TABLE OF CONTENTS

2
CHAPTER 1

Basic Economic Ideas And Resource Allocation

5
CHAPTER 2

The Price System & The Micro Economy

6
CHAPTER 3

Government Microeconomic Intervention

8 The Macro Economy

CHAPTER 4

13
CHAPTER 5

Macroeconomic Policies
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ENTERPRISE Production Profit
1. BASIC ECONOMIC IDEAS AND RESOURCE organization, risk-
ALLOCATION bearing

1.1 Scarcity, Choice & Opportunity Cost 1.4 Resource Allocation in Different
The fundamental economic problem: of scarcity arises Economic Systems & Issues of Transition
due to unlimited human wants of consumption exceeding • Different economic systems answer the 3 basic
finite economic resources for production. economic questions differently.
• Consumption: is process by which consumers satisfy o Note, that mixed economics try to gain advantages and
their wants. avoid disadvantages of both market and planned
• Production: is process of creating goods and services in economies.
an economy
QUESTION MARKET PLANNED
• Needs are necessary, wants are not. ECONOMY ECONOMY
o Thus, choices have to be made at all levels WHAT TO Price Cost-benefit
• Consumers – maximum satisfaction. PRODUCE mechanism analysis
• Producers – maximum profit. HOW TO Least cost Directives to
• Governments – maximum benefits. PRODUCE combination SOEs
o Choice: is the need to make decision about the FOR WHOM TO Purchasing Vulnerable
possible alternative uses of scarce resources due to PRODUCE power groups
scarcity. It gives rise to the concept of opportunity cost
and the 3 basic economic problems. COMPARISON BETWEEN MARKET & PLANNED
o Opportunity cost: is the cost of choosing something in ECONOMIES
terms of the benefit derived from the best alternative FEATURE Market Planned
economy economy
forgone.
OWNERSHIP Private State
o Economic resources/factors of production: are inputs
DECISION Consumers Governments
available for production of goods are [sic] services.
MECHANISM Price Directives to
mechanism SOEs
1.2 Positive and Normative Statements
KEY SECTOR Private Public
STATEMENT BASIS TYPE
PUBLIC GOODS Absent Present
POSITIVE Facts Objective
PROFIT MOTIVE Present Absent
NORMATIVE Value judgments Subjective
OTHER NAMES Free enterprise, Central,
private collectivist,
Value judgments: reflect particular beliefs, while facts: are
enterprise, state-owned.
evident to all.
laissez faire
1.3 Factors of Production EXAMPLES USA North Korea
FACTOR DEFINITION REWARD o Note that in reality, all economic systems are mixed.
LAND Natural resources Rent o SOE: State-owned enterprise.
LABOUR Physical and Wage
MARKET ECONOMY
mental human
Advantages Disadvantages
effort
• Efficiency. • Information failure.
CAPITAL Man-made Interest
• Consumer sovereignty. • Public goods not
resources
• Government freedom. provided
• Quick response. • Merit goods under-
• Profit incentive. consumed.
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• Maximizes producer • Demerit goods over-
and consumer surplus. consumed.
• Negative externalities.
• Unemployment of
resources.
• Factor immobility.
• Market power abuse.
• Advertising distortion.
• Too much consumer
goods.
• Poor lack purchasing
power.
• Inflation. • It is also known as production transformation frontier,
boundary or a production transformation curve. It
PLANNED ECONOMY demonstrates the ideas of choice, trade-offs and
Advantages Disadvantages opportunity cost.
• Provision of public • No incentives; low • Point inside curve indicates unemployment and point on
goods. production. curve shows full employment. This is productive
• Merit goods • Low competition; efficiency.
encouraged. efficiency. • Point shifting occurs owing to allocative efficiency.
• Demerit goods • Bureaucracy. • Production point shifting from C to F requires a
discouraged. • Unresponsive. reallocation of resources to capital goods and factor
• Full cost-benefit • Too much of capital mobility determines the speed of this. This would act as
analysis. goods.
an investment, shifting the PPC to the right. This
• Full employment. • Lack of consumer
indicates economic growth.
• Wasteful duplication sovereignty.
• Factor mobility: is extent of reallocation of resources or
avoided.
• Vulnerable groups ease of moving factors of production.
protected. • Investment: is expenditure of capital goods, both fixed
• Transitional economy: is one which is in process of and working.
changing from a planned economy to a mixed economy • Economic growth: is an expansion in the productive
where market forces have greater importance. capacity in an economy.
(Lowering of long-run average cost, i.e. LRAC ensures
• Issues of transition:
this.)
o Inflation.
• Other causes of PPC shifting right:
o Industrial unrest.
o New resources.
o Fall in output.
o Increased labour supply.
o Unemployment. o Improvements in human capital.
o Balance of payments’ deficit. o Improved resource management.
o Reduction in welfare services. o Privatisation.
• Straight PP line indicates constant opportunity cost
1.5 Production Possibility Curves which is next to impossible.
Production possibility curve: is one which joins together
• Curved PP line indicates increasing opportunity cost
the different combinations of products that can be
which occurs when the extra production of one good
produced in an economy, over a period of time, given
involves ever-increasing sacrifices of another as less
existing resources and technology.
suitable economic measures have to be diverted into the
production of the former, increasing marginal cost and
decreasing productivity.
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1.6 Money • Rivalry: refers to extent to which consumption limits
• Money: is anything which is universally acceptable as a availability.
means of payment for goods and services. Most money, • Excludability: refers to extent to which free-riders can
except coins is ‘legal tender’ for settlement of debt. be prohibited from consumption.
• Functions: • Free-rider: is someone who has no incentive to pay for
o Medium of exchange. the consumption of a product.
o Measure of value. • Rejectability: refers to extent to which consumers can
o Standard for deferred payment. avoid consumption of a product.
o Store of value. • Quasi-public goods: are those which have some but not
• Characteristics: all characteristics of public goods.
Acceptability. Scarcity. • Merit good/Demerit good: is a product which has
Divisibility. Stability of supply and value. positive/negative externalities, but would be under/over
Portability. Recognizable. consumed and produced in a market economy as a
Durability. Uniformity. result of imperfect information held by consumers.
• Advantages over barter: • Imperfect information: is a situation in which producers
o Avoids double coincidence of wants. and consumers lack information needed to make
o Permits evaluation. rational decisions, causing inefficiency. It is also known
o Enables giving change. as information failure. 2 situational examples in welfare
o Eases saving. economics include:
• Barter: is the direct exchange of one product for o Moral hazard: is the tendency of people who are
another. It was used before money. insured or otherwise protected to take greater risks
Cash + Bank deposits = Money due to information failure by producer.
• Cash: includes the notes and coins in an economy. It is o Adverse selection: is where information failure by
the most liquid form of asset. consumer leads to unsuitable person obtaining
• Bank deposits: are money held in accounts with a insurance.
financial institution, e.g. bank, building, society, etc. • Imperfection: is a situation where a market doesn’t
• Liquidity: refers to the extent and ease of converting a behave as expected, resulting in misallocation of
non-cash asset into cash. resources.
• Near money: or ‘quasi-money’ are non-cash assets that • Paternalism: is a situation where society knows best and
can be quickly and easily converted into cash. has some right to make a value judgment.
• Cheques: are written instruction to a financial institution • Subsidies: are government grants to:
to pay an amount of money from an account. So, they o Lower market prices of essential goods.
are means of payment through bank deposits, not o Encourage merit goods.
money. o Equitably redistribute income.
o Directly provide free merit goods and services, e.g.
1.7 Classification of Goods & Services education , healthcare, etc. (This may cause allocative
EXCLUDABIL
OPPORTUNI

REJECTABILI

inefficiency and extra tax burden)

FREE-RIDER
TY COST &
SCARCITY

o Raise producer’s income, especially farmers.

RIVALRY
GOOD

o Allow exporters to compete globally.

ITY

o Reduce import dependence by helping domestic

TY

FREE ✗ ✗ ✗ ✓ ✗ producers of close substitutes.

ECONOMIC ✓ ✓ ✓ ✗ ✓
/
PRIVATE
PUBLIC ✓ ✗ ✗ ✓ ✗

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• Products in alternative demand/supply: are those whose
consumption/production reduces need/availability of
the other.
• Multi-purpose products have composite demand.
• Products which help in producing other product have a
demand derived from the product produced.
• Note: As income rises, demand of normal goods rises,
inferior good falls.
• Contractions/Extensions of demand/supply: are
movement along curves due to changes in price, while:
• Shifts of demand/supply: are movements of the whole
curve due to changes in conditions.
• Their effects on equilibrium price, quantity and revenue
will depend on degree of shifting and price elasticity of
other curve.
DEMAND CONDITIONS SUPPLY CONDITIONS
• Disposable income. • Costs of production.
• Price of related • Price of related products.
products. • Climate.
• Taste and fashion. • Technology.
• Population structure. • Government regulations.
• Price speculation. • Availability of resources.
• Income distribution. • Taxes and subsidies.
• Taxes and subsidies.
• Note: Effect of taxes and subsidies on demand and
supply will depend on: impact, incidence and type of
2. THE PRICE SYSTEM & THE MICRO ECONOMY taxation.

2.1 Demand & Supply Curves 2.2 Price Elasticity, Income Elasticity &
• Demand/supply: is the quantity of a product that Cross-Elasticities of Demand, and Price
consumers/producers are willing and able to buy/sell at Elasticity of Supply
various prices per period time. • Elasticity: is responsiveness of quantity
• Note that demand & supply are also referred as market demanded/supplied to a change in price, income or
forces or the invisible hand. prices of related products.
• Laws of demand/supply:
𝑆𝑢𝑝𝑝𝑙𝑦 ∝ 𝑃𝑟𝑖𝑐𝑒 ∝ 1⁄𝐷𝑒𝑚𝑎𝑛𝑑 • Note: It is a numerical measure of the inverse of the
• Schedules: lists these relations while curves: graphically gradient, so lower elasticity gives steeper curve.
represent them.
• Notional demand/supply: isn’t backed up by ability to ELASTIC >1 Perfectly ∞ Horizontal line
pay/sell but effective demand/supply is. elastic
• Individual: refers to a certain producer/consumer in the INELASTIC <1 Perfectly 0 Vertical line
market: which is an arrangement for buyers and sellers inelastic
to trade. UNITARY =1; Such PED gives rectangular
• Products in joint demand/supply: are hyperbola, i.e. change in
produced/consumed together. demand/supply doesn’t affect
revenue.

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% ∆𝑸𝑫 (−)ve; used to inspect revenue -Corruption -Unemployment
𝑷𝑬𝑫 = % ∆𝑷
and tax effects. -Black market -Smuggling
% ∆𝑸𝑺 (+)ve; indicates allocative
𝑷𝑬𝑺 = % ∆𝑷
efficiency and need to expand.
% ∆𝑸𝑫 (+)ve – (−)ve – inferior
𝒀𝑬𝑫 = % ∆𝒀
normal good good
% ∆𝑸𝑫
𝑷𝑬𝑫 = (+)ve – (–)ve – • Buffer stock: is an amount of a commodity held to limit
% ∆𝑷 (𝒂𝒏𝒐𝒕𝒉𝒆𝒓)
substitutes complements price fluctuation.
Prevents wide fluctuation It has costs
PED CONDITIONS PES CONDITIONS Income stability Equilibrium price hard to
• Time period. • Time period. Long-term planning establish
• No. Of substitutes. • Availability of resources. High surpluses/shortages
• Degree of necessity. • Spare capacity/stocks. may strain stock
• Durability. • No. of firms in market.
• Proportion of income. • Allocative efficiency of
factors. 3.2 Taxes, Subsidies and Transfer Payment
FISCAL LEVIED ON/ SHIFT BURDEN/BENEFIT
2.3 Interaction of Demand & Supply, Market
MEASURE GIVEN TO
Equilibrium & Disequilibrium, and Consumer DIRECT Income D ← Consumer
& Producer Surplus TAX
Prices: INDIRECT Expenditure S ← Elastic demand –
• Signal surpluses/shortages. TAX producer &
• Ration resources to uses. converse
• Transmit preferences by encouraging producers to SUBSIDY Consumer D → Consumer
produce according to consumer demand. SUBSIDY Producer S → Inelastic demand –
consumer &
converse
Note: Specific measures cause parallel shift, ad valorem
ones non-parallel.
TAX ADVANTAGES DISADVANTAGES
TYPE
• Economic stability May discourage:
DIRECT

• Progressive • Saving
• Certain & convenient • Effort
3. GOVERNMENT MICROECONOMIC • Redistribute income • Risk-taking
INTERVENTION • Economic stability • Regressive
• May not discourage • Inflationary
3.1 Maximum & Minimum Prices effort • Reduce consumer
INDIRECT

Max. price control: is Min. price control: is • Difficult to evade surplus

where a price ceiling is where a price floor is • Can be adjusted • Move demand
established below established above quickly abroad
equilibrium price, creating equilibrium price, creating • Discourage imports • Distort choice
a shortage. a surplus. • Discourage demerit • Effect depends of
-Cheap essentials -Demerit goods goods 𝑃𝐸𝐷
-Rent control -Proper wages
-Restriction of fares -Import reduction
-Queueing -𝑷𝑬𝑫 dependent
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AIMS OF TAXES CANONS OF TAXES
• Demerit goods • Cost
• Income distribution • Efficiency
• Release resources • Equity
• Discourage imports • Transparency
• Demand/supply • Convenience
management

• Transfer payment: is a govt. provided benefit to poor

units, without protective effort; so funds shift from
taxpayers to recipients.
• Means-tested benefit: is paid to units whose income is
below a level.
• Universal benefit: is paid to units without income
reference.
• Poverty-trap: is a situation in which an individual has
work-disincentive, as additional income will be taken
away as taxes & lost benefits.
• Negative income-tax: is a system which brings together
payment of tax and receipt of benefits thus, making
markets more flexible by removing poverty-traps.

3.3 Direct Provision of Goods & Services

• Certain goods and services that ought to benefit the
public are under-provided, or under-consumed in the
economy.
• Impact of tax: refers to unit on which a tax is levied. • Direct provision of goods and services in the form of
• Incidence of tax: refers to burden of taxation. merit and public goods are a solution to this issue.
• Specific tax: is paid in fixed amount.
3.4 Nationalisation & Privatisation
• Ad valorem tax: on consumption, is paid as percentage
• Nationalisation: is a process whereby private sector
of value of product.
firms become part of the public sector of economy, with
• Average rate of tax: is the average percentage of total
state involved in direct provision of goods and services.
income that is paid in taxes.
• The converse is: Privatization: which is achieved by sale
• Marginal rate: is the proportion of additional income
of assets, deregulation, outsourcing & franchising.
that is taken in income tax.
• Marginal rate of taxation: is the addition to tax paid out
of change in income.
ADVANTAGES DISADVANTAGES
• Economies of scale. • Inefficient.
NATIONALISATI

• Avoids wasteful • Non-competitive.

duplication. • Political-mileage.
ON

• CBA is involved. • SOE monopoly.

• Private monopoly
prevented.

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• Economic efficiency. • Private monopoly. o Keynesians: believe that government intervention is
PRIVATIZATION

• Enterprise • Wasteful duplication. needed for employment.

encouraged. • Unemployment. o New classical economists: believe that 𝑳𝑹𝑨𝑺 curve is
• Lower price. • Non-regular funds. vertical and that an economy will achieve full
• Govt. revenue. • Regulations needed. employment without government intervention.
• Growth by
• Movement along 𝑺𝑹𝑨𝑺 is caused by:
investment.
• Government failure: occurs when government o Profit effect.
intervention reduces economic performance rather than o Cost effect.
increasing, thus failing to correct market failure, due to: o Misinterpretation effect.
o Imperfect information • It shifts because:
o Policy conflicts o Factor prices: •Wage rates unmatched by productivity
o Political mileage •Raw material costs
o Corruption o Taxes: • Corporation • Indirect
o Productive potential: (represented by 𝑷𝑷𝑪, also
affects 𝑳𝑹𝑨𝑺)
4. THE MACRO ECONOMY
o Resource o -Net o -Working years
4.1 Aggregate Demand & Aggregate Supply quantity: immigration o -Labour force
Analysis o -Net participation rate
• Macroeconomy: is the economy as a whole. investment o -Land reclamation
• Aggregate demand (𝑨𝑫): is the total spending on an
o -New resources
economy’s goods and services, at a given price level in a
o Resource quality: ◾Technology ◾Education and
given time period.
training
It consists of: Movement along it is caused by:
-Consumption (𝑪) -Wealth effect.
-Investment (𝑰) -International effect.
-Government -Interest rate effect.
expenditure (𝑮) -Note: 𝑨𝑫 = 𝑪 + 𝑰 + 𝑮 + (𝑿 − 𝑴)
• It shifts because:
o Consumption: •Consumer confidence •Wealth
•Income tax •Money supply •Population.
o Investment: •Business confidence •Technology
•Corporation tax
o Government expenditure: •Policy •Bureaucracy
o Net exports: •Exchange rate •Incomes abroad
•Product quality
4.2 Inflation
• Inflation: is a sustained increase in general price levels in
• Aggregate supply (𝑨𝑺): is the total output (real 𝑮𝑫𝑷)
an economy over a given time period, causing a fall in
that producers in an economy are willing and able to buy
purchasing power of a currency.
in a given time period.
• Creeping inflation: has a low rate.
• Short-run aggregate supply (𝑺𝑹𝑨𝑺): is the total output
• Hyper-inflation: has an exceptionally high rate of
that will be supplied in an economy when there hasn’t
inflation, which may result in people losing confidence in
been enough time for factor prices to change.
currency.
• Long-run aggregate supply (𝑳𝑹𝑨𝑺): is the total output
• Inflation rate can be measured by 𝑪𝑷𝑰 or 𝑹𝑷𝑰:
of an economy that will be supplied in the period when
o Selecting a stable base year for comparison.
factor prices have fully adjusted.
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o Carrying out surveys to find spending patterns. • Demand-pull inflation: is caused by increase in
o Attaching weights to products to indicate relative aggregate demand unmatched by equivalent rise in
importance. aggregate supply, e.g.
o Finding out price changes. o Consumer boom.
o Multiplying weights by price changes. o Money supply growing faster than output (monetarist)
• Deflation: is a sustained decrease in general price levels o Growing budget deficit.
in an economy over a given time period, causing a rise in o Increase in net exports.
purchasing power of a currency. ADVANTAGES DISADVANTAGES
• Disinflation: is a fall in the inflation rate. • Reduction in net exports. • Stimulate output.
CAUSES INFLATION DEFLATION • Unplanned redistribution • Reduce burden of debt.
GOOD 𝑨𝑫 ↑ 𝑨𝑺 ↑ of income. • Prevent some
BAD 𝑨𝑺 ↓ 𝑨𝑫 ↓ • Investment unemployment.
discouragement. Factors effecting extent of
• Money values: are of prices operating at the time.
• Unemployment. consequences
• Real values: are adjusted for inflation.
• Cost-wage spiral. • Cause of inflation.
• Menu costs: are incurred by firms for having to change • Menu costs. • Rate of inflation.
prices. • Shoe-leather costs. • Stability.
• Shoe-leather costs: are incurred by firms moving money • Fiscal drag. • Expectancy
for high-interest. • Inflationary noise. • Comparability.
• Fiscal drag: is pushing of income into higher tax 4.3 Balance of Payments
brackets by inflation. • Balance of payments: is a record of a country’s
• Inflationary noise: is confusion over relative prices. economic transactions with the rest of the world over a
• Causes of inflation: year. It consists of:
• Cost-push inflation: is caused by increases in costs of CURRENT ACCOUNT: FINANCIAL ACCOUNT:
production decreasing aggregate supply, e.g. • Visible trade in goods • Direct investment
o Wages rising by more than productivity. • Invisible trade in services • Portfolio investment
o Raw material costs rising (especially imported ones). • Income, e.g. profits, • Reserve assets
interest • Other investment
o Increase in indirect/corporate taxes.
• Current transfers (no
o Rise in profit margins.
exchange involved)
Capital account: Balancing item:
CONSEQUENCES OF DISEQUILIBRIUM
• Capital transfers • Net errors and omissions
Domestic External • Nonfinancial assets
• Change in money supply • Change in exchange Note: Money into country, credit (+) items, e.g. export.
• Change in government rate both Money out of country, debit (−) items, e.g. import.
policies appreciation & • Balance of payments equilibrium/disequilibrium:
• Changes in standard of depreciation naturally occurs when net inflow of money in a country is (not)
living owing to different and artificial
equal to the net outflow of money over a period of
access of imports. devaluation &
years, thus government intervention is (not) required.
• Confidence & FDI levels evaluation.
change, leading to • Government • Note:
changes in 𝑨𝑫, pressured to change o Surplus: 𝐶𝑟𝑒𝑑𝑖𝑡 > 𝐷𝑒𝑏𝑖𝑡
employment, growth etc protectionist o Deficit: 𝐶𝑟𝑒𝑑𝑖𝑡 < 𝐷𝑒𝑏𝑖𝑡
measures. o Short-run deficit: self-correcting
o Long-run deficit: non-self-correcting
• Causes of disequilibrium:
o Current account:
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▪ Deficit owing to limited domestic production and EFFECT OF CHANGING EXCHANGE RATES
lack of confidence in over-priced & poor-quality ASPECT Effect
products. Inflation Depreciation will make imports
▪ Overvalued exchanged rate, high inflation & low more expensive. (Imported cost
productivity. push inflation)

DOMESTIC
▪ Trade cycle and exchange of economic resources. Unemployment Appreciation will make exports
o Capital account: more expensive reducing 𝐴𝐷.
▪ Debt forgiveness Economic Depreciation will reduce terms of
▪ Sale of patents, copyrights, etc. growth trade, leading to economic
o Financial account: growth if Marshall-Lerner
▪ Hot money flows condition holds.
▪ Lack of business confidence
o Balancing item: ASPECT EFFECT
▪ Imperfect information Capital flows If change in exchange rate is
▪ Smuggling, black market speculated to be beneficial for
an economy, money will flow

EXTERNAL
4.4 Exchange Rates into economy.
• Factors determining exchange rate: Hot money Depreciation causes people to
o Balance of payments disequilibrium – Deficit causes speculate further fall
reduction. withdrawing money and
o Inflation rate – High rate reduces confidence, hence causing further fall. (Marshall-
demand. Lerner condition doesn’t hold.)
o Foreign direct investment – Inflows increase rate. Appreciation Depreciation Revaluation Devaluation
o Speculation – Acts in a way to aggravate problem. Term
RATE Increase ↑ Decrease Increase ↑ Decrease
• Purchasing power parity: is a way of comparing
↓ ↓
international living standards by using an exchange rate
CAU Market forces Government
based on amount of each currency needed to purchase
SE
some basket of products.
• Types of exchange rates:
• Nominal exchange rate: is price of one currency in
o Floating exchange rate: is determined by market
terms of another.
forces of demand and supply.
• Trade-weighted exchange rate: is price of one currency o Managed float: is influenced by state intervention.
against a basket of weighted currency. o Dirty float: is deliberately set low to gain a trade
• Real effective exchange rate: is a currency’s value in advantage.
terms of its real purchasing power. o Fixed exchange rate: is set by government and
maintained by the central bank buying and selling the
∴ 𝑅𝑒𝑎𝑙 𝑒𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑒𝑥𝑐ℎ𝑎𝑛𝑔𝑒 𝑟𝑎𝑡𝑒
currency and changing the interest rate.
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑒𝑥𝑐ℎ𝑎𝑛𝑔𝑒 𝑟𝑎𝑡𝑒 × 𝐷𝑜𝑚𝑒𝑠𝑡𝑖𝑐 𝑝𝑟𝑖𝑐𝑒 𝑟𝑖𝑠𝑒
=
𝐹𝑜𝑟𝑒𝑖𝑔𝑛 𝑒𝑥𝑐ℎ𝑎𝑛𝑔𝑒 𝑟𝑎𝑡𝑒 • Speculation: means people predicting and gambling on
the exchange rate of a currency.

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• Advantages o 𝑃𝐸𝐷
o Encourages trade by certainty. o Competition
o Perusal of macroeconomic objective. o Economic development
o Imposes discipline on government. o Protectionist measures
FIXED

• Disadvantages o Exchange rate

o Pressure from market forces. o Population growth
o Requires reserves of foreign currency. o Individual market forces of demand & supply of
o Interest rate can’t be used to affect economy. exports & imports
o No automatic restoral of current account. • Note that ToT tends to move against primary producing
countries (Prebisch-Singer hypothesis)
• Advantages
o No foreign currency reserves needed. • Impact of changes in terms of trade: is good if caused
o Automatic adjustment of current account. by rise in demand or fall in costs of production.
FLOATING

o Maintaining exchange rate is not an objective,

so interest rate can be used for other aims. 𝑷𝑬𝑫 >1 C.A.(−)
𝑻𝒐𝑻 ↑
• Disadvantages 𝑷𝑬𝑫 <1 C.A.(+)
o May discourage trade by uncertainty.
o Subject to ratchet effect by speculation. 𝑷𝑬𝑫 >1 C.A.(−)
𝑻𝒐𝑻 ↓
o Reduces pressure on government. 𝑷𝑬𝑫 <1 C.A.(+)
• Marshall-Lerner condition: states that sum of 𝑃𝐸𝐷 of
exports and imports must be >1 for depreciation to be 4.6 Principles of Absolute and Comparative
successful in reducing current account deficit. Advantage
• J-curve effect: is a depreciation raising current account • Absolute advantage: is the ability to produce more of a
deficit before reducing as it takes time for demand to product than another country using same amount of
respond, i.e. 𝑃𝐸𝐷 is inelastic in short-run. resources.
• Comparative advantage: is ability to produce at lower
opportunity cost.
• Trading possibilities curve: is the consumption
possibilities of rations post specialization and trade at
any term of trade.

4.5 Terms of Trade

• Terms of trade: is ratio of export prices to import prices.
∴ 𝑻𝒆𝒓𝒎𝒔 𝒐𝒇 𝒕𝒓𝒂𝒅𝒆 𝒊𝒏𝒅𝒆𝒙
𝑰𝒏𝒅𝒆𝒙 𝒐𝒇 𝒆𝒙𝒑𝒐𝒓𝒕 𝒑𝒓𝒊𝒄𝒆𝒔 4.7 Protectionism
= × 𝟏𝟎𝟎 • Protectionism: is an action designed to help domestic
𝑰𝒏𝒅𝒆𝒙 𝒐𝒇 𝒊𝒎𝒑𝒐𝒓𝒕 𝒑𝒓𝒊𝒄𝒆𝒔
• Globalization: is the expansion of world trade in goods products from foreign competition by reducing
and services, together with capital flows, leading to international trade.
greater international interdependence, reducing terms Measures include:
of trade for importing countries and increasing terms of • Tariffs (tax) • Embargoes (bans)
trade for exporting countries. • Quotas (limits) • Voluntary export restraint
• Foreign currency (agreed limit)
• Other factors influencing terms of trade:
exchange control
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• Export subsidies • Red tape (administrative
delays)
• Dirty float exchange rate.

FREE TRADE PROTECTIONISM

• Foreign products within • Avoids over
reach specialization
• Greater variety • Improve terms of trade
• Better quality • Reduce current account
• Lower price deficit
• Greater competition • Protect employment
• Larger market • Retaliation
• Economies of scale • Raise revenue
• More sales • Prevent dumping
• Importing raw materials • Infant/sunrise
• Spread of ideas & industries
technology • Declining/sunset
industries
• Strategic industries

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5. MACROECONOMIC POLICIES

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