY: THE HACHIUMA STEAMSHIP CO. LTD

A shipping company case (oil/chemical spillage from a vessel) — what is meant by water pollution? The contamination of water by business activity (e.g. oil discharged at sea), harming marine life and coastal communities.

GOVERNMENT INTERVENTION TO PROTECT THE ENVIRONMENT

TAXATION (environmental taxes): taxes on polluting activities act as an incentive to reduce activities that damage the environment. Examples: the landfill tax (tax per tonne of waste sent to landfill — rotting waste at landfill sites produces methane and attracts pests; Figure 29.4 shows the amount of waste going to landfill falling); carbon taxes on fossil fuels.
SUBSIDIES: grants/subsidies to activities that generate positive externalities — e.g. rail companies are subsidised because rail travel reduces road congestion and pollution; subsidies for renewables (solar, wind).
REGULATION AND LAWS: setting legal limits and standards: - The Clean Air Act 1993 (UK) — controls smoke and emissions from polluting ways of working. - The Water Resources Act 1991 (UK) — designed to preserve and protect water resources. - Fines and compensation — polluters must pay compensation to victims (e.g. people living by airports for noise), and may be fined for breaching limits.
BANS AND RESTRICTIONS: e.g. the lighting of fires may be prohibited (smoke-control areas); bans on single-use plastics; limits on emissions.
POLLUTION PERMITS (tradeable permits): a cap on total pollution; firms buy/sell permits — creates a market incentive to pollute less (recap Chapter 13).
PARK PROVISION (national parks and protected areas): governments set aside land where development and damaging activity are restricted — e.g. Yellowstone Park in the USA (and national parks worldwide), preserving habitats for future generations.

ECONOMICS IN PRACTICE — CASE STUDY: DEALING WITH ENVIRONMENTAL PROTECTION (LANDFILL TAX)

The landfill tax charges firms for waste sent to landfill → encourages recycling and reducing waste. Figure 29.4 shows the amount of waste going to landfill falling as the tax bites.
In 2016, the Chinese government demonstrated some commitment to environmental protection (new pollution laws, clean-energy investment) as it faced severe air pollution.

💡 Exam tips

Know the four/five types of pollution with examples (visual, noise, air, water + waste).
Know the policy toolkit: taxes, subsidies, regulation, permits, parks — and link each to how it corrects the externality.

✅ Quick check

Give three ways business damages the environment. (Visual, noise, air and water pollution; waste.)
Give one example of an environmental tax. (Landfill tax; carbon tax.)
How do subsidies help the environment? (Encourage positive externalities — e.g. rail travel, renewables.)
Name two pieces of UK environmental law. (Clean Air Act 1993; Water Resources Act 1991.)
How do pollution permits work? (Cap on pollution; firms trade permits → incentive to pollute less.)

Ch 30 Redistribution of Income

Chapter 30: Redistribution of Income

Income is distributed unequally across the world and within countries. Governments try to reduce poverty and inequality — through progressive taxation, welfare benefits, and investment in education and health care — for basic-needs, living-standards and ethical reasons.

LEARNING OBJECTIVES

Understand income inequality, absolute poverty and relative poverty.
Understand the reasons to reduce poverty and inequality.
Understand how governments intervene to redistribute income.

GETTING STARTED — TWO FAMILIES

The Gwengwe family: a poor family (in Africa) struggling to meet basic needs.
The Birnbaum family: extremely wealthy — Mr Birnbaum is a partner in an accounting firm earning about US$700 000 p.a.; Mrs Birnbaum is an investment banker earning between US$1 million and US$1.6 million p.a.; their children attend private schools with fees of US$40 000 per term; they own four cars and a yacht that cost US$4.1 million in 2012.
The gap between these families illustrates the inequality of income that exists in the world — and that the gap is growing.

INCOME INEQUALITY

SUBJECT VOCABULARY — income inequality: the extent to which income is distributed unevenly among a population.
In most countries the distribution of income is very unequal. The USA is an example where inequality is severe:
The top earners in the USA earned an average of about US$6 087 113 in 2014, while the bottom 90% of the population earned an average of just US$33 068 (Figure 30.1).
The Lorenz curve (Figure 30.2) is a graph showing the distribution of income: the further the curve bows away from the line of perfect equality, the more unequal the distribution.
Also compare: in France, a shop assistant might earn €17 600 p.a. while a company director might receive €2.4 million p.a.

ABSOLUTE POVERTY

SUBJECT VOCABULARY — absolute poverty: when people do not have enough resources to meet all of their basic human needs (food, water, shelter, clothing, health).
The World Bank defines it (roughly) as surviving on less than US$1.90 per day.
The World Bank estimated that 702 million people (9.6% of the world's population) lived in absolute poverty — most are to be found in Africa and Asia (Figure 30.3 shows the percentage of the world's population living in absolute poverty).
Examples: in Zambia and the Central African Republic, 47.8% (and similar) of the population live in absolute poverty.

RELATIVE POVERTY

SUBJECT VOCABULARY — relative poverty: poverty measured relative to the rest of society — people are in relative poverty if their income is well below the average (median) income of their country.
Example: if the median income in a country is €21 500, someone living on 60% of that (€12 900) is in relative poverty.
Groups often in relative poverty: the unemployed, sick, disabled and the elderly.

ACTIVITY 1 — CASE STUDY: GLOBAL INCOME INEQUALITY

Figure 30.4 shows the global population by income group, 2001 and 2011 — illustrating how the world's income is concentrated in a small share of the population (though extreme poverty has fallen).

REASONS TO REDUCE POVERTY AND INEQUALITY

MEET BASIC NEEDS: everyone has the right to food, water, shelter and health — reducing poverty saves lives and relieves suffering.
RAISE LIVING STANDARDS: higher incomes for the poor raise average living standards and human welfare.
ETHICAL REASONS: inequality on this scale is morally unacceptable; societies benefit from fairness and social cohesion.
(Economic spin-offs: the poor can then consume and contribute to the economy; better health/education raise productivity.)

GOVERNMENT INTERVENTION TO REDUCE POVERTY AND INCOME INEQUALITY

1. PROGRESSIVE TAXATION

SUBJECT VOCABULARY — progressive tax: a tax that takes a higher percentage of income from the rich than from the poor (the tax rate rises as income rises).
Example: a person earning US$10 000 might pay US$600 in tax (6%) while a high earner pays a much higher percentage. Those on very low incomes do not have to pay any tax at all (e.g. in France, low earners below the threshold pay no income tax).
GENERAL VOCABULARY — redistribution: taking money from some (through taxes) and giving it to others (through benefits/spending) to reduce inequality.

2. REDISTRIBUTION THROUGH BENEFIT PAYMENTS

Governments transfer income to the poor through welfare benefits: unemployment pay, sickness/disability benefits, state pensions for the elderly, child benefit, and payments for those who cannot work at all (e.g. in many European countries).
Benefits are funded by the taxpayer (especially through progressive taxes) — the state takes from the rich and gives to the poor, closing the gap between rich and poor.
(E.g. in 2000, about X% of the population received some form of benefit in many countries.)

3. INVESTMENT IN EDUCATION AND HEALTH CARE

Free/universal education and health care give the poor the chance to escape poverty (skills raise earning power; good health lets people work).
Education in many developing countries is inadequate — e.g. in most poor countries there are too few schools and teachers — so investing there reduces long-term inequality.

ACTIVITY 2 — CASE STUDY: PROGRESSIVE TAX IN FRANCE

France uses a progressive income tax: low earners pay little or no tax, high earners pay a high marginal rate — redistributing income to reduce inequality. (All societies have relative poverty; progressive tax + benefits help.)

ECONOMICS IN PRACTICE — CASE STUDY: POVERTY IN INDIA

India has reduced poverty sharply: Figure 30.6 shows Indian GDP per capita, 1960–2013, rising strongly, and Figure 30.5 shows an Indian slum — poverty still exists but the number of people living in poverty has fallen.
Progress comes from economic growth plus government action: e.g. in Uttar Pradesh, 99% of villages are electrified (though gaps remain); the government increased spending on education in recent years (2016 onwards) to raise the literacy rate.
Children are particularly at risk — one study found 3.1 million children at risk; investment in education is the key to breaking the poverty cycle.

💡 Exam tips

Distinguish absolute (below a minimum — US$1.90/day) from relative (below a % of median income) poverty.
Know the three intervention methods: progressive taxation, benefit payments, education/health investment.
Use the Lorenz curve for "explain inequality" questions.

✅ Quick check

Define income inequality. (Uneven distribution of income among a population.)
What is absolute poverty? (Not enough resources to meet basic human needs — below ~US$1.90/day.)
What is relative poverty? (Income well below the average/median of society.)
Give three reasons to reduce poverty and inequality. (Meet basic needs, raise living standards, ethical reasons.)
What is a progressive tax? (A tax that takes a higher % from the rich than the poor.)
Name the three government methods to redistribute income. (Progressive taxation, benefit payments, education/health investment.)

Ch 31 Fiscal Policy

Chapter 31: Fiscal Policy

Fiscal policy is the use of government spending and taxation to influence the economy. It includes the government's revenue (direct taxes, indirect taxes, environmental taxes), expenditure (current, capital, transfers), the fiscal balance (deficit or surplus), and how policy affects the macroeconomic objectives — growth, employment, inflation, the current account and the environment.

LEARNING OBJECTIVES

Understand fiscal policy and its instruments.
Understand government revenue (direct, indirect, environmental taxes) and expenditure.
Understand fiscal deficits and surpluses and their impact.
Understand the impact of fiscal policy on macroeconomic objectives.

GETTING STARTED — CASE STUDY: CANADIAN PUBLIC FINANCES 2015

In 2015 the Canadian government planned to spend CAD 3 688 000 million on government services (Figure 31.1) and planned income of a similar scale (Figure 31.2, including CAD 1 065 000 million in social insurance taxes).
Figure 31.2 also showed Canada planned to borrow CAD 439 000 million — spending more than it raised = a fiscal deficit.

FISCAL POLICY AND POLICY INSTRUMENTS

SUBJECT VOCABULARY — fiscal policy: the use of government spending and taxation to influence the economy (aggregate demand, inflation, unemployment and GDP).
The two instruments: (1) government expenditure and (2) taxation. By changing them, the government influences aggregate demand and the economy.
GENERAL VOCABULARY — stimulate: to encourage/boost an activity (e.g. stimulate demand).

GOVERNMENT REVENUE (WHERE THE MONEY COMES FROM)

SUBJECT VOCABULARY — direct tax: a tax on income and wealth — paid directly to the government by the person/firm (income tax, corporation tax, national insurance). The burden cannot easily be passed on.
SUBJECT VOCABULARY — indirect tax: a tax on spending — added to the price of goods/services (e.g. VAT/value-added or sales taxes). The burden can be passed to consumers in higher prices.
Taxes are also used to discourage certain activities — e.g. many governments place heavy taxes on cigarettes, alcohol and fuel.
ENVIRONMENTAL TAXES: taxes designed to protect the environment — e.g. landfill tax, the climate change levy, carbon taxes on electricity, gas and coal (see Chapters 13 and 29).

ACTIVITY 1 — CASE STUDY: TAXATION IN GHANA

In 2016 the government of Ghana planned to raise GHS 38 000 million in revenue (Figure 31.3 shows the main sources: income tax, company tax, VAT, import duties, etc.) to fund its spending plans — announced each year in the budget.

GOVERNMENT EXPENDITURE (WHERE THE MONEY GOES)

SUBJECT VOCABULARY — government expenditure: spending by the government on goods, services and benefits.
MAIN EXAMPLES:
Current (day-to-day) spending: wages of civil servants, teachers, nurses; running hospitals and schools; benefit payments (e.g. when someone is made redundant they receive unemployment benefit).
Capital (investment) spending: 'extra' or 'new' spending on long-lasting assets — e.g. new roads, hospitals, schools, defence equipment.
Transfer payments: money transferred from taxpayers to individuals (benefits, pensions) — no goods/services received in return.

FISCAL DEFICITS AND FISCAL SURPLUSES

SUBJECT VOCABULARY — fiscal deficit: the amount by which government spending is greater than government revenue in a year.
SUBJECT VOCABULARY — fiscal surplus: the amount by which government revenue exceeds government spending.
Figure 31.4 shows the pattern of fiscal deficits and surpluses for Sweden, 2005–15 — some years in deficit, some in surplus, depending on the economic cycle.
If spending exceeds revenue, the government must borrow money to fund the deficit (Canada borrowed CAD 439 000 million).

THE IMPACT OF A FISCAL DEFICIT AND A FISCAL SURPLUS

A FISCAL DEFICIT: - The government must borrow, adding to the national debt — and pay interest on that debt. - Borrowing has an opportunity cost — the money could have been spent on lower taxes or other programmes. - Heavy government borrowing can crowd out private borrowing (banks lend to the state instead of businesses) and can push up interest rates. - Analogy from the book: a US$5000 loan is fairly easy for someone earning US$80 000 to pay back, but someone earning US$15 000 a year may struggle to meet the interest and repayments — the bigger the debt relative to income, the harder it is to service.

A FISCAL SURPLUS: - Can be used to pay down the national debt (reducing future interest payments). - Can be spent on the future provision of services or on infrastructure. - Can allow tax cuts (returning money to taxpayers). - A surplus can also slow the economy if it is too large (withdrawing demand).

ACTIVITY 2 — CASE STUDY: FISCAL BALANCES IN LUXEMBOURG

Figure 31.5 shows Luxembourg's fiscal balances 2005–15. Question: if in 2016 a government spends €654.5 million and collects €631.6 million — the balance is a deficit of €22.9 million (spending > revenue). (Options: A €654.5m deficit ✗, B €22.9m surplus ✗, C €1286.1m surplus ✗, D €22.9m deficit ✓.)

THE IMPACT OF FISCAL POLICY ON MACROECONOMIC OBJECTIVES

EXPANSIONARY fiscal policy (spending ↑ and/or taxes ↓) stimulates aggregate demand:
→ ECONOMIC GROWTH and EMPLOYMENT rise (e.g. if more civil servants and council workers are employed, their incomes rise and they spend more).
→ But risks inflation (too much demand) and a bigger CURRENT ACCOUNT DEFICIT (if there is a large deficit already, higher demand sucks in more imports — "if there is a large deficit on the current account, ... would get bigger").
CONTRACTIONARY fiscal policy (spending ↓ and/or taxes ↑) reduces aggregate demand:
→ Cools inflation and reduces the fiscal deficit.
→ But risks slower growth and higher unemployment.
FISCAL POLICY AND THE ENVIRONMENT: environmental taxes (landfill tax, climate change levy) discourage pollution, while subsidies can encourage environmentally friendly activities (e.g. in the USA, tax breaks for renewable energy).

ECONOMICS IN PRACTICE — CASE STUDY: RECENT FISCAL POLICY IN GREECE

After its debt crisis, Greece was forced to borrow from the EU and the IMF (Figure 31.6 shows Greece's vs the EU's fiscal balances as % of GDP — Greece ran huge deficits).
Greece applied contractionary (austerity) fiscal policy: raising taxes many times and cutting spending (Figure 31.7 shows Greek government spending falling 2007–16), including cuts to most government departments.
What is meant by contractionary fiscal policy? Reducing aggregate demand by raising taxes and/or cutting government spending — used to shrink a budget deficit (but it slows growth and raises unemployment, which is what Greece experienced).

✅ Quick check

Define fiscal policy. (Use of government spending and taxation to influence the economy.)
Distinguish direct and indirect taxes. (Direct = on income/wealth; indirect = on spending.)
Give one example of an environmental tax. (Landfill tax, climate change levy, carbon tax.)
What is a fiscal deficit and a fiscal surplus? (Deficit: spending > revenue; surplus: revenue > spending.)
Give one impact of a fiscal deficit. (Borrowing/debt, interest costs, opportunity cost, crowding out.)
What is expansionary fiscal policy? (Spending ↑ / taxes ↓ → stimulates AD → growth and employment, but risks inflation and a bigger current-account deficit.)

Ch 32 Monetary Policy

Chapter 32: Monetary Policy

Monetary policy uses interest rates (set by the central bank) — and in some cases asset purchases ("quantitative easing") — to influence the economy. Changing interest rates affects consumer spending, borrowing, saving, investment, growth, inflation and the exchange rate/current balance.

LEARNING OBJECTIVES

Understand what monetary policy is.
Understand the role of central banks in setting interest rates.
Understand the impact of interest-rate changes on macroeconomic objectives (growth, inflation, current balance).
Understand the mechanism by which interest-rate changes affect consumers and firms, and the use of asset purchasing.

GETTING STARTED — TWO EXAMPLES

Francesca Panico (a consumer): her spending decisions are influenced by interest rates — when rates fall, her mortgage/loan payments fall and she has more to spend; when rates rise, she cuts spending.
Anton Autobrakes (a firm): borrowing costs affect investment — e.g. a firm borrowing US$100 000 from a bank to buy new machinery pays more in interest when rates are high.

MONETARY POLICY

SUBJECT VOCABULARY — monetary policy: the use of interest rates (and other measures, such as asset purchasing) by the central bank to influence the economy.
The aim is to manage aggregate demand to hit macroeconomic objectives (low inflation, growth, employment).

INTEREST RATES

SUBJECT VOCABULARY — interest rate: the price of borrowing money and the reward for saving (expressed as a percentage).
Rates are higher if money is borrowed without security (unsecured loans/credit cards cost more than secured mortgages).
Rates vary between banks/products — e.g. in February 2017, the rate charged on one particular loan was a specific figure; and if a bank lowers rates on a particular product, borrowing becomes cheaper for business.
Figure 32.1 shows the EU interest rate, 2007–16 (set by the European Central Bank).

THE ROLE OF CENTRAL BANKS IN SETTING INTEREST RATES

SUBJECT VOCABULARY — central bank: the government's bank, which controls the money supply and interest rates (e.g. the Bank of England, the European Central Bank, the Federal Reserve).
The central bank sets the base interest rate (the rate at which it lends to commercial banks), which influences all other rates in the economy.
Central banks consider other economic variables when setting rates — e.g. the rate of inflation, growth, unemployment and the economic cycle. Monetary policy might be used to help get an economy out of a recession (lower rates) or cool inflation (higher rates).

ACTIVITY 1 — CASE STUDY: INTEREST RATES IN SOUTH AFRICA

Figure 32.2 shows South Africa's interest rate (2007–17): the rate rose to 7% (in 2016) to control inflation — a real example of a central bank using rates to fight rising prices.

THE IMPACT OF INTEREST-RATE CHANGES ON MACROECONOMIC OBJECTIVES

Interest rates UP (contractionary):

ECONOMIC GROWTH slows: borrowing is dearer, saving is more attractive → consumer spending and investment fall → aggregate demand falls → growth slows (and unemployment may rise).
INFLATION falls: less spending → less demand-pull pressure.
THE CURRENT BALANCE improves: higher rates attract foreign capital → the exchange rate rises → imports cheaper, exports dearer → the current account deficit may worsen (or surplus shrink). (Alternatively, to reduce a deficit, a government might... see chapter text.)
Consumers/firms: mortgage and loan payments rise → less disposable income; firms' interest payments on existing loans rise → less profit and less investment.

Interest rates DOWN (expansionary):

Borrowing cheaper, saving less attractive → spending and investment rise → growth and employment rise; but inflation may rise and the current account may worsen (more imports).

THE MECHANISM BY WHICH INTEREST-RATE CHANGES AFFECT CONSUMERS AND FIRMS

Consumers: interest rate change → cost of mortgages/loans/credit cards changes → disposable income changes → spending changes (Francesca Panico example).
Firms: interest rate change → cost of borrowing for investment changes; interest payments on current loans change → profits and investment change (Anton Autobrakes example). When rates fall, firms are more likely to borrow to expand.
Savers: higher rates → more saving (less spending); lower rates → less saving, more spending.

THE USE OF ASSET PURCHASING (QUANTITATIVE EASING)

SUBJECT VOCABULARY — asset purchasing (quantitative easing): when the central bank creates money to buy financial assets (e.g. government bonds) — used when interest rates are already very low and can't go much lower.
It injects money into the economy, lowering long-term interest rates and encouraging lending, spending and investment — a tool to stimulate demand.

ACTIVITY 2 — CASE STUDY: MONETARY POLICY IN JAPAN

Japan has struggled with very low growth for decades (Figure 32.3: growth often negative and rarely above 2% since 1981 — e.g. GDP fell in 2009).
Japan used ultra-low interest rates and asset purchasing to try to stimulate its economy — an example of expansionary monetary policy fighting stagnation.

ECONOMICS IN PRACTICE — CASE STUDY: MONETARY POLICY IN RUSSIA

Russia had high inflation; interest rates were as high as 15% and trending downwards (Figure 32.4). The central bank's high rates were expected to reduce inflation further and encourage savings (Figure 32.5 shows Russian inflation falling).
This shows the trade-off: high rates cut inflation but also slow growth — the central bank must balance objectives.

💡 Exam tips

Know the transmission mechanism: rate change → borrowing/saving costs → consumer spending & firm investment → aggregate demand → growth/inflation/current balance.
"Higher rates → stronger currency → imports cheaper/exports dearer → current account worsens" is a favourite chain.

✅ Quick check

Define monetary policy. (Use of interest rates (and asset purchases) by the central bank to influence the economy.)
Who sets interest rates? (The central bank.)
What happens to consumer spending when interest rates rise? (It falls — borrowing dearer, saving more attractive.)
How do higher rates affect the exchange rate and current account? (Attract foreign capital → currency rises → imports cheaper/exports dearer → current account worsens.)
What is asset purchasing (QE)? (Central bank creates money to buy financial assets to stimulate lending/spending.)
Give the trade-off Russia faced. (High rates cut inflation but slow growth.)

Ch 33 Supply-side Policies and Government Controls

Chapter 33: Supply-side Policies and Government Controls

Supply-side policies aim to increase the economy's productive capacity — shifting the PPC outward and the aggregate-supply curve right — so the economy can grow without causing inflation. They include education and training, deregulation, regional policy, infrastructure spending, lower business taxes, lower income taxes, and labour-market reforms. This chapter contrasts supply-side measures with demand management.

LEARNING OBJECTIVES

Understand what supply-side policies are.
Understand their impact on productivity and total output.
Understand their impact on macroeconomic objectives.
Understand the main supply-side measures (education, regional policy, infrastructure, tax changes, government controls).

GETTING STARTED — CASE STUDY: ANDREI KARPOV

Andrei's story (a worker gaining skills/training) shows how improving the supply side (skills) raises the economy's ability to produce.

WHAT ARE SUPPLY-SIDE POLICIES?

SUBJECT VOCABULARY — supply-side policies: government measures designed to increase the productive capacity of the economy (raise aggregate supply, productivity and total output).
GENERAL VOCABULARY — productive capacity: the maximum output an economy can produce using its resources.
Unlike demand management (fiscal/monetary policy), supply-side policies work on the supply side — making the economy more efficient and able to produce more.
Figure 33.1 shows the impact of supply-side policies on total output: the PPC shifts outward — the country can produce more of both goods (more output without inflation).

THE IMPACT OF SUPPLY-SIDE POLICIES ON PRODUCTIVITY AND TOTAL OUTPUT

Supply-side policies raise productivity (output per worker) and total output (the PPC shifts right).
The economy can then grow without causing demand-pull inflation (supply rises alongside demand).

THE IMPACT OF SUPPLY-SIDE POLICIES ON MACROECONOMIC OBJECTIVES

Growth: higher productive capacity → sustainable growth.
Employment: training and labour-market reform help people into jobs → lower unemployment.
Inflation: raising supply reduces inflationary pressure.
Current balance: better productivity and lower costs improve international competitiveness → exports rise → the current account improves.

THE MAIN SUPPLY-SIDE MEASURES

1. EDUCATION AND TRAINING

Better schools, colleges and training raise skills and productivity — e.g. state education/training schemes (where state school may not be free — students/families may meet some costs), and apprenticeships.
GENERAL VOCABULARY (from the text): improving human capital.

2. POLICIES TO BOOST REGIONS WITH HIGH UNEMPLOYMENT (regional policy)

Some regions have far higher unemployment than others. Governments fund projects in the worst-hit regions — e.g. a specialist technology park or enterprise zones — to create jobs and growth there.

3. INFRASTRUCTURE SPENDING

Investment in roads, rail, ports, broadband and energy lowers business costs and raises productivity.
China is committed to a huge road construction programme (it has 5.23 million km of roads, 3.17 million km surfaced) and in 2015 said it would accelerate broadband network rollout.

4. LOWER BUSINESS TAXES TO STIMULATE INVESTMENT

Cutting corporation tax encourages investment: in Ireland the rate of corporation tax has been cut to just 10% (attracting foreign firms); investment allowances when buying machines and equipment; tax breaks for individuals who invest in new companies or IT companies.

5. LOWER INCOME TAXES TO ENCOURAGE WORKING

Lower income taxes increase the reward for working → people work more (the incentive effect) — e.g. in the UK, the top rate of income tax was reduced.
Lower taxes can also discourage people from setting up or developing businesses if they are too high (a disincentive).

6. DEREGULATION AND COMPETITION (GOVERNMENT CONTROLS)

GENERAL VOCABULARY — deregulation: removing government rules and controls to increase competition and efficiency.
Labour-market reform: making labour markets more flexible — e.g. in the UK, trade unions were often criticised for forcing up wages and making markets inflexible; closed shops and secondary picketing were made illegal → more flexible hiring and firing.
Privatisation and contracting out: private-sector firms have contracted out public services to cut costs (2010–2015 savings of £2200 million; since May 2015 annual savings to businesses of £800 million).
Caution: deregulation can bring problems — over recent years the world financial system suffered from too little regulation (the 2008 financial crisis).
Governments can also pass new laws/controls to achieve macroeconomic objectives.

ACTIVITY 1 — CASE STUDY: SUPPLY-SIDE POLICIES IN CHINA

China used supply-side policies to make growth more sustainable: massive infrastructure investment (roads, rail, broadband) and education to raise productivity.

ACTIVITY 2 — CASE STUDY: DEREGULATION IN THE USA

US deregulation of airlines, telecoms and energy increased competition and lowered prices for consumers — but also showed the dangers of removing too much control (financial deregulation).

ECONOMICS IN PRACTICE — CASE STUDY: SUPPLY-SIDE POLICIES IN ARGENTINA

Argentina faced highly uncertain conditions: inflation was over 20%, government spending was out of control (a big fiscal deficit).
The government introduced supply-side reforms:
Removed a number of controls in the economy (e.g. removed foreign-exchange controls).
Gave financial help to struggling dairy farmers.
Made changes to a range of taxes.
Promoted competition (opening markets).
Figure 33.2 shows Argentina's inflation (2006–16) — "too early to say" whether the measures work; supply-side reform takes time.

💡 Exam tip — demand-side vs supply-side

Demand-side (fiscal/monetary): manage aggregate demand — quick effects but risks inflation.
Supply-side: raise productive capacity — slower but sustainable growth without inflation. Both are needed.

✅ Quick check

Define supply-side policies. (Government measures to increase the economy's productive capacity — raise aggregate supply/productivity.)
What happens to the PPC under successful supply-side policy? (It shifts outward.)
Name five supply-side measures. (Education/training, regional policy, infrastructure spending, lower business/corporate taxes, lower income taxes, deregulation/labour-market reform.)
Why do supply-side policies help avoid inflation? (Supply rises alongside demand, so growth doesn't cause demand-pull inflation.)
What is deregulation? (Removing government rules/controls to increase competition.)
Give one risk of deregulation. (Too little regulation can cause problems — e.g. the 2008 financial crisis.)

Ch 34 Relationships Between Objectives and Policies

Chapter 34: Relationships Between Objectives and Policies

The macroeconomic objectives can conflict — you can't always hit them all at once. The big trade-offs: reducing inflation can raise unemployment, economic growth can damage the environment, and inflation policy affects the current account. This chapter explains these relationships and the policies (and trade-offs) used in real countries.

LEARNING OBJECTIVE

Understand the relationships between macroeconomic objectives and the policies used to achieve them (and the trade-offs involved).

GETTING STARTED — CASE STUDY: SAUDI ARABIA'S ECONOMIC POLICIES

With oil prices low, Saudi Arabia ran a fiscal deficit of SAR 367 000 million in 2015. The 2016 budget planned to cut that to SAR 326 000 million, cutting spending from SAR 975 000 million to SAR 840 000 million and selling off overseas assets to pay its bills (Figure 34.1).
This shows a government using fiscal policy (cuts + asset sales) to tackle a deficit — and the difficult trade-offs involved (cutting spending may slow growth and hit public services).

MACROECONOMIC OBJECTIVES CAN CONFLICT

SUBJECT VOCABULARY — trade-off: a situation where achieving one objective means sacrificing part of another — you cannot have both fully.
The main trade-offs in this chapter: 1. Reducing inflation ↔ higher unemployment. 2. Economic growth ↔ protecting the environment. 3. Anti-inflation policy ↔ the current account.

POLICIES TO REDUCE INFLATION — THE TRADE-OFF WITH UNEMPLOYMENT

To cut inflation, governments use contractionary policy: higher taxes and higher interest rates (or cuts in government expenditure).
How it works: higher taxes/rates reduce consumer spending and business investment → aggregate demand falls → inflation falls. BUT with lower demand, businesses sell less and may lay off workers → unemployment rises.
Example from the text: if consumption falls as a result of higher taxes, businesses' revenues fall and they reduce staff.
The result is a trade-off: the government may have to tolerate higher unemployment to bring inflation down (and vice versa).
Also: cutting government expenditure has opportunity costs — e.g. waiting times for NHS treatments may rise, fewer social workers, etc.

ECONOMIC GROWTH AND ENVIRONMENTAL PROTECTION — THE TRADE-OFF

Policies to promote growth (expansionary policy, supply-side measures) raise output — but growth often damages the environment:
More production → more pollution, more resource use, more congestion and waste (external costs).
Example: according to a government report, more than 80% of something (natural habitat/water bodies) is under pressure; housing, roads, pipelines and other industrial uses take land from nature.
KEY FACTS: in 2015, India planned to introduce tougher environmental standards (emissions rules) — balancing growth with protection.
The environment can also be protected while growing — via green taxes, renewable energy and regulation (see Chapter 29) — but there is a short-run trade-off: strict environmental rules can raise business costs and slow growth.

ACTIVITY 1 — CASE STUDY: THE TRADE-OFF BETWEEN ECONOMIC GROWTH AND ENVIRONMENTAL PROTECTION IN AUSTRALIA

Figure 34.2 shows the sources of electricity generation in Australia, 2015 — heavily reliant on coal (cheap, but high CO₂).
Australia plans to invest AUD 40 400 million between now and 2030 in cleaner energy — showing the trade-off between cheap fossil-fuel growth and protecting the environment, and the policies chosen to manage it.

INFLATION AND THE CURRENT ACCOUNT — THE RELATIONSHIP

Measures to reduce inflation (higher interest rates, higher taxes) affect the current account:
Higher interest rates attract foreign capital → exchange rate rises → imports cheaper, exports dearer → the current account can worsen.
Lower demand (from contractionary policy) reduces imports → the current account may improve ("a worsening of the current account might be avoided").
Measures to reduce inflation can therefore have mixed effects on the current account — another trade-off for policymakers.
Possible trade-off summary: the book's key line — a government may have to accept worse current-account results or higher unemployment depending on which objective it prioritises.

ECONOMICS IN PRACTICE — CASE STUDY: ANTI-INFLATIONARY POLICIES IN IRAN

Under the previous administration (Mahmoud Ahmadinejad's), Iran's inflation ran very high. The new government introduced anti-inflationary policies (tightening monetary and fiscal policy).
Figure 34.3 shows Iranian inflation falling (2012–16), but Figure 34.4 shows the Iranian unemployment rate (2014–16) — evidence of the trade-off: bringing inflation down went alongside high/persistent unemployment.

💡 Exam tip — the three trade-offs to quote

Inflation vs unemployment (contractionary policy cuts demand → jobs lost).
Growth vs environment (growth pollutes; protecting environment can slow growth).
Inflation policy vs current account (higher rates strengthen currency → imports cheap → current account worsens). Always name the policy and explain the mechanism, with a real country (Saudi Arabia, Australia, Iran).

✅ Quick check

What is a trade-off? (Achieving one objective means sacrificing part of another.)
Why does cutting inflation raise unemployment? (Contractionary policy cuts demand → firms lay off workers.)
How does growth harm the environment? (More pollution, resource use, congestion, habitat loss.)
How do higher interest rates affect the current account? (Strengthen the currency → imports cheaper/exports dearer → current account may worsen.)
Give one real example of a trade-off from the chapter. (Iran: inflation fell while unemployment stayed high; Australia: coal growth vs clean-energy investment.)

2.2 The Global Economy

Globalisation, MNCs, international trade, protectionism, trading blocs, the WTO and exchange rates.

Ch 35 Globalisation

Chapter 35: Globalisation

Globalisation is the process by which the world's economies become more integrated — through trade, investment, technology and migration. It is driven by fewer trade barriers, cheaper transport and communication, and the rise of multinationals. It brings big benefits (growth, jobs, choice, cheaper goods) but also costs (job losses in some industries, inequality, environmental damage).

LEARNING OBJECTIVES

Understand what globalisation is.
Understand the reasons for globalisation.
Understand the impact of globalisation and global companies on individual countries, people and the environment.

GETTING STARTED — CASE STUDY: THE GLOBAL CAR INDUSTRY

Economies have become more open — since the breakup of the Soviet bloc, trade has expanded massively.
Car makers are truly global: Ford has factories in the USA, UK, Spain and elsewhere; suppliers and sales are worldwide.
In 2015, global car sales reached 72.37 million cars (expected 75 million in 2016); sales in China alone were around 25 million in 2015. The biggest producers (e.g. Toyota, Volkswagen and GM — over 9 million each in 2015; all the big firms produced over 6 million) sell in global markets (Figures 35.1 and 35.2).

WHAT IS GLOBALISATION?

SUBJECT VOCABULARY — globalisation: the process by which the world's economies become more closely integrated — greater international trade, investment, migration and movement of capital and technology.
Features: goods are produced in one country and sold worldwide; people from many different nations live and work in the same city; events in one economy affect other economies (e.g. a slowdown in China affects the whole world).
GENERAL VOCABULARY — global company: a business that operates in many countries; companies can buy companies that operate in other countries (e.g. in 2016 a firm bought a foreign rival); patents granted in the USA are recognised across borders.

REASONS FOR GLOBALISATION (why it has grown)

FEWER TARIFFS AND QUOTAS: governments have reduced trade barriers (free-trade agreements, the WTO) — goods move more easily across borders (see Chapters 38–40).
REDUCED COST OF TRANSPORT: goods can be transported more cheaply — container shipping, bigger planes, better roads/ports (in India, improved transport; global air transport has soared — Figure 35.3 shows global air transport 1980–2015). Cheap flights mean many people are happy to fly abroad.
REDUCED COST OF COMMUNICATION: the internet, email, video calls and cheap phones make it easy to do business across borders — patents, designs and data flow instantly; firms can coordinate operations worldwide at low cost.
INCREASED SIGNIFICANCE OF MULTINATIONALS: MNCs operate factories and supply chains across many countries, spreading production globally (e.g. a company selects a country as a site for a new factory).

ACTIVITY 1 — CASE STUDY: AIR TRANSPORT AND GLOBALISATION

India now has many budget airlines (IndiGo, GoAir, JetLite, Simplifly — plus full-service carriers), connecting cities and countries cheaply — air transport growth (Figure 35.3) is both a cause and a consequence of globalisation.

THE IMPACT OF GLOBALISATION AND GLOBAL COMPANIES

On INDIVIDUAL COUNTRIES (developed)

Job losses in some industries: e.g. in the UK, huge numbers of manufacturing jobs have been lost as production moved to lower-cost countries (structural unemployment) — BUT new jobs have been created in services.
Cheaper goods for consumers (imports from low-cost producers).
More choice and new markets for exporters.

On INDIVIDUAL COUNTRIES (developing)

Benefits: multinationals often provide technical training, help develop new businesses (a new multinational may encourage local suppliers to set up), create jobs and tax revenue, and bring investment.
Risks: dependence on foreign firms, exploitation, environmental damage, profits flowing abroad.

On PEOPLE

Consumers: improved and cheaper transport/communications have opened up huge numbers of new destinations for tourists; global cuisine is available everywhere; cheaper, wider choice of goods.
Workers: can migrate to look for jobs in developed countries (migration flows).
Living standards: globalisation has helped raise living standards in many countries (e.g. Kenya, China) — and created winners and losers.

ON THE ENVIRONMENT

More production and trade usually means more environmental damage — as economies grow, emissions and resource use rise.
The damage is often underpriced — the UN reckons the environmental cost of global business is huge (a UN report estimated the cost of the damage caused by global companies).

ACTIVITY 2 — CASE STUDY: GLOBALISATION AND SMARTPHONE PRODUCERS

Smartphone production is global: design in one country, components from many, assembly in another, sold everywhere (Figure 35.4 shows global mobile phone sales, 2009–15, rising). It shows global supply chains and the benefits (cheaper, better phones) and costs (waste, e-waste, working conditions).

ECONOMICS IN PRACTICE — CASE STUDY: GLOBALISATION AND KENYA

Globalisation helped develop manufacturing in Kenya (e.g. Orbit, a Kenyan company whose produce is sold as far away as... earning US$100 million a year; the total number of people working increased from 20 million to 32 million).
But Kenya is vulnerable to global events: a slowdown in Chinese growth hurt Kenya (e.g. Nestlé released 46 employees in Kenya).
Figures 35.5–35.7 show Kenya's GDP growth, GDP per capita and fiscal deficit (2006–15/16) — growth with deficits, showing both the opportunities and risks of globalisation for developing countries.

💡 Exam tips

Define globalisation; give four reasons (fewer tariffs/quotas, cheaper transport, cheaper communication, MNCs).
Impact: three-way split — developed countries (manufacturing job losses), developing countries (jobs/investment but dependence), and the environment (damage).
Use real examples: cars, smartphones, Kenya, Nestlé.

✅ Quick check

Define globalisation. (The growing integration of the world's economies through trade, investment, migration and technology.)
Give four reasons for globalisation. (Fewer tariffs/quotas; cheaper transport; cheaper communication; rise of MNCs.)
Give one benefit and one cost for developed countries. (Benefit: cheaper goods, export markets. Cost: manufacturing job losses.)
How can globalisation help developing countries? (Jobs, investment, training, tax revenue, new businesses.)
Why is globalisation harmful to the environment? (More production and trade → more emissions, resource use and waste.)

Ch 36 Multinational Companies (MNCs) and Foreign Direct Investment

Chapter 36: Multinational Companies (MNCs) and Foreign Direct Investment (FDI)

Multinational companies (MNCs) are huge firms that operate in many countries. When they set up operations abroad, that investment is foreign direct investment (FDI). This chapter covers what MNCs are, why they emerge, and the advantages and disadvantages of MNCs/FDI for the host (developing) countries — jobs, infrastructure and skills versus tax avoidance, environmental damage and profit being moved abroad.

LEARNING OBJECTIVES

Understand what MNCs are.
Understand what FDI is.
Understand the reasons for the emergence of MNCs/FDI.
Understand the advantages and disadvantages of MNCs/FDI.

GETTING STARTED — CASE STUDY: FOREIGN INVESTMENT IN INDIA

India attracts foreign firms: in 2016, foreign investment in India rose by 29% to US$40 000 million (partly due to reforms). Figure 36.1 shows the top five sectors attracting foreign investment; Figure 36.2 the top five source nations.
India sees foreign investment as crucial to support future economic growth — it reckons around US$1 trillion is needed.
A foreign firm building a factory creates jobs, uses local suppliers and pays tax on profits — the benefits host countries hope for.

WHAT ARE MULTINATIONALS?

SUBJECT VOCABULARY — multinational company (MNC): a business that produces and sells in more than one country (a global company).
MNCs are enormous: they contribute a huge share of world GDP (about a third) and about two-thirds of global exports.
Features (KEY FACTS):
Huge assets (land, buildings, plant, machinery and money).
Global operations — factories, offices and sales worldwide.
Huge advertising budgets — Figure 36.3 shows Sony's advertising expenditure worldwide (2011–14), around US$80 000 million cumulative.
They can buy raw materials in huge quantities more cheaply (economies of scale).
Sony example: a Japanese MNC that generated more than 70% of its revenue outside Japan — it sells to the 7000 million people worldwide rather than only to Japan's ~50 million.

ACTIVITY 1 — CASE STUDY: SONY

Describe two features of MNCs using Sony: (1) operates in many countries (factories/offices worldwide); (2) sells to global markets (70%+ of revenue from outside its home country).

WHAT IS FOREIGN DIRECT INVESTMENT (FDI)?

SUBJECT VOCABULARY — foreign direct investment (FDI): investment by a firm or government of one country into business operations in another country — e.g. building a factory, a store or a distribution centre, or developing a mine or tea plantation.
Example: GM, the giant US car maker, invested in China — its joint ventures sold over 3.8 million vehicles in China (up 7.1%).
KEY POINT — FDI is NOT portfolio investment: it is direct — building/acquiring productive assets abroad (not just buying shares).

REASONS FOR THE EMERGENCE OF MNCs/FDI (why firms go global)

ECONOMIES OF SCALE: producing on a global scale lowers unit costs (buying inputs worldwide, using the cheapest locations).
ACCESS TO NATURAL RESOURCES / CHEAP MATERIALS: MNCs go where resources are — e.g. in 2014 the French oil company Total went ahead with a US$16 000 million project to extract oil off Africa's coast; firms locate near cheap raw materials.
LOWER TRANSPORT AND COMMUNICATION COSTS: transport costs have fallen and the speed of communication allows firms to organise activity across the world easily (video calls, email).
ACCESS TO CUSTOMERS IN DIFFERENT REGIONS: being inside a market (e.g. the EU or China) avoids tariffs and reaches customers directly — selling to billions rather than millions.

ACTIVITY 2 — CASE STUDY: MNCs/FDI IN AFRICA

Africa attracts FDI for its natural resources (still highly significant — Figure 36.4 shows factors that attract FDI to Africa) and growing consumer markets.
China's investment in Africa increased from US$7000 million in 2008 to US$26 000 million in 2013 — much of it for infrastructure development. China also pledged a US$60 000 million package of aid (interest-free loans) to Africa.

ADVANTAGES OF MNCs/FDI (for the host country)

JOB CREATION: MNCs employ local workers — evidence from Hungary and Brazil suggests that wages in MNC plants are higher than local average wages.
INVESTMENT IN INFRASTRUCTURE: MNCs build roads, ports, power and telecoms — benefiting the whole economy (e.g. Chinese-built infrastructure in Africa).
DEVELOPING SKILLS: MNCs train workers and provide the skills and motivation needed for enterprise — a skilled workforce benefits local firms too.
DEVELOPING CAPITAL: MNCs bring in capital and up-to-date technology — e.g. BMW's new plant is designed to be the most resource-efficient plant in the world.
CONTRIBUTING TO TAXES: MNCs pay taxes on profits, funding public services.
Boost to suppliers: local firms can supply the MNC (e.g. components, catering, transport).

DISADVANTAGES OF MNCs/FDI (for the host country)

TAX AVOIDANCE: MNCs use transfer pricing and tax havens to avoid paying tax — e.g. Apple CEO Tim Cook admitted his company routes profits through low-tax countries; in Mumbai, the Income Tax Department pursued MNCs. (One UK firm generated sales of £399 million in 2013 but paid about £10 million in tax.)
ENVIRONMENTAL DAMAGE: MNCs may pollute where regulation is weak (see Nigeria below).
MOVING PROFITS ABROAD: profits (and capital) are repatriated to the home country, not reinvested in the host — the host gets jobs but not the profits.
Dominance/crowding out: MNCs can force domestic producers out — e.g. in the UK, 46% of the food consumed is supplied by large (often foreign) firms.
Lack of accountability: if MNCs were held financially accountable for their damage, it would cost an estimated US$2.2 trillion — huge external costs.

ECONOMICS IN PRACTICE — CASE STUDY: FDI IN NIGERIA

FALLING FDI IN NIGERIA: as the oil price collapsed (Figure 36.6, 2012–16), Nigeria's FDI fell (Figure 36.7, 2008–15) — the economy's dependence on oil scared off investors.
MNC ENVIRONMENTAL DAMAGE IN NIGERIA: oil companies (like Shell) polluted the Niger Delta; a court forced Shell to pay US$84 million in compensation — the 15 600 farmers and fishermen affected by the spills were to receive about £2000 each.
Positive example: GE said it was investing US$150 million in Nigeria's railway system — "the beginning of a long-term US$2000 million investment project".
Lesson: FDI brings both development (railways) and harm (oil pollution) — host governments must regulate.

💡 Exam tips

Define MNC and FDI precisely (MNC = produces/sells in many countries; FDI = investment in productive assets abroad).
Reasons: economies of scale, resources/cheap materials, lower transport/communication costs, access to customers.
For/against: jobs, infrastructure, skills, capital, taxes, suppliers (for) vs tax avoidance, environmental damage, profits abroad, crowding out (against). Use Nigeria (Shell), Apple, BMW, Sony.

✅ Quick check

Define an MNC. (A business that produces and sells in more than one country.)
Define FDI. (Investment by one country's firm/government into business operations in another country.)
Give three reasons MNCs emerge. (Economies of scale, access to resources/cheap materials, lower transport/communication costs, access to customers.)
Give three advantages of FDI for a host country. (Jobs, infrastructure, skills, capital/technology, tax revenue, supplier contracts.)
Give three disadvantages. (Tax avoidance, environmental damage, profits moved abroad, crowding out local firms.)
What happened with Shell in Nigeria? (Ordered to pay US$84m compensation for oil pollution affecting 15 600 farmers/fishermen.)

Ch 37 International Trade

Chapter 37: International Trade

International trade is the buying and selling of goods and services between countries. Countries trade because of specialisation — they cannot produce everything, or can buy things more cheaply abroad, or must sell their surplus. Free trade (trade without barriers) brings lower prices, more choice and wider markets — but also creates competition for domestic businesses and job losses in some industries.

LEARNING OBJECTIVE

Understand the reasons for international trade and the advantages and disadvantages of free trade.

GETTING STARTED — THREE TRADING COUNTRIES

ICELAND: imports many goods it cannot easily produce (its climate and size limit domestic production).
SEYCHELLES: imports an estimated US$873.7 million of goods and services — again, a small island economy depending on trade.
QATAR: one of the highest GDP per capita in the world (US$73 653 in 2015) — driven largely by the oil and gas sector (92% of export earnings and 56% of GDP). With oil reserves in excess of 25 000 million barrels, it will keep earning from exporting (Figure 37.1).

WHY DO COUNTRIES TRADE? (reasons for international trade)

OBTAINING GOODS THAT CANNOT BE PRODUCED DOMESTICALLY: countries lack the climate, resources or skills for some products — e.g. consumers in Norway can buy goods that are impossible to produce at home (tropical fruit, coffee).
OBTAINING GOODS THAT CAN BE BOUGHT MORE CHEAPLY FROM OVERSEAS: countries specialise in what they do best and import the rest — e.g. China produces manufactured goods at a much lower cost and imports a lot of raw materials (e.g. iron ore — Figure 37.4 shows Australia's iron exports rising, because iron is a key input for many industries).
SELLING OFF UNWANTED COMMODITIES (surpluses): countries export what they produce in surplus — e.g. Qatar's oil, Australia's iron.

ACTIVITY 1 — CASE STUDY: ESTONIA

Estonia is a small, open economy: it exports to neighbouring countries (Figure 37.2 shows Estonia's exports by destination, 2015, as % of total — mostly to the EU) and its export value has grown strongly (Figure 37.3, 1991–2016). Trade is essential for a small country.

ADVANTAGES OF FREE TRADE

SUBJECT VOCABULARY — free trade: trade between countries without barriers (no tariffs, quotas or other restrictions). 1. LOWER PRICES AND INCREASED CHOICE FOR CONSUMERS: imports from the cheapest producers mean cheaper goods and more variety. 2. LOWER INPUT PRICES FOR BUSINESSES: firms can buy raw materials and components from the cheapest sources worldwide → lower costs → cheaper products (e.g. iron as an input for industry). 3. WIDER MARKETS FOR BUSINESSES: exporters can sell to hundreds of millions of consumers abroad — e.g. Toyota sells across regions (Figure 37.5 shows Toyota sales by region, 2016) and can offset a decline in one market by selling more in others. 4. (Plus: specialisation → efficiency → higher output and living standards; access to new technology.)

DISADVANTAGES OF FREE TRADE

COMPETITION FOR DOMESTIC BUSINESSES: cheap imports can undercut local firms — e.g. when China and other emerging economies started to export manufactured goods, Western manufacturers struggled (for the first time in 2014, Chinese manufacturing output was the highest in the world at US$1.9 trillion).
JOB LOSSES IN SOME INDUSTRIES: the US lost 5 million manufacturing jobs between January 2000 and December 2014 (and 3.6 million in a similar period); Figure 37.6 shows manufacturing employment falling in selected countries, 1990–2015.
OVER-RELIANCE ON PRIMARY PRODUCTS: some developing nations may rely too much on primary products (e.g. oil, coffee) — vulnerable to price swings.
DOMINATION BY FOREIGN FIRMS: powerful foreign companies are allowed to dominate markets.
LOSS OF SOVEREIGNTY: free trade agreements can limit a country's independence — e.g. in the UK, the EU determined many laws, which was one reason for Brexit.

ECONOMICS IN PRACTICE — CASE STUDY: MALAYSIA

Malaysia is an open, trading economy (home of the Petronas Twin Towers), with exports of electronics, palm oil and natural gas. Figure 37.7 shows Malaysia's current account balance, 2014–16 — mostly in surplus thanks to strong exports — showing how a country that trades well can run a healthy external position.

💡 Exam tips

Reasons to trade: can't produce it, cheaper abroad, sell surplus (Iceland/Seychelles/Qatar).
Free trade advantages: lower prices, more choice, cheaper inputs, wider markets.
Free trade disadvantages: competition, job losses, over-reliance, domination, loss of sovereignty (US manufacturing job losses; Brexit).

✅ Quick check

Give three reasons countries trade. (Can't produce domestically; cheaper to import; to sell surplus.)
What is free trade? (Trade without barriers — no tariffs or quotas.)
Give three advantages of free trade. (Lower prices, more choice, cheaper inputs, wider markets.)
Give three disadvantages. (Competition for domestic firms, manufacturing job losses, over-reliance on primary products, foreign domination, loss of sovereignty.)
Why is Qatar so rich? (Oil and gas exports — 92% of export earnings.)

Ch 38 Protectionism

Chapter 38: Protectionism

Protectionism is when governments restrict imports using trade barriers — tariffs, quotas, subsidies and embargoes. Countries protect themselves to prevent dumping, save jobs, shelter infant industries, raise tax revenue, block harmful goods, and reduce current account deficits — but protection has costs for consumers and can provoke retaliation.

LEARNING OBJECTIVES

Understand the reasons for protectionism.
Understand the methods of protection (tariffs, quotas, subsidies, embargoes).
Understand the impact of tariffs, quotas and subsidies on markets.

GETTING STARTED — TWO CASES

HELP FOR RWANDAN EXPORTERS: Rwanda's horticulture (flower/vegetable) industry is expected to bring in more than RWF 96 000 million (US$129 million) per year by 2018, up from RWF 7000 million (US$10 million) — exporting successfully.
CANADIAN TAXES ON US GYPSUM BOARD: Canada imposed a tax (tariff) on US gypsum board imports — the book notes the tax could have serious consequences for the construction industry (higher input costs for builders).

WHAT IS PROTECTIONISM?

SUBJECT VOCABULARY — protectionism: government measures to restrict trade (protect domestic industries from foreign competition).
SUBJECT VOCABULARY — trade barriers: the measures used to restrict trade (tariffs, quotas, subsidies, embargoes).

REASONS FOR PROTECTIONISM

PREVENTING DUMPING: SUBJECT VOCABULARY — dumping: selling goods in another country below the cost of production (or below the domestic price) to drive local firms out of business. Example: tyres that entered the US market — worth about US$1000 million — were accused of being dumped. Local firms find it very difficult to survive in the long term.
PROTECTING EMPLOYMENT: protecting domestic industries saves jobs — supporters point to the loss of 57 000 American factories and 25 million jobs claimed to result from free trade.
PROTECTING INFANT INDUSTRIES: new/young industries (infant industries) need protection from established foreign competitors while they grow and become efficient; without protection they cannot survive in the long term.
TO GAIN TARIFF REVENUE: tariffs raise money for the government — e.g. the UK government could collect around £12 900 million on imports coming in from the EU (and the EU would collect £5200 million on its imports from the UK).
PREVENTING THE ENTRY OF HARMFUL OR UNWANTED GOODS: governments restrict goods that are unsafe, unhealthy or politically unwanted — e.g. in 2015, an arms embargo had been imposed on a country; restrictions on dangerous foods, drugs or weapons.
TO REDUCE CURRENT ACCOUNT DEFICITS: cutting imports helps reduce a trade/current account deficit — e.g. in 2014, the Indian government used trade barriers to reduce its deficit.

METHODS OF PROTECTION

1. TARIFFS (customs duties)

SUBJECT VOCABULARY — tariff: a tax on imported goods. It raises the import's price, making domestic goods relatively cheaper.
Example: if a government adds £50 to the price of an imported product; in 2015, Ecuador imposed tariffs of 21% and 7% on certain imports.
Figure 38.1 shows the effect of a tariff: when the government imposes a tariff, the price rises and the quantity imported falls — domestic producers gain, consumers lose.

2. QUOTAS

SUBJECT VOCABULARY — quota: a physical limit on the quantity of a good that can be imported in a given period. (Also shown in Figure 38.1 — restricting supply raises price and protects domestic firms.)

3. SUBSIDIES

SUBJECT VOCABULARY — subsidy: a government payment to a domestic producer — lowering their costs so they can compete with imports (and sell more at home and abroad).
Figure 38.2 shows the effect of a subsidy: it increases domestic supply (the supply curve shifts right), lowering the market price for consumers.

4. EMBARGOES

SUBJECT VOCABULARY — embargo: a complete ban on trade with a particular country or on particular goods (e.g. the 2015 arms embargo).

ACTIVITY 2 — CASE STUDY: CHINESE COAL TARIFFS

China imposed tariffs on imported coal to protect its domestic coal industry and cut imports — raising the price of imported coal and boosting domestic producers (but raising energy costs).

THE IMPACT OF TARIFFS, QUOTAS AND SUBSIDIES ON MARKETS

TARIFFS AND QUOTAS (Figure 38.1):
Domestic price rises (tariff adds tax; quota restricts supply).
Quantity imported falls; domestic producers produce and sell more.
Consumers pay more and have less choice (consumers lose).
Government gains tariff revenue; domestic firms and their workers gain.
SUBSIDIES (Figure 38.2):
Domestic supply increases (curve shifts right) → price falls for consumers.
Domestic producers are protected from cheap imports.
Cost to taxpayers (the subsidy must be funded).

ECONOMICS IN PRACTICE — CASE STUDY: US TARIFFS ON FOREIGN STEEL

The USA imposed tariffs on foreign steel, claiming China was giving unfair subsidies to its producers (it was claimed 9 million tonnes were involved). The steel price had fallen from US$136 in 2011 to US$65 in 2015 — hurting US steel firms.
China took action against the USA to protect its US$818 million of exports — showing that protectionism can provoke retaliation (trade wars) which harms both sides.

💡 Exam tips

Define the 4 methods: tariff (tax), quota (limit), subsidy (payment), embargo (ban).
Reasons: dumping, employment, infant industries, revenue, harmful goods, deficits.
Effects diagram (Figure 38.1): tariff/quota → price up, imports down; subsidy → supply up, price down.
Evaluation: protection helps domestic firms/jobs but raises prices for consumers and invites retaliation.

✅ Quick check

Define protectionism. (Government measures to restrict trade / protect domestic industries.)
What is dumping? (Selling goods below cost of production to drive out local firms.)
Give four reasons for protectionism. (Prevent dumping, protect employment, protect infant industries, raise tariff revenue, block harmful goods, cut deficits.)
Distinguish tariff, quota, subsidy and embargo. (Tariff = tax on imports; quota = limit on quantity; subsidy = payment to domestic producers; embargo = ban.)
What happens to price and imports when a tariff is imposed? (Price rises; imports fall.)
Why can protectionism backfire? (Retaliation — trade wars harm both sides.)

Ch 39 Trading Blocs

Chapter 39: Trading Blocs

A trading bloc is a group of countries that agree to reduce or remove trade barriers between themselves (while often keeping barriers against the rest of the world). Examples include the EU, NAFTA, ASEAN, SACU, Mercosur and the GCC. Membership brings benefits (free trade, bigger markets, cooperation) but can hurt non-members (trade diversion).

LEARNING OBJECTIVES

Understand what trading blocs are and their impact on member and non-member states.
Understand some examples of trading blocs.

GETTING STARTED — CASE STUDY: CROATIA AND THE EU

Croatia joined the EU (in 2013). Figure 39.1 shows Croatia's current balance as % of GDP (2006–16) and Figure 39.2 its economic growth rate (2012–16) — growth picked up after joining.
Croatia's producers realise that investment and support for rural products is beginning to pay off — EU membership opened markets and brought investment and support (e.g. agricultural subsidies).

WHAT IS A TRADING BLOC?

SUBJECT VOCABULARY — trading bloc: a group of countries that agree to reduce or remove trade barriers between themselves.
Members trade freely with each other but may keep tariffs/quotas against non-members.
MEMBER STATES — benefits of membership:
Free trade between members → bigger markets, lower prices, more choice.
Common external tariffs on imports from non-members (protects members).
Free movement of labour and capital in the most integrated blocs (e.g. the EU's single market).
Cooperation: countries may share resources, help each other out and coordinate policy (e.g. shared infrastructure, standards).
Political and economic stability and bargaining power in world trade.

THE IMPACT OF TRADING BLOCS ON NON-MEMBER STATES

Non-members face trade barriers (tariffs/quotas) when selling into the bloc → their exports are less competitive.
Trade diversion: members switch from efficient non-member suppliers to less efficient member suppliers (because members get free trade) — non-members lose sales.
Non-members may be excluded from investment (firms locate inside the bloc to avoid the barriers — so FDI goes to members, not non-members).
Some non-members can still benefit from the bloc's growth (bigger market to sell into, if they can get in).

EXAMPLES OF TRADING BLOCS

1. THE EU (European Union)

The most integrated bloc: a single market with free movement of goods, services, labour and capital, a common external tariff, and (for the eurozone) a common currency. (The UK voted to leave in 2016 — Brexit.)

2. NAFTA (NORTH AMERICAN FREE TRADE AGREEMENT)

Its members are the USA, Canada and Mexico — free trade between the three (soon to be replaced/renamed USMCA).

3. ASEAN (ASSOCIATION OF SOUTHEAST ASIAN NATIONS)

A bloc of Southeast Asian countries (including Vietnam, Thailand, Indonesia, Malaysia, Singapore...) promoting free trade and economic cooperation in the region.

4. SACU (SOUTH AFRICAN CUSTOMS UNION)

A customs union of southern African countries (South Africa, Botswana, Lesotho, Namibia, Eswatini) — they share a common external tariff and pool customs revenue.

5. MERCOSUR

A South American bloc — makes transactions between members easier (and some members aim for even more integration, e.g. a common currency).

6. GCC (GULF COOPERATION COUNCIL)

Its member states are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE — economic cooperation among Gulf oil states.

ECONOMICS IN PRACTICE — CASE STUDY: THE EAST AFRICAN COMMUNITY (EAC)

The East African Community is a trading bloc of East African countries (e.g. Kenya, Tanzania, Uganda, Rwanda, Burundi).
Members benefit from free trade between them — e.g. Rwandan flowers/vegetables (Chapter 38) can be sold across the region — and cooperation on infrastructure (roads, railways) and common standards. Smaller members gain access to larger neighbours' markets.

💡 Exam tips

Define trading bloc; distinguish free trade area / customs union / single market (increasing integration).
Members: free trade, bigger markets, cooperation, investment.
Non-members: face barriers, trade diversion, lose FDI.
Name real blocs: EU, NAFTA, ASEAN, SACU, Mercosur, GCC, EAC.

✅ Quick check

Define a trading bloc. (A group of countries that reduce/remove trade barriers between themselves.)
Give three benefits of bloc membership. (Free trade/bigger markets, common external protection, free movement of labour/capital, cooperation.)
How do blocs affect non-members? (They face barriers, suffer trade diversion, and lose investment.)
Name NAFTA's members. (USA, Canada, Mexico.)
What is a customs union (like SACU)? (Members share a common external tariff and pool revenue.)

Ch 40 The World Trade Organization and Patterns of World Trade

Chapter 40: The World Trade Organization and Patterns of World Trade

The World Trade Organization (WTO) is the international body that promotes free trade — negotiating agreements, monitoring members' policies and settling trade disputes. World trade has grown enormously, with developed countries dominating but developing countries' share rising. Many developing countries remain dependent on commodities, which makes them vulnerable.

LEARNING OBJECTIVES

Understand the role of the WTO.
Understand the pattern of world trade (developed vs developing countries).

GETTING STARTED — CASE STUDY: BRAZIL v THAILAND TRADE DISPUTE

A trade dispute between Brazil and Thailand (over trade barriers on a product) — such disputes are settled by the WTO.
SUBJECT VOCABULARY — trade dispute: a disagreement between countries about trade (e.g. one country claims another's tariffs/subsidies break trade rules).

THE WORLD TRADE ORGANIZATION (WTO)

SUBJECT VOCABULARY — World Trade Organization (WTO): an international organisation that promotes free trade by negotiating the reduction of trade barriers and settling trade disputes between countries.
Its main activities: 1. TRADE NEGOTIATIONS: rounds of talks to lower tariffs, quotas and other barriers worldwide. 2. IMPLEMENTATION AND MONITORING: the WTO may examine trade policies to ensure members follow the rules (e.g. protecting intellectual property rights). 3. SETTLING TRADE DISPUTES: when countries disagree (e.g. Brazil v Thailand, Pakistan v South Africa), the WTO rules on whether trade practices break the rules. 4. BUILDING MEMBERSHIP: almost every country is now a member (in 2015 the WTO had a budget of over US$195 million and a staff of trade/communications experts) — it works to bring developing countries into world trade.

ACTIVITY 1 — CASE STUDY: TRADE DISPUTE BETWEEN PAKISTAN AND SOUTH AFRICA

Pakistan challenged South Africa over anti-dumping duties on a product. The WTO panel found South Africa had failed to examine the entire product range under investigation and had only looked at part of it — what is meant by a trade dispute? A disagreement over whether a country's trade measures break agreed rules; the WTO panel investigates and rules.

CRITICISMS OF THE WTO

IT FAVOURS WEALTHY NATIONS OVER POORER ONES: negotiators from rich countries are said to dominate; bodies like Global Exchange (which promotes people-centred trade) argue the rules favour the powerful. Example: developing countries gathered evidence that they were losing US$1200 million p.a. in revenue as a result of subsidies paid by rich countries to their own farmers.
IT IS DESTROYING THE ENVIRONMENT: critics point out that the very first WTO panel ruled that it was illegal for a government to ban a product on environmental grounds unless based on sound science — seen as putting free trade above the environment.
(Related: rich countries keep their own protection while forcing poor countries to open up.)

THE INCREASE IN WORLD TRADE

World trade has increased enormously in the last 55 years — Figure 40.1 shows the value of global exports, 1960–2015 rising steeply.
Causes: falling trade barriers, cheaper transport, and better communication — sellers and buyers can communicate more easily; consumers can buy goods online from anywhere.
Air travel has also soared (Figure 40.3: number of passengers carried by air, 1980–2015), and migration has risen — the number of international migrants rose from 82.3 million (1990) to 135.6 million (2013).

TRADE IN DEVELOPED COUNTRIES

It is the developed nations that continue to dominate world trade — Figure 40.2 shows the world's leading merchandising traders in 2014 (USA, China, Germany, etc.).
But the centre of gravity is shifting to Far Eastern countries such as China and South Korea — e.g. the USA now imports far more from these countries.

TRADE IN DEVELOPING COUNTRIES

Developing countries have increased their share of world trade — Figure 40.4 compares the share of world trade in 1995 and 2014 (their share grew).
FDI to Sub-Saharan Africa grew from US$4583 million (1995) to US$42 000 million (2015) — FDI is very important for these economies.
Huge challenges remain: e.g. 30% of Indians — over 200 million people — still live in absolute poverty; many poor countries carry heavy debts (the book mentions US$40 000 million of debt owed by 18 heavily indebted poor countries — much of which was cancelled/relieved).
Migration of workers from developing to developed countries also plays a role (migrant remittances flow back).

ECONOMICS IN PRACTICE — CASE STUDY: COMMODITY DEPENDENCY

SUBJECT VOCABULARY — commodity: a basic product traded in bulk, e.g. farm products (coffee, cotton, cocoa), oil, minerals.
Many developing countries depend on commodities for international trade (Figure 40.7 shows developing-country dependency on commodities, 2012–13; Figure 40.5 the pattern of agricultural trade for developing countries, 1961–2000).
Problem: when commodity prices fall, the exporting country's income collapses — Figure 40.6 shows commodity prices falling sharply (2012–16). Over-reliance on one or two commodities is very risky.
Reducing dependency: countries can plan for the future — e.g. Uganda has diversified; developing 'green' energy will change demand patterns; China's interest in African commodities drives prices.

✅ Quick check

What does the WTO do? (Promotes free trade — negotiates barrier reductions, monitors policies, settles trade disputes.)
Give two criticisms of the WTO. (Favours wealthy nations; prioritises trade over the environment; rich keep subsidies while poor open up.)
What has happened to world trade over the last 55 years? (It has increased enormously.)
Who dominates world trade? (Developed countries — though developing countries' share is rising.)
Why is commodity dependency risky? (If commodity prices fall, export income collapses.)

Ch 41 Exchange Rates and Their Determination

Chapter 41: Exchange Rates and Their Determination

The exchange rate is the price of one currency in terms of another (e.g. £1 = US$1.50). In a floating system it is set by supply and demand for the currency. Demand for a currency comes from exports, foreign investment and speculation; supply comes from imports, foreign investment abroad and speculation. Any change in supply or demand changes the exchange rate.

LEARNING OBJECTIVES

Understand what an exchange rate is.
Understand the factors affecting the demand for and supply of a currency.
Understand how supply and demand determine the exchange rate (and how changes shift it).

GETTING STARTED — WHY WE NEED EXCHANGE RATES

Most countries use different currencies: the UAE has the dirham, the USA the dollar, the UK the pound, Japan the yen.
Ruhr Metal Products (a German firm buying/selling abroad) and tourists like Sally Wong and Hans Kroos need to convert money between currencies → we need exchange rates.

WHAT IS AN EXCHANGE RATE?

SUBJECT VOCABULARY — exchange rate: the price of one currency in terms of another.
Example: £1 = US$1.50 means one pound buys one and a half US dollars.
Worked conversions (from the book):
French firm buying £400 000 of goods, £1 = €1.10: cost = £400 000 × 1.1 = €440 000.
British firm buying US$300 000 of goods, £1 = US$1.50: cost = US$300 000 ÷ 1.5 = £200 000.
British firm buying £55 000 of goods from a US firm, £1 = US$1.50: cost = £55 000 × US$1.50 = US$82 500.
Japanese visitor with JPY 100 000, £1 = JPY 150: pounds bought = JPY 100 000 ÷ 150 = £666.67.
Rule: to convert foreign into home currency, divide; to convert home into foreign, multiply.

ACTIVITY 1 — CASE STUDY: TORRES MACHINE TOOLS (TMT, a Mexican firm)

A US firm bought machines from TMT costing MXN 3.6 million (assume MXN 1 = US$0.05 → worth US$180 000).
TMT bought components from a German firm for €2.5 million (MXN 1 = €0.45 → TMT pays in MXN: €2.5m ÷ 0.45 ≈ MXN 5.56m).
TMT bought materials from a Spanish firm for MXN 20 million — TMT needs to convert MXN into euros.
These show the daily currency conversions every international business makes.

FACTORS AFFECTING THE DEMAND FOR A CURRENCY

Demand for pounds comes from anyone who needs pounds to buy UK goods/assets: 1. THE DEMAND FOR EXPORTS: foreigners need pounds to buy UK exports — e.g. firms in the UK selling goods to Australian firms are paid in pounds, so Australians must buy pounds. If UK exports rise, demand for pounds shifts right (D₁ → D₂, Figure 41.4). 2. INTEREST RATES: if UK interest rates are relatively high, foreigners buy pounds to save/invest in UK banks and assets → demand for pounds rises. High rates attract "hot money". 3. CURRENCY SPECULATORS: if speculators think the value of the pound is going to rise, they buy pounds now to sell at a higher price later → demand rises (Figure 41.4). 4. Foreign investment: if a foreign multinational wants to build a factory in the UK, it must buy pounds to pay UK workers/suppliers → demand rises.

FACTORS AFFECTING THE SUPPLY OF A CURRENCY

Supply of pounds comes from anyone selling pounds to buy foreign currency: 1. THE DEMAND FOR IMPORTS: UK firms/consumers need foreign currency to buy imports → they sell pounds → supply of pounds rises. 2. INTEREST RATES IN OTHER COUNTRIES: if foreign interest rates are higher, UK savers sell pounds to invest abroad → supply rises. 3. Foreign investment by UK firms: if UK MNCs develop business interests abroad (building factories), they sell pounds to buy foreign currency → supply rises. 4. Speculation: if speculators believe the pound will fall, they sell pounds → supply rises.

HOW ARE EXCHANGE RATES DETERMINED?

In a floating exchange-rate system, the rate is set by supply and demand — exactly like any other market.
Figure 41.1 (the market for sterling): the supply and demand for pounds cross at the equilibrium exchange rate of £1 = US$1.50; at this rate, Q₁ pounds are traded on the market.
Figure 41.2 (the market for US dollars): S₁ is the supply of dollars, D₁ the demand; the price of dollars is set where they cross.

ACTIVITY 2 — CASE STUDY: EXCHANGE-RATE DETERMINATION

Use the supply/demand diagram for a currency (e.g. the dollar) to read off the equilibrium rate and quantity, and to predict what happens when demand or supply changes.

THE EFFECT OF CHANGES IN SUPPLY AND DEMAND ON EXCHANGE RATES

CHANGE IN SUPPLY (Figure 41.3): an increase in the supply of pounds (e.g. more imports, UK investment abroad) shifts supply right → the exchange rate FALLS (pounds become cheaper — a depreciation).
CHANGE IN DEMAND (Figure 41.4): an increase in the demand for pounds (more exports, higher UK interest rates, speculation) shifts demand right (D₁ → D₂) → the exchange rate RISES (an appreciation).

ECONOMICS IN PRACTICE — CASE STUDY: THE EXCHANGE RATE BETWEEN THE INDIAN RUPEE AND THE US DOLLAR

India is a popular tourist destination for US travellers — in 2015, more than 1.2 million US residents visited India (they must buy rupees → demand for rupees).
India sold US$45 988 million of goods to the USA (demand for rupees) while the USA sold US$21 689 million of goods to India (supply of rupees).
Figure 41.5 shows the US dollar/rupee exchange rate over 10 years; Figure 41.6 shows the market for rupees at the current equilibrium rate ER₁ — and what happens when demand or supply shifts.

📊 KEY DIAGRAM — Exchange Rate Determination

Exchange Rate Determination

✅ Quick check

Define the exchange rate. (The price of one currency in terms of another.)
Name three factors affecting the DEMAND for a currency. (Exports, interest rates, speculation, foreign investment.)
Name three factors affecting the SUPPLY of a currency. (Imports, foreign interest rates, UK investment abroad, speculation.)
How is a floating exchange rate determined? (By supply and demand for the currency.)
What happens to the exchange rate if demand for the currency rises? (It rises/appreciates.) What if supply rises? (It falls/depreciates.)*
If £1 = US$1.50, how much is US$300 000 in pounds? (£200 000 — divide.)

Ch 42 Impact of Changing Exchange Rates

Chapter 42: The Impact of Changing Exchange Rates

Exchange rates change as supply and demand for a currency change. A rise in the rate (appreciation / official revaluation) makes exports dearer and imports cheaper — hurting exporters but helping consumers and importers, and typically worsening the current account. A fall (depreciation / devaluation) does the opposite. Governments can influence rates (e.g. via interest rates), and the size of the effect depends on price elasticity.

LEARNING OBJECTIVES

Understand why exchange rates change (appreciation/revaluation vs depreciation/devaluation).
Understand the impact of exchange-rate changes on exports, imports and the current account.
Understand the role of government policy and price elasticity.

GETTING STARTED — CASE STUDY: THE POUND–EURO EXCHANGE RATE

Figure 42.1 shows the pound–euro exchange rate, 2013–17. It rose from £1 = €1.28 to £1 = €1.31 between the beginning and middle of 2015 (an appreciation), then fell sharply after the UK's vote to leave the EU in June 2016 — from £1 = €1.31 to £1 = €1.10 in just a couple of months (a depreciation of about 16%).

WHY DO EXCHANGE RATES CHANGE?

At any time, supply and demand conditions can change:
Higher UK interest rates attract foreign money → demand for pounds rises → the exchange rate rises.
Lower UK interest rates → pounds sold → the rate falls.
Changes in exports, imports, speculation and investment all shift supply/demand (see Chapter 41).

APPRECIATION AND REVALUATION

SUBJECT VOCABULARY — appreciation: a rise in the value of a currency in a floating exchange-rate system — a unit of one currency buys more of another. Example: the rate rises from £1 = US$1.50 to £1 = US$2 (Figure 42.1 shows the pound appreciating against the euro in 2015).
SUBJECT VOCABULARY — revaluation: a rise in the value of a currency in a fixed exchange-rate system — the government officially raises the rate.
Fixed exchange rates are used in a minority of countries, e.g. Bulgaria (its currency is pegged to the euro).

DEPRECIATION AND DEVALUATION

SUBJECT VOCABULARY — depreciation: a fall in the value of a currency in a floating system — a unit of one currency buys less of another (e.g. the pound after Brexit).
SUBJECT VOCABULARY — devaluation: a fall in the value of a currency in a fixed system — the government officially lowers the rate.
💡 Exam tip: appreciation/depreciation = market-driven (floating); revaluation/devaluation = government-changed (fixed).

THE IMPACT OF EXCHANGE-RATE CHANGES

IMPACT ON EXPORTS (appreciation example)

If the rate rises from £1 = US$1.50 to £1 = US$2:
A UK firm selling £2 million of goods to a US customer: the dollar price was US$3 million (£2m × 1.50); it rises to US$4 million (£2m × 2).
Foreign buyers must pay more → demand for UK exports is likely to FALL.
If the rate falls (e.g. to £1 = US$1.20): the dollar price falls to US$2.4 million → exports become cheaper → demand for UK exports RISES.

IMPACT ON IMPORTS (appreciation example)

A UK firm buying US$600 000 of goods from a US supplier:
At £1 = US$1.50, the sterling price is £400 000; at £1 = US$2, it falls to £300 000.
Imports become cheaper → demand for imports RISES (this means a current account deficit would worsen).
If the rate falls: the sterling price to the importer rises → imports dearer → demand for imports FALLS.

IMPACT ON THE CURRENT ACCOUNT

Appreciation: exports fall (dearer) + imports rise (cheaper) → the current account worsens (deficit grows / surplus shrinks).
Depreciation: exports rise (cheaper) + imports fall (dearer) → the current account improves.
Other effects of a depreciation: imported inflation (imports dearer push up prices), tourism changes, and FDI effects — but the big trade effects are the two above.

ACTIVITY 1 — CASE STUDY: IMPACT OF EXCHANGE-RATE CHANGES

Work through the table: PRICE OF exports/imports and DEMAND FOR them as the exchange rate rises or falls — fill in whether price rises/falls and demand rises/falls (as in the worked examples above).

ACTIVITY 2 — CASE STUDY: NG MOTOR PARTS

NG Motor Parts (a UK firm) buys components priced in dollars/euros and sells parts abroad — work out how an appreciation/depreciation changes its costs, prices and competitiveness.

EXCHANGE RATES AND GOVERNMENT POLICY

What can the government do if, for example, there is a large and persistent current account deficit?
It can try to depreciate the currency — e.g. reduce interest rates (in the UK, set by the Monetary Policy Committee of the Bank of England) → the value of the pound falls → exports cheaper → deficit improves.
But policies can conflict: reducing interest rates when a government is also trying to control inflation would worsen inflation (cheaper imports? actually depreciation raises import prices). Policymakers must balance objectives (links to Chapter 34).

EXCHANGE RATE CHANGES AND PRICE ELASTICITY

The effect of an exchange-rate change depends on the price elasticity of demand for imports and exports:
If demand for exports is inelastic, a depreciation would have very little effect on demand (and therefore little effect on export revenue/current account).
If demand is elastic, the quantity response is large — depreciation boosts exports and improves the current account significantly.
Conclusion: the Marshall–Lerner-style point — depreciation only improves the current account if the combined elasticities are high enough.

ECONOMICS IN PRACTICE — CASE STUDY: THE EFFECTS OF CHANGING EXCHANGE RATES IN THE UAE

The UAE (dirham): the exchange rate affects its trade and tourism.
Dubai International Airport — Figure 42.2 shows passenger traffic rising since 2010 (2010–20 projected) — more tourists (many paying in foreign currency) boost services revenue when their currencies are strong against the dirham.
Airlines pay for fuel in US dollars: in June 2016 a carrier paid US$900 000 for a fuel order — a stronger dollar (or weaker dirham) raises fuel costs.
The AED exchange rate table (AED 1 = JPY 1.6 / AUD 0.35 / CNY 1.9 etc.) is used to work out the cost of imports and value of exports in different currencies.

✅ Quick check

Define appreciation and depreciation. (Appreciation = rise in a floating rate; depreciation = fall in a floating rate.)
Define revaluation and devaluation. (Revaluation = rise in a fixed rate; devaluation = fall in a fixed rate.)
What happens to exports when the currency appreciates? (They become dearer abroad → demand falls.)
What happens to imports when the currency depreciates? (They become dearer → demand falls.)
How does a depreciation affect the current account? (It improves it — exports up, imports down.)
Why does elasticity matter? (If import/export demand is inelastic, exchange-rate changes have little effect on the current account.)
How can the government depreciate the currency? (Lower interest rates → currency falls.)

Exam Skills + Glossary

Paper walkthroughs, command words decoded and the full glossary — everything for the two exam papers.

🎯 Exam Preparation — Paper 1 & Paper 2

Exam Preparation — Paper 1 & Paper 2

The book ends with two full practice papers that mirror the real International GCSE exams. Both papers are 1 hour 45 minutes, worth 80 marks each, and count 50% each toward the final grade. Each paper has 4 questions of 20 marks, with sub-parts that get harder as they go.

PAPER 1 — MICROECONOMICS AND BUSINESS ECONOMICS

Content: Section 1.1 The Market System (Ch 1–13) + Section 1.2 Business Economics (Ch 14–24).
Structure: 4 questions × 20 marks = 80 marks.
Question 1 is often based on a case/data stimulus (e.g. a hotel in Sri Lanka) with parts (a)–(i); Questions 2–4 mix multiple-choice, short answer, calculation, diagram and extended-response parts.

What Paper 1 looks like (from the practice paper)

Q1 (a) Multiple choice (1 mark): e.g. "Which will cause the supply curve for motor cars to shift left?" → answer C: A rise in the cost of wages paid to car workers.
(b) Multiple choice (1 mark): e.g. which good is most likely provided by the private sector? → Hotels.
(c) "What is meant by opportunity cost?" (2 marks) — definition, two-part.
(d)/(e) Define terms: collusion, supply (1 mark each).
(f) Calculate profit: fixed costs LKR 400 000, variable cost LKR 1000 per room, price LKR 2000 per night, 430 rooms let:
TC = 400 000 + (1000 × 430) = LKR 830 000; TR = 2000 × 430 = LKR 860 000; profit = LKR 30 000.
(g) Calculate revenue from a disequilibrium diagram (Price £20, units 7000): TR = £20 × 7000 = £140 000.
(h) Explain what happens if production costs fall (3 marks): supply shifts right, price falls, quantity rises.
(i) Analyse (6 marks): impact of restricting migration on UK labour markets — fewer workers → supply of labour falls → wages rise in health care/agriculture/hotels; shortages; firms may automate or relocate.
Q2 (a) If PED = −2, a 10% price rise → 20% decrease in demand (D). (b) Fishing = primary sector. (c) State the PES formula = %ΔQS ÷ %ΔP, then calculate: quantity supplied +18%, price +12% → PES = 18/12 = 1.5. (d) State one factor of production (land/labour/capital/enterprise). (e) What is meant by market failure? (2 marks). (f) Explain the role of the public sector (3 marks).
Q3 & Q4 (from the practice paper): include diagrams (e.g. competition in the mobile telephone market), monopoly/competition analysis, and 6–8 mark evaluate questions weighing factors and reaching a supported conclusion.

PAPER 2 — MACROECONOMICS AND THE GLOBAL ECONOMY

Content: Section 2.1 Government & the Economy (Ch 25–34) + Section 2.2 The Global Economy (Ch 35–42).
Structure: 4 questions × 20 marks = 80 marks.
Expect: data (inflation rates, GDP growth, exchange-rate tables), calculations, diagrams (AD/AS, economic cycle), and analysis/evaluation of fiscal, monetary and supply-side policy and trade/exchange-rate issues.

What Paper 2 looks like

Multiple-choice on macroeconomic objectives and definitions.
Calculate growth rates, unemployment rates, exchange-rate conversions (e.g. a UK firm converting US$ into pounds — see Ch 41 worked examples).
Explain the causes of inflation (demand-pull vs cost-push), types of unemployment, effects of interest-rate changes.
Analyse/Evaluate (6–8 marks): e.g. "Discuss whether the government should use fiscal policy or monetary policy to reduce inflation"; "Evaluate the impact of a depreciation of the currency on the UK economy".
Skills badges shown throughout: Problem Solving, Critical Thinking, Analysis — showing which assessment objectives (AO1/AO2/AO3) are being tested.

HOW THE MARK SCHEME WORKS (Assessment Objectives)

AO1 — Knowledge and understanding (1–2 mark parts): definitions, stating facts.
AO2 — Application (2–3 mark parts): applying knowledge to the data/context, calculations.
AO3 — Analysis and evaluation (4–8 mark parts): develop chains of reasoning ("this leads to... which means..."), weigh factors, and reach a supported conclusion.

💡 Exam technique (from the command words)

Define / State / What is meant by: give the precise definition — for "what is meant by" give two separate parts to the definition.
Calculate: show your workings — method marks are awarded even if the final answer is wrong. Calculators allowed.
Draw: label axes, curves and the equilibrium/shift clearly — each awardable point scores.
Explain: state the fact plus two expansion points, in context.
Analyse: extended answer exploring the concept/issue in context.
Assess: use the data to weigh up factors and compare them.
Evaluate: apply knowledge and reach a supported conclusion about an economic situation.
Time management: 1h45 for 4 questions — roughly 25 minutes per question; leave time for the big 6–8 mark parts.

✅ Final revision checklist

[ ] Know ALL definitions from the glossary (AO1 marks are free marks).
[ ] Can draw: PPC, demand/supply curves, market equilibrium, PED/PES, labour market, minimum wage, AD/AS, economic cycle, exchange-rate market.
[ ] Can calculate: PED, PES, YED, revenue, profit, costs, exchange-rate conversions, growth rates.
[ ] Can give 2 real-world examples per topic (from the case studies in these notes).
[ ] Practise one full Paper 1 and one full Paper 2 under timed conditions.

🔤 Command Words

Command Words (from the Edexcel IGCSE Economics specification)

These are the exact command words used in Paper 1 and Paper 2. Learning what each one demands is the fastest way to gain marks — the examiner is literally telling you what to do.

Command word	What the question requires
Multiple-choice question	Select the one correct answer (sometimes more than one) from the choices. Tests recall of specification content, or requires a calculation to reach the answer.
Define	Give the definition of the term from the specification content.
State	Give an answer, no longer than a sentence, referring to a piece of information from the specification content.
What is meant by…	Define the term — there must be two separate parts to the definition (e.g. "demand is the amount of a good that consumers are willing and able to buy at a given price over a given time period").
Calculate	Use mathematical skills to reach the answer from given data. Calculators may be used and workings should be shown (method marks).
Draw	Draw a diagram containing two/three separate awardable points (e.g. labelled axes, correct curve, correct shift/equilibrium).
Explain	Give a statement of fact plus two further expansion points (these may build on each other, or both come from the same fact). The answer must be placed in context by the question.
Analyse	Write an extended answer requiring the expansion and exploration of an economic concept or issue. The answer will be placed in context by the question.
Assess	Write an extended answer, using the given information to weigh up factors and compare them in an economics context.
Evaluate	Write an extended answer, applying knowledge of specification content, to reach a supported conclusion about an economic situation.

💡 How to use this table

1-mark questions = Define / State (AO1).
2-mark questions = "What is meant by…" (two-part definition) or a small calculation (AO1/AO2).
3–4 mark questions = Explain/Calculate/Draw (AO2).
6-mark questions = Analyse (AO3) — chains of reasoning.
8-mark questions = Assess/Evaluate (AO3) — weigh factors, compare, and conclude.
Match the depth of your answer to the mark value — a 1-mark question deserves a definition, not an essay.

📖 Glossary of Key Terms

Glossary of Key Terms

The complete glossary from the back of the book, reorganised into a clean A–Z reference. Every definition in these notes uses these exact terms — they are the ones examiners reward with AO1 marks.

Term	Definition
absolute poverty	Where people do not have enough resources to meet all of their basic human needs.
administration	Activities involved with managing and organising the work of a company or organisation.
aggregate demand	Total demand in the economy, including consumption, investment, government expenditure and exports minus imports.
aggregate supply	Total amount of goods and services produced in a country at a given price level in a given time period.
anti-competitive practices (restrictive trade practices)	Attempts by firms to prevent or restrict competition.
appreciate (of a currency)	Where the value of a currency rises due to market forces — the exchange rate increases.
assembly plants	Factories where parts are put together to make a final product.
assets	Things or resources belonging to an individual or a business that have value or the power to earn money.
austerity	Official action taken by a government in order to reduce the amount of money that it spends or the amount it borrows.
balance of payments	Record of all transactions relating to international trade (all flows of money into and out of a country).
balance of trade (visible balance)	Difference between visible exports and visible imports.
barriers to entry	Obstacles that might discourage a firm from entering a market.
base rate	Rate of interest set by the government or regional central bank for lending to other banks, which in turn influences all other rates in the economy.
basic economic problem	Allocation of a nation's scarce resources between competing uses that represent infinite wants.
bi-lateral trade agreement	Trade deal between only two countries.
boom	Peak of the economic cycle where GDP is growing at its fastest; time when business activity increases rapidly, so demand for goods increases, prices and wages go up, and unemployment falls.
boom and bust	When an economy regularly becomes more active and successful and then suddenly fails.
budget	Government's spending and revenue plans for the next year.
budget deficit	Amount by which government spending is greater than government revenue.
bulk buying	Buying goods in large quantities, which is usually cheaper than buying in small quantities.
capital and financial account	That part of the balance of payments where flows of savings, investment and currencies are recorded.
capital goods	Those purchased by firms and used to produce other goods, such as factories, machinery, tools and equipment.
capital intensive	Production that relies more heavily on machinery relative to labour.
cartel	Where a group of firms or countries join together and agree on pricing or output levels in the market.
closed shop	Company or factory where all the workers must belong to a particular trade union.
commodities	Products that can be sold to make a profit, especially in basic form before being used or changed in an industrial process; examples are farm products and metals.
competition	Rivalry that exists between firms when trying to sell goods to the same group of customers.
complementary goods	Goods purchased together because they are consumed together.
consumer goods	Those purchased by households, such as food, confectionery, cars, tablets and furniture.
consumer price index (CPI)	Measure of the general price level (excluding housing costs).
consumption	Amount of goods, services, energy or natural materials used in a particular period of time.
contractionary fiscal policy	Fiscal measures designed to reduce demand in the economy.
cost-push inflation	Inflation caused by rising business costs.
costs	Expenses that must be met when setting up and running a business.
current account	Part of the balance of payments where all exports and imports are recorded.
current account deficit	When the value of imports exceeds the value of exports.
current account surplus	When the value of exports exceeds the value of imports.
current balance	Difference between total exports and total imports (visible and invisible).
cyclical or demand-deficient unemployment	Unemployment caused by falling demand as a result of a downturn in the economic cycle.
de-industrialisation	Decline in manufacturing.
deflation	Period where the level of aggregate demand is falling.
demand curve	Line drawn on a graph that shows how much of a good will be bought at different prices.
demand schedule	Table of the quantity demanded of a good at different price levels — can be used to calculate the expected quantity demanded.
demand-pull inflation	Inflation caused by too much demand in the economy relative to supply.
depreciate (of a currency)	Where the value of a currency falls due to market forces — the exchange rate falls.
depression or slump	Bottom of the economic cycle where GDP starts to fall with significant increases in unemployment.
derived demand	Demand that arises because there is demand for another good.
devalued (of a currency)	When a government fixes a new lower exchange rate.
direct taxes	Taxes levied on the income earned by firms and individuals.
discretionary expenditure	Non-essential spending or spending that is not automatic.
diseconomies of scale	Rising average costs when a firm becomes too big.
disposable income	Income that is available to someone over a period of time to spend; it includes state benefits but excludes direct taxes.
diversified	If a company or economy diversifies, it increases the range of goods or services it produces.
dividend	Part of a company's profit that is divided among the people with shares in the company.
division of labour	Breaking down of the production process into small parts, with each worker allocated to a specific task.
downturn	Period in the economic cycle where GDP grows, but more slowly.
dumping	Where an overseas firm sells large quantities of a product below cost in the domestic market.
economic growth	Increase in the level of output by a nation.
economies of scale	Falling average costs due to expansion.
economy	System that attempts to solve the basic economic problem.
effective demand	Amount of a good people are willing to buy at given prices over a given period of time, supported by the ability to pay.
elastic demand	Change in price results in a greater change in the quantity demanded (alternative term: price elastic).
elastic supply	Change in price results in a proportionately greater change in the quantity supplied (alternative term: price elastic).
embargo	Official order to stop trade with another country.
enterprises	Companies, organisations or businesses.
entrepreneurs	Individuals who organise the other factors of production and risk their own money in a business venture.
equilibrium price	Price at which supply and demand are equal.
excess demand	Where demand is greater than supply and there are shortages in the market.
excess supply	Where supply is greater than demand and there are unsold goods in the market.
exchange rate	Price of one currency in terms of another.
excise duty	Government tax on certain goods, such as cigarettes, alcoholic drinks and petrol, sold in the country.
expansionary fiscal policy	Fiscal measures designed to stimulate demand in the economy.
expenditure	Spending by a government, usually a national government.
exports	Goods and services sold overseas.
external benefits	Positive spillover effects of consumption or production — they bring benefits to third parties.
external costs	Negative spillover effects of consumption or production — they affect third parties in a negative way.
external economies of scale	Cost benefits that all firms in an industry can enjoy when the industry expands.
factors of production	Resources used to produce goods and services, which include land, labour, capital and enterprise.
fast-moving consumer good (FMCG)	Goods, especially food, that sell very quickly and in large amounts.
finite	Having an end or a limit.
fiscal deficit	Amount by which government spending exceeds government revenue.
fiscal policy	Decisions about government spending, taxation and levels of borrowing that affect aggregate demand in the economy.
fiscal surplus	Amount by which government revenue exceeds government spending.
fit for purpose	Usable (by a consumer) for the purpose for which it was intended.
fixed capital	Stock of 'man-made' resources, such as machines and tools, used to help make goods and services.
fixed costs (overheads)	Costs that do not vary with the level of output.
foreign exchange market	Market where foreign currencies can be bought and sold.
free rider	Individual who enjoys the benefit of a good but allows others to pay for it.
free trade	Situation in which goods coming into or going out of a country are not controlled or taxed.
frictional unemployment	When workers are unemployed for a short period of time as they move from one job to another.
globalisation	Growing interconnection of the world's economies.
goods	Things that are produced in order to be sold.
gross domestic product (GDP)	Market value of all final goods and services produced in a period (usually yearly) — an internationally recognised measure of national income.
hostile takeover	Takeover that the company being taken over does not want or agree to.
human capital	Value of the workforce or an individual worker.
hyperinflation	Very high levels of inflation; rising prices get out of control.
imports	Goods and services bought from overseas.
income elasticity of demand	Responsiveness of demand to a change in income.
income inequality	Differences in income that exist between the different groups of earners in society — the gap between the rich and the poor.
indirect taxes	Taxes levied on spending, such as VAT.
inelastic demand	Change in price results in a proportionately smaller change in the quantity demanded (alternative term: price inelastic).
inelastic supply	Change in price results in a proportionately smaller change in the quantity supplied (alternative term: price inelastic).
infant industries	New industries yet to establish themselves.
inferior goods	Goods for which demand will fall if income rises, or rise if income falls.
infinite	Without limits.
inflation	Rate at which prices rise — a general and continuing rise in prices.
innovative	Commercial exploitation of a new invention.
interdependence	Where the actions of one country or large firm will have a direct effect on others.
interest rates	Price paid to lenders for borrowed money; the price of money.
internal economies of scale	Cost benefits that an individual firm can enjoy when it expands.
inverse relationship (price and quantity demanded)	When price goes up, the quantity demanded falls, and when price goes down, the quantity demanded rises.
invisible trade	Trade in services.
job rotation	Practice of regularly changing the person who does a particular job.
labour intensive	Production that relies more heavily on labour relative to machinery.
labour mobility	Ease with which workers can move geographically and occupationally between different jobs.
labour	People used in production.
laying off	To stop employing someone because there is no work for them to do.
liabilities	Amount of debt that is owed or must be paid.
Lorenz curve	Graphical representation of the degree of income or wealth inequality in a country.
macroeconomics	Study of large economic systems, such as those of a whole country or area of the world.
market clearing price	Price at which the amount supplied in a market matches exactly the amount demanded.
market failure	Where markets lead to inefficiency.
market niche	Smaller market, usually within a large market or industry.
market segments	Groups of customers that share similar characteristics, such as age, income, interests and social class.
maximise	To increase something, such as profit, satisfaction or income, as much as possible.
menu costs	Costs to firms of having to make repeated price changes.
merit goods	Goods that are under-provided by the private sector.
microeconomics	Study of small economic systems that are part of national or international systems.
minimum wage	Minimum amount per hour which most workers are legally entitled to be paid.
mixed economy	Economy where goods and services are provided by both the private and the public sectors.
monetarists	Economists who believe there is a strong link between growth in the money supply and inflation.
monetary policy	Use of interest rates and the money supply to control aggregate demand in the economy.
money supply	Amount of money circulating in the economy.
monopoly	Situation where there is one dominant seller in a market.
monopolies	Situation where a business activity is controlled by only one company or by the government, and other companies do not compete with it.
mortgage	Legal arrangement where you borrow money from a financial institution to buy land or a house, and pay the money back over a period of years; if you miss payments the lender can take and sell the property.
multinational corporations (MNCs)	Companies that operate in many different countries.
national debt	Total amount of money owed by a country.
national income	Value of income, output or expenditure over a period of time.
nationalised industries	Public corporations previously part of the private sector that were taken into state ownership.
natural monopoly	Situation where one firm in an industry can serve the entire market at a lower cost than several smaller firms could.
new entrant	Company that starts to sell goods or services in a market where they have not sold them before.
niche market	Market for a product or service, perhaps an expensive or unusual one, that does not have many buyers but may make good profits for the companies that sell it.
normal goods	Goods for which demand will increase if income increases, or fall if income falls.
offset	If something, such as a cost or sum of money, offsets another cost, it has the effect of reducing or balancing it, so the situation remains the same.
offshoring	Practice of getting work done in another country in order to save money.
oligopoly	Market dominated by a few large firms.
opportunity cost	Cost of the next best alternative given up when making a choice.
overheat	If an economy overheats, demand rises too fast, causing prices and imports to rise — a situation governments may try to correct by raising taxes and interest rates.
patent	Licence that grants permission to operate as a sole producer of a newly designed product.
perfectly elastic (demand)	Where PED = ∞ (an increase in price will result in zero demand).
perfectly elastic (supply)	Where PES = ∞ (producers will supply an infinite amount at the given price).
perfectly inelastic (demand)	Where PED = 0 (a change in price results in no change in the quantity demanded).
perfectly inelastic (supply)	Where PES = 0 (the quantity supplied is fixed and cannot be adjusted whatever the price).
piece rate	Amount of money that is paid for each item a worker produces, rather than for the time taken to make it.
policy instruments	Tools governments use to implement their policies, such as interest rates, rates of taxation and levels of government spending.
price elasticity of demand	Responsiveness of demand to a change in price.
price elasticity of supply	Responsiveness of supply to a change in price.
price maker	Where a dominant business is able to set the price charged in the whole market.
price war	Where one firm in the industry reduces price, causing others to do the same.
primary income	Money received from the loan of production factors abroad.
primary sector/industry	Production involving the extraction of raw materials from the earth.
private benefits	Rewards to individuals and firms of an economic activity, such as consumption or production.
private costs	Costs of an economic activity to individuals and firms.
private sector	Provision of goods and services by businesses that are owned by individuals or groups of individuals.
privatisation	Act of selling a company or activity controlled by the government to private investors.
product differentiation	Attempt by a firm to distinguish its product from that of a rival.
production possibility curve (PPC)	Line that shows the different combinations of two goods an economy can produce if all resources are used up.
production	Process that involves converting resources into goods or services.
productivity	Rate at which goods are produced, and the amount produced in relation to the work, time and money needed to produce them.
progressive taxation	Where the proportion of income paid in tax rises as the income of the taxpayer rises.
proportionate relationship (price and quantity supplied)	When the price goes up, the quantity supplied also goes up, and when the price goes down, the quantity supplied goes down.
protectionism	Approach used by governments to protect domestic producers.
public goods	Goods that are not likely to be provided by the private sector.
public sector	Government organisations that provide goods and services in the economy.
purchasing power of money	Amount of goods and services that can be bought with a fixed sum of money.
quantitative easing	Buying of financial assets, such as government bonds, from commercial banks, which results in a flow of money from the central bank to commercial banks.
quota	Physical limit on the quantity of imports allowed into a country.
rate of interest	Price of borrowing money.
raw materials	Substances used to make a product.
real economy	Part of the economy concerned with actually producing goods and services, as opposed to buying and selling on the financial markets.
recession	Period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.
regressive taxation	Tax system that places the burden of the tax more heavily on the poor.
relative poverty	Poverty that is defined relative to existing living standards for the average individual.
repatriation (of profit)	Where a multinational returns the profits from an overseas venture to the country where it is based, typically from a developing country to a developed country.
reserves	Amount of something valuable, such as oil, gas or metal ore.
retail price index (RPI)	Measure of the general price level which includes house prices and council tax.
revalued (of a currency)	When a government fixes a new higher exchange rate.
revenue	Money that a business receives over a period of time, especially from selling goods or services.
saturated market	Market in which there is more of a product for sale than people want to buy.
scale	Size of a business.
scarce resources	Amount of resources available when supply is limited.
seasonal unemployment	Unemployment caused when seasonal workers, such as those in the holiday industry, are laid off because the season has ended.
secondary income	Government transfers to and from overseas agencies such as the EU.
secondary picketing	Workers in one workplace or company striking in a group at a particular location in order to support striking workers in a different workplace or company.
secondary sector/industry	Production involving the processing of raw materials into finished and semi-finished goods.
shareholders	People or organisations that own shares in a company.
shift in the demand curve	Movement to the left or right of the entire demand curve when there is a change in any factor affecting demand except the price.
shift in the supply curve	Movement to the left or right of the entire supply curve when there is any change in the conditions of supply except the price.
shoe leather costs	Costs to firms and consumers of searching for new suppliers when inflation is high.
social benefits	Benefits of an economic activity to society as well as to the individual or firm.
social costs	Costs of an economic activity to society as well as the individual or firm.
specialisation	Production of a limited range of goods by individuals, firms, regions or countries.
spillover effects	Effect that one situation or problem has on another situation.
structural unemployment	Unemployment caused by changes in the structure of the economy, such as the decline of an industry.
subsidiaries	Companies that are at least half-owned by another company.
subsidy	Money that is paid by a government or organisation to make prices lower, reduce the cost of producing goods or providing a service, or encourage production of a certain good.
substitute goods	Goods bought as an alternative to another but performing the same function.
supply	Amount that producers are willing to offer for sale at different prices in a given period of time.
supply curve	Line drawn on a graph which shows how much of a good sellers are willing to supply at different prices.
supply-side policies	Government measures designed to increase aggregate supply in the economy.
takeover	Act of getting control of a company by buying over 50% of its shares.
tariffs or customs duties	Tax on imports to make them more expensive.
tax avoidance	Practice of trying to pay less tax in legal ways.
taxes	Amounts of money that must be paid to the government according to income/profit, property or spending, used to pay for public services.
tertiary sector/industry	Production of services in the economy.
total cost	Fixed costs and variable costs added together.
total revenue	Amount of money generated from the sale of goods, calculated by multiplying price by quantity.
trade barriers	Measures designed to restrict imports.
trade liberalisation	Move towards greater free trade through the removal of trade barriers.
trading blocs	Groups of countries situated in the same region that join together and enjoy trade free of tariffs, quotas and other forms of trade barrier.
transactions	Payment, or the process of making one.
unemployment	When those actively seeking work are unable to find a job.
unitary elasticity	Where PED = −1 (the responsiveness of demand is proportionately equal to the change in price).
unitary elasticity (supply)	Where PES = 1 (a change in price will be matched by an identical change in the quantity supplied).
unsustainable growth	Economic growth that it is not possible to sustain without causing environmental problems.
value-added products	Products or services that have increased value because work has been done on them or they have been combined with other products.
valued-added tax (VAT)	Tax on some goods and services; businesses pay VAT on most goods and services they buy and, if VAT registered, charge value-added tax on the goods and services they sell.
variable costs	Costs that change when output levels change.
variables	Something that affects a situation in a way that means you cannot be sure what will happen.
ventures	New business activities or projects that involve taking risks.
visible trade	Trade in physical goods.
voluntary unemployment	Unemployment resulting from people choosing not to work.
wage rate	The amount of money paid to workers for their services over a period of time (the price of labour).
wholesalers	Person or company that sells goods in large quantities to businesses, rather than to the general public.
working capital (circulating capital)	Resources used up in production, such as raw materials and components.
World Trade Organization (WTO)	International organisation that promotes free trade by persuading countries to abolish tariffs and other barriers; it polices free trade agreements, settles trade disputes between governments and organises trade negotiations.