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® IGCSE is the registered trademark of Cambridge International Examinations.

CUP IGCSE_Eco_Section-1_Ch.1 to Ch.3.indd 2 11/6/13 4:56:21 PM

 To the memory of my mother, Pat Grant,
who was a woman of great cheerfulness and courage.

CUP IGCSE_Eco_Section-1_Ch.1 to Ch.3.indd 3 11/6/13 4:56:21 PM

CUP IGCSE_Eco_Section-1_Ch.1 to Ch.3.indd 4 11/6/13 4:56:21 PM
 Contents
Introduction ix
Preparing for Examination xi
Acknowledgement xii

SECTION I The Basic Economic Problem 1

Unit 1 Scarcity 3

Unit 2 Factors of Production 7

Unit 3 Opportunity Cost 16

Answer Key 22

Examination Practice 25

SECTION II Allocation of Resources 27

Unit 4 Market and Mixed Economies 29

Unit 5 Equilibrium Price 39

Unit 6 Changes in Demand 50

Unit 7 Changes in Supply 59

Unit 8 Price Elasticity of Demand 68

Unit 9 Price Elasticity of Supply 78

Unit 10 Merits of the Market System 85

Unit 11 Market Failure 94

Unit 12 Use of Resources 105

Unit 13 Public Expenditure versus Private Expenditure 111

Answer Key 117

Examination Practice 134

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 SECTION III The Individual as Producer,
Consumer and Borrower 137
Unit 14 Specialisation, Exchange and Money 139

Unit 15 Banks 147

Unit 16 Stock Exchanges 155

Unit 17 Choice of Occupation 162

Unit 18 Differences in Earnings 170

Unit 19 Changes in Earnings 178

Unit 20 Trade Unions 188

Unit 21 Motives for Spending, Saving and Borrowing 196

Unit 22 Differences in Expenditure Patterns 203

Answer Key 210
Examination Practice 220

SECTION IV The Private Firm as Producer and Employer 225

Unit 23 Types of Business Organisations 227

Unit 24 Demand for Factors of Production 240

Unit 25 Costs of Production 248

Unit 26 Principle of Profit Maximisation 256

Unit 27 Pricing and Output Strategies 265

Unit 28 Different Size of Firms and Integration 273

Unit 29 Economies of Scale 281

Answer Key 289
Examination Practice 298

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 SECTION V Role of Government in an Economy 303
Unit 30 The Government as a Producer and an Employer 305

Unit 31 Aims of Government 310

Unit 32 The Government’s Influence on Private Producers 318

Unit 33 Conflicts between Government Aims 328

Unit 34 Types of Taxation 334

Unit 35 Incidence and Impact of Taxation 340

Answer Key 346
Examination Practice 353

SECTION VI Economic Indicators 357

Unit 36 Consumer Prices Index 359

Unit 37 Causes and Consequences of Inflation and Deflation 365

Unit 38 Employment 374

Unit 39 Causes and Consequences of Unemployment 381

Unit 40 Gross Domestic Product and Economic Growth 388

Unit 41 Living Standards 397

Answer Key 405
Examination Practice 411

SECTION VII Developed and Developing Countries 415

Unit 42 Different Stages of Development 417

Unit 43 Inequality and Poverty 423

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 Unit 44 Population Growth 430

Unit 45 The Effects of Changes in Population 437

Unit 46 Problems of Development 444

Answer Key 451
Examination Practice 456

SECTION VIII International Aspects 459

Unit 47 The Structure of the Balance of Payments 461

Unit 48 Changing Patterns of Exports and Imports 467

Unit 49 International Trade 475

Unit 50 Exchange Rates 482

Unit 51 Changes in Exchange Rates 488

Unit 52 Free Trade and Protection 493

Answer Key 499
Examination Practice 505
Answers to Examination Practice Questions 509
Additional Structured Questions 551
Useful Resources 557
Index 561

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 Introduction

This book is designed to introduce you to the study of economics and to help you
progress through your IGCSE Level course. The book follows the structure of the
IGCSE courses closely.

It covers all the topics of the course. In places, the book goes beyond the syllabus
to include concepts which will stretch your understanding and which will provide
you with additional possible ways to approach particular topics and strengthen the
depth of your answers. These are:

Allocative, productive and dynamic efficiency (pages 87–89)

Cost-benefit analysis (page 114)

Aggregate demand and aggregate supply analysis (page 312)

Velocity of circulation (page 367)

Flexible employment (page 376)

Purchasing power parity (page 399)

Lorenz curve (page 427)

The capital and financial accounts of the balance of payments (pages 463–464)

Absolute and comparative advantage (pages 476–478)

The terms of trade (page 479).

The Book is divided into 52 units. Each of these units explores a key economic topic
and provides activities and multiple choice questions to assess your understanding
of the same. At the end of each unit a teacher’s tip is given. This may remind you of a
key point, warn you about a common confusion, give you advice on how to approach
a question or recommend an activity which will enhance your understanding. There
is also a summary of the main points covered in the unit.

The units have been arranged into eight sections. At the end of each section, there
are answers to the activities and multiple choice questions. Do not look at them
until you have worked through the questions. Besides ‘Answer Key’, a section on
‘Examination Practice’ also contains ten multiple choice questions covering the whole

Introduction ix

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 section and some structured questions from past examination papers. Answers to
these multiple choice questions and structured questions can be found at the end of
the book. You must remember that the answers, included for structured questions,
are only suggested answers. There can be different approaches, particularly in the
case of the higher marked questions, which are equally valid.

Economics
Economics is an important, well-respected and exciting subject. Economists play a
key role in the world. They give advice to firms and governments to improve their
performance and also comment on their success or failure. The work of economists
can make a significant difference to people’s lives. For instance, the policies they
recommend to governments may reduce poverty and improve the quality of the
environment.

Whilst some of the people, who study economics, go on to become economists,

others enter a range of professions including accountancy, banking, education,
journalism and the law. Economists enjoy a lot of respect in universities and
professional organisations. They regard it as a rigorous subject, that develops logical
thinking and analytical and mathematical ability.

There are certain concepts – such as opportunity cost and price elasticity of demand,
and certain topics – including price determination, unemployment and inflation, that
are central to economics. The subject, however, is ever changing as new theories
develop, new institutions are created and new problems are encountered. This makes
it an interesting and challenging subject.

The Skills of an Economist

To be a good economist, you need to be informed of the developments in your
economy and other economies. You need to be able to think and write clearly
and apply relevant economic terms and concepts. You need to be confident in
handling figures. This involves being able to add, divide, subtract, multiply, calculate
percentage changes and understand index numbers. You also need to be able to
draw relevant, well-labelled and accurate diagrams. This book is designed to help
you develop these skills.

x Cambridge IGCSE Economics

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 Preparing
Introduction
for Examination

Revision is a continuous process. After every lesson, check your work and if
necessary, add extra notes. As an examination approaches, you will need to do
intensive revision. Try to engage in active revision. This involves, not just reading
notes, but also using the information. There are a number of ways through which
this can be done. These include testing other members of the class and getting
them to test you, drawing spider diagrams and producing tables and revision
cards.

Examination Technique
It is not sufficient to have a sound knowledge and good skills in the subject. You
also have to demonstrate these under examination conditions. So, it is essential to
develop examination techniques.

Before an examination, check out the duration of the examination and the number
of questions you have to answer. Read the instructions on the examination paper
carefully. Do not rush into writing your answers.

In answering multiple choice papers, consider every option in a question carefully.

If you are uncertain of an answer to a particular question, proceed further and
return to it when you have answered the other questions. At the end, check that
you have answered all the questions. Never leave a question unanswered, even if
you have to guess.

In answering structured questions read the questions very carefully, paying

particular attention to the directive (instruction) words. A questions which asks
you to identify or state something will only require a brief answer, consisting of
a few words. In contrast, a question which asks you to explain, assess or discuss
something will require a longer answer, written in sentences and paragraphs.
Unless specifically asked for, do not produce a list. Such an approach is likely to
gain you a few marks.

The marks allocated to a question or part of a question should give you a clear
indication of the extent of detail required. It is often useful to include a diagram
(or diagrams) in your answers. These should be clear, accurate, well-labelled and
backed up by an explanation in the text.

Preparing for Examination xi

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 Acknowledgement
Photo credits : Shutterstock
Section I: 24164749, 61753705, 117364918, 71048386, 59788057, 430205, 60779491, 54791671 Section II: 84084331,
77951401, 3844432, 109624334, 1380985, 50418028, 102745670, 101904619, 95330008, 54151870, 111999368,
86325814, 89663761, 61547215, 1748151, 65030281, 72653824, 29434846, 8864401, 4646644, 114104152, 33111940,
79657726, 115490365, 56239708, 89343070 Section III: 76590274, 91539893, 65714203, 12196441, 88516873,
109392416, 83133064, 80324677, 111946214, 101827642, 95521039, 115151443, 80227009, 116667094, 9203965,
114541927, 77192542 Section IV: 77042365, 64124296, 100158233, 107447666, 109515845, 88781662, 79172839,
111328973, 103588754, 110533598, 81974545, 56131003, 38412814, 56239708 Section V: 63608758, 85259425,
72852049, 114871843, 66673771, 114440692, 99014546 Section VI: 94986733, 106095458, 81155452, 86416297,
93928222, 32739469, 54279004, 68716657, 57367663, 80334658 Section VII: 80548063, 98264402, 77179411,
59788057, 86843710, 68148946 Section VIII: 48918724, 104212088, 38104051, 11430322
The questions taken from past examination papers are reproduced by permission of Cambridge
International Examinations.
Syllabus Name & Code Paper & Question Number Month/Year Section/Page in book
Cambridge IGCSE Economics 0455 Paper 2 Q5 Nov 1997 Section I Page 26
Cambridge IGCSE Economics 0455 Paper 4 Q3a May/June 2006 Section I Page 26
Cambridge IGCSE Economics 0455 Paper 2 Q2a and b May/June 2002 Section II Page 136
Cambridge IGCSE Economics 0455 Paper 2 Q2 Oct/Nov 2007 Section II Page 136
Cambridge IGCSE Economics 0455 Paper 2 Q3 Oct/Nov 2003 Section II Page 136
Cambridge IGCSE Economics 0455 Paper 2 Q4 May/June 2005 Section III Page 222
Cambridge IGCSE Economics 0455 Paper 4 Q7 Oct/Nov 2005 Section III Page 222
Cambridge IGCSE Economics 0455 Paper 4 Q6 May/June 2004 Section III Page 223
Cambridge IGCSE Economics 0455 Paper 4 Q2 May/June 2006 Section IV Page 301
Cambridge IGCSE Economics 0455 Paper 6 Q1 May/June 2006 Section IV Page 302
Cambridge IGCSE Economics 0455 Paper 4 Q3 May/June 2005 Section IV Page 302
Cambridge IGCSE Economics 0455 Paper 4 Q4 Oct/Nov 2002 Section V Page 355
Cambridge IGCSE Economics 0455 Paper 6 Q2 May/June 2002 Section V Page 355
Cambridge IGCSE Economics 0455 Paper 2 Q6 Oct/Nov 2006 Section V Page 355
Cambridge IGCSE Economics 0455 Paper 6 Q2 May/June 2003 Section VI Page 413
Cambridge IGCSE Economics 0455 Paper 4 Q4 May/June 2006 Section VI Page 413
Cambridge IGCSE Economics 0455 Paper 6 Q2 May/June 2004 Section VI Page 414
Cambridge IGCSE Economics 0455 Paper 4 Q7 May/June 2006 Section VII Page 457
Cambridge IGCSE Economics 0455 Paper 4 Q7 May/June 2005 Section VII Page 458
Cambridge IGCSE Economics 0455 Paper 4 Q7 May/June 2004 Section VII Page 458
Cambridge IGCSE Economics 0455 Paper 4 Q5 May/June 2005 Section VIII Page 507
Cambridge IGCSE Economics 0455 Paper 4 Q5 Oct/Nov 2005 Section VIII Page 507
Cambridge IGCSE Economics 0455 Paper Q6 Oct/Nov 2004 Section VIII Page 508
Cambridge IGCSE Economics 0455 Paper 2 Q2 May/June 2004 Section I Page 551
Cambridge IGCSE Economics 0455 Paper 22 Q2 Oct/Nov 2011 Section I Page 551
Cambridge IGCSE Economics 0455 Paper 2 Q2 May/June 2004 Section II Page 551
Cambridge IGCSE Economics 0455 Paper 4 Q7 May/June 2002 Section II Page 552
Cambridge IGCSE Economics 0455 Paper 2 Q3 Oct/Nov 2006 Section III Page 552
Cambridge IGCSE Economics 0455 Paper 4 Q2 May/June 2002 Section III Page 552
Cambridge IGCSE Economics 0455 Paper 2 Q7 Oct/Nov 2006 Section IV Page 553
Cambridge IGCSE Economics 0455 Paper 4 Q7 Oct/Nov 2003 Section IV Page 553
Cambridge IGCSE Economics 0455 Paper 4 Q6 May/June 2005 Section V Page 553
Cambridge IGCSE Economics 0455 Paper 4 Q3 Oct/Nov 2004 Section V Page 553
Cambridge IGCSE Economics 0455 Paper 2 Q4 Oct/Nov 2006 Section VI Page 554
Cambridge IGCSE Economics 0455 Paper 4 Q7 Oct/Nov 2002 Section VI Page 554
Cambridge IGCSE Economics 0455 Paper 4 Q6 Oct/Nov 2005 Section VII Page 554
Cambridge IGCSE Economics 0455 Paper 4 Q5 Oct/Nov 2002 Section VII Page 555
Cambridge IGCSE Economics 0455 Paper 4 Q6 May/June 2006 Section VIII Page 555
Cambridge IGCSE Economics 0455 Paper 4 Q5 May/June 2004 Section VIII Page 555

xii Cambridge IGCSE Economics

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 section I
The Basic Economic Problem

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CUP IGCSE_Eco_Section-1_Ch.1 to Ch.3.indd 2 11/6/13 4:56:23 PM
 Unit 13

Scarcity
In this first unit you will be introduced to the basic problem facing all economies.
This is the problem of scarcity.

The Nature of Scarcity

In all the countries throughout the world, people would like to have more goods and
services. It was estimated that in India, in 2006, at least 6 million people were living in
slums. These people would clearly like to have better quality housing. Even many of those
living in the rich suburbs would like to improve the quality of their living accommodation
by, for instance, adding a swimming pool. What stops people enjoying all the products
they would like to have? It is a lack of resources to produce them. Resources, including
workers and machinery, are scarce.

Key Point
Scarcity: a situation where there is not enough to satisfy everyone’s wants.

Scarcity 3

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 The Continuing Nature of Scarcity
Scarcity continues to exist. More goods and services are being produced today than ever
before but the growth in wants is exceeding the growth of economic resources. People
still want more products than the resources available can produce. Over a period of time,
wants continue to grow and change.

The Economic Problem

The economic problem arises because of scarcity. There is no limit to people’s wants –
they are infinite. For instance, people want more and better clothing and health care and
improved transport infrastructure. The number of workers, machines, offices, factories,
raw materials and land used to produce these products, however, is limited. At any given
time, for example, there are only a limited number of workers and they can produce only
a specified amount. This mismatch, between what people want and the maximum that
can be produced, gives rise to the economic problem.

Key Point
The economic problem: unlimited wants exceed scarce resources.

Evidence of the Existence of Scarcity

The fact that people have to choose which products to buy, which subjects to study, what
jobs to do and which products to produce shows that there are insufficient resources, As
consumers, we cannot have everything we want. We have limited incomes. Students have
to select which courses to study. It is not possible to study economics and chemistry at
the same time. Some teachers may carry out other work in the evening but when they are
teaching, they are not working as writers! Time is in limited supply. Farmers cannot grow
rice and wheat on the same land. They have to select one crop as land is scarce.

4 Cambridge IGCSE Economics

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 Activity 1

Decide which of the following are scarce:

a.  acancies for university degree courses
v
b. foreign holidays
c. health care.

Summary

• People’s wants continue to grow.

• Resources such as workers, machines and land are limited in supply.

• The economic problem of scarcity arises because wants exceed resources.

Teacher’s Tip
It is very important to learn definitions. The more you apply a term such as scarcity in
your work, the more you will become familiar with it. You may also want to compile your
own economics dictionary by writing down terms in alphabetical order, as you come
across them.

Scarcity 5

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 Multiple Choice Questions
1. Why does scarcity exist?
a. Each year workers tend to produce less than previously.
b. Machines wear out with time.
c. There are not sufficient resources to produce all the products people want.
d. There is a limit to people’s wants.

2. Why will scarcity continue to be a problem in the future?

a. Prices will rise.
b. The quantity of resources will decline.
c. Wants will continue to increase.
d. World population will fall.

6 Cambridge IGCSE Economics

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 Unit 2

Factors of Production
This unit explores the key characteristics of the factors of production, the influences
on their supply and also discusses the mobility of these factors. It also mentions
the payments to factors of production. Factors of production is another term for
economic resources. Unit 1 explained that economic resources are used to produce
goods and services and are in limited supply.

What are the Factors of Production?

Most economists identify four factors of production. These are land, capital, labour and
enterprise. Some economists, however, claim that there is really only three factors of
production and that enterprise is a special form of labour.

Key Point
Factors of production: the economic resources of capital, enterprise, labour and land.

Land
Land in general terms includes the earth in which crops are grown and on which offices
and factories are built, but in economics it has a wider meaning. It covers any natural
resource which is used in production. So besides the land itself, it also includes what is
beneath the land, such as coal, what occurs naturally on the land e.g. rainforests and the
sea, oceans and rivers and what is found in them, for instance fish.

To attract foreign tourists, for instance, a travel

company will make use of water in its swimming
pools, good climate and beaches in the holidays
it provides. Equivalently, the land used by a
safari park includes not only the grass on which
some of the animals graze but also the animals
themselves.

Factors of Production 7

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 Key Point
Land: gifts of nature available for production.

The Supply of Land

The amount of physical land in existence does not change much with time. There is a
certain degree of soil erosion which reduces the supply of arable land but also a certain
amount of land reclamation which increases its supply.

Other natural resources, however, can change quite significantly. Rainforests are currently
declining at a rapid rate.

Some natural resources are renewable whilst others are non-renewable. Renewable
resources, for instance wind power, are replaced by nature and hence can be used again
and again. In contrast, non-renewable resources, e.g. gold and oil, are reduced by use.
There is a risk that renewable resources can be turned into non-renewable resources
if they are over-exploited, that is used at a faster rate than they are replenished.
Over-fishing and the hunting of wildlife can diminish numbers to a point where they
cannot be restored.

The Mobility of Land

Most land is occupationally mobile. This means that it can be used for a number of
purposes. Land which is currently being used for farming may instead be used to build
houses. Trees can be used to make tables or sleepers for railway lines.

Land, in its traditional sense, is however geographically immobile. It is not possible to

move a section of land from Sri Lanka to India, for instance. Some forms of land, in its
wider meaning, can be moved to a certain extent. For example, the course of rivers can
be diverted and wildlife can be moved.

Key Points
Occupationally mobile: capable of changing use.
Geographically immobile: incapable of moving from one location to another location.

Activity 1

Identify two forms of land that are used by a paper mill.

8 Cambridge IGCSE Economics

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 Capital
Capital would have to be used in the diversion of the course
of a river. Capital is any human-made (manufactured)
good used to produce other goods and services. It
includes, for example, offices, factories, machinery,
railways and tools.

Capital is also referred to as capital goods and producer

goods. Economists distinguish between capital and
consumer goods. Capital goods are not wanted for their own sake but for what they
can produce. In contrast consumer goods, such as food, clothing and entertainment, are
wanted for the satisfaction they provide to their owners.

In deciding whether a good is a capital or a consumer good, it is necessary to consider

who the user is and the purpose of its use. A computer, for example, will be a capital
good if it is used by an insurance company to process insurance claims – it is producing
a service. If, however, it is used by a person to play games, it is a consumer good.

Key Point
Capital: human-made goods used in production.

Activity 2

Decide which of the following are capital goods and which are
consumer goods:
a. a chocolate bar
b. a car
c. a child’s toy
d. a farm tractor
e. a dentist’s drill
f. a courtroom.

The Supply of Capital

The supply of capital tends to increase with time. Every year some capital goods physically
wear out and some become outdated. A farm barn may fall down, for instance, and some
machinery may be replaced by newer, more efficient machinery.

New capital goods, however, usually take the place of those goods, which firms are unable
(or choose not) to use any more. The total value of the output of capital goods produced

Factors of Production 9

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 is referred to as gross investment or sometimes just investment. Some of the capital
goods being produced will be replacing those which have worn out or become obsolete.
The value of replacement capital is called depreciation or capital consumption.

Net investment is the value of the extra capital goods made. It is equal to gross investment
minus depreciation. For instance, if a country produces $200m capital goods one year and
there is depreciation of $70m, net investment is $130m. The country will have more capital
goods. These additional capital goods will allow it to produce more goods and services.

Occasionally gross investment may be lower than depreciation. This means that some
of the capital goods taken out of use, are not replaced. This is said to be negative net
investment.

Key Point
Investment: spending on capital goods.

Activity 3

A firm is currently using 12 machines. Each machine is capable of

producing 100 units of output. It anticipates that by the end of the year,
3 of its machines will wear out. If it expects to sell 1 600 units next year:
a. How many machines will it buy?
b. Why in the future may fewer machines be needed to produce the
same output?

The Mobility of Capital

The geographical and occupational mobility of capital varies according to the type of
capital goods. Some types of capital goods can be transferred from one part of the
country to the other. A photocopier used by a bank in one area of a country can be sold
to and then used by a bank in another area. A coal mine and a dock, however, are fixed
in position and so are geographically immobile. They are also occupationally immobile
since their use cannot be changed, as they have been made for a specific purpose. In
contrast, a delivery van, used originally by a book publisher may be bought and employed
by a toy manufacturer to distribute its products. Similarly, an office block may be used for
a variety of purposes. It may house a call centre or an accountancy firm.

10 Cambridge IGCSE Economics

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 Labour
Labour covers all human effort – both mental and physical, involved in
producing goods and services. A road sweeper, a steel worker and a
bank manager all contribute their labour.

Some what confusingly, reference is sometimes made to human

capital. This means the education, training and experience that
workers have gained. The more human capital workers have, the
more they should be capable of producing.

The Supply of Labour

The supply of labour is influenced by two key factors. One is the number of workers
available and the second is the number of hours for which they work.

The number of available workers is determined by:

•  he size of the population. The larger the population, the more workers there
T
are likely to be.

• The age structure of the population. A country with a high proportion of people
of working age will have more workers than a country with the same population
size but a higher proportion of younger or older people.

• The retirement age. The higher the retirement age, the more potential workers
there will be.

•  he school leaving age. Raising the school leaving age would reduce the number
T
of workers.

•  ttitude to working women. Countries, where it is acceptable for women to

A
work, have more workers to draw on.

Those people who are working or are seeking work form, what is known as, the labour
force. This is also known as the workforce or working population. Those of working
age are people between the school leaving age and the retirement age. In the UK, this
covers people aged between 17 and 65. Not all of these people, however, are in the
labour force. Some may be in full time education, some may have retired and some
may be sick or disabled.

The number of hours, for which people work, is influenced by (among other factors):

• the length of the average working day. For instance, full time workers in USA tend
to work for longer hours than those in the European Union.

• whether they work full or part time. For example, more people in the UK work
part time than those in France.

Factors of Production 11

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 • the duration of over-time.

• the length of holidays availed by workers.

• the amount of time lost through sickness and illness.

As with all the factors of production, it is not just the quantity of labour which is
important but also the quality. More can be produced with the same number of
workers if the workers become more skilled. Increase in productivity is a major cause
of an increase in a country’s output.

Key Point
Productivity: output per worker hour.

Activity 4

Decide which of the following would raise labour productivity:

a. improved education and training
b. better equipment
c. worse working conditions.

The Mobility of Labour

The mobility of labour varies. Some workers may find it difficult to move from one area
of the country to another or from one country to another (geographical immobility) and
some may find it difficult to switch from one type of job to another type (occupational
immobilty).

The causes of geographical immobility include:

•  ifferences in the price and availability of housing in different areas and

d
countries. Workers who lose their jobs in poor areas may not be able to take up
jobs in rich areas because they cannot afford or find housing there.

• f amily ties. People may be reluctant to leave the country they are currently living
in because they do not want to live away from friends and relatives.

•  ifferences in educational systems in different areas and countries. People

d
may not be willing to move to a job elsewhere if it disrupts their children’s
education.

• lack of information. People without jobs or those in poorly paid jobs may stay
where they are because they are unaware of job opportunities elsewhere.

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 • r estrictions on the movement of workers. It is often necessary to obtain a
work visa to work in another country and these can be limited in supply.

There are also a number of causes of occupational immobility. Again there may be a
lack of information about vacancies in other types of jobs. The main cause, however,
is a lack of appropriate skills and qualifications. A shortage of doctors cannot be
solved by hiring street hawkers!

Enterprise
Enterprise is the willingness and ability to bear uncertain risks and to make decisions in
a business. Entrepreneurs are the people who organise the other factors of production
and who crucially bear the risk of losing their money, if their business fails. Entrepreneurs
decide what to produce – taking into account consumer demand, and how to produce
it. Some of the risks faced by any business can be insured against. These include
fire, flood and theft. Other risks, however, have to be borne by entrepreneurs. This
is because some events are not anticipated, based on past events and so cannot be
insured against. These include the uninsurable risks of other firms bringing out rival
products and rising costs of production.

The two key tasks of an entrepreneur can be carried out by different people. In large
companies, it is the shareholders who run the risk of losing their money if the companies
go out of business whilst the managing directors take production decisions and organise
the factors of production.

Key Point
Enterprise: risk bearing and decision making in business.

The Supply of Entrepreneurs

A good education system, including university degree courses in
economics and business studies, may help to develop entrepreneurs
in an economy. Lower taxes on firms’ profits (corporate taxes) and a
reduction in government regulations may encourage more people to
set up their own businesses. Sometimes, a disproportionate number
of immigrants become entrepreneurs. These are people who have
had the drive to leave home in search of a better life and this drive
often leads them to become entrepreneurs in the new country.

The Mobility of Enterprise

Enterprise is the most mobile factor of production. The skill involved can be applied in every
industry. Someone who has borne uncertain risks and organised factors of production in

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 the car industry should be able to do this in, for instance, the textile industry too. Apart
from being occupationally mobile, enterprise is also geographically mobile. Someone
who has been successful in starting up and running a business in one country is likely to
be successful in another country also.

Activity 5

The following is a list of economic resources. In each case, decide whether

the resource is an example of capital, enterprise, labour or land:
a. chemical fertiliser
b. a school
c. a lake
d. the work of a nurse
e. the initiative needed to set up and run a bicycle repair shop.

Payments to Factors of Production

Payments are made for the use of factors of production. Firms pay wages for the services
of the workers. For bearing uncertain risks and organising the other factors of production,
entrepreneurs earn profit. Land receives rent and interest is a payment for capital.

Summary

• The four factors of production are capital, enterprise, labour and land.

•  hilst most land is occupationally mobile, land in its traditional meaning

W
is geographically immobile.

• Net investment increases a country’s stock of capital goods.

•  he supply of labour is influenced by the number of workers and the number

T
of hours for which they work.

• Entrepreneurs bear uninsurable risks and make production decisions.

Teacher’s Tip
Remember when economists refer to capital, they mean human-made goods, such as
machinery and office buildings, that are used to produce other products.

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 Multiple Choice Questions
1. Which factor of production’s function is to make decisions and take risks?
a. Capital
b. Enterprise
c. Labour
d. Land

2. Which type of factor of production is a road?

a. Capital
b. Enterprise
c. Labour
d. Land

3. A
 country produces 3 000 new capital goods in a week. 500 of these
replace worn out capital goods. What is the net investment made?
a. 500 b. 2 500
c. 3 000 d. 3 500

4. Which factor of production is the most mobile?

a. Capital
b. Enterprise
c. Labour
d. Land

Factors of Production 15

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 Unit 3

Opportunity Cost
There are not enough economic resources to produce all the goods and services
we would desire, as was noted in Unit 1. Capital, enterprise, land and labour are
scarce and so decisions have to be made about the method and purpose of their
use. A classroom can be used to teach English or economics in the some room but
not at the same time. In deciding what to use the classroom for, and in making
other decisions, the concept of opportunity cost is important as this unit will seek
to explain.

Opportunity Cost
When we decide to do one thing, we are deciding not to do something else. To ensure that
we make the right decisions, it is important that we consider the alternatives, particularly
the best alternative. Opportunity Cost is the cost of a decision in terms of the best
alternative given up to achieve it. For instance, there are a variety of things you could do
tomorrow between 5pm and 6pm. These may be to go shopping, to read a chapter of an
economics book, to do some paid work or to visit a friend. You may narrow those choices
down to reading the chapter or visiting a friend. You will have to consider very carefully
which one will give you the best return. If you choose to read the chapter, you will not be
able to visit your friend and vice versa.

Key Point
Opportunity cost: the best alternative forgone.

Opportunity Cost and Consumers

Consumers are buyers and users of goods and services. We all are consumers. The vast
majority of us cannot buy everything we like. I may, for example, have to choose which
economics dictionary to buy. I will probably consider a number of different ones, taking
into account their prices. The choice will then tend to settle on two of them. I will select
the one with the widest and the most accurate informative coverage. The closer the two
dictionaries are in quality and price, the harder the choice will be.

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 Opportunity Cost and Workers
Undertaking one job involves an opportunity cost. People employed as teachers might
also be able to work as civil servants. They need to carefully consider their preference for
the jobs available. This would be influenced by a number of factors, including the wage
paid, chances of promotion and the job satisfaction to be gained from each job. If the
pay of civil servants or their working conditions improve, the opportunity cost of being a
teacher will increase. It may even increase to the point where some teachers resign and
become civil servants instead.

Opportunity Cost and Producers

Producers have to decide what to make. If a farmer uses a field to grow sugar beet, he
cannot keep cattle on that field. If a car producer uses some of his factory space and
workers to produce one model of a car, he cannot use the same space and workers to
make another model of the car at the same time.

In deciding what to produce, private sector firms will tend to choose the option which will
give them the maximum profit. They will also take into account, the demand for different
products and the cost of producing those products.

Opportunity Cost and the Government

Government has to carefully consider, its expenditure
of tax revenue on various things. If it decides to spend
more on education, the opportunity cost involved may
be a reduced expenditure on health care. It could, of
course, raise tax revenue in order to spend more on
education. In this case, the opportunity cost would be
put on the taxpayers. To pay higher taxes, people may
have to give up the opportunity to buy certain products
or to save.

Activity 1

In each of the following cases, consider what might be the opportunity cost.
a. A person wanting to buy fruit, decides to buy apples.
b. A person decides to study economics at a university.
c. A factory is built on farm land.
d. A woman has a television set which cost her $800 two years ago. A new set
would cost her $1 000 and she could sell her television set for $450. What is
the opportunity cost of keeping the old television?

Opportunity Cost 17

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 Economic Goods and Free Goods
A vast majority of goods are economic goods. This means that it takes resources to
produce them and hence, their production involves an opportunity cost. Also, they are
limited in supply. For example, a carpet is an economic good. The material and labour
used to produce it, could have been used to make another good (or goods). It is easy to
find examples of economic goods. Almost every good and service you can think of is an
economic good. Your education is an economic good, since your teachers and the other
resources used to provide it could have been employed for making other products.

Free goods are much rarer. When most people talk about free goods, they mean products
they do not have to pay for. These are not usually free goods in the economic sense since
resources have been used to produce them.
Economists define a free good as one, which
takes no resources to make it and thus does not
involve an opportunity cost. It is hard to think
of examples of free goods. Sunshine is one
such example, so is water in a river. However,
as soon as this water is processed for drinking
or used for irrigation of fields, it becomes an
economic good.

Key Points
Economic good: a product which requires resources to produce it and therefore has an
opportunity cost.
Free good: a product which does not require any resources to make it and so does not have
an opportunity cost.

Activity 2

Decide whether each of the following is an economic or a free good:

a. air
b. education
c. newspapers
d. public libraries
e. state education.

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 Production Possibility Curves
A good way to illustrate opportunity cost is to use a production possibility curve (PPC).
In fact, a PPC can also be called an opportunity cost curve. Its other names are a production
possibility boundary (PPB) and a production possibility frontier (PPF).

A PPC shows the maximum output of two products and combinations of these products
that can be produced with existing resources and technology. Figure 1 shows, that a
country can produce either 100 units of manufactured goods or 150 units of agricultural
goods or a range of combinations of these two goods.

A country may decide to produce 80 units

of manufactured goods and 75 units of
100

Manufactured goods
agricultural goods. If it then decides to
produce 100 units of agricultural goods, it will 80
have to switch resources away from producing 60
manufactured goods. The diagram shows the
reduction of output of manufactured goods
to 60 units. In this case, the opportunity cost
of producing 25 extra units of agricultural 0 75 100 150
Agricultural goods
goods is 20 units of manufactured goods.
Fig. 1 A production possibility curve
Key Point
Production possibility curve: a curve that shows the maximum output of two types of
products and combination of those products that can be produced with existing resources
and technology.

Activity 3

Using Figure 2:
a. s tate the maximum number of capital
Capital goods

goods the country can produce if

50
it devotes all of its resources for 35
30
making capital goods.

b. c alculate the opportunity cost of

0 80 90 120
increasing the output of consumer Consumer goods
goods from 80 to 90 units. Fig. 2

Opportunity Cost 19

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 Summary

•  pportunity cost is an important concept as it emphasises that people have

O
to consider what they are sacrificing when they decide what to buy, what
job to do and what to produce and when governments are deciding what to
spend their tax revenue on.

•  conomic goods have an opportunity cost as the resources used to produce

E
them could have been used to make something else.

• Free goods exist without the use of resources and hence do not have an
opportunity cost.

• PPC curves can be used to illustrate opportunity cost. They show what can
be produced with the given economic resources.

Teacher’s Tip
In explaining opportunity cost, it is always useful to give an example.

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 Multiple Choice Questions
1. What is meant by ‘opportunity cost’?
a. The best alternative forgone.
b. The cost of the item selected.
c. The cost of exploring business opportunities.
d. The labour used in producing the product.

2. A
 person decides to go to the university for three years, to study economics.
If he had not gone, he could have taken up a job which would have paid
him $15 000 a year. After he graduates he expects to find a job paying him
$40 000 a year. What is the opportunity cost of going to the university
for him?
a. $15 000 b. $40 000
c. $45 000 d. $120 000

3. Which of the following is a free good?

a. Inoculation provided without charge by the state.
b. Prizes of food items given away by a supermarket.
c. Recycled paper.
d. Wind coming in from the sea.

4. U
 sing Figure 3, determine the opportunity cost of increasing the output of
luxury goods from 25 to 35.
a. 8 basic goods
b. 10 luxury goods
85
Luxury goods

c. 25 luxury goods
d. 92 basic goods
35
25

0 92 100 120
Fig. 3

Opportunity Cost 21

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 Answer Key
Unit 1
Activity 1
All three items are scarce. In each case, people want more than what is currently being
produced. More people want to study at university than there are places available. Most
of us would like to holiday abroad and those of us fortunate enough to do so, would like
to undertake more trips. Also there are not enough resources to provide good quality
health care quickly, to every one who requires it.

Multiple Choice Questions

1. c
Scarcity arises because wants are greater than the resources that can be used to
produce them. Workers tend to produce more each year, as they become more
experienced and work with better machinery. Machines wear out with time but they
are usually replaced by more efficient ones and are often added to. There is no limit
to people’s wants.

2. c
Both wants and resources will continue to increase with time. World population is
likely to rise. Prices are also likely to increase in the future but such a change will
reflect changes in demand and supply and will not be a cause of scarcity.

Unit 2
Activity 1
Among the forms of land used by a paper mill, are the land on which the mill is built and
the water and wood used in the process of making paper.

Activity 2
a. a consumer good
b. a consumer or capital good depending on who uses it
c. a consumer good
d. a capital good
e. a capital good
f. a capital good

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 Activity 3
a. It will need 16 machines in total. It starts with 9 machines (12 – 3) so it needs to buy
7 machines – 3 for replacement and 4 to expand capacity.

b. There may be advances in the technology.

Activity 4
a. and b. would raise labour productivity. Improved education and training would make
workers more skilful and hence capable of producing a higher output. Better equipment
should also enable each worker to produce more. On the other hand, c. would probably
cause a fall in output per worker. Worse working conditions would reduce workers’
motivation and may make it more difficult for them, to carry out their tasks.

Activity 5
a. capital
b. capital
c. land – if a naturally formed lake but capital, if man made
d. labour
e. enterprise

Multiple Choice Questions

1. a
Enterprise is the ability and willingness to bear uncertain risks and make production
decisions.

2. a
Capital is a human made good used to produce other goods and services. A road
enables passengers to travel and freight to be transported.

3. b
Net investment is gross investment minus depreciation. In this case, it is
3 000 – 500.

4. b
Enterprise and the entrepreneurs that provide it, find it relatively easy to switch from
one industry to another and from one location to another.

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 Unit 3
Activity 1
a. Other types of fruits e.g. bananas, mangoes or pears.

b. Another degree course e.g. mathematics or a job.

c. Other uses of the land including housing, an office or a park.

d. $450 – by keeping the TV, she is forgoing $450.

Activity 2
a. free good b. economic good
c. economic good d. economic good
e. economic good

Economic resources are used to produce b – e.

Activity 3
a. 50 capital goods
b. 5 capital goods are given up. To increase the output of consumer goods from 80 to
90, the output of capital goods has to fall from 35 to 30.

Multiple Choice Questions

1. a
A straightforward question.

2. c
By going to the university, the student is giving up the opportunity to earn $15 000
a year for three years – a total of $45 000.

3. d
Wind coming in from the sea does not take resources to produce it. All the other
items mentioned have to be produced and, in each case, the production involves an
opportunity cost.

4. a
To produce 10 more luxury goods, the output of basic goods has to fall from 100 to
92. The opportunity to make 8 basic goods has been given up.

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 Examination Practice
Multiple Choice Questions
1. What gives rise to the problem of scarcity?
a. A lack of money.
b. An uneven distribution of income.
c. Capital equipment being greater than labour.
d. Wants exceeding resources.

2. As an economy becomes richer, what happens to resources and wants?

Resources Wants
a. decrease decrease
b. decrease increase
c. increase decrease
d. increase increase

3. Which of the following is an example of the factor of production ‘capital’?

a. The money a farmer has borrowed to buy livestock.
b. The money a farmer has saved in the bank.
c. A farm worker.
d. A tractor.

4. Which type of factor of production can be described as a ‘natural resource’?

a. Capital
b. Entrepreneur
c. Labour
d. Land

5. A woman owns a TV which she bought for $300. She is considering buying a better
model for $450. Her neighbour offers her $200 for her TV. What is the opportunity
cost of her rejecting this offer?
a. $100
b. $200
c. $300
d. $450

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 6. A man presently works as a builder. His previous jobs included working as a farm
labourer and a street trader. His next best-paid job is that of a carpenter but he would
rather choose to work as a gardener, if not a builder. What will be the opportunity
cost of him working as a builder? Working as:
a. a carpenter
b. a farm labourer
c. a gardener
d. a street trader

Structured Questions
1. After studying for this examination you decide to continue your studies and take
further examinations.
a. How does this decision involve an opportunity cost? Explain your answer. (4)
b. What are the economic factors you might consider while making such a
decision? (6)

(Cambridge 0455 Paper 2 Q5 Nov 1997)

2. Explain the terms scarcity and opportunity cost. (4)

(Cambridge 0455 Paper 4 Q3a May/June 2006)

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 section II
Allocation of Resources

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 Unit 4
3

Market and Mixed

Economies
The previous section explored the nature of resources and explained that wants
exceed resources. Hence, decisions have to be made as to how the resources need
to be used. This unit examines how these choices are made in different economic
systems.

The Three Main Economic Systems

All economies have to answer three fundamental economic questions.

These are:
• what to produce

• how to produce it and

• who is to receive the products produced.

These questions arise because of the basic economic problem of unlimited wants
exceeding finite resources. A decision has to made as to how the economy’s resources
are to be allocated. For example, how many resources should be devoted to health care,
how many to leisure goods and services and how many to defence.

Once this decision has been taken, an economy has to decide on how the products are
to be manufactured. For example, whether a large number of workers should be used in
agriculture or more reliance be placed on capital equipment? Finally, because as many
goods and services cannot be produced, as required to satisfy the needs of everyone, a
decision has to be reached as to how the products should be distributed. Should products
be distributed to people according to their needs or their ability to earn a high income?

The answers to the above questions differ in different economic systems. An economic
system covers the institutions, organisations and mechanisms in a country that influence
economic behaviour.

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 Different Economic Systems
There are three main economic systems. One is a planned economy, which can also
be called a centrally planned, command or collectivist economy. It is one in which the
state (government) makes the decisions about what to produce, how to produce it and
who receives it. The state owns all or at least most of the land and capital and employs
workers. It gives instructions, sometimes called directives, to state-owned enterprises
(SOEs) on what to produce and how to produce it. It determines who gets the products
made, both by deciding on the remuneration paid to the workers and by controlling
prices. It will usually provide basic necessities and important products such as housing,
transport and education free of cost or at a low price.

The other two type of economic systems are a market economy and a mixed economy.
Given the decline in the number of countries operating planned economies, this unit will
focus largely on these two types.

Key Point
A planned economy: an economy where the government makes the crucial decisions,
land and capital are state-owned and resources are allocated by directives.

A Market Economy
A market economy, also known as a free enterprise economy, is one in which consumers
determine what is produced. They signal their preferences through the price mechanism.
If they want more of a product, they will be willing to pay more for it. The higher price
offered will encourage firms to produce the good in more amounts as then the firms
make more profit.

In a market economy, resources switch from products that are becoming less popular to
those which are becoming more popular. Fig. 1 shows the effect of demand for bananas
increasing whilst demand for apples decreases.

In a market economy, government intervention is minimum. Land and capital are privately
owned. Private sector firms decide how to produce the products consumers want to buy.
Some firms, for instance steel firms, may employ large amounts of capital relative to
labour. They are said to be capital intensive. Others, for example, hotels may use a
relatively high numbers of workers in comparison with the amount of capital used. They

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 Bananas Apples
Increase in demand Decrease in demand

Rise in price Fall in price

Rise in profit Fall in profit

Firms produce more Firms produce less

Hire more workers, use Reduce number of workers,

more capital and land capital and land employed

Fig. 1 Changes in resource allocation in a market economy.

are labour intensive. In making their decision on which factors of production to employ,
firms will seek to achieve the least cost method of production. This may also involve
use of new, more productive capital equipment, to
replace older equipment.

In a market economy, those who earn the highest

incomes exercise the maximum influence on what is
produced. Those workers whose skills are in highest
demand and the most successful entrepreneurs will be
able to buy more products than those whose skills are
in low demand and unsuccessful entrepreneurs.

Key Point
A market economy: an economy where consumers determine what is produced, resources
are allocated by the price mechanism and land and capital are privately owned.

The Advantages of a Market Economy

A market economy should be very responsive to changes in consumer demand. In fact,
in this economic system, consumers are said to be sovereign.

There is also choice in a market economy. Consumers can choose which firms to buy from,
firms can decide what they want to produce and workers can choose who to work for.

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 The profit motive and competition promote efficiency also. Those firms, which produce
what consumers want at the lowest possible prices, are rewarded with high profits. But
those which do not change their output quickly to reflect what is in demand and have
high costs (and consequently high prices) are likely to go out of business.

High incomes provide an incentive for people to work hard and for entrepreneurs to set
up and expand firms. (See unit 10 for a more detailed discussion of the merits of the
market system.)

Disadvantages of a Market Economy

There is a risk that the market forces of demand and supply may not work well. In fact,
there may occur, what is called market failure with market forces failing to ensure the
maximum benefit for society. There are a number of reasons for this.

a. One is that consumers and private sector firms only take into account the costs and
benefits to themselves and not the costs and benefits of their decisions on others.
For example, some people may smoke even if it annoys and endangers the health
of those around them. To keep their costs and prices down, firms may dump waste
material in local rivers rather than process it.

b. Competition between firms should ensure efficiency but, in practice, there may be
little competition. A market may become dominated by one or a few firms. These
firms have considerable market power leading to limited or no choice for consumers.
They can raise the prices of their products and produce poor quality products, as
people have no choice but to buy from them.

c. Even when there is competition and firms want to respond to desires of consumers,
they may not be able to do this. This may be because they cannot attract more
workers as workers lack the right skills or are geographically immobile.

d. Firms will not make products unless they think they can charge for them. There are
some products, such as defence, which most people may want but know that if they
are provided for some, they will have to be provided for all. In such cases people can
act as free riders. They can enjoy the product even if they do not pay for it. When it
is not possible to exclude non-payers, private sector firms do not have the financial
incentive to produce the product.

e. Advertising can distort consumer choice. It can

persuade people to buy products they would not
otherwise have wanted or encourage them to
buy larger quantities. Consumers and producers
may also lack information and hence may make
inefficient choices.

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 f. In a market economy, some consumers will also have a lack of income. There can be
a very uneven distribution of income, with some people being very rich while some
others being very poor. The sick and disabled may find it difficult to earn incomes.
The old may not have made adequate financial provision for their retirement.
Some workers may become unemployed and may find it difficult to find new jobs.

Differences in income will increase over time. Those earning high incomes can afford
to save and buy shares. Their savings and shares will earn them interest and dividends
(a share of profits). In contrast, the poor
cannot afford to save. The children of the rich
will be more likely, than the children of the
poor, to earn high incomes. This is because
their parents are able to spend more on their
education, provide better equipment such as
computers at home for them and thus they
have high hopes of what they can achieve.
(See unit 11 for a more detailed exploration
of market failure.)

Activity 1

In USA, there is a considerable gap between the rich and the poor.
Explain, how in a market economy, some people can be:
a. rich
b. poor.

Activity 2

Decide which of the following may be found in a market economy:

a. most people working for SOEs
b. controls on the prices of most products
c. entrepreneurs earning high profits
d. most land being privately owned.

A Mixed Economy
A mixed economy has a combination of the features of a planned and a market economy.
Some firms are privately owned (in the private sector) and some are government owned
(in the public sector). Some prices are determined by the market forces of demand
and supply and some are set by the government. In this type of economic system, both
consumers and the government influence what is produced.

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 A mixed economy seeks to gain the advantages of both a market and a planned economy
whilst avoiding their disadvantages. Having some products produced by the private
sector may generate choice, increase efficiency and create incentives. Benefits may also
be gained as a result of state intervention. These are listed below.

• The government should take into account all

the costs and benefits that will arise from their
decisions. This should mean, for example, that
even if a railway line and station would not make
a profit in the private sector, they would be
maintained by the state if the benefit to society is
greater than the cost.

• Government can also encourage the consumption of products that are more
beneficial for consumers and others than they realise by granting subsidies, providing
information or passing legislation.

• Government can discourage the consumption of products that are more harmful for
consumers and others than they appreciate by imposing taxes on such products,
providing information or passing legislation.

• Government can finance the production of products that cannot be charged for
directly, for example, defence.

• Government can seek to prevent private sector firms from exploiting consumers by
charging high prices.

• Government is likely to seek to make maximum use of resources, including labour,

and hence try to ensure that those people willing and able to work can find jobs.

• There is a possibility that the government will plan ahead to a greater extent than
private sector firms and hence may devote more of its resources to capital goods.

• Government can help vulnerable groups, ensuring that they have access to basic
necessities. It can also create a more even distribution of income, by taxing the rich
at a high rate.

There are, nevertheless, risks attached even to a mixed economy and there is no guarantee
that it will perform better than the other two types of economies. Market failure can
occur and government intervention may make the situation worse.

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 Key Point
A mixed economy: an economy in which both the private and public sectors play an
important role.

Examples of the Different Economic Systems

To a certain extent, all economies are mixed economies. This is because there is some
government intervention in all economies and some private sector production. The
term – a mixed economy, however, is largely used to describe an economy which has
market and government sectors of reasonably similar sizes. An example of such an
economy is Sweden.

Whilst there is no economy without a government sector, USA is often described as

a market economy. The US government does carry out some functions, for instance,
providing defence. The economy is, nevertheless, considered to be a market economy
as most capital and land is owned by individuals and groups of individuals and market
forces play the key role in deciding the fundamental economic questions.

In Cuba, there is a limited degree of small scale private sector agricultural production
but the economy is largely a planned economy. Most land and capital is owned by the
government and it makes most of the decisions as to what to produce, how to produce
it and who receives the output.

Changes in Economic Systems

In the 1980s and 1990s a number of economies, including the UK and New Zealand,
moved from being largely mixed economies to being mainly market economies. The role
of the government was reduced by removing a number of government regulations, selling
off SOEs and parts of SOEs (privatisation) and lowering taxation.

There was an even more dramatic change in

the economies of Eastern Europe, including
Poland and Russia, in the 1990s. They moved
from being planned economies to market
economies. These economies have experienced
a significant increase in consumer choice and
a rise in the quality of products produced.
They have also, however, seen a rise in income
inequality and poverty.

Market and Mixed Economies 35

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 Recent years have witnessed an increasing role of market forces in a number of economies
in Asia, including China and India, and in Africa, including South Africa. In contrast, there
has been a rise in government intervention in a number of Latin American economies,
including Bolivia and Venezuela.

Activity 3

India has a long tradition of government planning but the degree of

government intervention in the economy has been reduced in the last
two decades. Privatisation started in 1991, with the creation and sale of
a small number of shares in some SOEs. This process speeded up in the
first decade of the 2000s. In 2004, for instance, the Indian government
sold off some of its shares in the Oil and National Gas Corporation and
some shares in the airports of Delhi and Mumbai, hoping that this would
stimulate more investment and greater efficiency. This privatisation has
been opposed by the communist parties of India which argue that firms
perform better in the public sector.
a. What is meant by privatisation?
b. Explain one reason for better performance of a firm when:
(i) it is in the private sector
(ii) it is in the public sector.

Summary

•  he main factors that determine the type of economic system are — who
T
decides what is produced, how resources are allocated and who owns the
capital and land.

•  he three main economic systems are (i) planned economy, (ii) market
T
economy and (iii) a mixed economy. Over the last three decades there has
been a decline in the number of planned economies.

•  he main advantage claimed for a market economy are that output reflects
T
consumer tastes, consumers have greater choice, competition promotes
efficiency and financial incentives encourage hard work and enterprise.

continued....>

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 •  mong the disadvantages that may arise from operating a market economy
A
are that output may not reflect the full costs and benefits, private sector
firms may abuse their market power, resources may be immobile, products
that consumers want but cannot be charged for directly cannot be produced
and there may be poverty.

• In a mixed economy, resources are allocated by means both of the price
mechanism and government decision.

•  ecent decades have seen a number of countries in Eastern Europe,

R
Asia and Africa move towards a market economy.

Teacher’s Tip
Be careful not to confuse a market and a mixed economy. In a market economy, it is the
price mechanism which allocates resources. In a mixed economy, it is both the price
mechanism and the government which decide the use of resources.

Market and Mixed Economies 37

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 Multiple Choice Questions
1. What are the three questions faced by all economies?
a. What to produce, when to produce it and who receives it
b. What to produce, how to produce it and who receives it
c. Where to produce, how to produce and when to produce
d. Where to produce, when to produce and how to produce

2. How are resources allocated in a market economy?

a. By directives
b. By the price mechanism
c. By directives or the price mechanism
d. By directives and the price mechanism

3. What is an advantage of a market economy?

a. An absence of poverty
b. Consumer sovereignty
c. Firms having considerable market power
d. Full employment

4. What is an argument for state intervention in an economy?

a. To encourage the consumption of harmful products
b. To increase the role of the price mechanism in allocating resources
c. To make the distribution of income more uneven
d. To prevent private sector firms from overcharging consumers

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