8mm spine

CAMBRIDGE
IGCSE® ECONOMICS

IGCSE ECONOMICS
Letts Cambridge IGCSE ® Economics Revision Guide provides clear and accessible revision content to
support all students, with lots of practice opportunities to build your confidence and help you prepare
for your Cambridge IGCSE® (0455) and O Level (2281) Economics assessments.
• Clear and concise syllabus coverage, with topics in short, user-friendly sections to help you plan
your revision in manageable chunks
• Revision tips to provide essential assessment guidance
• Quick tests for every topic, so you can check your progress
• Multiple choice and structured exam-style practice questions with every chapter so you can
develop your exam skills
• A supporting glossary with easy-to-understand definitions of key terms
Author: Andrew Gillespie

CAMBRIDGE IGCSE® ECONOMICS • Revision Guide

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60132_Cover Economics.indd 1 15/01/2018 15:40

 IGCSE ECONOMICS
CAMBRIDGE
®

Andrew
Gillespie

Revision Guide

60132_P001.indd 1 03/01/2018 16:21

 Contentts

Chapter 1 The basic economic problem

The nature of the economic problem
Finite resources and unlimited wants p. 8
Economic and free goods p. 9
Factors of production
Factors of production and their rewards p. 10
Mobility of the factors of production p. 10
Quantity and quality of the factors of production p. 10
Opportunity cost and the production possibility curve diagram (PPC)
Opportunity cost and its influence on decision-making p. 12
The production possibility curve diagram (PPC) p. 12
Exam-style practice questions p. 14

Chapter 2 The allocation of resources

Micro and macroeconomics
Microeconomics p. 17
Macroeconomics p. 17
The role of markets in allocating resources
The market system p. 18
Introduction to the price mechanism p. 18
Demand
Demand p. 19
Price and demand p. 19
Conditions of demand p. 20
Individual and market demand p. 21
Supply
Supply p. 22
Price and supply p. 22
Conditions of supply p. 22
Individual and market supply p. 23
Price determination
Markets p. 24
Market equilibrium and disequilibrium p. 25
Price changes
Changes in supply and demand conditions p. 26
The effect of an increase in indirect tax p. 27
The effect of a production subsidy p. 28

2 Contents

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 Price elasticity of demand (PED)
Price elasticity of demand (PED) p. 29
PED and revenue p. 30
Determinants of PED p. 32
Significance of PED p. 32
Price elasticity of supply (PES)
Price elasticity of supply (PES) p. 33
Determinants of PES p. 35
Market economic system
Market economic system p. 36
Advantages and disadvantages of the market economic system p. 37
Market failure
Causes and consequences of market failure p. 38
Mixed economic system
Government intervention to address market failure p. 40
Exam-style practice questions p. 42

Chapter 3 Microeconomic decision makers

Money and banking
Money p. 46
Banking p. 46
Households
Income p. 47
Spending p. 47
Savings p. 48
Borrowing p. 48
Workers
Choice of occupation p. 50
Wage determination p. 50
Reasons for differences in earnings p. 50
Specialisation p. 51
Trade unions
Trade unions and their role in the economy p. 52
The advantages and disadvantages of trade union membership p. 53
Firms
Sectors of the economy p. 54
Small firms p. 54
Causes of growth of firms p. 54
Mergers p. 54
Economies and diseconomies of scale p. 55

Contents 3

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 Firms and production
Demand for factors of production p. 57
Labour-intensive and capital intensive production p. 57
Production and productivity p. 58
Firms’ costs, revenue and objectives
Costs of production p. 59
Revenue p. 60
Objectives of firms p. 62
Market structure
Competitive markets p. 63
Monopoly markets p. 63
Exam-style practice questions p. 66

Chapter 4 Government and macroeconomy

The role and macroeconomic aims of government
Government and its role p. 69
The macroeconomic aims of government p. 70
Possible conflicts between macroeconomic aims p. 71
Fiscal policy
Fiscal policy and government spending p. 72
The government budget position p. 72
Taxation p. 72
Principles of taxation p. 73
Impact of taxation p. 73
Taxation and macroeconomic objectives p. 74
Monetary policy
Monetary policy measures p. 75
Effects of monetary policy on macroeconomic objectives p. 76
Supply-side policy
Supply-side policy measures p. 77
The effects of supply-side policy measures on macroeconomic aims p. 78
Economic growth
Measurement of economic growth p. 79
The economic (or business or trade) cycle p. 80
Employment and unemployment
Changing patterns and levels of employment p. 82
Causes and types of unemployment p. 82
Consequences of unemployment p. 83
Policies to reduce unemployment p. 83

4 Contents

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 Inflation and deflation
Measurement of inflation p. 84
Consumer Price Index (CPI) p. 84
A fall in inflation p. 84
Causes of inflation and policies to control it p. 85
Consequences of inflation p. 85
Deflation p. 86
Exam-style practice questions p. 87

Chapter 5 Economic development

Living standards
Real national income per capita p. 90
Comparing incomes between countries p. 91
Comparing living standards and income distribution p. 91
Measuring economic development p. 91
Poverty
Poverty p. 93
Causes and effects of poverty p. 94
Policies to alleviate poverty p. 94
Population
The factors that affect population growth p. 95
The effects of changes in the size and structure of the population p. 96
Differences in economic development between countries
Classification of economies p. 98
Features of developing and more developed economies p. 98
The importance of trade in developing economies p. 99
Exam-style practice questions p. 100

Chapter 6 International trade and globalisation

International specialisation
Specialisation at a national level p. 103
Advantages and disadvantages of specialisation p. 103
Free trade and protection
Globalisation and multinational companies (MNCs) p. 105
The benefits of MNCs p. 105
The costs of MNCs p. 106
Free trade p. 106
Protection p. 107

Contents 5

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 Foreign exchange rates
Foreign exchange rates p. 108
Determination of the foreign exchange rate p. 108
Causes and consequences of fluctuations p. 111
Current account of balance of payments
The structure of the current account of balance of payments p. 113
The current account position of a country p. 113
Current account balance calculations p. 114
Current account deficit and surplus p. 114
Policies to achieve stability p. 115
Exam-style practice questions p. 116

Answers p. 119

Glossary p. 128

6 Contents

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 Introduction

This revision guide will help you to revise and practise the skills and
knowledge required by the Cambridge IGCSE and O Level Economics
syllabuses. It covers all of the learning objectives in the Economics
syllabuses.
The guide is divided into six chapters. Each chapter covers one of the
topics in the syllabuses.
The syllabuses contain a lot of subject specific vocabulary that you need
to learn. Key words are highlighted in bold in the main text and the
definitions are summarised in the Glossary at the end of the book.
You will find Revision tips on many of the pages in the guide. They explain
how to avoid some common errors that students make when they write
answers to questions.
Revision is only successful if you do something active, rather than simply
reading. You could try rewriting some of the material in a different form.
For example, you could convert a paragraph of text into a series of bullet
points, or change a set of bullet points into a table.
There are Quick test questions at the end of each sub-topic. Use these to
check that you have understood and remembered the content you have
just worked through. The answers to these questions are at the back of
the book.
At the end of each chapter, there is a set of Exam-style practice questions.
These are designed to help you prepare for the theory parts of your
examinations. Each question has a mark allocation, which you should
use to help you decide how much to write and how much detail to give
in your answer. The questions, example answers, marks awarded and
comments that appear in the book were written by the author. Note that
in examinations, the way marks would be awarded to answers like these
may be different.
You will find a list of the contents on pages 2 to 6. You could use this to
keep track of your progress as you work through the guide – tick the box
in one colour when you have first worked through a section and then in
another colour when you have gone over it again and answered all of the
questions correctly.

Introduction 7

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 Chapter 1
The basic
economic
problem The natture of the economicc problem

Finite re
esources and
d unlimited
d wants You must be able to:
• understand what is meant by
The resources of an economy are inputs into the production process. ‘resources’
They are: • understand the meaning
of finite and renewable
• land resources
• labour • define the economic problem
• capital • explain what is meant by
‘economic agents’
• enterprise. • distinguish between a free
Most resources are finite – once they have been used, they cannot be good and an economic good.
replaced.
Renewable resources are commodities that are replaceable, such as solar
energy, fish stocks or forestry. They can be sustained over time, providing
the rate of extraction is less than or equal to the rate of renewal.
At any moment in time, resources are fixed in terms of their quantity and
quality, which means there is a limit to what can be produced. This affects
all the economic agents (different groups in the economy): Revision tip
• consumers – have limited income and must decide how to use it When answering a question,
• employees (workers) – have limited time and must decide how to remember to think about the
use it effect of any change on the
different economic agents:
• producers – have limited funds and must decide what to do with them, consumers, employees, producers
e.g. whether to invest in new machinery or new office space and government. A given policy
may be good for some agents but
• government – have limited funds and must decide what to do with not for others.
them, e.g. whether to invest in education or healthcare.

Consumers

Economic Employees/
Government
agents workers

Producers

Finite resources limit what can be produced. However, human wants

(what we would like) and needs (what we must have, e.g. water and food)
are unlimited. This means resources are scarce and choices have to be
made about what to do with them.

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 Finite resources and unlimited wants lead to scarcity and choice. The basic
economic problem is that decisions have to be made about the choice and
allocation of resources to determine:
• what is produced
• how it is produced
• who products are produced for.

What to How to
produce? produce?

Who to
produce for?

Econom
mic and free goods Revision tip
The provision of economic goods involves an opportunity cost – to
produce the good, resources have to be moved from the production of Sometimes free goods become
economic goods. For example,
another good. For example, to produce more laptops, employees may if air becomes polluted and has
be moved from producing PCs. We have more of one product, but have to be cleaned up, this process
involves resources and has an
sacrificed something in return. opportunity cost.
The opportunity cost of any decision is measured in terms of what has
been sacrificed in the next best alternative.
The provision of a free good does not involve an opportunity cost. Air is
a free good – it exists and, in general, does not require other goods to be
sacrificed to have more of it.

Quick test
1. Explain the difference between an economic good and a
free good.
2. Explain what is meant by a ‘finite resource’.
3. State three economic agents.
4. Explain what is meant by ‘the basic economic problem’.
5. Explain what is meant by a ‘renewable resource’.

The nature of the economic problem 9

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 Chapter 1
The basic
economic
problem Factorss of producttion

Factors of productio
on and the
eir rewards You must be able to:
• explain what is meant by
The factors of production in an economy are used in the production ‘factors of production’
process to produce goods and services. They are: • explain what is meant by the
‘mobility’ and ‘immobility’ of
• land – including natural resources such as oil factors of production
• labour – the number and skills of the workforce • explain why the quantity and
• capital – the quality and quantity of machinery and equipment quality factors of production
may change over time.
• enterprise – the management expertise needed to think of new
products and processes and combine resources to set up a new project
or business.
The people who come up with new ideas and take the risk to develop new
business opportunities are called entrepreneurs.

Factors of
production

Land Labour Capital Enterprise

The rewards for the factors of production are:

Revision tip
• wages for employees
• rent for land The word ‘capital’ can be
• interest earned on capital confusing as it has different
meanings. It can mean ‘capital
• profit for enterprise.
goods’, such as machines or
equipment. However, money is
Mobility
y of the facto
ors of prod
duction often referred to as ‘capital’ too.

Factor mobility refers to how easily factors can move from one business
or industry to another. Immobility means it is difficult for resources to be
reallocated.
Labour immobility may occur due to:
• occupational immobility, when there are differences in the skills
needed, e.g. a plumber cannot easily become a doctor; it would take
several years to retrain
• geographical immobility, when it is difficult to move to another area,
e.g. high house prices in a particular region may make it difficult for
people from other regions to relocate there.

Quantityy and qualitty of the factors of

producttion
The amount of output that can be produced with the factors of
production depends on their quality and quality. For example: Revision tip
• the more people there are in the workforce, and the better their Remember, resources are fixed in
training and skills, the more productive it can be terms of quantity and quality at
any moment, but can change over
• machinery that uses the latest technology may be more productive
time.
than older machinery.

10 IGCSE® Economics Revision Guide

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 Changes in factors of production can occur over time. For example:
• investment in technology and equipment can improve the quantity
and quality of capital
• better training and education or more apprenticeships can improve
the quality of the workforce
• a growth in the population size, e.g. more people coming into a
country than leaving it (net migration), can increase the number of the
workforce
• the use of better technology, e.g. use of fertilisers on farmland or
better technology to access shale gas, can improve the productivity of
the land.

Quick test
1. What is meant by ‘enterprise’?
2. Give three factors of production.
3. Explain how the quantity of capital may be improved over time.
4. Explain what is meant by ‘labour immobility’.
5. Explain how the quality of labour may be improved over time.
6. What is an ‘entrepreneur’?

Factors of production 11

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 Opporttunity cost and the production
Chapter 1
The basic
economic
problem
possibility curve diagram (P
PPC)

Opportuunity cost an
nd its influence on You must be able to:
• explain what is meant by
n-making
decision ‘opportunity cost’
• explain the significance of
Opportunity cost refers to what is sacrificed in the next best alternative opportunity cost
when a decision is made. For example, if resources are put into the • understand the meaning of
provision of more schools, the opportunity cost may be fewer hospitals. the production possibility
curve (PPC)
Given the fact that there are limited resources at any given moment, it is • show the concept of
impossible to have more of everything – something has to be sacrificed to opportunity cost on a
production possibility curve.
have more of one product, i.e. there is an opportunity cost.
When making any decision, the decision maker should consider what
else could be done with the resources, i.e. what is the opportunity cost?
This is known as the real cost of an economic decision (as opposed to its
financial cost).

The prod
duction posssibility currve
m (PPC)
diagram
The production possibility curve (PPC) shows the maximum goods and
services that can be produced given the existing resources and technology. Revision tip
If the economy is producing on the PPC, it is productively efficient – more Remember that any policy
of one product can only be produced if less of another is produced. There decision will involve an
is an opportunity cost. opportunity cost. This should
be considered before deciding
For example, in the diagram below, if resources are moved out of whether to go ahead with the
policy.
Product A and into Product B, the economy may move from Y to Z. The
opportunity cost of the extra XZ units of B is the YX units of A.
If the economy is producing inside the PPC (e.g. at X), it is productively
inefficient – more of one product could be produced without producing
less of another. This is because resources are being used inefficiently or the
economy is not working at full capacity, e.g. there is unemployment.

Productive inefficiency
Product A Revision tip
When drawing the PPC,
Y
remember to label the axes
‘Product A’ and ‘Product B’.

Z
X

Product B

12 IGCSE® Economics Revision Guide

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 Over time, the PPC can shift outwards if there is an improvement in the
quality and quantity of resources. This shows economic growth. Revision tip
The PPC is an important concept
Economic growth in economics. Make sure you can
Product A use it to show a reallocation of
resources between industries,
a growth in the economy and
economic inefficiency.

Product B

Trade
A country cannot produce outside of its PPC given its existing resources.
However, if it trades some of its goods abroad, it is possible for a country to
consume outside the PPC. If a country specialises in producing Product A,
it may be able to trade some of Product A abroad in return for higher
levels of Product B than it could produce itself. If countries specialise in
producing goods and services that they are particularly good at and then
trade them with others who are particularly good at something else, they
can all benefit.
Capital goods versus consumption goods
Capital goods, such as machines, are an investment for the future.
Consumption goods, such as food, are consumed now. If an economy
puts most if its resources into capital goods, it may lead to greater output
and economic growth in the future. If the economy produces mainly
consumption goods, it means there is little investment in the future and
economic growth is likely to be lower.

Quick test
1. Explain what is meant by ‘opportunity cost’.
2. Explain what is shown by the production possibility curve (PPC).
3. Explain how opportunity cost can be shown on a PPC.
4. Explain why operating on the PPC is productively efficient.
5. Explain why the PPC may move outwards over time.

Opportunity cost and the production possibility curve diagram (PPC) 13

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 Chapter 1
The basic
economic
problem Exam-sstyle practicce questio
ons

1 What is meant by ‘the basic economic problem’? [1]

a) abundance and choice

b) abundance and freedom

c) scarcity and choice

d) scarcity and freedom

2 A business invests in a new factory. Which factor of production has increased? [1]

a) capital

b) enterprise

c) labour

d) land

3 Opportunity cost refers to the sacrifice of what? [1]

a) a more modern alternative

b) the lowest cost alternative

c) the most different alternative

d) the next best alternative

4 How does a production possibility curve (PPC) show that scarcity exists? [1]

a) It shows that as demand increases for a product, its price rises.

b) It shows that as more resources are used to produce a product, its price rises.

c) It shows that at any point outside the PPC, an economy is wasting resources.

d) It shows that there is a limit to the quantity of products that can be produced with existing
resources and technology.

5 An economy is producing efficiently and shifts resources from producing food to computers.
Which could describe the movement? [1]
Output of food
a) AB

b) BQ

B c) CQ
A Q
D
d) CD
C

Output of
0 computers

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 6 Why are wants not fully satisfied in an economy? [1]

a) An economy can only produce a limited amount of goods and services.

b) Governments cannot print enough money to pay for goods and services.

c) There is an over-production of goods and services by business organisations.

d) Workers are too skilled for the requirements of the jobs available.

7 South Korea’s balance of trade

Fig. 1: South Korea’s GDP (income), 1960–2016 Fig. 2: South Korea’s population, 1960–2016
Trillion Million

55
1.6

1.4 50

1.2
45
1.0

0.8 40

0.6 35
0.4
30
0.2

0.0 25
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Fig. 3: South Korea’s balance of trade, 2012–2016

USD million

15 000

10 000

5000

–5000
2012 2014 2016
The balance of trade measures the difference
between a country’s export revenue from goods and
services and import spending over a given period.

South Korea is a modern economic miracle. Over the last forty years it has experienced rapid
economic growth and has become a high-technology industrialised economy. By comparison, the
economy of its neighbour, North Korea, remains very much based on the primary sector (farming and
extractive industries) and the income per person is low.

Much of South Korea’s progress is due to the government, which encouraged investment in capital,
education and training. As a result, the country has a well-equipped and highly-qualified workforce.

The South Korean government appreciated the importance of trade for the future of the economy.
It encouraged the import of raw materials and components rather than consumer goods in order
to help businesses grow. It also gave incentives for saving and for the production of capital goods,
rather than encouraging money to be spent on consumption. These savings provided funds for
investment.

Exam-style practice questions 15

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 South Korea now has well-developed secondary (manufacturing) and tertiary (service) sectors.

a) Calculate the percentage increase in population in South Korea between 2015 and 1960. [2]

b) Explain what is meant by the primary sector. [2]

c) Explain what is meant by ‘rapid economic growth’ in South Korea. [2]

d) Show the economic growth of South Korea using a production possibility curve (PPC) diagram. [4]

e) Explain how investment in capital by South Korean businesses can encourage economic
growth. [4]

f) Analyse how greater trade by South Korea can help lead to consumption outside the
PPC of the economy. [4]

g) South Korea has invested heavily in education. Discuss whether investing in education is a
good way to help an economy grow. [6]

h) South Korea has encouraged the production of capital goods. Discuss whether it is better for
economies to produce capital goods or goods for consumption. [6]

8 Nigeria's spending on education is low compared to most other countries. In 2017, the Nigerian
National Assembly allocated 6.4% of its total budget. By comparison, 31% of Ghana's annual budget
goes to education, followed by Cote d'Ivoire which allocates 22% of its annual budget to education.
Many students from Nigeria go abroad to study. This education abroad has an opportunity cost for
consumers and for all economic agents in the country, especially when most students do not return
home after their studies.

a) Define opportunity cost. [2]

b) Explain how the production possibility curve (PPC) can show the concept of opportunity cost.
Use a diagram in your answer. [4]

c) Analyse the possible effect of low investment in education on the growth of an economy. [6]

d) Discuss the extent to which the concept of opportunity cost is only of use to consumers. [8]

9 China has a high supply of some factors of production. For many years the solution to the basic
economic problem in China came through a command (planned) economy. The government
introduced reforms to become more of a free market in 1978. Since then, GDP growth has averaged
nearly 10 per cent a year and has lifted more than 800 million people out of poverty.

a) Identify factors of production in an economy. [2]

b) Explain what is meant by ‘the basic economic problem’. [4]

c) Analyse the possible causes of economic growth. [6]

d) Discuss whether the free market is a better way to allocate resources than a command
economy. [8]

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 The allocation
of resources

Chapter 2
Miccro and ma
acroeconom
mics

Types of You must be able to:

economics
• distinguish between micro
and macroeconomics.

Microeconomics Macroeconomics

Microecconomics
Microeconomics refers to the allocation of resources within specific
markets, i.e. the market for a particular good or service.
Microeconomics may consider factors such as:
• the price of oil
• house prices in an area
• the wages of a particular type of worker.

Macroecconomics
Macroeconomics refers to the allocation of resources within the economy
as a whole. Revision tip
Macroeconomics involves factors such as: Microeconomics and
macroeconomics are related. The
• unemployment
whole economy (macro) is made
• trade flows up of many different individual
• price levels in an economy. markets (micro).

Quick test
1. What is meant by ‘microeconomics’?
2. What is meant by ‘macroeconomics’?
3. Analysing changes in the growth of the economy is part of
macroeconomics. True or false?
4. Analysing changes in property prices in the capital of a country is
part of macroeconomics. True or false?
5. Analysing changes in the unemployment levels in a country is part
of microeconomics. True or false?

Micro and macroeconomics 17

60132_IGCSE Economics Topic 02.indd 17 18/01/18 3:53 pm

 The allocation
of resources
Chapter 2

The role
e of marketts in alloca
ating resou
urces

The marrket system You must be able to:

• explain what is meant by
Markets are made up of demand and supply. They have buyers and sellers. ‘a market’ and the ‘market
system’
The price adjusts in a market to bring about equilibrium between supply
• explain the role of the price
and demand, i.e. a point where the quantity supplied equals the quantity mechanism
demanded. • explain what is meant by
‘equilibrium’.
There are prices in many different markets within an economy, e.g. the price
of a car, the price of a house, the price of a currency or the price of labour.

Introducction to the price mech

hanism Revision tip
Equilibrium occurs when, at the given price, the quantity supplied equals It is important to remember
that economic diagrams, such as
the quantity demanded. supply curves and demand curves,
Disequilibrium occurs when, at the given price: assume that all other factors are
unchanged.
• the quantity demanded is greater than the quantity supplied (there is
a shortage)
OR
• the quantity supplied is greater than the quantity demanded (there is Revision tip
a surplus).
It is important to identify
The price mechanism is the process whereby the price adjusts to bring the cause of a change in the
equilibrium price or quantity, e.g.
about equilibrium in a market. The price acts as:
was it a shift in demand or a shift
• an incentive to producers to produce more or less in supply?
• a signal to other producers to enter or exit the industry
• a rationing device – it affects the quantity demanded.
For example, if there is too much demand in a market, the price will rise.
This will:
• act as an incentive for existing producers to produce more
• encourage other producers to enter the market
• reduce the quantity demanded.
The price will continue to rise until equilibrium was restored.
Equilibrium is a position of stability in a market – there is no incentive to
change at the given price and existing supply and demand conditions.
If the price in a market increases or decreases, it will be due to a shift in
demand or supply. The shift will create excess demand or excess supply
and the price will adjust, changing the quantity demanded and quantity
supplied until a new equilibrium is reached.

Quick test
1. Explain what is shown by a supply curve.
2. Explain what is shown by a demand curve.
3. Explain what is meant by ‘equilibrium’ in a market.
4. What is the role of the price mechanism?
5. What causes price changes in markets?

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 The allocation
of resources

Chapter 2
Dem
mand

Demand
d You must be able to:
• explain what is shown by a
A demand curve shows the quantity that consumers are willing and able demand curve
to buy at each and every price, all other factors unchanged. • distinguish between a
movement along the curve
Other influences on demand, apart from price, include: and a shift in demand
• explain the causes of shifts in
• the prices of other goods and services
demand
• income levels • distinguish between an
• the marketing activities of the business individual and a market
• the size of the buying population. demand curve.

Price an
nd demand
A movement along a demand curve leads to a change in the quantity
demanded:
• a contraction of demand occurs when the price rises and there is a
decrease in the quantity demanded
• an extension of demand occurs when the price falls and there is an
increase in the quantity demanded.
Price

P2 M
ov
em
en
ts
alo
ng
ad
P0 em
an
d
cu
rv
e

P1

Quantity
Q2 Q0 Q1

Demand 19

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 Conditio
ons of dema
and
A shift in demand occurs due to a change in factors other than price,
e.g. income, advertising, the price of other products or the number
of consumers. When these change, there is a change in the quantity
demanded at each and every price and the demand curve shifts.

Price

An increase
in demand
Shifts in demand

D2
A decrease
in demand D1
D3
Quantity

An outward shift (an increase) in demand can be caused by:

Revision tip
• more effective marketing, e.g. better advertising and greater brand
loyalty Make sure you clearly understand
• an increase in income – for normal goods or services, more is the difference between a
movement along a demand curve
demanded when income increases (note that for inferior goods or
and a shift in demand.
services, when income increases, less is demanded at each and every
price, e.g. with more income, people may switch from using buses to
buying and using their own car)
• an increase in the price of a substitute – consumers may switch from
a substitute product (similar competitor product), which has become
relatively expensive, to this product
• a decrease in the price of a complement, e.g. computer printers and
printer cartridges are complements (the consumer needs both) so, if
the price of the printer cartridges decreases, demand for the printer
may increase (products that are brought together are in joint demand).
An inward shift (a decrease) in demand can be cause by:
• a reduction in marketing activities – with less promotion, the quantity
demanded may fall Revision tip
• a decrease in income – for normal goods and services, less is demanded
when income decreases (note that for inferior goods and services, Remember that, when income
increases, demand increases for a
when income decreases, more is demanded at each and every price, normal good but demand will fall
i.e. customers switch back to the inferior products) for an inferior good.
• a decrease in the price of a substitute – this will increase the quantity
demanded of the substitute and reduce the quantity demanded of this
product
• an increase in the price of a complement – this will cause less demand
for the complement and for the product itself
• a decrease in the market size – a fall in the number of buyers will
reduce demand.

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 Individu
ual and mark
ket demand
An individual demand curve shows the quantity an individual consumer is
willing and able to buy at each price, all other factors unchanged.
The market demand curve, for the market as a whole (i.e. for all
consumers), is constructed by adding together the quantity demanded
by all the different consumers at each and every price, all other factors
unchanged. It is the horizontal summation of the individual demand curves.

P P P

$10

DA DB DA +B
Q Q Q
20 30 50
Individual A Individual B Market demand A + B

Quick test
1. What assumption is made when drawing a demand curve?
2. Give one reason why a demand curve for a product may shift
outwards.
3. Give one reason why a demand curve for a product may shift
inwards.
4. Explain the difference between a movement along a demand curve
and a shift in demand.
5. Explain the difference between individual and market demand curves.

Demand 21

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 The allocation
of resources
Chapter 2

Supply

Supply You must be able to:

• explain what is shown by a
A supply curve shows the quantity that producers are willing and able to supply curve
produce at each and every price, all other factors unchanged. • explain the difference
between a movement along
The amount that can be supplied at any price depends on factors such as: the curve and a shift in supply
• explain what can cause the
• the number of producers
supply curve to shift
• the costs of resources, such as materials and labour • explain the difference
• the state of technology between an individual and
• the way in which work is organised and managed market supply curve.
• taxes on producers or subsidies for producers.

Price an
nd supply
A movement along a supply curve occurs when the price changes: Revision tip
• an extension in supply is due to a rise in price, which increases the Make sure you clearly understand
quantity supplied the difference between a
movement along a supply curve
• a contraction in supply is due to a fall in price, which reduces the and a shift in supply.
quantity supplied.

Price

P1
ng
lo
ta
en

P0
em
ov
M

P2

Quantity
Q2 Q0 Q1

Conditio
ons of supply
A shift in supply means more or less is supplied at each and every price.

Price
S3
S1
S2

Decrease Increase
in supply in supply

Quantity

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 Increase in supply Decrease in supply
(outward shift) (inward shift)
more producers fewer producers
lower costs, e.g. lower wages or higher costs, e.g. higher wages or
more subsidies indirect taxes
better technology / working
poorer working methods
methods
more capital equipment less capital equipment

Individu
ual and mark
ket supply
An individual supply curve shows the quantity an individual producer is
willing and able to produce at each price and every price, all other factors
unchanged.
The market supply curve, for the market as a whole (i.e. for all producers),
is constructed by adding together the quantity supplied by all the
different producers at each price and every price. It is the horizontal
summation of the individual supply curves.

P P P
SA SB SA + B

+ =

Q Q Q
20 30 50
Firm A Firm B Industry supply A + B

Quick test
1. What assumption is made when drawing a supply curve?
2. Give one reason why a supply curve for a product may shift
outwards.
3. Explain one reason why a supply curve for a product may shift
inwards.
4. Explain the difference between a movement along a supply curve
and a shift in supply.
5. Explain the difference between individual and market supply curves.

Supply 23

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 The allocation
of resources
Chapter 2

Price de
eterminatio
on

Marketss You must be able to:

• explain the meaning of ‘a
The demand curve for a product is assumed to be downward sloping – at shortage’
lower prices, the quantity demanded is greater. • explain the meaning of ‘a
surplus’
The supply curve is assumed to be upward sloping – at higher prices, the • explain the meaning of
quantity producers are willing and able to produce increases. market equilibrium and
disequilibrium
A shortage • use supply and demand
Price diagrams to identify
equilibrium and
S disequilibrium prices.

P0

P1
D

Quantity
Q1 Q0 Q2

A shortage occurs if the quantity demanded (Q2) is greater than the

quantity supplied (Q1), e.g. at P1. The price will increase, which reduces
the quantity demanded and increases the quantity supplied until
equilibrium is reached at P0Q0.
A surplus
Price

Surplus S
P1

P0

Quantity
Q1 Q0 Q2

A surplus occurs when, at the given price, the quantity supplied (Q2)
is greater than the quantity demanded (Q1). The price will fall, which
reduces the quantity supplied and increases the quantity demanded until
equilibrium is reached at P0Q0.

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 Market equilibrium and disequilibrium Revision tip
Market equilibrium occurs at the price where quantity supplied equals
quantity demanded and there is no incentive to change. Make sure you can differentiate
between the cause and the
Disequilibrium occurs when, at the given price, the quantity demanded effect of a change. An increase
in demand may lead to a higher
is greater than the quantity supplied (there is a shortage) or the quantity equilibrium price in a market. A
supplied is greater than the quantity demanded (excess supply). higher price does not lead to an
increase in demand.

Quick test
1. What is meant by ‘market equilibrium’?
2. What is it called if, at a given price, the quantity demanded is
greater than the quantity supplied?
3. What is it called if, at a given price, the quantity demanded is less
than the quantity supplied?
4. If the quantity demanded is greater than the quantity supplied at a
given price, is the price likely to increase or decrease?
5. What is meant by ‘market disequilibrium’?

Price determination 25

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 The allocation
of resources
Chapter 2

Price ch
hanges

Changess in supply and deman

nd condition
ns You must be able to:
• explain the effect of a shift in
An increase in demand demand on the equilibrium
Price price and quantity
• explain the effect of a shift
S in supply on the equilibrium
price and quantity
• explain the effect of an
P1 indirect tax and production
subsidy on the equilibrium
P0
Excess price and quantity.
demand

D2
D1
Quantity
Q0 Q1

The market is initially at equilibrium at P0Q0. Demand increases and

shifts outwards. At the existing price, there is now excess demand. The
price increases, which reduces the quantity demanded and increases the
quantity supplied until a new equilibrium price and quantity is reached.
A decrease in demand
Price

Excess
supply
P0

P1

D1
D2
Quantity
Q1 Q0

The market is initially at equilibrium at P0Q0. Demand decreases and

shifts inwards. At the existing price, there is now excess supply. The price
decreases, which increases the quantity demanded and decreases the
quantity supplied until a new equilibrium price and quantity is reached.
An increase in supply
Price

S1
S2
Excess
supply
P0

P1

Quantity
Q0 Q1

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 The market is initially at equilibrium at P0Q0. Supply increases and shifts
outwards. At the existing price there is now excess supply. The price
decreases, increasing the quantity demanded and decreasing the quantity
supplied until a new equilibrium price and quantity is reached.
A decrease in supply
Price
S2
S1

P1

P0

D
Quantity
Q1 Q0

The market is initially at equilibrium at P0Q0. Supply decreases and shifts

inwards. At the existing price, there is now excess demand. The price
increases and this decreases the quantity demanded and increases the
quantity supplied until a new equilibrium price and quantity is reached.
Summary

Effect on Effect on
equilibrium equilibrium
price quantity
outward shift (increase) in demand increase increase
inward shift (fall) in demand decrease decrease
outward shift (increase) in supply decrease increase
inward shift (fall) in supply increase decrease

The effe
ect of an incrrease in ind
direct tax
An indirect tax increases producer costs and shifts supply inwards.
Specific unit tax Ad valorem tax, e.g. of 10%
Price Price

S1 S1
S +5 S
50

+1
10

Quantity Quantity
Q0 Q1

A specific tax adds a fixed An ad valorem tax adds a percentage

amount to costs, so the supply to the costs. The higher the initial
curve moves in parallel. price, the greater the tax in $, e.g.
10% of $10 = $1, 10% of $50 = $5.

Price changes 27

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 The effe
ect of a production sub
bsidy
A production subsidy reduces producer costs and shifts supply outwards.
Production subsidy
Price

S1

Subsidy

Quantity

Quick test
A market is initially at equilibrium with supply curve S0 and demand
curve D0.
Price S1
S1
B
C S3
D
A
E F
H
D1
G
D0
I
D2
Quantity

Select the change in market conditions that would explain the

movement from:
1. A to B
2. A to C
3. A to D
4. A to E
a) an outward shift in demand and inward shift in supply

b) an outward shift in demand and outward shift in supply

c) an inward shift in demand and inward shift in supply

d) an inward shift in demand and outward shift in supply

e) an inward shift in supply only

f) an outward shift in supply only

g) an inward shift in demand only

h) an outward shift in demand only

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 The allocation
of resources

Chapter 2
Price ela
asticity off demand (P
PED)

Price ela
asticity of de
emand (PED) You must be able to:
• explain what is meant by the
Price elasticity of demand (PED) measures the percentage change in ‘price elasticity’ of demand
quantity demanded in relation to percentage change in price, all other • interpret the significance
factors unchanged. of the value of the price
elasticity of demand
% change in quantity demanded • calculate the price elasticity
PED = of demand
% change in price
• describe factors that
The sign of the result shows the direction of movement. A negative result influence the price elasticity
shows that the price and quantity demanded move in different directions, of demand
e.g. an increase in price reduces the quantity demanded or vice versa. • explain the difference
between price elastic and
The size of the result shows how responsive the quantity demanded is to price inelastic demand
changes in price, e.g. • explain the significance of
price elasticity of demand
• if the PED value is 2, a 1% change in price leads to a 2 × 1% change in when making pricing
quantity demanded decisions.
• if the PED value is 0.2, a 1% change in price leads to a 0.2 × 1% change
in quantity demanded.
Revision tip
Value
(ignoring Description Explanation Remember that price elasticity
shows how much the quantity
the sign) demanded changes (as a %)
infinity completely a given % change in price leads to an compared to the change in price
(as a %). Is the change in quantity
price elastic infinite change in quantity demanded
demanded greater or smaller than
>1 price elastic a given % change in price leads to a the change in price?
greater % change in quantity demanded
=1 unit elastic a given % change in price leads to the
same % change in quantity demanded
<1 price inelastic a given % change in price leads to a
smaller % change in quantity demanded
0 completely a given % change in price leads to no
price inelastic change in quantity demanded

Price elasticity of demand (PED) 29

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 Examples of price elasticity
Price Price
Price
D

Demand is
P1 Demand is –20% unitary elastic
Demand is
P D perfectly PED = 1
perfectly inelastic
elastic
PED = 0
P0 PED = ∝
D
Quantity
Quantity Quantity +20%

Price Price

Price elastic demand:

P0 Price inelastic:
the % change in quantity
the % change in
demanded is larger than
quantity demanded is P0
–20% the % change in price
smaller than the % –10% PED > 1
change in price P1
P1 PED < 1

D D

Quantity Quantity
Q0 Q1 Q0 Q1
+60%
+10%

PED and rev

venue
Value Price change Effect on revenue Explanation
price inelastic price increase increases revenue • higher price per unit
(< 1) (and spending) • % fall in quantity demanded is smaller than
% increase in price
price inelastic price decrease decreases revenue • lower price per unit
(< 1) (and spending) • % rise in quantity demanded is smaller than
% increase in price
price elastic price increase decreases revenue • higher price per unit
(> 1) (and spending) • % fall in quantity demanded is greater than
% increase in price
price elastic price decrease increases revenue • lower price per unit
(> 1) (and spending) • % rise in quantity demanded is greater
than % increase in price
unitary price price increase no change % change in quantity demanded is the same
elastic (= 1) or decrease as % change in price

When deciding whether to put the price up or down, a producer will

consider the price elasticity of demand: Revision tip
• if demand is price inelastic, the producer will increase the price to Remember, if you know the
increase revenue PED, you can estimate the effect
of a price change on revenue.
• if demand is price elastic, the producer will lower the price to increase
However, to understand the
revenue. impact on profits, you would
need to know what is happening
to costs as well.

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 Example
A product has a price elasticity of demand of –2. The unit price is $40
and the quantity demanded is 20 units.
If the price increases by 10%, what is the effect on total revenue?
% price increase = 10 × 40 = $4.
( )
100
New price = $40 + $4 = $44
Quantity demanded will change by –2 × 10% = –20%
20% of 20 units = 20 × 20 = 4( )
100
Quantity demanded = 20 – 4 = 16.
Revenue = price × quantity
Original revenue = $40 × 20 = $800
New revenue = $44 × 16 = $704
The 10% increase in price has led to a $96 fall in revenue because
demand is price elastic.
You can use a formula triangle to help with these calculations:
b=a
c a
a=b×c %
change
c=a b c
in quantity
b demanded

price
% change
elasticity
in price
of demand

If a 10% increase in price leads to a

20% fall in quantity demanded, the
PED is –2. –20%

If you know two of the elements

of the triangle, the third can be
calculated: price
elasticity +10%
PED = –20 = –2 of demand
+10

%
change
in quantity
demanded

–2 +10%

% change in quantity demanded = –2 × (+10) = –20%

Price elasticity of demand (PED) 31

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 Determiinants of PED
Factor More price inelastic if…

number of substitutes few are available (as consumers cannot easily

available switch)
branding heavily branded (as consumers will not be
sensitive to price)
percentage of income a small percentage is spent on the product
spent on the product (as consumers will not be sensitive to a price
change if it does not have significant impact)
time short term (as consumers will not immediately
find substitutes to switch to)

Significa
ance of PED
Understanding the PED enables firms to anticipate the impact of changes
in price on the quantity demanded. This is important as it allows them to:
• plan stock and staff levels
• forecast sales, cash flow and profit.
A government will be interested in PED as it will affect the extent to
which indirect taxes and subsidies have an impact on price and quantity.
For example, if the government taxes cigarettes, by how much will the
quantity demanded fall? This will have an impact on consumption and its
tax revenue.

Quick test
1. State the equation for the price elasticity of demand.
2. What does it mean if demand is ‘price inelastic’?
3. If the price elasticity of demand is –2.5 and price increases, will total
revenue rise or fall?
4. Give one factor that can influence the price elasticity of demand of
a product.
5. A product has a price elasticity of demand of –0.5. Sales are
200 units.
If the price increases by 10%, what will the new level of sales be?

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 The allocation
of resources

Chapter 2
Price elasticity of supply (P
PES)

Price ela
asticity of su
upply (PES)) You must be able to:
• explain what is meant by the
Price elasticity of supply (PES) measures the percentage change in ‘price elasticity’ of supply
quantity supplied in response to a percentage change in price. • understand the difference
between price elastic and
% change in quantity supplied price inelastic supply
PES =
% change in price • interpret the value of the
price elasticity of supply
The sign of the result shows the direction of movement. A positive result
• calculate the price elasticity
shows that the price and quantity supplied move in the same direction, of supply
e.g. an increase in price increases the quantity supplied or vice versa. • explain the factors that
influence the price elasticity
The size of the result shows how responsive the quantity supplied is to of supply.
changes in price, e.g.
• if the PES value is 2, a 1% change in price leads to a 2 × 1% change in
quantity supplied
• if the PES value is 0.2, a 1% change in price leads to a 0.2 × 1% change
in quantity supplied.

Value Description Explanation

infinity completely a given % change in price leads to an

price elastic infinite change in quantity supplied
>1 price elastic a given % change in price leads to a
greater % change in quantity supplied
=1 unit elastic a given % change in price leads to the
same % change in quantity supplied
< 1 price inelastic a given % change in price leads to a
smaller % change in quantity supplied
0 completely a given % change in price has no effect
price inelastic on the quantity supplied

Examples of price elasticity

Price Price
S

Perfectly price Perfectly price

S elastic supply inelastic supply
PES = ∝ PES = 0

Quantity Quantity

Price Price
S

S Price inelastic supply

+30% A change in price in %
Price elastic leads to a smaller %
+20% PES > 1 change in quantity supplied.
PES < 1

Quantity Quantity
+80% +10%

Price elasticity of supply (PES) 33

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 Example 1
The price of a product increases from $10 to $11. The quantity
supplied increases from 5 units to 6 units. Is supply price elastic or price
inelastic?
(new value – old value)
% change = (old value
× 100 )
(6 – 5)
% change in quantity supplied =
5 (
× 100 = +20% )
(11 – 10)
% change in price =
10 ( )
× 100 = +10%
+20
PES = = +2
+10
Supply is price elastic as the percentage change in quantity supplied is
greater than the percentage change in price.
Example 2
The price of a product increases from $10 to $15. The quantity
supplied increases from 5 units to 6 units. Is supply price elastic or price
inelastic?
(6 – 5)
% change in quantity supplied =
5 (
× 100 = +20% )
(15 – 10)
Percentage change in price =
10 (
× 100 = +50%)
+20
PES = = + 0.4
+50
Supply is price inelastic as the change
%
in quantity supplied is less than the change
percentage change in price. in quantity
supplied
Remember, you can use a formula triangle
to help with these calculations.
PES % change
in price
If a 10% increase in price leads to a
20% increase in quantity supplied, the
Revision tip
PES is +2.
If you know two of the elements of the The supply of agricultural
products is often completely price
triangle, the third can be calculated. inelastic in the immediate run.
+20%
Once a crop is harvested there
is a certain amount available
+20 regardless of price. Over time,
PES = = +2 % more or fewer resources can be
+10 change put into a particular crop to make
in quantity PES +10% supply more price elastic.
supplied

+2 +10%

+20
% change in quantity supplied = 2 × (+10) = +20%

+2 % change
% change in price = +20 = +10% in price
+2

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 Determiinants of PES
Factors More price elastic if…

capacity there is capacity available (as can easily produce

more)
factor substitution it is easy to switch factors from one production to
another
time long term (as it is possible to switch more
factors of production from other industries into
producing in this industry)
stocks a business has high levels of stock (as it can more
easily supply more given a price change)

Quick test
1. State the equation for the price elasticity of supply.
2. What does it mean if supply is price inelastic?
3. The price elasticity of supply of a product is +2.5. If the price
increases by 5%, what will be the percentage increase in quantity
supplied?
4. Give one factor that can influence the price elasticity of supply
of a product.
5. The price elasticity of supply of a product is +0.5. There are
200 units supplied. If the price increases by 2%, how many
units will now be supplied?

Price elasticity of supply (PES) 35

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 The allocation
of resources
Chapter 2

Market economic system

Market economic sy
ystem You must be able to:
• explain the difference
The private sector refers to businesses owned by private individuals. These between the private and
are assumed to profit maximise. The public sector refers to businesses public sectors
owned by the government. These may have social objectives. • understand the advantages
and disadvantages of the free
In a free market economy, the basic economic questions (what to produce, market economy
who to produce it for and how to produce it) are solved by the decisions • understand the advantages
and disadvantages of
of firms and households in the private sector. the planned (command)
In a command (or planned) economy, the basic economic questions are economy.
solved by the government allocating resources.
In a mixed economy there is both a private sector and public sector. The
basic economic questions are solved partly by the free market and partly
by the government. Revision tip
Mixed economy
Free Command or All economies are mixed to some
market planned economy degree. The extent to which the
A mixture of private
and public sector government intervenes is where
they differ.
Resources
Resources
allocated by What is provided by the public
allocated
market forces of sector in one country may be
by the government
supply and demand provided by the private sector in
another. For example, in the UK,
Private sector Public sector healthcare is mainly provided by
the government and is generally
free of charge. In the USA, more
If a government takes over a private sector business, it is called
healthcare is provided by the free
nationalisation. If a business is sold, so it is no longer under government market and is paid for.
control and is privately owned, it is called privatisation.

Public Private
Privatisation
sector sector

Private Public
Nationalisation
sector sector

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 Advanta
ages and dissadvantage
es of the ma
arket
mic system
econom
Command (planned) economy

Advantages Disadvantages

can pursue social objectives and removes profit incentive, which

take account of social costs and may lead to a lack of innovation
benefits and enterprise
can overcome market failures, government has to make many
such as monopoly power and the decisions and may be dealing with
lack of provision of public goods too much information to make the
right ones

Free market economy

Advantages Disadvantages

incentive to be profitable means

may only focus on private costs
firms innovate, which leads to new
and benefits and not take into
products and new ways of doing
account social costs and benefits
things
decisions are made by individual price can fluctuate as supply and
firms and households – does not demand conditions change – this
need a government to decide can cause instability and make
what to do, so reduces costs planning difficult

Quick test
1. What is meant by ‘the private sector’?
2. What is meant by ‘the public sector’?
3. Explain how the objectives of a public sector organisation may differ
from the private sector.
4. What is meant by a ‘mixed economy’?
5. Give one advantage of a free market economy compared to a
planned economy.

Market economic system 37

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 The allocation
of resources
Chapter 2

Market failure

Causes and consequ

uences of market failurre You must be able to:
• define ‘market failure’
Market failures are failings that occur within the free market. • explain different types of
market failure, such as public
Public goods
goods and merit goods
Public goods, such as defence, are: • understand external costs and
benefits.
• non-diminishable – if someone consumes more of a product, it does
not reduce the amount available for others
• non-excludable – you cannot prevent someone from consuming the
product.
Revision tip
This creates the free rider problem, where people use a public good or There can be differences between
resource without paying their share of the cost. private costs and benefits and
social costs and benefits in both
production and consumption.
Public
goods

Non- Non-
diminishable excludable Revision tip

Merit goods Some aspects of monopolies

may be undesirable for society.
Merit goods are better for the individual than the individual may However, some aspects may be
positive. This is why governments
appreciate. For example, young people may not value education enough,
usually make sure they have the
so the government may need to make it compulsory to ensure they have it. right to investigate monopolies,
but do not always assume they
Demerit goods are bad.
Demerit goods are worse for the individual that the individual may
appreciate, e.g. cigarettes and drugs. The government may intervene to
stop individuals doing things that are bad for them.
Private benefits and private costs versus social benefits and social costs
In the private sector, businesses will only take account of the benefits they
get (e.g. the revenue from sales) or the costs that they generate (e.g. the
amount they have to pay for labour and land).
These private benefits and costs may not reflect the full costs and benefits
to society, i.e. the decisions taken by private firms may not be the best
decisions for society as a whole.
For example, the production process of a business may generate external
costs, such as noise and pollution. A private firm would not take account
of these and, therefore, would over produce. The government may need
to intervene to make businesses aware of these costs, e.g. by taxing them.
The social costs = private costs + external costs
Similarly, if a business sells a cure for a disease, it will only measure the
private benefits, i.e. the revenue it earns. However, if the workforce is
healthier and fitter, it will be more productive and this will benefit society
as a whole. There is an external benefit of producing these cures.
The social benefit = private benefit + external benefit

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 social benefit private benefit + external benefit
social cost private cost + external cost

External cost /
Example
benefit
external cost of
pollution; traffic congestion
production
external cost of
the effect of smoking on others (passive smoking)
consumption
external if more people cycle to work, it reduces congestion
benefit of on the roads and reduces the journey time for those
production who still drive
external by getting an inoculation you protect yourself and
benefit of others; by getting training you improve your own
consumption productivity and earnings, but also the output of the
economy (providing more goods for others)

Monopoly power
Monopoly power occurs when one firm dominates a market, e.g. if
its sales are more than 25% of all of the sales in an industry. In a pure
monopoly, there is only one firm in the industry.
A monopoly can be a price maker, i.e. it can push up the price. In a
monopoly, the price is likely to be higher than in a competitive market
and the quantity less – consumers pay more and less is produced overall.

Quick test
1. What is meant by a ‘market failure’?
2. What is meant by a ‘merit good’?
3. Explain why monopoly power is a market failure.
4. Explain why private and social costs may differ.
5. State the two features of a public good.

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 The allocation
of resources
Chapter 2

Mixed economic system

Governm ment interve

ention to address market You must be able to:
• explain the ways in which a
failure government may intervene in
the market
A government may intervene in an economy to overcome market failures: • explain the effects of
minimum and maximum
Minimum and maximum prices
prices
A maximum price is set by the government to limit the price that can be • explain the effects of indirect
charged in a market. For example, the government may set a maximum taxes and subsidies
• understand the meaning of
rent for properties to try and keep rents lower than they may otherwise nationalisation.
be in a free market.
A maximum price set below the equilibrium price will create a shortage,
i.e. a greater quantity demanded than supplied. Revision tip

Price If the maximum price is above the

equilibrium price, it has no effect
S
on the equilibrium price and
quantity.
P1

Maximum D
price
Quantity
Q1 Q0

A minimum price is set by the government to limit how low the price can
go in a market. For example, the government may set a minimum wage to
try and keep wages higher than they may otherwise be in a free market.
A minimum price set above the equilibrium price will create a surplus, i.e.
a greater quantity supplied than demanded.

Price

S
Minimum P0 Surplus
price

P1

Quantity
Q0 Q1

These price controls can be used in different markets, e.g. setting a

minimum wage in the labour market, a maximum value of currency in the Revision tip
currency market or a minimum price for a product.
If the minimum price is below the
Indirect taxation equilibrium price, it has no effect
on the equilibrium price and
Indirect taxes may be imposed on producers to make them take quantity.
account of the external costs of their production (e.g. producer taxes)
or to make consumers aware of the external costs of what they are

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 consuming (e.g. a tax on cigarettes). By increasing costs, the aim is to
reduce the equilibrium output to the optimum level for society. Revision tip
Subsidies A change in indirect taxes and
production subsidies will have
Subsidies may be used to pay producers to reduce their costs if there
an impact on the price paid by
are social benefits to production (e.g. to encourage energy-saving consumers. Some of the effect will
measures to help society as a whole) or they may be paid to consumers to be absorbed by producers. The
relative impact on consumers and
encourage consumption where there is an external benefit to consuming. producers is called the incidence
of the tax burden.
Regulation
The government may introduce rules and regulations to make businesses
behave in certain ways, e.g. to ensure that businesses label products
and take account of health and safety measures and to ensure that
monopolies do not abuse their power and push up prices.
Buffer stocks
Sometimes government may want to keep the price of a product stable.
In this case, if supply is high and the price is likely to fall, the government
intervenes and buys up the excess supply. This is called buffer stock. If in
the future supply falls and there is a shortage, the government can sell
the buffer stock to increase supply and keep the price stable. Buffer stock
systems are often used in agricultural markets where the supply can shift
a lot due to weather or disease and the government wants to keep food
prices stable for producers and consumers.
Nationalisation
The government could take control of an industry to ensure it pursues
social objectives. This is called nationalisation. Alternatively, if the
government thinks a business would be more efficient with a profit
incentive, it may privatise it. Privatisation occurs when a business is
transferred from the public sector to the private sector.
Short run and long run
One reason for government intervention is that it wants to plan long
term. Many consumers and firms will focus on short-term costs and
benefits rather than long-term cost and benefits. For example, firms will
consider the immediate cost of buying energy but, in a free market, will
not take account of the long-term impact on the environment (from using
up stocks of non-renewable resources and the environmental damage
caused), whereas the government may consider the benefits of conserving
resources for future generations.

Quick test
1. Explain how a minimum price set higher than the equilibrium price
affects the price and quantity in a market.
2. Explain how a maximum price set lower than the equilibrium price
affects the price and quantity in a market.
3. Explain how nationalisation may reduce market failures.
4. Explain how indirect taxation may be used to reduce a market
failure.
5. Explain how an indirect tax may affect the equilibrium price and
quantity in a market.

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 The allocation
of resources
Chapter 2

Exam-sstyle practicce questio

ons

1 Which is most likely to make demand for a product more price inelastic? [1]

a) a higher proportion of income spent on the product

b) an increase in the number of close substitutes

c) more awareness of the availability of alternative options

d) stronger branding

2 What does it mean if the price elasticity of demand is –0.2? [1]

a) demand is price elastic and total revenue decreases as price increases

b) demand is price elastic and total revenue increases as price increases

c) demand is price inelastic and total revenue decreases as price increases

d) demand is price inelastic and total revenue increases as price increases

3 What is most likely to encourage domestic producers to grow more wheat? [1]

a) increasing the sales tax on wheat

b) more subsidies to wheat producers

c) removing guaranteed minimum prices for wheat

d) removing quotas on imported wheat

4 Which is an example of an external cost? [1]

a) a company’s labour costs

b) the cost of industrial pollution

c) the cost of supplies

d) the cost of a takeover

5 What is most likely to lead to an increase in the equilibrium price and a decrease in
the equilibrium quantity? [1]

a) a decrease in demand

b) a decrease in supply

c) an increase in demand

d) an increase in supply

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 6 What is most likely to explain a movement from B to A? [1]

Price
S2
D2
S1
D1
A
B S3
D3
X

C
D

Quantity
0

a) a decrease in indirect taxes

b) a decrease in spending on marketing

c) an increase in input costs

d) an increase in the price of a substitute product

7 What is most likely to explain a movement from B to C? [1]

a) a decrease in indirect taxes

b) a decrease in spending on marketing

c) an increase in input costs

d) an increase in the price of a substitute product

8 The property market

In 2017, the Organisation for Economic Cooperation and Development (OECD) warned that property
prices were very high in a number of countries and could collapse in the future. In several economies
property prices had increased significantly in preceding years and there was a danger that they might
fall quite suddenly by 10% or more.

In Canada, for example, average property prices had doubled since the start of the century. Prices
in London were also particularly high. Of 30 economists surveyed, 20 predicted that house prices in
London would stay stable or fall in the near future.

For most people buying a house is the biggest expenditure of their lives. They have to borrow to
afford it and then repay over many years. The Royal Institution of Surveyors in the UK reported
that the number of new buyer inquiries was very low. There were concerns over the state of the UK
economy and it seemed to be affecting people’s willingness to spend large sums on housing. Also,
employees in the UK were generally experiencing very slow wage growth – with wages increasing at
a slower rate than prices, there had been a fall in consumer purchasing power.

Banks were keen to reduce the risks of lending. Changes were made by banks in many countries,
which required house buyers to provide bigger deposits and restricted the amount they could
borrow. The number of new properties on the market was also at a record low.

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 Fig. 1: Annual percentage change in house prices and the growth of incomes in leading economies
(1970–2015)

Real GDP growth House prices growth

10.0

8.0

6.0

4.0

2.0

0.0

–2.0

–4.0

–6.0
70

73

76

79

82

85

88

91

94

97

00

03

06

09

12

15
19

19

19

19

19

19

19

19

19

19

20

20

20

20

20

20
Fig. 2: Annual percentage change in UK house prices

15
10

5
0

–5

–10

–15

–20
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

a) Explain the effect on the purchasing power of a consumer if wages are constant
but prices rise. [2]

b) What risks do banks take when lending to house buyers? [2]

c) Explain why the apparent relationship between house prices and national income growth
in Fig. 1. might exist. [4]

d) With reference to Fig. 2, explain what was happening to UK house prices in 2008 and 2009. [2]

e) Explain the factors that may influence the demand for property apart from income. [4]

f) Using a supply and demand diagram, explain why house prices might have been so high
in the UK in 2017. [4]

g) Discuss the possible effects on an economy of a fall in property prices. [6]

h) Discuss whether buying a house is a good investment for households. [6]

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 9 In 2017, Europe experienced a shortage of butter which has affected its price. This shortage was
caused by falling milk production in many countries and a lack of stocks to use up. The supply of
butter cannot increase easily because many dairy farms in Europe and Brazil are suffering from a
shortage of young cows to bring into the herd to produce the milk needed. This was partly because
in recent years, production had been too high and many governments in Europe had introduced
voluntary output cuts and compensated farmers for not producing milk.

a) Define ‘shortage’. [2]

b) Explain two factors that may influence the supply of products. [4]

c) Analyse the effect of a decrease in supply on the equilibrium price and output. Show the
effect using a supply and demand diagram. [6]

d) Discuss whether a government should introduce a maximum price for products. [8]

10 In 2017 in Scotland, the government discussed a minimum price for tobacco. This policy was
intended to reduce overconsumption of tobacco. Critics said that the effect on consumption
would be limited because of the price elasticity of demand.

a) Define a ‘minimum price’. [2]

b) Explain the factors that might influence the price elasticity of demand of tobacco. [4]

c) Using a demand and supply diagram, analyse the likely effect of introducing a minimum
price in a market. [6]

d) Discuss the extent to which knowledge of price elasticity of demand is of use to a government. [8]

11 Although Singapore is a relatively free market economy, the government does intervene to
influence the allocation of resources. The government of Singapore has recently introduced
tougher standards to limit vehicle emissions to achieve cleaner and greener vehicles in the
country. Air pollution is a big environmental health risk, particularly for heart diseases and
strokes. Vehicles are also taxed in Singapore to reduce their usage.

a) Describe how resources are allocated in a free market economy. [2]

b) Explain using a diagram how pollution can lead to inefficiency in a market economy. [4]

c) Analyse how taxes can be used to reduce the inefficiency caused by pollution in a free market. [6]

d) Discuss whether introducing tougher standards on vehicle emissions is a better way of

reducing pollution in an economy than taxation. [8]

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 Microeconomic
Chapter 3

decision
makers Money and bankin
ng

Money You must be able to:

• understand the forms and
Money has many forms, including notes, coins and bank accounts. It is: functions of money
• explain the role of central
• a store of value – it can be saved and will retain value
banks
• a unit of account – it is used to measure the value of goods and services • understand the role of
• a medium of exchange – individuals and firms are willing to trade commercial banks
goods and services for it because they know they can use it later to • understand the role of stock
exchanges.
purchase other items
• a standard of deferred payment – many transactions in an economy
are on credit; individuals and firms are willing to sell items on credit
and be paid later because money is a store of value.

Banking
g
Commercial banks
Commercial banks are the high street banks, such as Barclays and HSBC.
The main functions of commercial banks are to:
• accept deposits from savers
• lend to households and firms
• provide efficient means of payment.
Commercial banks are financial intermediaries and play a key role in
moving funds from those who have surplus funds (lenders / savers) to
those who want those funds (borrowers).

Savers Bank Borrowers

Central banks
A central bank manages a country’s currency, money supply and interest
rates on behalf of the government. It is responsible for monetary policy.
The main responsibilities of a central bank are:
• issuing banknotes and managing the currency
• providing monetary stability, e.g. a central bank may be tasked with
delivering stable prices, which it will aim to achieve by setting interest
rates
• providing financial stability and ensuring that financial institutions
can be trusted, e.g. if necessary the bank intervenes to manage failing
financial organisations
• banker to the government, i.e. it helps the government to raise money
• a lender of the last resort to the banking system.

Quick test
1. Explain why money is ‘a store of value’.
2. State two functions of money other than being a store of value.
3. Give two functions of a commercial bank.
4. Explain the role of a central bank.

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 Microeconomic
Chapter 3
decision
makers
Households

Income You must be able to:

• explain the different motives
Households earn income from work. What they spend out of their income for spending, saving and
on goods and services is called consumption. What they do not spend out borrowing
of their income is called savings. To increase their funds, households may • explain the factors that can
influence spending and
borrow money. saving.
Income by age

Savings
Income

Consumption
over lifespan
$
Dissaving
Dissaving

0 15 35 45 55 65 75
Age

Spendin
ng
Households spend some or all of their income. In some cases, they borrow
so they can spend more than their income. Households may spend on
essentials, such as food and housing, or non-essentials, such as eating out
or holidays.
Consumer spending (or expenditure) patterns will change according to
different factors:
The stage in an individual’s life cycle
When an individual leaves school or university, they may start spending
on rent for accommodation. If they start a family, they may have to spend
on specific items, such as school clothes. This is very different from what a
retired individual spends their income on.
The time of year
There may be seasonal patterns to spending. For example, an individual
may spend more in summer when on holiday.
Income
If an individual has a low income, most of their spending is likely to be
on essentials, such as rent and food. As income increases, individuals may
start to spend more on eating out and holidays.

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 Savings
Households save to finance future spending, e.g. they save now to finance
a holiday or a deposit on a car or house later. The amount that households
save depends on different factors:
Interest rates
The rate of interest is the return that individuals receive by putting money
in a bank. For example, if the interest rate is 2% a year, an individual who
saves $100 in the bank will receive an interest payment of $2 at the end of
the year. If the interest rate is 5%, the individual will receive $5.
If interest rates increase, there is a greater incentive for individuals to save
their income. If interest rates decrease, there is less incentive to save as the
rewards are lower, so individuals are more likely to spend their income.
Income
The higher an individual’s income, the more they tend to save. When
incomes are low, all or most of the money is spent on essential purchases.
As incomes increase, households have more than they need for essential
purchases and can start to save.
Their stage in an individual’s life cycle
Generally, younger people save less. This may be because they have less
income, but it may also be because they plan less for the future. In middle
age, people earn more and are able save more. They are also saving for
retirement. Retirement households may dissave, i.e. spend more than they
earn, as they use the savings from earlier in their lives.
Confidence in the future
If households are worried about whether they will have a job in the
future, they may save more for security.
Government incentives
Governments may offer incentives to encourage more saving, e.g. a tax
incentive to those who save for their retirement.

Borrowiing
People borrow when they want to buy something but do not have
enough money to pay for it. They borrow and pay back over time. People
may borrow because:
• the sum required is large, e.g. people may borrow to buy a house (this
is called a mortgage) and then repay over a long period of time (often
25 years)
• of timing, e.g. there may be times during the year (such as celebrations
or summer holidays) when there are major outflows and, to finance
this or to provide finances after this, it may be necessary to borrow
money short term.
Overdrafts versus loans
An overdraft occurs when a household can borrow up to a certain amount
agreed with a bank. Interest is paid on how much is actually borrowed. A
loan occurs when a fixed amount is borrowed and repaid at agreed rates.

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 If a household knows exactly how much it wants to borrow (e.g. to buy a
car), it may take out a loan and agree in advance how much it will repay
in instalments (e.g. over five years).
If a household may need money (e.g. in case of high levels of spending
whilst on holiday), it may organise an overdraft. Interest is only paid on
what is used. However, interest is high so, if households know how much
they need, a loan is better.
Fixed-rate and variable-rate borrowing
A fixed-rate loan is where interest repayments are agreed at the start. A
variable-rate loan is where the interest repayments may vary as interest
rates in the economy change.
The amount households can borrow depends on:
• whether they can find others to lend to them (this may depend on
what security or collateral they can provide to potential lenders)
• the interest rate, i.e. the cost of borrowing money and the reward
for saving money – the higher the interest rate, the higher the cost of
borrowing and the higher the reward for saving (this usually leads to
less spending and more savings)
• consumer confidence – if consumers think that the economy is doing
well and that they are likely to keep their job and may even get a pay
increase, then they are more likely to spend; if they think they may
lose their job, they are more likely to save
• what they wish to buy and how important they think it is to have it
now and repay over time.

Quick test
1. What is meant by an ‘interest rate’?
2. State two factors, other than interest rates, that may affect the
spending of a household.
3. Give two motives for saving.
4. Give one reason why expenditure patterns vary between
households.
5. What is the difference between an overdraft and a loan?

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 Microeconomic
Chapter 3

decision
makers Workerrs

Choice of occupatio
on You must be able to:
• understand the factors that
An individual’s choice of job will depend on factors such as: influence an individual’s
choice of occupation
• the wage rate – usually when the wage rate increases more people are
• understand the factors that
willing to work in an industry influence earnings
• non-monetary factors, e.g. is the job very repetitive or dangerous and • understand what is meant by
what are working conditions like? specialisation.

• skills – to be a doctor, for example, requires very good qualifications

and high levels of training, which limits the number of people who can
do the job
• the alternatives and the opportunity cost.

Wage de
etermination
n
When an individual first starts earning, their income is likely to be
relatively low. Individuals are often dissaving. Over time, individuals will
hopefully earn more as they:
• gain more skills and can do more skilled work
• get promoted to higher-earning positions.
Typically, individuals begin to save as they earn more. When individuals
retire, they often use up their savings to enable them to consume more
than their income at that time.

Reasonss for differen

nces in earnings
The earnings of an individual will depend on supply and demand
conditions. Earnings are likely to be high if:
• supply is limited, e.g. if it takes many years to train to do the job (such
as architect or lawyer)
• demand is high, e.g. the business will earn large sums from selling
their output (such as top footballers).
Typically, skilled workers will earn more than unskilled workers because
the supply is more limited and the workers’ output is worth more, so
demand is higher.
Earnings in the public sector tend to be lower than in the private sector.
This is because governments usually have limited funds. Much of the
output (e.g. health and education) is not sold or is sold at a lower price
because maximising profits is not an objective. As a result, output does
not generate the revenue to pay high wages. However, lower pay is
sometimes compensated for by greater job security and good pensions
when people retire.
Private sector output is sold in markets and earns money for the business.
If demand for the product is higher, the business can pay its employees
more.
Women often earn less than men. In some cases this is due to
discrimination – employers do not always treat women in the same way as
men, even though most countries have legislation requiring them to do so.

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 Earnings in manufacturing will typically be higher than in agriculture. This
is because it is easier to increase productivity in manufacturing through
investment in technology and capital. This enables workers to produce
more and, assuming there is a market for the products, it enables them
to generate more money for the business. As a result, the business can
reward them more highly.
Trade unions are organisations that represent employees and bargain
with employers. By representing groups of employees, trade unions have
more power than an individual would alone. This can enable a trade
union to increase the wages of its members.

Specialisation
Specialisation occurs when jobs are divided into smaller tasks and
employees are trained to do one of these specific tasks.
For the worker, specialisation means:
• it is relatively easy to learn what to do
• by repeating the same task, they can become very productive, which
may lead to more earnings.
However, the work is repetitive and not very challenging.
For the business, specialisation means:
• it is relatively easy to recruit and train workers to do the jobs
• productivity may be high through repetition.
However, workers may be demotivated as the work can become boring
and they may leave to get more interesting jobs.

Quick test
1. State two factors that influence an individual’s choice of
occupation.
2. What is the likely effect of a limited supply of labour on the wages
paid in an industry?
3. What is the likely effect of a high demand for labour on the wages
paid in an industry?
4. Explain why the wages paid in the public sector are often lower
than in the private sector.
5. Explain why skilled workers usually earn more than unskilled
workers.

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 Microeconomic
Chapter 3

decision
makers Trade unions

Trade un
nions and th
heir role in the econom
my You must be able to:
• explain the role of trade
Trade unions are organisations formed to represent employees’ interests unions
and act as a counterbalance to the power of employers. • understand the actions that
trade unions can take
Trade unions may be involved in decision-making. Managers may: • understand the advantages
and disadvantages of trade
• inform trade unions of decisions (i.e. tell them)
union membership.
• consult with trade unions (i.e. ask for their opinion)
• negotiate with trade unions (i.e. bargain with them).
Trade unions may be involved in a range of issues, such as:
• redundancies – these occur when workers lose their jobs because the
jobs no longer exist
• dismissals – these occur when a worker loses their job because they are
no longer competent at undertaking it
• training
• working conditions
• payment
• terms and conditions of employment
• changes to job descriptions.
The actions that trade unions take include:
• representing employees’ views in meetings
• representing employees’ views to the media
• undertaking a work to rule, i.e. when employees do exactly what is
in their contract and no more – over time people are often expected
to do more than is in the job description, so if unions force a work to
rule, it often slows up the rate of work as people revert to what they
were originally expected to do
• an overtime ban, i.e. when employees work the number of hours in
their contract but do not volunteer for overtime – in many businesses,
overtime work is a common way of making sure they can cope with
sudden increases in orders, so a reduction in overtime will increase the
time taken for work to be done
• a strike, i.e. when employees withdraw their labour – there is no
production (on strike employees do not receive pay from their employers)
• restricting supply – in some countries, trade unions insist that
employees belong to a trade union, which can restrict supply.

Wage rate

SL2
SL1

W1

W2

DL
Quantity of
L1 L2 labour

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 The adv
vantages and
d disadvan
ntages of trade
union membership
The benefits of joining a trade union for employees are that it:
• provides greater protection (employees have greater power if they act
as a group)
• provides expertise, e.g. legal advice
• will bargain for better pay and conditions.
The disadvantages of trade union membership are that:
• there is a cost to join
• employees may prefer to bargain individually
• the trade union may take actions that an individual employee
disagrees with.
Trade unions can help managers:
• find solutions to problems
• gain the agreement and cooperation of employees
• understand issues from employees’ perspectives.
Trade unions may cause problems for managers by:
• pushing up wages and costs
• opposing changes, e.g. to increase productivity
• taking strike action, so output and revenue is lost.

Quick test
1. What is a trade union?
2. What is it called when employees withdraw their labour?
3. What term is used to describe the action taken by employees who
will only do what is in their contracts?
4. What is it called when employees lose their jobs because there is
no longer a demand for them?
5. State one benefit of trade unions to a business.

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 Microeconomic
Chapter 3

decision
makers Firms

Sectors of the econo

omy You must be able to:
• explain the different sectors
Firms may be operating in the: of the economy
• understand how to measure
• primary sector – these firms are involved in farming and the extractive
the size of firms
industries, such as oil and coal • understand the advantages
• secondary sector – these firms take raw materials and process them, and disadvantages of being a
e.g. manufacturing small firm
• explain the different
• tertiary (service) sector – these firms provide services, e.g. education forms of business growth
and banking. and their advantages and
disadvantages
Small firrms • describe how internal and
external economies of scale
The size of a firm can be measured by: can affect a business.

• its sales (turnover)

• what it owns (assets)
Revision tip
• the number of employees.
Other measures may also be appropriate depending on the nature of the As economies develop, their
resources tend to move from the
business, e.g. the number of outlets (for a retail business) or the number primary sector into the secondary
of lorries (for a transportation business). sector and then into the tertiary
sector.
Small firms can make decisions fast, be innovative and create new
products. However, they:
• lack market power
• may lack experience
• may lack the assets needed to raise funds
• may have high unit costs, as they lack economies of scale.

Causes of growth off firms

Firms may grow:
• internally, by selling more goods and services and investing the profits
made
• externally, by joining (integrating) with another business – this could
be through:
• a merger – two or more firms join together to become one business
• a takeover (or acquisition) – one business gains control of another.

Mergerss Revision tip

The types of integration are:
The motives for integration
• horizontal – firms at the same stage of production join together, e.g. depend on the type of merger or
one car manufacturer joins with another car manufacturer takeover.
• backward vertical – a firm joins with another firm at an earlier stage of
the same production process, e.g. a car manufacturer joins with a tyre
manufacturer
• forward vertical – a firm joins with another business at a later stage
(closer to the consumer) of the same production process, e.g. a car
manufacturer joins with a car dealership

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 • conglomerate integration – a firm joins with a business in a different
sector, e.g. a car rental company joins with a food hotel chain.

Type of
Motive
integration
horizontal • to remove competitors
integration • to gain market share
• to gain cost advantage by being bigger and
getting better prices from suppliers
forward vertical • to gain and secure access to the market, e.g. a
integration business can sell through its own outlets
backward vertical • to secure supplies – by owning a supplier, a
integration firm can reduce costs and ensure quality
conglomerate • to spread risk by operating in different
integration markets, so less vulnerable to changes in sales
in one market

Econom
mies and dise
economies of scale
Internal economies of scale
Internal economies of scale occur when unit costs (or average costs) fall as
a firm increases the scale of its production.
These may be due to
• purchasing economies – cost savings through bulk buying
• marketing economies – savings on advertising and marketing through
having more power when negotiating
• technical economies – cost savings through use of mass production
techniques
• risk-bearing economies – these occur when a business operates in
different markets (geographically or product), because there is less
risk of a fall in sales; if sales are affected in one market they may not
be so affected in other markets, so sales are generally more stable and
costs can be spread over more units than a business that is reliant on
one market
• managerial economies – these occur for two reasons:
• the number of managers will not grow at the same rate as output,
e.g. output may double but it may be possible for the same
manager to oversee the business, so the costs of the manager can
be spread over more units
• as the business grows, specialist managers can be employed in
areas such as marketing and human resources, which can lead to
better and more efficient decision-making.
Internal diseconomies of scale
Internal diseconomies of scale occur when unit costs rise as a firm
increases the scale if its production, e.g. due to communication,
coordination and control problems.

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 Unit (or average)
costs $
Average
cost

Output
Internal Internal
economies diseconomies
of scale of scale

External economies of scale

External economies of scale occur when the unit costs are lower at every level
of output. This is due to factors outside of the business itself. For example:
• if the whole industry grows, there may be a growth in specialist
suppliers and training providers Revision tip
• being located in an area where there is already a trained workforce
Remember that internal
reduces training costs, e.g. a computing business locating in Silicon economies of scale occur when
Valley can benefit from all the skills and suppliers already in this area. the scale of production of the
individual business increases.
Unit (or average) External economies are due to
costs $ factors outside the business and
Average reduce unit costs at all levels of
costs1 output.

Average
costs2

Output
External economies of scale

Quick test
1. State one way in which the size of a business may be measured.
2. State one type of production in the primary sector and one type of
production in the secondary sector.
3. Explain the difference between a merger and a takeover.
4. Explain the difference between backward vertical integration and
forward vertical integration.
5. Define ‘internal economies of scale’.
6. Explain one possible reason for horizontal integration.

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 Microeconomic
Chapter 3
decision
makers
Firms and producction

Demand
d for factors of production You must be able to:
• explain what influences
The factors of production are land, labour, capital and enterprise. The the demand for factors of
overall demand for factors of production depends on the demand for production
the final good or service, i.e. the demand for a factor of production is • understand the difference
between labour-intensive and
a derived demand. For example, labour is demanded because there is a capital-intensive production
need to produce – if there was no demand for the products, the business • explain the difference
would not need labour. between production and
productivity.
The demand for any particular factor of production will depend on:
• what is being produced
• the availability and price of the factors of production.
For example, medical advice has traditionally relied on a doctor (labour),
although improved technology means more diagnoses may now be
carried out via computers and machines (capital). Greater demand for
education typically requires more teachers (labour). By comparison,
greater demand for chemicals or soft drinks requires investment in
factories (land and capital).
If labour is readily available and cheap, a business may produce using a
high amount of labour. If labour is expensive and takes a long time to
recruit, a business may look for ways of producing with more capital.

Labour--intensive an
nd capital-intensive
producttion
Some forms of production are labour intensive, i.e. labour is the main
factor of production. For example, hairdressing and accountancy are
labour-intensive processes. Labour-intensive processes generally require a
relatively high level of skills and are quite flexible to the different needs
of customers.
Other processes are more capital intensive, i.e. capital is the main factor
of production. For example, a bottling plant or car production process has
high levels of investment in machinery and relatively little human input.
These processes require heavy investment. Sometimes these processes
are inflexible, i.e. they produce high quantities of standard products.
However, developments in technology mean that the variety of products
that can be produced is increasing.

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 Producttion and pro
oductivity
Production measures the total output of a business. Productivity measures
output in relation to the inputs used to produce it. Both are measured in
units.
output
Productivity =
input
For example, if 200 units are produced by 40 employees:
output 200
Labour productivity = = = 5 units per employee
number of employees 40
Businesses are very interested in productivity because it measures how
well its resources are being used. An increase in productivity means:
• more units can be produced with the same inputs, which should
increase sales and revenue
• the same output can be produced with fewer inputs, which should
reduce costs.
The productivity of the workforce will depend on factors such as:
• the quantity and quality of capital equipment they have to work with
• the way their work is organised
• the training they have received
• their level of motivation.
Managers will try to increase productivity by:
• investing in equipment and technology
• using different rewards to motivate workers
• organising work in different ways to make it more efficient
• investing in training

Quick test
1. State the four factors of production.
2. State the equation for labour productivity.
3. The output of a business is 400 units. The number of employees is
80. What is the labour productivity?
4. State two factors that influence labour productivity.
5. Explain why productivity is important for managers.

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 Microeconomic
Chapter 3
decision
makers
Firms’ costs,, revenue and objecttives

Costs off production

n You must be able to:
• explain the different types of
Costs are the charges that a business has to pay to produce. Types of cost costs of production
include: • understand average and total
costs
• Total cost (TC) = fixed costs + variable costs • understand the meaning of
• Fixed costs (FC), e.g. rent and interest on a loan, do not change with total, average and marginal
the level of output; they can change (e.g. rent can be increased), but revenue
• understand what is meant
do not change with output by ‘profit’ and ‘profit
• Variable costs (VC), e.g. the cost of materials used in production, do maximising’
change with the level of output. • explain different objectives of
business.
Costs

Total costs

Total variable costs

Revision tip
The distance between the total costs and the Remember that fixed costs can
total variable costs is equal to the fixed costs. change, e.g. rents can increase.
It simply means that they do not
Total fixed costs change with output, e.g. if there
are more people entering a shop
Output
0 and buying clothes, it does not
affect the rent.
Variable costs increase with output. In the diagram above, they increase In the long run, all costs are
by less with each unit initially and then by more as the business keeps variable as all resources can be
changed.
producing more (which is why the 'variable costs' line gets steeper).
This is because adding more labour to fixed factors of production will
eventually lead to less extra productivity in the short-run – there will be
too many people and not enough equipment. This is known as the Law
of Diminishing Returns. With less productivity from extra employees, the
variable cost of a unit increases.

Total costs are found by adding the fixed costs to the variable costs.

Average cost (AC) is a measure of the cost per unit.

total cost
Average cost =
output
Average cost = average fixed cost + average variable cost
AC = AFC + AVC
total cost fixed cost variable cost
= +
output output output

Average fixed costs fall as output increases

Cost

Average fixed costs

Quantity

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 Variable
Total costs = Average cost = Revision tip
Output Fixed costs ($) if
fixed costs + total cost
(units) costs ($) VC are $500 ($) As output increases, the fixed
variable costs ($) output
per unit costs are spread over more units
and the average fixed cost falls.
0 10 000 0 10 000 n/a This means the average total cost
10 10 000 5000 15 000 1500 is mainly made up of average
variable cost.
20 10 000 10 000 20 000 1000
30 10 000 15 000 25 000 833.33

Revision tip
Item Meaning Equation
Costs are what the business has
total cost fixed costs + variable TC = FC + VC to pay. Revenue is what is paid
to the business for its products.
costs Profit is the difference between
average (unit) cost average cost per unit = TC revenue and costs.
AC = = AFC + AVC
average fixed cost + Q
average variable cost
average fixed cost fixed cost per unit FC
AFC =
Q
average variable variable cost per unit VC
AVC =
cost Q

e
Revenue
Revenue (or total revenue) measures the income of the business. It is
equal to the spending (or expenditure) of consumers.
Total revenue = TR = price per unit × number of units sold = P × Q
Average revenue (AR) is the revenue per unit. It is equal to the price.
AR = P
Profit
Profit is the difference between revenue and costs.
Profit = revenue – costs (or TR – TC)
If the price is held constant and more is sold at the same price, the total
revenue will be a straight line.

Price Output Total revenue

$ $ $
10 0 0
10 1 10
10 2 20
10 3 30
10 4 40
10 5 50
10 6 60
10 7 70

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 Total revenue
80
70
60
50
Revenue
40
30
20
10
0
0 1 2 3 4 5 6 7
Output

If the demand curve is downward sloping, then to sell more the price
must fall. This means the total revenue curve will not be a straight line. It
will actually increase at a decreasing rate because to sell more, the price
must be reduced, not just on the extra unit but on all the units before.
It is actually possible for the total revenue to fall because of the price
reductions on the earlier units.

Price Output Total revenue

$ $ $
10 0 0
9 1 9
8 2 16
7 3 21
6 4 24
5 5 25
4 6 24
3 7 21

Total revenue
30
25
20
Revenue

15
10
5
0
0 1 2 3 4 5 6 7
Output

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 Objectiv
ves of firms

Profit

Business
Social Survival
objectives

Growth

Profit maximisation occurs when there is the biggest positive difference

possible between total revenue and total costs. Firms may want to earn
profit to:
• reward their owners
• use as a source of funds.
Other business objectives may be:
• social – to provide a service for society, e.g. heath service
• survival – when starting out or when struggling, a business may be
more interested in surviving even if profits are low; it may lower price
to and try and keep sales going
• growth – a business may invest in expansion; this investment may
reduce profits but lead to growth and potentially more profits in the
long term.

Quick test
1. State the equation to calculate profit.
2. Define ‘fixed costs’.
3. Define ‘variable costs’.
4. What is the difference between total cost and average cost?
5. State two uses of profit.

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 Microeconomic
Chapter 3
decision
makers
Ma
arket structure

Compettitive marketts You must be able to:

• explain the benefits of
The competitiveness of a market will depend on how many firms there are competition
within it and their relative size. A competitive market will have many firms • understand what a
of a similar size competing for customers. This means there is an incentive monopoly is
• explain the potential
to get better and to be better than your competitors in order to win sales. problems of monopoly power
Businesses will be constantly trying to develop a better product to attract • explain the potential benefits
customers away from their rivals. They will also be trying to be as efficient of monopoly power.
as they can as this will allow them to lower prices to increase the quantity
demanded. Competitive forces should, therefore, be good for customers.
It should lead to:
• more innovation as businesses try to improve what they offer (their
products) or the processes they use to produce and deliver their
Revision tip
products
• lower prices for consumers as businesses try to become more efficient Remember, there are arguments
to allow them to cut prices lower than their competitors for and against monopolies. Do
not assume they only have a
• better quality products for consumers as businesses try to attract
negative impact on the economy.
customers
• a better quality service.
In competitive markets, each firm will have to try harder to attract and
keep customers. If they do not, then existing firms or new firms will take
their customers from them.
Competitive markets mean customers have choice and this puts pressure
on firms to deliver high quality at a relatively low price.

Monopo
oly markets
Monopoly power exists when one firm dominates a market and has a
high market share, i.e. the sales of the firm are a high percentage of the
total market sales. In a pure monopoly, there is only one firm selling in the
market, i.e the market share of the business is 100%. In reality when one
business has a market share of around 25% or more, this is regarded by
governments as a monopoly because it is so dominant.
Monopolies are carefully watched by governments because they are
potentially so powerful. Monopolies mean customers have limited (if
any) choice. This means the monopoly can be a price maker (rather than
a price taker which is what happens in competitive markets because
firms have to watch what others firms charge and take their price from
this). The danger is that monopolies can abuse their power and push up
prices to 'exploit' the customer who has no choice. The monopolist may
also lack much incentive to innovate because there is no pressure to do
so. There is no competition from others so they can carry on as they are
and the service could be poor for customers. Governments can regulate
monopolies to ensure that the price they charge is fair and that the service
they provide is appropriate.

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 However it should not be assumed that monopolies are always bad. For
example, the business may be a monopoly because it is innovative:
• its monopoly power may come from developing new products and
processes better than competitors
• the quality of the product and service may be outstanding, which is
why the business dominates the market
• the profits the monopolist makes may encourage more businesses to
be innovative to try and replace this firm, i.e. the dominance of one
firm encourages others to innovate
• having a monopoly may mean resources are not wasted by having
several firms doing exactly the same thing
• the monopolist may be more efficient and gain more internal
economies of scale.
This is why monopolies are not assumed to be bad – each case is usually
investigated by the government to assess on its own merits. In fact
monopolies are sometimes encouraged by governments. For example,
when someone invents a new product or process, they can usually be
granted a patent by a government which prevents others copying it for a
number of years. This is intended to encourage innovation in an economy.
Barriers to entry
A monopoly occurs because of barriers to entry. These prevent other forms
coming into a market. They include:
• legal protection by the government, e.g. a patent or the protection of
a domestic industry from foreign competition
• state provision, e.g. the government takes control of the industry and
becomes the only provider
• brand loyalty achieved through marketing meaning that others cannot
gain customers
• technological advantages that others do not know how to copy
• control over resources, e.g. control over natural resources
• cost advantages, e.g. efficient production processes that enable the
business to produce at much lower unit costs and sell at much lower
prices than others can.

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 Argument against monopolies Argument for monopolies

charges a higher price to may use the high profits to invest

consumers than in competitive in research and development,
market which may lead to innovation
over time – it could lead to better
products and lower costs than a
competitive market
may provide poor quality goods / may encourage other firms to be
services because customers have no more innovative to remove the
choice monopoly
may be little incentive to innovate may mean there is a not a waste of
or improve because it dominates resources, e.g. with two business
a market and there is a lack of providing the same service
competition

Quick test
1. State two possible benefits for consumers of a competitive market.
2. What is meant by ‘market share’?
3. Explain what is meant by ‘monopoly power’.
4. Give one reason why monopolies may not be in the public interest.
5. Give one reason why monopolies may be in the public interest.

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 Microeconomic
Chapter 3

decision
makers Exam-sstyle practicce questio
ons

1 Which statement is true? [1]

a) fixed costs divided by revenue equals total costs

b) fixed costs do not change with output

c) fixed costs never change

d) fixed costs plus average costs equal total costs

2 Prices tend to be lower in a competitive industry than in a monopoly. Why is this? [1]

a) a monopoly has less influence on the market

b) competitive industry has more economies of scale

c) new firms are free to enter the competitive industry

d) profits are lower in a monopoly

3 Which is most likely to make consumers save more? [1]

a) a belief that the prices of goods and services will rise in the future

b) an increase in the individual's wish to enjoy higher consumption immediately

c) lower interest rates paid by banks

d) worries that they will lose their jobs and income will fall in the future

4 Wages are most likely to be low in industries where [1]

a) there is an excess supply of labour.

b) the work is dangerous.

c) workers are paid on a monthly basis.

d) workers need several years of training.

5 A trade union is negotiating a wage rise for its members.

What is likely to increase the chance of the wage rise being granted? [1]

a) the economy is beginning to enter a recession

b) the government has made strike action illegal

c) the product the business produces has many substitutes

d) wages are a small part of the company's costs

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 6 A tyre manufacturer expands by taking over a rubber plantation.
What is this an example of? [1]

a) backward vertical integration

b) diversifying integration

c) forward vertical integration

d) horizontal integration

7 Google

In 2017, the internet giant, Google, was fined $2.7 billion by the European Union’s (EU) Competition
Commission. The Commission investigated the company for abusing its monopoly power and found
that Google was dominant in general internet search markets in Europe with a market share of
about 90%.

The Commission stated that when people were searching for items, Google would promote its own
shopping comparison sites and set these out at the top of the search results without people knowing
they were Google. The company had to stop doing this or face more fines.

A spokesperson said: ‘Google has come up with many innovative products and services that have
made a difference to our lives. That’s a good thing. But Google’s strategy for its comparison shopping
service wasn’t just about attracting customers by making its product better than those of its rivals.
Instead, Google abused its market dominance as a search engine by promoting its own comparison
shopping service in its search results, and demoting those of competitors.

What Google has done is illegal under the EU rules to control monopoly behaviour. It denied other
companies the chance to compete on their merits and to innovate. And most importantly, it denied
European consumers a genuine choice of services and the full benefits of innovation.’

Google immediately rejected the Commission’s findings, and said it would appeal.

Google’s revenue in 2016 was around $89 billion. The company has over $52 billion in cash, which is
held abroad because of the taxes it would have to pay if the money was brought back to the US.

Whilst being a monopoly is not in itself illegal, under EU law, companies that are dominant are not
allowed to abuse their position by restricting competition. On the back of the finding that Google is
the dominant player in the European search engine market, the EU regulator is further investigating
how else the company may have abused its position, specifically in its provision of maps, images and
information on local services.

a) What is meant by ‘market share’? [2]

b) Define ‘a monopoly’. [2]

c) Explain why Google was investigated by the Competition Commission. [4]

d) Calculate Google’s fine as a percentage of its revenue in 2016. [2]

e) Explain why Google might want to become a monopoly. [4]

f) Analyse how Google might have achieved its monopoly position. [4]

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 g) Discuss whether taxing monopolies is a good way to ensure they behave in the public interest. [6]

h) Discuss whether monopolies are bad for consumers. [6]

8 Nearly 80% of employees in the United Arab Emirates work in the service sector. The region has
attracted many large firms in industries such as tourism and finance and energy. Operating on a large
scale may give these firms lower unit costs, helping them to be globally competitive. However, the
region also has many startups and small businesses. Small and medium-sized enterprises account for
around 40% of all jobs and income in the region.

a) Define tertiary sector. [2]

b) Explain how the size of a business may be measured. [4]

c) Analyse the benefits small firms can bring to an economy. [6]

d) Discuss whether large firms inevitably have lower unit costs than smaller firms. [8]

9 The trade union representing thousands of low-paid production workers employed by the BBC in
the UK recently called for a minimum salary of $26 000. BECTU – the Broadcasting, Entertainment,
Cinematograph and Theatre Union – said it was 'unjustifiable' for some in the organisation to be
earning more than $198 000 when thousands of engineers, technical and other production staff were
paid much less than that amount. The minimum wage in the UK is around $9.90 per hour.

a) Identify three factors that may determine an individual's choice of occupation. [2]

b) Explain why the minimum wage legislation in the UK may not have an effect on the earnings of
most BBC staff. [4]

c) Analyse the factors that determine how much someone earns. [6]

d) Discuss whether membership of a trade union will always benefit a worker. [8]

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 macroeconomy

Government
Th
he role and macroeco
onomic aim
ms of

Chapter 4
and
governmment

Governm
ment and itss role You must be able to:
• understand the role of
The government is: government in the public and
private sectors
• a producer of goods and services in an economy, e.g. a government
• explain what is meant by the
may provide some of the transport in a country, education, healthcare, macroeconomic objectives
emergency services and defence • explain how these objectives
• an employer of workers, such as nurses, doctors, teachers, and police may complement each other
or conflict with each other.
and military personnel.
Organisations that are owned by the government are part of the public
sector. The size of the public sector varies from country to country, e.g. it
is relatively large in China and relatively small in the USA.
A government will influence:
• the local economy – local government is often responsible for the
provision of local services, such as libraries, roads and waste collection
• the national economy – government policies (actions taken by
government) will affect how easy it to set up in business, demand
levels, the growth of the economy, and the costs and prices of factors
of production
• the international economy – government policies will influence the
trade between one country and another, which will affect growth in
the world economy.
The government can influence the private sector by:
• nationalisation, i.e. taking over the provision of a good or service
• privatisation, i.e. selling public sector assets to the private sector
• taxation, e.g. indirect taxes on goods and services (paid when the item
is bought) or direct taxes on income and profits (taken directly from
earnings)
• subsidies, e.g. cash payments or tax reductions for producers
• regulation, e.g. laws influencing the amount produced, how it is
produced, how people are employed, how products are marketed.

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 The maccroeconomicc aims of government
A government objective is a target that it sets for the economy as
a whole.

Policies are designed

objectives
to achieve…

Government macroeconomic objectives include:

Economic growth
Economic growth is shown by an increase in national income. Generally
the government will want economic growth so that its citizens are earning
more. If income increases and the population remains the same, the
income per person rises. Higher income per person is usually associated
with a higher standard of living.
Full employment
Full employment means that all those willing and able to work at the
given real wage are in work. The government will want low levels of
unemployment as it is a waste of resources (inefficient) and socially
undesirable. If people are working, it should help economic growth and
give people a better standard of living.
Price stability
If prices are changing unpredictably, it is difficult for firms to plan
investment or for households to plan how much they will spend and how
much they need to save. Stable prices enable better planning and give
businesses and households more confidence in the government’s control
of the economy.
Balance of payments stability
The balance of payments position measures the financial transactions
between one country and the rest of the world. If a country is buying in Revision tip
heavily from abroad, it suggests its businesses are uncompetitive. If it is
Governments will have different
selling far more abroad than it is buying in, other governments may want
priorities at different times.
to take action to protect their own industries. A government will aim for a
stable trade position in terms of exports and imports.

Government
macroeconomic
objectives

Full employment Balance of Resdistribution

Stable prices / Economic
/ low payments of
low inflation growth
unemployment stabilty income

Other macroeconomic objectives of government may relate to:

• redistribution of income, e.g. to reduce inequality and poverty
• environmental targets, e.g. reducing carbon emissions and reducing
global warming.

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 Possible
e conflicts be
etween ma
acroeconomic
aims
Some macroeconomic objectives may work well together, for example:
• economic growth can help create jobs and reduce unemployment Revision tip
• stable prices may make trade more appealing and help a country’s
Remember, the government has
trade position. different objectives and some
will conflict with each other.
However, some macroeconomic objectives may conflict with each other, Therefore, governments must
for example: choose what the priorities are at
any moment.
• increased spending to reduce unemployment may lead to higher prices
• economic growth may lead to more spending on imports, which may
worsen the trade position
• economic growth may have negative environmental effects
• higher taxes on high income earners (to make the distribution of
income more even) may deter entrepreneurs and lead to slower
economic growth.

Quick test
1. What is meant by ‘economic growth’?
2. Why may economic growth be an objective of government?
3. Why does a government want low unemployment?
4. What is the purpose of the balance of payments?
5. What is the ‘public sector’?

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 macroeconomy
Government
Chapter 4

Fiscal policy
and

Fiscal po
olicy and go
overnment spending You must be able to:
• explain the meaning of ‘fiscal
Fiscal policy involves changes to government spending and the taxation policy’
and benefits system to influence the economy. • understand different types of
government spending
Government spending may be at a national or local government level and • explain different types
may be on areas such as defence, transport, healthcare, education and of taxation systems and
justice. understand the impact of
taxation
• understand the meaning of
The gov
vernment bu
udget posittion the budget, a ‘budget deficit’
and ‘budget surplus’
The budget position is the difference between government spending and • understand the impact of
government revenue in a given period, usually a year. government spending and
taxation changes on the
• A budget deficit occurs when government revenue is less than economy and macroeconomic
government spending. objectives.
• A budget surplus occurs when government revenue is more than
government spending.

Taxation
n
Taxation is a charge made by the government (e.g. on goods and services),
which: Revision tip
• raises the revenue of the government Remember, if the government
• can be used to influence behavior, e.g. encourage consumers to use has a deficit, it is spending more
than it earns, which should boost
more environmentally-friendly energy.
demand.
Taxation can take the form of:
• direct tax – taken directly from earnings, e.g. income tax and
corporation tax (a tax charged on profits)
• indirect tax – charged when items are bought, e.g. value added tax
(VAT).
Progressive taxation
• The average rate of tax increases as income increases. This occurs
when the marginal rate of tax gets higher as earnings increase. The
higher proportion of extra tax being paid pulls up the average rate of
taxation.
Regressive taxation
The average rate of tax decreases as income increases. This occurs when
the marginal rate of tax gets lower as earnings increase. The lower
proportion of extra tax being paid pulls down the average rate of
taxation.

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 Proportional taxation
The average rate of tax stays the same regardless of income. This occurs
when the marginal rate of tax remains constant as earnings increase.
Types of taxation system
Total tax
paid
Progressive
taxation Proportional
Average tax taxation
rate rises Average tax
rate is constant

Regressive taxation
Average tax rate falls

Income

Principle
es of taxatio
on
A good tax system should be:
• easy to administer
• cost effective – it should not be too expensive to collect the taxes or to
monitor whether people and businesses are paying the right amount
of tax
• fair – it must treat people in the same financial situation in the
same way
• easy to understand – people need to know what they are supposed
to pay.

Impact of taxation
Taxation can have an impact on different economic agents:
Revision tip
• consumers – tax may reduce earnings (e.g. income tax), reduce wealth
(e.g. inheritance tax) and increase the cost of living (e.g. VAT) The effect of a change in the
• employees – the benefits and tax system will affect the incentive to taxation rate will depend on
which tax it is, e.g. income tax
work
affects households directly,
• firms – tax may reduce profits (e.g. corporation tax), increase costs (e.g. whereas corporation tax affects
taxes on imported goods) and affect selling price (e.g. VAT) firms.

• government – tax may be used to reduce consumption (e.g. tobacco) or It is also important to consider the
system as a whole. For example,
raise revenue (e.g. income tax).
for income tax, you need to
Taxation can affect: consider the different levels of
income at which different tax
• the demand in the economy, e.g. higher income tax will reduce rates are applied.
disposable incomes (income after tax), which is likely to reduce
consumption spending; higher corporation tax may affect the funds
firms have for investment and reduce spending on capital goods
• the supply in the economy, e.g. higher income tax may reduce the
incentive for employees to work, which will reduce the labour force
and output in the economy; tax incentives may encourage investment,
which can increase productivity and supply in the long run.

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 Taxation
n and macro
oeconomic objectives
Macroeconomic objectives Taxation can…

economic growth • affect the supply of resources,

e.g. by affecting the incentive
to invest and work
full employment • affect the demand in the
economy, e.g. through income
tax and corporation tax, which
can affect the demand for jobs
price stability • affect costs (indirect taxes) and,
therefore, prices
• affect the level of demand,
which can also affect prices
balance of payments stability • be placed on goods and services
from abroad, which will affect
spending on overseas products

Quick test
1. What is meant by ‘fiscal policy’?
2. The rate of tax increases as income increases. What type of tax
system is this?
3. Explain the difference between a direct tax and an indirect tax.
4. What is meant by a ‘budget deficit’?
5. State three areas of government spending.

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 macroeconomy

Government
Chapter 4
Monetary po
olicy

and
Monetary policy me
easures You must be able to:
• explain what is meant by
Monetary policy involves the central bank taking action to influence ‘monetary policy’
interest rates, the supply of money and the exchange rate to affect the • understand what is meant by
economy. the ‘interest rate’
• explain the effect of changes
The interest rate is the cost of borrowing money (and the reward for in the interest rate on
saving). By changing the interest rate, the central bank changes the households, firms and the
economy
incentive for households and firms to save and spend. This influences • explain the effects of changes
spending in the economy. in the interest rate on
macroeconomic objectives.
A higher interest rate may:
• decrease consumption by discouraging households to borrow (because
it is more expensive to do so) – the effect depends on how sensitive Revision tip
borrowing is to interest rates
• decrease investment by discouraging businesses to borrow (because The interest rate is the reward to
savers and the cost of borrowing.
it is more expensive to do so) – the effect depends on how sensitive The effect will be different on
borrowing is to interest rates these different groups. Higher
• decrease exports by increasing the demand to save in the country interest rates may be welcomed
by savers but not by borrowers.
(because of the higher returns) – this will increase demand for the
currency, which is likely to increase its value; a higher exchange rate
makes exports more expensive in foreign currency, which is likely to
decrease the sale of exports and export spending.
A lower interest rate may:
• increase consumption by encouraging households to borrow (because
it is cheap to do so)
• increase investment by encouraging businesses to borrow (because it is
cheap to do so)
• increase exports by reducing demand to save in the country (because
of the lower returns) – this will reduce demand for the currency,
which is likely to lower its value; a lower exchange rate makes exports
cheaper in foreign currency, which is likely to increase the sale of
exports and export spending.

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 Effects of monetary
y policy on macroecono
omic
objectivves
Macroeconomic
Monetary policy
objective
economic growth interest rates can affect the level of investment in an
economy
full employment interest rates can affect borrowing and spending by
households and firms and, therefore, demand for
goods and services and jobs
price stability interest rates will affect demand; increases in
demand are likely to pull up prices
balance of interest rates will affect the incentive to save within
payments a country – higher interest rates will affect the
stability demand for its currency and, therefore, the price of
its currency (exchange rate); higher interest rates
tend to increase the value of the exchange rate,
which means exports are more expensive in foreign
currency and, therefore, fall

Quick test
1. What is meant by ‘monetary policy’?
2. What is meant by an ‘interest rate’?
3. Explain how a low interest rate may affect investment in an
economy.
4. Explain how a low interest rate may affect consumption in an
economy.
5. Explain how a high interest rate may affect the exchange rate of
an economy.

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 macroeconomy

Government
Chapter 4
Sup
pply-side po
olicy

and
Supply-side policy measures You must be able to:
• define ‘supply-side policy’
Supply-side policies aim to improve the quantity and quality of the factors • explain different forms of
of production in an economy to increase its productive potential. This supply-side policy
should increase the long-term supply of goods and services in an economy. • decribe the effect of
supply-side policies on
A policy is a deliberate set of actions taken by the government to bring macroeconomic objectives.
about an improvement in supply-side conditions.
Supply-sides policies aim to shift the supply outwards by increasing the
quantity and / or quality of resources. They increase the amount produced
at each and every price level.
An increase in the long-run supply in the economy can lead to:
• economic growth and more output
• more employment
• lower prices, which can increase the international competitiveness of a
country.
Supply-side policies include intervention by the government:

Supply-side
policies

In goods and
In the labour In financial
services Infrastructure
market markets
markets

The labour market

Supply-side policies in the labour market include:
• reducing welfare benefits to provide a greater incentive to work
• providing more training to employees to increase their skills and to
provide the skills needed in the modern economy
• reducing direct taxation to provide greater incentive to work
• providing more information to employees so they know what jobs are
available
• helping employees relocate to where the jobs are (e.g. helping with
housing costs)
• improving healthcare so that employees are off work less due to illness
• changing legislation to reduce trade union power.
The financial markets
Supply-side policies in the financial markets include:
• helping businesses to have easier access to finance
• providing cheaper finance to enable businesses to invest and grow.
Goods and services markets
Supply-side policies in goods and services markets include:
• reducing startup bureaucracy to encourage entrepreneurs
• encouraging investment in research and development and innovation
• subsidising investment in some industries
• protecting infant industries to help their development

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 • encouraging more competition to generate more innovation and
research, e.g. governments may limit takeovers and mergers if they
lead to monopoly power.
Infrastructure
Supply-side policies in relation to infrastructure include:
• improving the number of business and firms with fast broadband
• improving the transport system
• improving broadband access and the speed of internet access.

The effe
ects of supply-side poliicy measure
es on
macroecconomic aim ms
Supply-side policies can increase the long-run supply. An increase in supply
can lead to: Revision tip
• less unemployment
Sometimes the focus of
• lower prices government policy may be
• economic growth. supply-side. At other times,
a government may think the
Supply-side improvements do not only come through the government. key issue is to raise aggregate
demand.
They also come from the private sector, e.g. in terms of innovation and
productivity gains.
Productivity may be increased through:
• better training
• better management
• investment in capital and technology.
Innovation may be encouraged by:
• a stable business environment
• tax incentives for businesses who invest
• efforts to link innovators and investors (e.g. universities and business).

Macroeconomic
Supply-side policies…
objective
economic growth • can increase supply leading to economic
growth
full employment • can provide more incentive to work
• can increase the level of full employment
price stability • can increase supply and, therefore, lower prices
balance of payments • can improve supply and, therefore, increase
stability exports

Quick test
1. What is meant by ‘supply-side policies’?
2. State two possible supply-side policies for the labour market.
3. State one possible supply-side policy for the infrastructure.
4. State one possible example of supply-side policies in relation to
industries.
5. State one possible example of supply-side policies in relation to
financial markets.

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 macroeconomy

Government
Chapter 4
Eco
onomic gro
owth

and
Measure
ement of eco
onomic gro
owth You must be able to:
• define ‘economic growth’
Economic growth occurs when there is an increase in national income over • explain how economic
time, e.g. 2% annual growth means national income has increased by 2% growth is measured
over the year. • explain why economic growth
is a government objective
Gross domestic product (GDP) is the value of all the income generated • understand the causes of
in an economy over a year. Real GDP is the value of GDP adjusted for economic growth
• understand the stages of the
inflation, e.g. if national income grows by 2% but, over the same period, economic cycle.
prices have increased by 2% as well, the real GDP has not changed.
Real GDP
Real GDP per head (or per capita) =
population
If real GDP stays the same and the population increases, the real GDP per
head would fall. Revision tip
Real GDP per head is the most common measure of standard of living in a Real GDP per head only shows an
country. It is the average income per person. average. When considering the
standard of living in a country, it
Economic growth may be shown by: is important to consider how the
income was distributed.
• an increase in the productive potential of the economy – an outward
shift of the production possibility curve
• a movement towards full employment – a movement from within
the PPC onto the curve; this is actual growth, but involves getting the
economy up to its potential output and removing a negative output
gap rather than increasing its productive potential.
Economic growth

Product A
Revision tip
Remember, there is a difference
between an increase in national
income that is achieved by using
Z existing resources more efficiently,
and an increase in national
income that is due to an increase
Y in the quantity or quality of the
factors of production.

Product B

The movement from X to Y is an increase in output, but

it is reducing inefficiency and restoring the economy
to its productive capacity. The movement from Y to Z
represents growth in the productive capacity of the
economy – the PPC has shifted outwards.

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 The econ
nomic (or bu
usiness or trade) cycle
The economic (business or trade) cycle describes the growth pattern of
an economy’s income over time. Typically an economy goes through the
following stages:

Boom Boom
GDP growth %

0 Recession Recession
Recovery

Slump

Boom
A boom occurs when output is growing faster than the average trend
rate. In a boom there is usually:
• a high level of consumption, which increases demand and can pull
up prices
• an increase in investment as businesses invest in extra capacity
• low levels of unemployment
• high spending on imports due to higher incomes
• higher tax revenue for the government due to higher incomes, profits
and spending.
Slowdown
A slowdown occurs when the rate of income growth slows down, but the
economy is still growing.
Recession
A recession occurs when there is a fall in national income (GDP) for two
consecutive quarters (i.e. six months). A recession is associated with:
• lower profits
• less upward pressure on prices
• greater capacity
• less employment
• less investment
• less tax revenue for the government as there are lower profits and
incomes
• less confidence by consumers, which can reduce spending further
• less spending on imports as there is less income.
Slump
A slump is a sustained and major recession leading to a significant fall in
output. A depression occurs when there is a fall in real GDP of more than
10% from the peak of the economic cycle to its lowest point of recession.

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 Recovery
A recovery occurs when real GDP picks up from the low point of the
recession. This may be because business and household confidence starts
to improve, leading to more spending and investment. It may also be due
to government policies to promote a recovery, such as:
• lower interest rates to encourage borrowing
• expansionist spending on goods and services by the government
• lower taxation by the government to encourage investment and
spending.
Economic growth can lead to:
• more income for households
• greater consumer confidence, which can lead to more spending and
act as an incentive for firms to invest
• more tax revenue for governments (e.g. from taxes on spending and
profits) and less spending on benefits, as there will be fewer people
unemployed, which means the budget position should improve
• higher profits for businesses, enabling more investment in innovation,
research and development, which enables future economic growth.
The causes of economic growth include:
• an increase in the amount of capital in an economy, enabling more to
be produced
• an increase in the working population or the quality of labour
• improvements in technology
• increased demand for exports
• government policies that encourage innovation and startup businesses
and remove barriers to setting up and running a business.

Quick test
1. What is meant by ‘GDP’?
2. What is meant by ‘real GDP’?
3. What is meant by a ‘recession’?
4. State two ways in which a government may stimulate economic
growth.
5. How would economic growth be shown on a production
possibility curve?

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 macroeconomy
Government
Chapter 4

Employ
yment and unemploy
yment
and

Changin
ng patterns and levels of employm
ment You must be able to:
• define ‘employment’ and
Employment is the number of people in work. The pattern of employment ‘unemployment’
is the types of jobs that people do. Typically, economies begin with many • understand what is meant
people working in the primary sector (e.g. in North Korea). Over time, by changing patterns of
employment
more people tend to move into manufacturing in the secondary sector • understand how
(e.g. in China). With further economic growth, more developed economies unemployment is measured
tend to have a large tertiary sector (e.g. in the UK). • distinguish between the
unemployment level and the
Other changes in employment patterns may include: unemployment rate
• understand different causes
• changes to the number of women in the workforce
of unemployment
• changes to the age at which people tend to retire (length of time • explain the policies a
worked) government may adopt to
• shifts between the private and public sectors, e.g. if the government reduce unemployment.

takes less responsibility for the provision of goods and services, the
public sector declines and, as more labour moves into it, the private
sector grows. Revision tip
The level of unemployment measures the number of people who are The level of unemployment
willing and able to work but are not employed at the given wage rate at is measured as the number of
people. The unemployment rate is
a given moment in time. a percentage of the labour force.
The unemployment rate is the number of people unemployed as a
percentage of the total workforce.
number of people unemployed
Unemployment rate (%) = × 100
number of people in workforce
Unemployment can be measured by:
• the claimant count – the number of people entitled to claim
unemployment benefit over a given time period
• a labour force survey – a survey that measures the number of people
who say they are looking for work at the given real wage rate.

Causes and types off unemploy

yment

Seasonal

Types of
Cyclical Frictional
unemployment

Structural

Seasonal unemployment
People are unemployed because of the time of year, e.g. they worked on
fruit farms in the summer and are unemployed in the winter.

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 Frictional unemployment
People are between jobs, e.g. someone has left one job and is waiting
before starting another job. As long as there is a continual flow into and
out of work, frictional unemployment is not necessarily a concern.
Structural unemployment
The competitiveness of different parts of an economy change, e.g.
a country may become less competitive in shipbuilding but more
competitive in software design. People are made unemployed in
shipbuilding, but may not be able to retrain to become software designers
due to occupational or geographical immobility.
Cyclical (demand deficient) unemployment
There is a lack of aggregate demand in the economy. With less demand
for products, there is less demand for labour, which causes unemployment.

Consequ
uences of un
nemployment
The private costs of unemployment (for the individual) include:
• lower income
• possible loss of self-esteem.
The social costs of unemployment include:
• a waste of resources, which means output and growth in the economy
is less than it could be
• possible social divisions (between the employed and unemployed)
• a possible increase in crime.

Policies to reduce unemploym

ment
The best way for a government to reduce unemployment depends on the
underlying cause. For example, a government may:
• increase aggregate demand to create jobs for those who are cyclically
unemployed Revision tip
• retrain workers to reduce structural unemployment
For the government to reduce
• reduce unemployment benefits and make accepting a job more unemployment, it needs to know
financially attractive (e.g. by reducing income tax) to reduce frictional what is causing it.
unemployment.

Quick test
1. State two social problems caused by unemployment.
2. Define ‘structural unemployment’.
3. State one way of reducing cyclical unemployment.
4. State one way of reducing structural unemployment.
5. What is the difference between level of unemployment and
unemployment rate as measures?

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 macroeconomy
Government
Chapter 4

Inflatio
on and defla
ation
and

Measure
ement of infflation You must be able to:
• define ‘inflation’
Inflation occurs when there is a sustained increase in the general price • understand how inflation is
level over a period of time, e.g. if annual inflation is 2%, it means that measured
prices in general increased by 2% over the last year. • understand the causes of
inflation
Inflation measures the cost of living. This is a measure of changes in the • understand policies to control
average cost of buying a basket of different goods and services for a inflation
• explain the consequences of
typical household. inflation
• define ‘deflation’.
Consum
mer Price Index (CPI)
The Consumer Price Index (CPI) is a weighted price index and is a common
measure of inflation. The weights reflect the relative importance of Revision tip
different items in a typical household’s shopping basket and come from
Remember, the cost of living
the Family Expenditure Survey. refers to the price of items in an
economy. The standard of living
Examples measures how much real income
(purchasing power) people
Category Price index Weighting Price × weight have. The cost of living could be
increasing but, if incomes are
food 105 20 2100 rising faster, the standard of living
alcohol & tobacco 108 5 540 could rise.

clothing 95 15 1425
transport 110 14 1540
housing 105 20 2100
leisure services 102 8 816
household goods 94 12 1128
other items 110 6 660
100 10 309

In the example index above, food has a higher weighting than alcohol
and tobacco, i.e. changes in the price of food will have a greater
Revision tip
impact on the overall inflation rate.
sum of (price × weight) The CPI measures inflation for
Price index = the average household. If a
sum of weight household’s spending patterns are
10 309 different from the average then
In this case, price index = = 103.09. This is a 3.09% increase on their inflation may be different
100
the base year value of 100. from the official figures.

A fall in inflation
Inflation measures the rate of increase in prices. If inflation falls, prices are
still increasing but at a slower rate, e.g. if inflation falls from 3% to 2%,
the rate of increase in prices is slower, but there is still an increase.

Inflation 3% Revision tip

(Prices are Inflation 2%
growing by (Prices are still
Lower inflation means that prices
3%) growing but by
are increasing at a slower rate,
2% not 3%)
not that they are falling.
Year 1 Year 2

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 Causes of inflation and policie
es to controll it
There are two types of inflation:
Demand-pull inflation
An increase in demand can lead to higher prices. The impact on prices
depends on the extent of the increase and how price inelastic supply
is, e.g. supply becomes more price inelastic as the economy approaches
full employment. Government may attempt to reduce demand-pull
inflation by using deflationary policies to reduce demand, e.g. reducing
government spending or increasing taxation rates. Demand-pull inflation
is associated with high levels of demand, waiting lists, queues and
shortages.
Cost-push inflation
An increase in costs can lead to higher prices, e.g. an increase in energy
costs can push up the costs of production. Supply moves inwards.
Government may attempt to reduce cost-push inflation by controlling
wage increases (through income policies) or by intervening to increase the
value of the exchange rate to reduce import prices. Cost-push inflation is
associated with higher prices, lower levels of output and higher levels of
unemployment.

Consequ
uences of inflation
Inflation can affect consumers, firms, government, workers and society.
Inflation can create uncertainty – businesses do not know how much their
resources will cost and what they will be selling their products for, which
can deter investment. It can also affect:
• menu costs, as businesses have to change their prices regularly
• shoe leather costs (administrative costs), as businesses, workers and
households look for the best returns to compensate for inflation.
Households may have less real income depending on their ability to
increase nominal earnings in line with inflation. Workers with relatively
little bargaining power, such as the unemployed and pensioners, are likely
to be worse off in real terms. This can lead to more inequality in society.
Households may also find their savings have fallen in real terms because
they can buy less (unless the return they are earning is greater than
inflation).
If inflation is higher than abroad then, assuming the exchange rate is
unaltered, a country’s exports will decline because they are relatively
expensive and uncompetitive. This may affect government policy.
Tax revenue for the government may increase as, with more nominal
income, people pay more taxes, e.g. if your income rises 3% and inflation
is 3%, you are not better off in real terms but may be in a higher tax
bracket and have to pay a higher tax rate. This is called fiscal drag.

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 Deflatio
on
Deflation occurs when there is a sustained fall in the general price level
over a given period. It means there is a negative inflation rate. This can be
caused by a fall in demand.
If prices are falling:
• consumers and businesses may decide to save and spend later when
prices are lower, which can lead to a further decrease in demand, Revision tip
creating a deflationary spiral
• the real value of a debt increases, which can reduce consumer and To reduce inflation, the cause has
to be known. The right policy
business confidence and spending depends on the underlying cause.
• profit margins may fall, leading to efforts to reduce costs, such as job
losses.

Quick test
1. Define ‘inflation’.
2. What is meant by ‘demand-pull inflation’?
3. What is meant by ‘cost-push inflation’?
4. State two effects of inflation on firms.
5. State one effect of deflation on firms.

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 macroeconomy

Government
Chapter 4
Exam--style pracctice questions

and
1 Economic growth can be defined as [1]

a) an increase in a country’s exports.

b) an increase in a country’s population.

c) an increase in the productive capacity of an economy.

d) a reduction in inflation.

2 What effect is a decrease in interest rates likely to have on consumers and firms? [1]

a) borrow less, invest less

b) borrow less, invest more

c) save less, invest less

d) save less, invest more

3 When may high inflation and low interest rates most worry consumers? [1]

a) when a consumer has a pension that is linked to the consumer price index

b) when a consumer pays a fixed rent for their accommodation

c) when a consumer relies on his or her savings

d) when a consumer wants to buy a product on credit

4 Which best describes unemployment caused by the decline of an industry due to technological
change? [1]

a) CPI unemployment

b) frictional unemployment

c) seasonal unemployment

d) structural unemployment

5 Which is an inevitable consequence of deflation? [1]

a) a fall in exports

b) a fall in the standard of living

c) an increase in the cost of living

d) an increase in the real value of money

6 Which is a supply-side policy likely to promote economic growth? [1]

a) an increase in benefit payments

b) an increase in the funding of training

c) an increase in the rate of corporation tax

d) an increase in the rate of income tax

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 7 The South African budget deficit

In 2017, the South African government decided to raise taxes to improve the government’s budget
position. The finance minister said that the Treasury would need to raise an extra R28 billion ($2.1
billion) in taxes to help meet the budget deficit target for the year of 3.1% of GDP. The shortfall
between revenue and spending was very noticeable because the economy was expected to grow by
only about 1.3% that year, making the deficit a larger percentage of national income.

To reduce the deficit, the Treasury cut spending in many areas. It also announced a top income tax
rate of 45% for people earning more than R1.5 million. The tax increases were aimed at higher
income earners to make the system more progressive. The government also raised fuel taxes.
However, it decided not to increase VAT, as this was felt to be too politically unpopular.

In preceding years, the South African government had been good at maintaining a healthy budget
position. This allowed it to borrow from domestic and international lenders. However, growth had
been slow and unemployment and poverty were high. South Africa’s unemployment rate hit a
12-year high in 2016, at 27.3% in the third quarter of the year. The unemployment rate was even
higher among youths, close to 50%.

South Africa also has one of the highest inequality rates in the world. The poorest 20% of the South
African population consume less than 3% of total expenditure, while the wealthiest 20% consume
65%. The government knows it has to reduce inequality and ensure black South Africans fully share
in expanded job and wealth creation, while boosting incomes for everyone.

Fig. 1: South African government budget

2
1

–0

–1 percent of GDP
–2

–4
–4.1 –3.9
–4.4 –4.3
–4.7 –4.7 –5
–6
–6.3
–8
2006 2008 2010 2012 2014 2016

a) What is meant by ‘GDP’? [2]

b) South Africa has a budget deficit. Explain what is meant by a ‘budget deficit’. [2]

c) Explain what is meant by a ‘progressive tax system’. [2]

d) Explain two possible reasons why South Africa has a budget deficit. [4]

e) Explain two possible causes of inequality in South Africa. [4]

f) Explain two reasons why the South African government might have taxed fuel. [4]

g) Discuss the possible consequences of high unemployment in South Africa. [6]

h) Discuss how the South African government may try to increase economic growth in the country. [6]

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 8 Gambia has a very high unemployment rate and this has increased in recent years with lower demand
in the economy. Lower demand means output is below its potential level. Tourism normally brings in
about 20% of Gambia’s GDP, but the country suffered in 2014 from tourists’ fears of the Ebola virus in
neighbouring West African countries. The economy has also suffered from a lack of investment due
to high interest rates. The government is committed to reducing unemployment and is considering
whether demand or supply-side policies are better.

a) Define the 'potential output' of an economy. [2]

b) Explain the consequences of high unemployment. [4]

c) Analyse the different causes of unemployment that could exist in an economy. [6]

d) Discuss the best way for a government to reduce unemployment in its economy. [8]

9 The economic policy of the prime minister Mr Abe in Japan was called the 'three arrows'. It involves
a stimulus from monetary policy, fiscal policy and supply-side policies in areas of the economy, such
as the labour market. These were aimed at helping economic growth and reducing unemployment.
However, by 2017, there were calls for greater spending by the government to increase demand.
Some advisers said there had not been a fiscal policy boost as the government had raised taxes to
raise revenue and reduce the budget deficit.

a) Define ‘budget deficit’. [2]

b) Explain how supply-side policies in the labour market might reduce unemployment. [4]

c) Analyse how changes in fiscal policy can affect economic growth. [6]

d) Discuss whether an increase in spending or a reduction in tax is the better way of reducing
unemployment. [8]

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 development
Economic
Chapter 5

Living standards

Real nattional incom

me per capita You must be able to:
• explain what is meant by
The standard of living in a country is usually measured by real GDP per ‘the standard of living’ and
head. how to measure it
• describe why some countries
Real GDP is the value of gross national income (GNI) after it has been are classified as ‘developed’
adjusted to take account of inflation. For example: and others are not
• discuss differences in
• if income increases by 3% but prices increase by 3%, in real terms you standards of living within
are no better off – real GDP remains the same countries and between
• if income increases by 5% and prices increase by 3%, real GDP has different countries.
increased by 2%.
Real GDP per capita measures the average income per person.
real GDP
Real GDP per capita =
population
Therefore, the standard of living between countries may vary according to:
• the size of national income
• the population size.
There are problems with real income per capita as a measure of the
standard of living:
• It does not take into account accumulated wealth and assets.
• It does not take account of the quality of goods and services – over
time, the price of products (e.g. consumer electronics) and, therefore,
income may fall even though quality may be increasing.
• It does not take into account quality of life, e.g. how many hours were
worked for the income.
• It does not take account of the income distribution – there could be
major income inequality within the economy.
• It does not account for the value of unpaid work and trade, e.g.
improvements made by the owners to their homes are not counted,
whereas improvements made by paid tradespeople are. Similarly, it
does not include anything traded through barter, because it has not
been sold for a price.
• It does not account for undeclared activity (the ‘shadow economy’) – in
some economies, there is a significant amount of buying and selling
that goes unreported to avoid taxes.
To increase living standards as measured by real national income per
capita, a government will want to increase economic growth. It may do
this through supply-side policies to increase the amount that the economy
can produce, e.g. invest in infrastructure, encourage innovation and
provide more incentive to work.

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 Comparring incomess between countries
Differences in income between countries may be due to:
• the productivity of the workforce – this will depend on skills and
training and the quality and quantity of resources it has to work with
• the size and structure of the population
• the quality of the education sector
• the amount of investment in capital
• the quality of the healthcare system – if the workforce is healthier,
it may be more productive
• access to export markets and the ability to trade abroad
• the size of the primary, secondary and tertiary sectors – the secondary
sector tends to become more productive with investment than the
primary sector.

Comparring living sttandards and income

ution
distribu
The income per person will depend on what the overall income of the
economy is and how many people there are. Over time, it will depend
on the growth rates of both of these. For example, if the population is
growing at 7% a year, the national income needs to grow at a similar rate
for the income per person to stay constant.
The income distribution will depend on factors such as:
• the tax system and how progressive or regressive this is
• the benefits system
• how many people are of working age relative to those not working.

Measuriing economiic development

Measuring income may not be the best measure of economic development,
i.e. the quality of a country’s development and living standards may be
better measured using a range of indicators. A country can have high
income without being ‘developed’, e.g. if the income is earned by relatively
few, the quality of life is poor and most people are not politically free.
The most common measurement of development is the Human
Development Index (HDI), published each year by the United Nations
Development Programme. The index was developed to highlight the
view that people and their capabilities are a better measure of the
development of a country rather than economic growth alone. HDI is
a summary measure of average achievement in a number of important
dimensions, such as health, education and standard of living:

HDI

Standard
Health Education
of living

• The health dimension is measured by life expectancy at birth.

• Education is measured by the mean (average) years of schooling for
adults (aged 15 and above) and expected years of schooling for children.
• The standard of living is measured by gross national income (GNI)
per capita.

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 Human Development Index (HDI)
Human development Dimensions Long and healthy life Knowledge A decent standard of living
index (HDI)
Indicators Life expectancy Mean years Expected years GNI per capita (PPP $)
at birth of schooling of schooling

Dimension Life expectancy Education index GNI index

index index

Human development index (HDI)

The HDI has a value of 0 to 1:

• 1 is total developed
• 0.8 and above is highly developed
• 0.5 to 0.8 is medium developed
• less than 0.5 is a low level of development.

Quick test
1. Define ‘real GDP per head’?
2. What is meant by ‘income distribution’?
3. State two limitations of real national income per capita as an
indicator of the standard of living.
4. What is the difference between the standard of living and the
cost of living?
5. Suggest one way a government may try to improve the country’s
standard of living.

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 development

Chapter 5
Economic
Poverty

Poverty You must be able to:

• understand the difference
Income is a flow concept. It shows the flow of earnings going to factors between income and wealth
of production over a given period (usually a year), e.g. wages, rental • describe the difference
income, interest from savings and profits. The flow of income earned in an between absolute and
relative poverty
economy over a year is measured by gross domestic product (GDP). • understand the causes and
Wealth is a stock concept. It shows the stock of assets (e.g. shares and effects of poverty
• recognise and discuss policies
property) a person, business or economy has at a given moment in time. to alleviate poverty.
Income versus wealth
A person’s wealth is everything they own minus what they owe. It may
include their car, their apartment or house and their other possessions.
These could have been bought at any time in their lives. Their income is
their salary for that year. For example:
• if a person has a lot of assets but is not earning, they have high wealth
and low income
• if a person has just started working and has a good income but
relatively few assets, they have relatively low wealth and high income.
Income inequality measures how income is distributed within an economy.
Reducing the inequality within an economy (i.e. the difference between
those with high and low incomes) is often an objective of government.
This is deemed to be ‘fair’ but, in economic terms, it does not mean it is
efficient. For example, a labour market may be economically efficient and
lead to some people earning far more than others, which may not be seen
as fair or good for society.
Very unequal incomes may lead to social unrest, as those with less become
unhappy with those who have far more.
Absolute poverty
Absolute poverty is defined by the United Nations as ‘a condition
characterised by severe deprivation of basic human needs, including food,
safe drinking water, sanitation facilities, health, shelter, education and
information’. It depends not only on income, but also on access to services.
It occurs when incomes fall significantly below what is required to live
a modest but adequate existence. Obviously, the decision about what is
a modest and adequate existence is a value judgement, i.e. a matter of
opinion, and society’s views may change over time.
Relative poverty
Relative poverty occurs when an individual or household’s income falls
below a national average or median income.
Overall poverty
Overall poverty, as defined by the United Nations, takes various forms,
including:
• a lack of income and a lack of productive resources to ensure
sustainable livelihoods
• hunger and malnutrition
• ill health

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 • limited or lack of access to education and other basic services
• increased morbidity and mortality from illness
• homelessness and inadequate housing
• unsafe environments and social discrimination and exclusion.
It is also characterised by a lack of participation in decision-making and in
civil and social issues.

Causes and effects of poverty

Poverty can lead to:
• a loss of status and income
• a decline in people’s self-respect
• health issues
• a sense of social exclusion, which can create social conflict.
The main causes of poverty include:
• long-term unemployment (short-term unemployment, where people
are simply between jobs, is less of an issue)
• low pay, e.g. due to discrimination or a lack of a minimum wage in the
economy
• homelessness
• addiction, affecting health and employability.

Policies to alleviate poverty

Government policies to reduce poverty include:
• changes to the rate of taxation and benefits systems, e.g. reductions in
the amount of tax paid by low earners (progressive taxation) and more
generous state benefits
• increases in the national minimum wage
• changes in the taxation system, e.g. taxing luxury goods heavily
• promoting economic growth
• encouraging of startups and promoting business growth
• job creation
• the provision of free services, such as education and healthcare, and
investment to improve them
• investment in training to give people more skills (although these take
time to take effect)
• subsidies for certain services, e.g. subsidies for childcare to enable
more people to take a job.

Quick test
1. Define ‘absolute poverty’.
2. Define ‘relative poverty’.
3. Give two possible causes of poverty.
4. Give two effects of poverty.
5. State two possible ways of reducing poverty.

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 development

Chapter 5
Economic
Popu
ulation

The facttors that affe

ect population growth
h You must be able to:
• describe the factors that
Population measures the total number of people in a country at a given affect population growth
moment. It is affected by: • discuss reasons for different
rates of population growth in
• birth rate – usually measured by the number of live births per different countries
thousand people in the population per year • describe the effects of an
• death rate – usually measured by the number of deaths per thousand ageing population on an
economy.
people in the population per year
• fertility rate – the average number of children a woman will give birth
to over her lifetime
• net migration – the difference between the number of people
entering a country and the number leaving over a period:
• net immigration occurs when the number entering a country
exceeds the number leaving over that period
• net emigration occurs when the number leaving a country exceeds
the number entering over that period.
The number of people entering and leaving a country depends on the:
• perceived quality of life in different countries
• standard of living in different countries
• ease of entering and leaving different countries, e.g. visa controls
• ease of travel.
The birth and death rates in a country depends on many factors:
The health of the population
• Better healthcare and diet can reduce infant mortality and lead to
longer life expectancy.
Education
• Better education can ensure that people know how to reduce infection
and disease, how to eat properly and the importance of a healthy
lifestyle.
• If there are more women educated, entering and staying in the
workforce, it may reduce the birth rate.
Social provisions
• Good social care can mean that older people are better looked after
and live longer.
• Clean water can reduce diseases, such as cholera, and reduce the
death rate.
Cultural factors
• In some cultures, there is social pressure to have large families, which
increases birth rates.
• In some religions, birth control is opposed, which increases the
birth rate.

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 Political factors
• Government policies will determine the benefits available to those
with children in relation to the rewards from working, which will
affect the birth rate.
• Some countries have policies that encourage smaller families.
• Government policies will determine the benefits available to the
elderly, which will impact on their standard of living and may affect
life expectancy.
Environmental factors
• Some countries are vulnerable to natural disasters and disease, due to
the climate, and / or have high levels of pollution – these may affect
the birth and death rates.

The effe
ects of changges in the size and
structurre of the pop
pulation
The population structure examines how the population is divided up
between males and females of different age groups. It is often shown on
a population pyramid.

Male Female
100+
Many elderly
95–99
dependants
90–94
85–89
80–84
75–79
70–74
65–69
60–64
55–59
50–54
45–49
40–44
35–39
30–34
25–29
20–24
15–19
Few young 10–14
dependants 5–9
0–4
2.5 2.0 1.5 1.0 0.5 0.0 0.0 0.5 1.0 1.5 2.0 2.5
Population (millions)

Diagrams like this show:

• how many people there are within working age
• how many young and elderly people there are who may be dependent
on those in work for support.
An ageing population occurs if the median age of the population
increases. This could be due to:
• lower birth rates
• declining fertility rates
• lower death rates, e.g. due to better healthcare.

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 With an ageing population:
• more people may become dependent on those in work, which may
lead to higher taxes for those in work
• there may be a shortage of labour, as there may be fewer people
available for work.
The optimum population is a theoretical number. It is the population size
at which, working with all available resources, there would be the highest
standard of living for all people in the country. The optimum population
figure can change. With improvements in technology and new resources,
the optimum population may increase.
Underpopulation occurs when there are too few people in an area to
use the resources effectively, given the level of technology. An increase
in the population would lead to a more effective use of resources and an
increased standard of living for all people. Underpopulated areas tend to
have high average incomes and low unemployment, which may attract
people into the area.
Overpopulation occurs when there are too many people in a country
given the resources available – if the population reduced, living standards
would increase.
Population growth refers to the increase or decrease in the size of the
population:
• The population will decline if death rate is greater than birth rate.
• The population will increase if death rate is less than birth rate.
Within an economy, the dependency ratio measures the percentage of
dependants (under or above working age) compared to the number of
people of working age (economically active).

Quick test
1. What is meant by ‘an ageing population’?
2. Define ‘net migration’.
3. State one influence on the death rate.
4. State one factor that may lead to more immigration.
5. Give one consequence of an ageing population.

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 development Differen
nces in economic
Economic
Chapter 5

developpment betw ween coun

ntries

Classificcation of eco
onomies You must be able to:
• explain the difference
As of July 2017, the World Bank income classifications by GNI per between a developing and
capita (US$) are as follows: developed economy.

• Low-income: < $1005

• Lower-middle income: $1006 to $3955
• Upper-middle income: $3956 to $12 235
• High-income: > $12 235
Low and middle income economies are sometimes referred to as
developing economies.

Featuress of develop
ping and more
ped economiies
develop
Although each developing country is different, they often display the
same characteristics:
• relatively low income per person
• low level of productivity
• high levels of natural resources
• very dependent on primary product exports
• high levels of external debt
• large numbers of people living in agricultural areas
• fast population growth
• relatively young population
• poor infrastructure (e.g. telecommunications, transport and energy)
• political and economic instability
• corruption within the system.
By comparison, a developed economy typically:
• has a relatively high income per person
• is usually industrialised
• has higher literacy rates
• has good infrastructure
• has high life expectancy
• has low birth rates
• has high death rates
• has good housing
• has safe water supplies
• has good access to medical care.

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 The imp
portance of trade in developing
econommies
Trade can be an important part of the development of an economy
because it can provide:
• an increase in aggregate demand through exports
• more jobs, leading to more income and demand within the economy
• a source of foreign exchange
• a source of finance to invest in technology and innovation.
Developing economies
Good A

Sell 20 units of
A abroad for
100
80 units of B
–20
80

0 Good B
60 80

However, trade can cause problems for developing economies, e.g. the
volatility of some global commodities means that price changes can have
major effects on the exporting economy.

Quick test
1. What is a ‘developing economy’?
2. In a developing economy, income per person tends to be low. True
or false?
3. In a developing economy, the population tends to be relatively
young. True or false?
4. Developing economies are often dependent on primary products.
True or false?
5. Describe one way in which developed economies may help
developing economies.

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 development
Economic
Chapter 5

Exam-sstyle practicce questio

ons

1 Which will increase the level of economic development in a country? [1]

a) a higher infant mortality rate

b) a higher inflation rate

c) a higher interest rate

d) a higher literacy rate

2 Which is most likely to reduce the average age of the population in a developed country? [1]

a) a fall in the birth rate

b) a fall in the death rate

c) an increase in emigration

d) an increase in immigration

3 Which is most likely to be found in a typical developing country? [1]

a) a good education sector

b) a small average family size

c) a small percentage of very old people

d) high spending on entertainment

4 The standard of living in a country is usually measured by [1]

a) consumer price index.

b) real national income.

c) real national income per capita.

d) real price per capita.

5 The Human Development Index is made up of measures of [1]

a) health, education and standard of living.

b) health, education and wealth.

c) health, wealth and standard of living.

d) wealth, education and standard of living.

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 6 Ethiopia’s growing economy

Fig. 1: National income per person (US$)

Trillion

650
600
550
500
450
400
350
300
250
200
150
0
1985 1990 1995 2000 2005 2010 2015

Fig. 2: GDP composition by sector of origin (2016)

Sector of origin % of GDP

agriculture 36.2
industry 17.0
services 46.8

The Ethiopian economy is growing fast. After years of famine and low growth, the country has
experienced high levels of foreign investment more recently, much of which has come from China.
The result has been an economic boom. However, average incomes remain very low – the per capita
income of $590 is substantially lower than the regional average.

In the last 10 years, Ethiopia has grown on average by more than 10% a year. The country is Africa’s
second most populous country with a population of over 99 million people and has become the
largest economy in East Africa according to the International Monetary Fund.

As costs rise in other countries, Ethiopia is aiming to become a global manufacturing base for foreign
companies. The government wants to move the country from an agricultural economy to one where
the secondary and tertiary sectors are more dominant.

The country is near seaports, has a large workforce, low wage levels and cheap power. Investment in
industry is supported by the government. It is opening industrial areas, where setting up and running
businesses will be cheaper and easier, and aims to create 200 000 jobs every year until 2025.

While 55.3% of Ethiopians lived in extreme poverty in 2000, by 2011 this figure was reduced to
33.5% (based on the international poverty line of less than $1.90 per day). Over the past two decades,
there has been significant progress in key human development indicators: primary school enrolments
are four times higher than they were, child mortality has been cut in half, and the number of people
with access to clean water has more than doubled.

However, the challenges facing the government remain significant. For example, the economy needs
to grow fast to support the 2.3m Ethiopians that are born every year. It also needs major investment
in education: at the moment 80% of young people in the countryside do not finish primary school
and 75% of the population still rely on subsistence farming for their livelihood.

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 a) What is meant by ‘a developing economy’? [2]

b) What is meant by ‘the tertiary sector’? [2]

c) What is meant by ‘the per capita income’? [2]

d) Explain the challenges that still face Ethiopia. [4]

e) Explain why the Ethiopian government has a target of economic growth. [4]

f) Explain why foreign companies may want to invest in Ethiopia. [4]

g) Discuss whether the development of Ethiopia is best measured by the income per person. [6]

h) Discuss how greater trade may help an economy such as Ethiopia. [6]

7 China has experienced fast economic growth helped partly by allowing investment of multinationals
into the economy. However, China remains a developing country and has high levels of poverty.
According to China’s current poverty standard (per capita rural net income of RMB 2300 per year),
there were 55 million poor in rural areas in 2015. China also faces demographic pressures related to
an ageing population. The extent of poverty, both absolute and relative, is a major problem in many
countries.

a) Define ‘fast economic growth’. [2]

b) Explain the possible causes of poverty in a country. [4]

c) Analyse the possible consequences of an ageing population. [6]

d) Discuss whether encouraging multinational companies to locate to a country is likely to

significantly reduce the extent of poverty there. [8]

8 India's human development index (HDI) value of 0.624 puts it in the ‘medium human development’
category, alongside countries such as Congo, Namibia and Pakistan. Absolute and relative poverty are
significant issues in India, despite having one of the fastest-growing economies in the world, with
national income growing at 7.6% in 2011. According to the World Bank in 2016, India had 17.5% of
the total world population but a 20.6% share of the world’s poorest. In 2011 India’s poverty rate for
the period 2011–12 stood at 12.4% of the total population, or about 172 million people; taking the
poverty line as $1.90 a day. The country has a high birth rate, which affects its population structure.

a) Define ‘absolute poverty’. [2]

b) Explain how a high birth rate can affect the population structure. [4]

c) Analyse how changes in gross domestic product (GDP) per head may differ from changes in the
Human Development Index. [6]

d) Discuss whether increasing the minimum wage is the best way to reduce poverty in a country. [8]

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 globalisation

International
Chapter 6
trade and
International spe
ecialisatio
on

Specialisation at a national lev

vel You must be able to:
• explain the basis of
International trade occurs when one country sells and buys goods and specialisation at a national
services from another. It involves exports (sales abroad) and imports level
(purchases from abroad). • explain the benefits of
specialisation
Trade occurs because one country can produce products at a lower • explain the disadvantages of
opportunity cost than another. specialisation.

Specialisation occurs when a country or region specialises in producing the

product where it has a comparative advantage.

Advantaages and dissadvantage

es of
specialissation
A country or region can benefit from trade and specialisation by:
• growing faster than it could on its own
• enjoying a wider range of goods and services at lower prices than it
could produce on its own.
The benefits of trade may be even greater than those suggested if there
are gains from specialising, e.g. if by doubling resources in an industry,
output more than doubles (this is called increasing returns).
Specialisation can also lead to economies of scale because of the greater
scale of production. This reduces the unit cost and can make the country
or region even more price competitive when trading.
Production Possibility Curve (PPC)
A country can sell some of the output of the product where it has
comparative advantage abroad (e.g. product X) for more of other
products (e.g. product Y) than it could produce domestically. This means it
can now consume outside the PPC.

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 For example:
• Country A produces only 100 units of X.
• It exports 30 of these units to Country B, which is inefficient at
producing X itself but efficient at producing Y.
• Country A is able to sell the 30 units of X for 60 units of Y (this is still
cheaper for Country B than trying to produce X itself).
• 60 units is a greater number of Y than Country A would have produced
had it transferred resources out of Industry X and into Industry Y
domestically.
Production Possibility
Good X

100

70

Good Y
50 60

Quick test
1. Define ‘comparative advantage’.
2. A country should specialise in the production of goods and services
where it has a comparative advantage. True or false?
3. Give one reason why a country may have a comparative advantage
in the production of a product.
4. Suggest one advantage of specialisation for consumers.
5. State one benefit of specialisation for an economy.

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 globalisation

International
Chapter 6
trade and
Free trrade and prrotection

Globalissation and multination

nal You must be able to:
• define ‘globalisation’
compannies (MNCs) • explain the role of
multinational companies
Globalisation is the process by which the links between countries increase. • explain the benefits and costs
This is because of developments in communication and transport and of multinational companies
greater trade between countries. • understand the meaning and
benefits of free trade
A multinational company (MNC) is a company that has production bases in • understand the meaning
more than one country. A business may want to become a multinational to: of and reasons for
protectionism.
• benefit from resources overseas, e.g. cheaper labour, cheaper land,
access to resources such as minerals and oil
• gain access to new markets, e.g. by being based within a country, a
company may overcome some trade barriers that prevent companies
outside the country from selling to it
• gain rewards from the local government, e.g. some governments will
offer incentives (such as lower taxes or subsidies) to multinationals to
set up base in their country
• reduce risk, e.g. by having bases in more than one country a company
has less risk if there is political damage, an environmental disaster or a
strike by employees in one country.

The ben
nefits of MNC
Cs
To the host country
MNCs can:
• bring jobs and increase incomes – this has a direct effect on the
employees of the MNC, who then spend their money on local goods
and services, which increases demand and incomes there; this money
will then be spent on other goods and services, and so on
• bring technology and expertise – other businesses will learn from this
and gain as well.
To the home country
MNCs can:
• earn profits, which can be returned to the home country and lead to
more investment there
• benefit from lower costs and more resources than at home, which
leads to more profits for the company’s owners.

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 The costts of MNCs
To the host country
An MNC may:
• exploit the country’s resources and not invest the profits locally
• abuse its power, e.g. pushing down wages, demanding less regulation
or subsidies
• not train local staff, e.g. it may use cheaper local labour for low skill
jobs only
• use up resources and relocate once they have gone
• force local businesses to close
• replace national culture with global brands / culture, e.g. change culture
of country to become less distinctive nationally and more global.
To home country
An MNC may:
• take jobs abroad
• invest in technology and training abroad rather than at home.

Free trad
de
Free trade occurs when there are no barriers to trade, current account of
balance of payments, i.e. countries can trade with each other without any
restrictions.
Barriers to trade include:
• quotas – limits on the number of foreign goods and services that can
be sold in a country
• tariffs – taxes on foreign goods and services
• regulations that make it more difficult or expensive to sell into the
country
• legislation that protects certain industries, e.g. laws that insist that
services in some industries are provided by domestic firms only
• export subsidies – if a government provides aid to domestic producers,
it will shift the domestic supply downwards by the subsidy because
costs have been reduced
• embargoes – when a country bans trade in particular goods and
services with another country, often for political reasons.
The benefits of free trade are:
• a country can specialise in the production of goods and services where
it has a comparative advantage and export these items at a profit
• a country can buy in goods and services where it does not have a
comparative advantage at a price that is lower than it could produce
them for itself
• a country’s consumers will have a wider choice of goods and services
from around the world
• a country can consume outside of its production possibility curve (PPC).

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 Protectiion
Protectionism occurs when there are barriers to trade. Protectionist
measures are designed to protect one country’s producers from
competition abroad.
Protectionism may occur when governments want to:
• protect ‘infant industries’ – these are startup businesses that need
protecting against more established overseas businesses (that have
economies of scale and can sell at such a low price that domestic firms
could not compete); protecting the infant industries allows them
to grow, gain internal economies of scale and eventually be able to
compete internationally
• protect key strategic industries, such as defence and agriculture, to
ensure the country is not overly reliant on foreign firms in case of war
(this is a political reason not an economic one)
• protect / support an industry that is struggling, perhaps because it has
lost its comparative advantage and international competitiveness Revision tip
• retaliate against the protectionist actions of other governments
Some of the arguments for
• protect against dumping, i.e. when a country sells some products at a protectionism are political reasons
loss to destroy the foreign competition. rather than economic reasons.

Protectionism can lead to:

• less choice for a country’s consumers
• higher prices for a country’s consumers, which can lead to inflation
• less competition for domestic producers, which may reduce quality and
customer service
• more protection for domestic producers, which may allow inefficient
producers to survive and increase the profits of certain domestic
industries
• fewer exports for other countries, which may reduce income and
growth in these countries.

Quick test
1. What is the term for a tax placed on foreign goods and services?
2. What is the term for a limit placed on the number of goods
allowed into a country?
3. What is the name given to startup industries that may need
protection to enable them to become more internationally
competitive?
4. Explain what is meant by ‘retaliation’ in relation to protectionism.
5. Give one argument against protectionism.

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 globalisation
International
Chapter 6

trade and
Foreign
n exchange
e rates

Foreign exchange ra
ates You must be able to:
• understand what is meant by
An exchange rate is the price of one currency in terms of another, e.g. an ‘exchange rate’
the number of euros received in exchange for one dollar. There are many • understand the meaning of a
‘floating exchange rate’
exchanges rates, such as the value of the dollar in euros, pounds, yen and
• understand what determines
yuan. equilibrium in the exchange
In a floating exchange rate system, the price of a currency is determined rate market
• explain the reasons why an
by market forces, i.e. by the supply and demand of the currency in the exchange rate may increase or
foreign currency markets: decrease in value
• explain the consequences of
• If the price of the currency increases, the currency is getting exchange rate fluctuations.
‘stronger’ – this is an appreciation of the currency.
• If the price of the currency decreases, the currency is getting
‘weaker’ – this is a depreciation of the currency.

Determiination of th
he foreign exchange ra
ate
Demand for a currency Revision tip
Demand for a currency is the demand from others to convert their
The exchange rate is the external
currency into this one. It shows the quantity demanded at each and every
value of the currency – it is its
exchange rate, all other factors unchanged. A change in the exchange price in terms of other currencies.
rate leads to a movement along the demand curve.
This demand for a currency depends on factors such as:
• the demand for the country’s goods and services
• the attractiveness of saving in the country– the higher the domestic
interest rate, the more likely it is that people or firms will want to
invest in the country
• speculation:
• if speculators believe a currency is going to fall in value in the
future, they will sell now – this reduces demand
• if speculators believe that a currency will increase in value in the
future, they will buy now – this increases demand
• the behavior of MNCs:
• if MNCs want to invest in a country, it will increase demand for
the currency – this type of investment is called foreign direct
investment (FDI)
• if MNCs are leaving a country, they will need less currency, so
demand for the currency falls.
A change in any of these factors (other than exchange rate) leads to a
shift in the demand curve.
The demand for the currency is downward sloping. As the exchange
rate increases in value, it makes exports more expensive in foreign
currency. The higher the price in foreign currency, the lower the sales and,
therefore, the lower the amount of domestic currency earned.
The slope of the demand for the currency will depend on the price elasticity
of demand for exports. The more price elastic demand for exports is:
• the greater the fall in sales given an increase in the exchange rate
• the greater the fall in domestic currency.

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 Example
Price of US product = $100
Sales of product = 500 units
Export earnings = 500 × $100 = $50 000
The exchange rate increases by 10%.
Assume sales fall by 20% (this means the price elasticity of demand for
exports is –2).
Sales would now be 400 and export earnings would be 400 × £100
= $40 000
If sales only fell by 1% (in which case the price elasticity of demand
is –0.1), they would be 495 units. Export earnings would now be
495 × $100 = $49 500

The more price elastic the demand for exports:

• the more an increase in the value of the exchange rate will reduce
export earnings
• the more price elastic the demand for the currency is.
Exchange
rate, e.g. $ : £

$2 : £1

$1 : £1

D£
£
Q1 Q0

Supply of a currency
The supply of a currency shows the quantity supplied of a currency to
the foreign exchange market at each and every exchange rate, all other
factors unchanged. A change in the exchange rate leads to a movement
along the supply curve.
The supply of a currency to the foreign currency market depends on the
desire to change this currency into another currency. This depends on
factors such as:
• the demand for foreign goods and services
• the interest rate abroad (how attractive saving in a foreign currency
would be)
• speculation, e.g. if speculators believe a currency will fall, they may sell
it now – this increases the quantity supplied.
A change in any of these factors (other than exchange rate) leads to a
shift in the supply curve – more or less currency is supplied at each and
every exchange rate.
The shape of the supply curve for a currency depends on the price
elasticity of demand for imports. An increase in the exchange rate

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 reduces the local price of imports. If the demand for imports is price
elastic, the increase is the quantity demanded is relatively high and the
total spending on imports increases. With the higher exchange rate, the
spending on imports increases and the supply of the currency increases.
The supply of the currency is upward sloping.
If the demand for imports is price inelastic, the increase in the quantity
demanded is relatively low and the total spending on imports decreases.
With the higher exchange rate, the spending on imports decreases
and the supply of the currency decreases. The supply of the currency is
downward sloping.
Exchange
rate

S£

$2 : £1

$1 : £1

£
Q0 Q1

Equilibrium in the foreign currency market

Assuming a downward-sloping demand curve for the currency and an
upward-sloping supply curve for the currency:
• If the exchange rate is below equilibrium, there is excess demand for
the currency. The value will increase, which reduces quantity demanded
and increases the quantity supplied until equilibrium is reached.
• If the exchange rate is above equilibrium, there is excess supply for the
currency. The value will decrease, which increases the quantity demanded
and decreases the quantity supplied until equilibrium is reached.
Exchange rate

Excess supply S£
Er2

Er0

Er1
Excess demand D£

£
Q2

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 The effect of changes in supply and demand for a currency

Change in supply and demand conditions Effect in the market

increase in demand for the currency increases the exchange rate and quantity
decrease in demand for the currency decreases the exchange rate and quantity
increase in supply of the currency decreases the exchange rate and increases the quantity
decrease in supply of the currency increases the exchange rate and reduces the quantity

Exchange rate Exchange rate

S1 S1
S2

Er1 Er0
Er0
Er1
Revision tip
D2
The impact of a change in
D1 D1 the exchange rate depends
on whether the business is an
£ £ importer or exporter.
Q0 Q1 Q0 Q1

Causes and consequ

uences of fluctuations
Government and exchange rates
A government may make it a policy to keep the exchange rate at a
particular level. This is known as a fixed (or managed) exchange rate
system. The government may want to do this:
• to keep it stable – to help businesses plan and to encourage
investment
• to keep it relatively low – to encourage exports (all other things
unchanged, a low exchange rate makes exports cheaper in a foreign
currency)
• to keep it high – to reduce demand for exports and reduce import Revision tip
prices to dampen inflationary pressures.
When explaining the effect of a
Government intervention in currency markets change in the exchange rate, it is
A government can intervene in the currency market by: often useful to give a numerical
example, e.g. if the US exchange
• buying and selling currency: rate falls from $1 : 1€ to $1 : 0.8€,
then a $100 product that would
• to keep the currency higher in value, the government buys its have sold at 100€ will now sell
currency (increasing demand), using up its foreign currency reserves at 80€.
• to reduce the value of its currency, the government sells its
currency, building up its foreign currency reserves
• changing interest rates:
• an increase in interest rates attracts demand for the currency from
abroad (as more foreign investors want to save that country) and,
all other things unchanged, increases its value
• a decrease in interest rates is likely to reduce demand for the
currency and reduce its value.

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 The effect of an appreciation of the currency
A stronger currency (due to an appreciation) will make a country’s goods
and services more expensive in the foreign currency, all other factors
unchanged. For example, if a product is $5 and the exchange rate is $1 :
10 yen, then this product will sell for 50 yen abroad. If the exchange rate
increases to $1 : 20 yen, then the same product will now sell for 100 yen.
This will reduce the quantity demanded of exports and the earnings in the
domestic currency.
The greater the price elasticity of demand for exports, the greater the fall
in export earnings.
A strong currency will also make imports cheaper in the domestic currency.
For example, if a product is 60 yen and the exchange rate is
$1 : 10 yen, then this product will cost $6. If the exchange rate increases to
$1 : 20 yen, then the same product will now cost $3. This will reduce costs
and can, over time, improve the profits of the business.
The extent to which demand for imports increases in response to a fall in
price depends on the price elasticity of demand for imports. The greater
the price elasticity, the more sensitive demand is to price changes. This
means that an appreciation of currency may mean:
• fewer export sales for firms
• cheaper foreign components for firms
• cheaper imported product for consumers.
A depreciation of the currency
A depreciation of a currency means it loses value – it becomes cheaper in
terms of other currencies. This may be because of less demand or more
supply.
A depreciation means:
• exports are cheaper in foreign currencies, which should increase sales
and export revenue – the scale of the impact depends on the price
elasticity of demand for exports
• imports are more expensive in domestic currency and:
• the total spending on imports will fall if demand for imports is
price elastic
• the total spending on imports increases if the demand for imports
is price inelastic.

Quick test
1. What is meant by an ‘exchange rate’?
2. Explain why an exchange rate may increase in value.
3. What is the term given to an increase in the value of a currency?
4. Give one reason why a currency may fall in value.
5. Explain how an increase in the exchange rate may affect the costs
of imports.

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 globalisation

International
Chapter 6
trade and
Current acccount of balance of payments

The stru
ucture of the
e current acccount of You must be able to:
• describe the structure of the
balancee of paymentts current account of balance of
payments
The balance of payments is a record of all of a country’s financial • explain what is meant by a
transactions with the rest of the world over a year. It has three elements: current account ‘deficit’ or
‘surplus’ on the balance of
• the current account payments
• the capital account • understand the possible
• the financial account. reasons for a current account
deficit or surplus
The current account • explain policies to achieve
The current account is made up of the: stability on the balance of
payments.
• balance of trade (trade in goods and services account)
• primary income account
• secondary income account.
The balance of these accounts is known as the current account balance.
The balance of trade
The balance of trade measures the difference between the value of:
• exports, i.e. goods and services that are made by a country and sold
abroad – these represent money coming into the country
• imports, i.e. goods and services made abroad and sold to people
within the country – these represent money leaving the country.
The balance of trade can be divided even further by analysing the:
• trade in goods (visible trade), e.g. cars, electronics or machinery
• trade in services (invisible trade), e.g. banking, education or
management consultancy.
Primary income
Primary income is made up of income earned by a country’s citizens who
own assets overseas. It includes earnings, profits, dividends on investments
abroad (payments made to shareholders by companies who earn a profit)
and interest. This is export income.
Import spending is made up of the profits and dividends earned in a
country but belonging to foreign citizens.
Secondary income
Secondary income involves:
• money transfers between central governments (who lend and borrow
money from each other)
• grants, such as those that a country may receive as part of the
Common Agricultural Policy if it is part of the European Union (EU).

The currrent accountt position of a country

y
The current account position of a country on the balance of payments will
depend on:
Exchange rates
If the value of a currency increases, it makes exports more expensive
overseas in other currencies. This reduces sales and export revenue and
worsens the current account position.

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 The extent of the effect on export revenue depends on how much the
value of currency changes and the price elasticity of demand for exports.
A stronger currency will also make imports cheaper in the domestic
currency, which is likely to lead to less spending on imports.
Relative inflation rates
Relative inflation rates will affect the relative prices of a country’s goods
abroad and, therefore, how competitive its goods and services are. For
example, relatively high inflation rates tend to make a country’s products
uncompetitive abroad, all other things unchanged, and will reduce export
revenue.
Income level
The income level of a country will affect its spending on imports. The
income of other countries will affect how much they are likely to buy. This
will affect its exports and may lead to more imports.
Productivity
Increasing productivity in a country will reduce the unit costs of production,
all other factors unchanged. This is likely to make a country’s goods and
services more attractive abroad.

Current account ballance calcu

ulations
Year 1 Year 2
($bn) ($bn)
export earnings from goods and services 200 200
import spending on goods and services 160 220
balance of trade 40 –20
(export earnings – import spending)
primary income balance 10 5
(inflows – outflows)
secondary income balance –5 2
(inflows – outflows)
current account balance 45 –13
(balance of trade + primary income balance (surplus) (deficit)
+ secondary income balance)

Current account defficit and su

urplus
If there is a current account deficit, then the value of money leaving
the country on the current account is greater than the value of money
entering the country.
If there is a current account surplus, then the value of money entering the
country on the current account is greater than the value of money leaving
the country.
A current account deficit may mean:
• a country is importing a higher volume of goods and services than it is
exporting – this may improve living standards, because consumers are
consuming more products
• a country is importing valuable capital equipment – this will improve
its productive capacity in the long run.

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 Therefore, in the short run, a current account deficit may not be a problem.
However, having higher import spending than export earnings reduces
aggregate demand, which can lead to unemployment.
In the long run, a current account deficit can:
• reduce jobs in domestic industries
• reflect a long-term underlying lack of competitiveness
• lead to a fall in the value of the currency and high import prices,
which causes cost-push inflation.

Policies to achieve stability

Reducing a
current
account deficit

Reducing the Reducing Getting people

value of the spending on to switch from
currency imports imports

Reducing the value of the currency

Reducing the value of the currency reduces the price of exports, all other
factors unchanged, and makes the price of imports higher in the domestic
currency. It should increase earnings from exports and usually reduces
spending on imports. This should reduce the deficit. However, the higher
import prices may, over time, cause cost-push inflation.
Reducing spending on imports by reducing income
The government may use policies aimed at reducing total spending in
an economy (increased taxes, reduced public spending or raised interest
rates). This will reduce aggregate demand, which reduces spending on
imports. However, the effect is to reduce spending generally, which can
lead to slower growth and unemployment.
Policies aimed at getting people to switch away from imports
Policies can be aimed at getting consumers to switch away from foreign
products to domestic products. They include tariffs (taxes on foreign
products) and quotas (limits on the number of imported items). However,
these measures lead to higher prices for consumers and less choice. They also
allow inefficient domestic producers to produce because they are protected.

Quick test
1. Define ‘the current account on the balance of payments’.
2. What is meant by a current account ‘deficit’?
3. Explain why a country may have a current account deficit on its
balance of payments.
4. Explain how a current account deficit may affect inflation.
5. Explain how a government may use the exchange rate to reduce a
deficit on the current account.

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 globalisation
International
Chapter 6

trade and
Exam-sstyle practicce questio
ons

1 Which change is most likely to increase the demand for imports? [1]

a) an increase in income tax rates

b) an increase in tariffs imposed by the government

c) an increase in the cost of consumer borrowing

d) an increase in the exchange rate

2 Which is likely to lead to an increase in the size of a country’s current account deficit? [1]

a) an increase in the competitiveness of domestic goods

b) an increase in the earnings of foreign investors in domestic companies

c) an increase in the number of overseas visitors to the country

d) an increase in quotas

3 Which could not be a reason for imposing tariffs on imported goods? [1]

a) to encourage self-sufficient production within an economy

b) to lower the general price level within the economy

c) to protect a new and growing domestic industry

d) to reduce the current account deficit on the balance of payments

4 Which action will the government take in a fixed exchange rate system? [1]

a) It will buy its currency if there is a shortage in the foreign exchange market.

b) It will buy its currency if there is excess demand in the foreign exchange market.

c) It will sell its currency if there is excess demand in the foreign exchange market.

d) It will sell its currency if there is excess supply in the foreign exchange market.

5 Trade between JAPAN and the EU

In 2017, the European Union (EU) and Japan, two of the world’s biggest economic areas, agreed a
deal that would allow free trade between them.

Japan is the EU’s second biggest trading partner in Asia after China. It is also the seventh biggest export
market for European producers. Imports from Japan to the EU are mainly machinery, electrical equipment,
motor vehicles, optical and medical instruments, and chemicals. EU exports to Japan are mainly motor
vehicles, machinery, pharmaceuticals, optical and medical instruments, and electrical equipment.

One of the most important trade categories for the EU is dairy goods. The EU’s dairy farmers have
been struggling due to falling prices within Europe. Farmers say they are paid less than the cost of
production. They sell their milk mainly to the large supermarkets. However, demand for milk and
milk-based products in Japan has been growing steadily in recent years.

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 Exporters from the EU pay €1 billion ($1.1 billion) in export duties to Japan each year, with tariffs of
around 20% on agricultural products. The trade deal will reduce Japanese tariffs on beef, pork, wine,
textiles, clothing and shoes. Meanwhile tariffs on Japanese cars sold in the EU will be lowered from
their present 10% over seven years.

Some commentators think the deal may increase the value of the EU’s exports to Japan by 34%, and
Japan’s to the EU by 29%. Because of the potential impact on domestic industries, the deal is likely to
have long transition clauses of up to 15 years to allow sectors in both countries to adjust.

Fig. 1: Japan’s income and population, 2016

Income $4.932 trillion

Population 127 million

Fig. 2: EU–Japan trade and investment

Billions EU–Japan: Trade in goods
100

50

–50
2014 2015 2016
Years

EU imports EU exports Balance

Billions EU–Japan: Trade in services

100

50

0
2014 2015 2016
Years

EU imports EU exports Balance

2015 EU–Japan: Foreigen direct investment

–150 –100 –50 0 50 100 150 200

Inward stocks Outward stocks Balance

a) State whether the EU balance of trade in goods between the EU and Japan was in surplus
or deficit in 2016. [1]

b) Describe what is meant by the ‘European Union’. [2]

c) Define ‘free trade’. [2]

d) Explain the possible reasons why Japan is the EU’s second biggest trading partner. [4]

e) Explain why the EU–Japan trade deal is likely to have a 15-year transition period for
businesses to adjust. [4]

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 f) Calculate the average income per person in Japan in 2016. [2]

g) Explain why the EU may export motor vehicles to Japan and import motor vehicles from Japan. [4]

h) Explain why the price of milk might have been falling in the EU. [5]

i) With reference to Fig. 2, discuss whether the EU–Japan trade deal is a good idea. [6]

6 The world's top 60 economies have adopted more than 7000 protectionist trade measures since
the financial crisis in 2008. Tariffs are now worth more than $400 billion. These are used to raise
revenue and to try and aid current account deficit. The United States and European Union were each
responsible for more than 1000 of the restrictions. The impact of protectionism and any retaliation
depends on how much trade a country undertakes. In the United States, for example, trade as a
percentage of its GDP is around 28 per cent. Russia and Germany have much higher trade to GDP
ratios of 51 per cent and 86 per cent respectively.

a) Define ‘current account deficit of the balance of payments’. [2]

b) Explain two methods of trade protection that a country could use. [4]

c) Analyse the reasons why a government might introduce protectionism. [6]

d) Discuss whether trade protection is always preferable to free trade. [8]

7 Turkey’s current account deficit reached $5.1 billion in July 2017, bringing the annual deficit to
$37.1 billion in total. The increase in the current account deficit was mainly due to the rise in the
deficit in goods items by nearly $3.8 billion to $7.3 billion in the month. Travel items, which constitute
a major part of the services account, recorded a net inflow of $2.3 billion in July. Secondary income
recorded a net inflow of $226 million. The overall deficit is expected to lead to a fall in Turkey’s
exchange rate, which may improve the current account position. The government may also introduce
protectionism.

a) Define ‘exchange rate’. [2]

b) Explain why a country might have a deficit in its goods trade. [4]

c) Analyse the possible effect of protectionism on different economic agents. [6]

d) Discuss whether a fall in the exchange rate is likely to improve a current account deficit. [8]

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 Answers
d) The PPC curve will shift outwards [1]; if there is an
Marking your answer increase in the quantity or quality of a country’s
For each exam-style practice question in this book, to help you resources [1]. Your answer must include a clear and
mark your own answers, the key points that should be included accurately labelled diagram of the PPC shifting
in an effective answer are listed. However, it is important to outwards [1] showing growth [1]. [4 marks]
remember that answers should be communicated in a clear, e) Explanations which might include:
accurate and well-developed way. The questions, example • an investment in capital may lead to an increase
answers, marks awarded and comments that appear in this book in the quantity of capital [1] and / or the quality of
were written by the author. In examinations, the way marks capital [1]; this can improve the productivity of the
would be awarded to answers like these may be different. other resources in the economy [1], which would
increase the capacity of the economy [1]. [4 marks]
f) Coherent analysis which might include:
1 The basic economic problem • a country can specialise in producing what it is good
at [1] and sell it abroad in return for more of other
The nature of the economic problem goods [1] than it could produce itself [1]; if each
1. The production of an economic good has an opportunity country specialises in what it is good at it can lead to
cost; a free good does not more consumption [1]. [4 marks]
2. Resources that are limited and can be used up g) Award up to 4 marks for logical reasons why investment
3. Any three from: consumers / households; employees / in education can lead to an improvement in skills, e.g.
workers; producers / firms / businesses; governments explain how an improvement in skills can lead to greater
4. Given the limited resources and unlimited wants, an productivity and, therefore, economic growth.
economy must decide what to produce, how to produce, Award up to 4 marks for logical reasons why investment
and who to produce it for in education may not lead to an improvement in skills,
5. A resource that can be replaced / comes from a sustainable e.g. depends on what money is spent on and how it is
source, e.g. trees used, e.g. are people trained in the correct skills.
Factors of production [6 marks]
1. A willingness and ability to take risks to develop business ideas h) Your answer should:
2. Any three from: land; labour; capital; enterprise Award up to 4 marks for logical reasons why producing
3. By investment (in machinery and equipment) capital goods may be better because it will lead to more
4. There are barriers / factors that prevent people moving output in the future but involve a sacrifice of resources,
between jobs and locations i.e. if an economy puts resources into capital goods, the
5. Through training opportunity cost is less consumption now.
6. Someone who identifies business opportunities and is Award up to 4 marks for logical reasons why producing
willing to take the risk to invest in them consumption goods may be better because it will mean
more is consumed now but there is less investment for
Opportunity cost and the production possibility curve the future. [6 marks]
diagram (PPC) 8. a) Every decision involves a commitment of resources
1. It is what is given up / sacrificed in the next best alternative that could have been used elsewhere; therefore, there
when a decision is made is always a sacrifice, i.e. an opportunity cost for every
1. The maximum goods and services that can be produced in decision [1]. More spending on education means less
an economy at a given time spending on something else given the budget
2. As resources are transferred from one industry to another, available [1]. [2 marks]
output of one product (e.g. B) increases and output of the b) Explanations which might include:
other product (e.g. A) falls; the amount of A given up to • explain how the transfer of resources from one sector
produce the extra amount of B is the opportunity cost to another increases output in the one industry [1]
3. No more of one product can be produced without reducing but involves a sacrifice of output from the other
production of another industry, i.e. there is an opportunity cost [1]
4. With more or better resources, the maximum goods and • include an accurately drawn and labelled PPC
services that can be produced can increase diagram [1] showing less output of one product for
more of another [1]. [4 marks]
Exam-style practice questions c) Coherent analysis which might include:
1. C [1 mark]
• labour is a factor of production [1] that affects
2. A [1 mark]
output [1]
3. D [1 mark]
• education affects skills and productivity [1]; it
4. D [1 mark]
improves the quality of labour [1]
5. B [1 mark]
• low investment means that workers are likely to
6. A [1 mark]
produce less [1]; this reduces output and is likely
7. a) 2015 population = 52 million
to reduce economic growth, all other factors
1960 population = 25 million
constant [1]. [6 marks]
Percentage change = [(52 – 25) ÷ 25] × 100 [1] = 108% [1]
[2 marks]
b) It involves the extractive industries [1], i.e. the first stage
of production such as farming and oil [1]. [2 marks]
c) It means the national income of the country [1] is
growing at a rapid rate [1]. [2 marks]

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 d) Explain why opportunity costs are important to 4. A movement along a demand curve is due to a change in
consumers, e.g. when deciding how best to spend their price; a shift in demand is due to a change in other factors
income. Any decision involves an opportunity cost. You 5. The market demand curve is the horizontal summation of all
could give an example, e.g. if they have to buy school the individual demand curves
clothes for their child, they may not have enough money
Supply
to buy other goods.
1. It assumes that price changes but all other factors are held
Explain why opportunity costs are important to other
constant / remain unchanged
economic agents, for example:
2. Any one from: there are more producers; resource prices are
• the government, when deciding whether to invest in
lower; technology improves; production subsidies are paid
a particular area of the economy, e.g. education
3. Any one from: there are fewer producers; resource prices
• producers / firms, when deciding whether to invest in
are higher; taxes are placed on producers
a project, e.g. what else could they have done with
4. A movement along a supply curve is due to a change in
the funds. [8 marks]
price; a shift in supply occurs due to a change in other
9. a) Factors of production are used in the production of
factors
goods and services [1]; they are land, labour, capital and
5. The market supply curve is the horizontal summation of all
enterprise [1]. [2 marks]
the individual supply curves
b) Explanations which might include:
• the scarcity of resources at any time [1] and the Price determination
unlimited wants [1] 1. The price at which the quantity demanded equals the quantity
• the need to allocate resources and make choices [1] supplied
about what to produce, how to produce it, and who 2. Surplus
to produce it for [1]. [4 marks] 3. Shortage
c) Coherent analysis which might include: 4. Increase
• an improvement in the quality [1], e.g. more 5. It means the quantity demanded is not equal to the quantity
training [1] or better management [1] supplied
• increase in the quantity of factors of production [1], Price changes
e.g. more labour due to birth rates [1] or immigration 1. a)
[1], more capital [1], more land (e.g. reclamation) [1], 2. e)
better technology [1]. [6 marks] 3. g)
d) Explain the benefits of the free market compared to 4. c)
government intervention, e.g. an incentive to innovate
and be efficient to achieve higher profits. Price elasticity of demand (PED)
Explain the problems of the free market and therefore
the potential advantages of the command economy, e.g. 1. Price elasticity of demand (PED)
problems in free market of inequality, price fluctuations, % change in quantity demanded
=
some products being over or under provided. [8 marks] % change in price
2. The percentage change in quantity demanded is less than
2 The allocation of resources the percentage change in price
3. Fall
4. Any one from: brand loyalty; improved / increased
Micro and macroeconomics
advertising; ease of switching to another product; the time
1. A study of what happens in individual markets
period being considered
2. A study of what happens in the economy as a whole
5. Change in sales = –0.5 × 10 = –5%; sales will fall by 5%, i.e.
3. True
0.05 × 200 = 10 units; sales will now be (200 – 10 =) 190 units
4. False
5. False Price elasticity of supply (PES)
The role of markets in allocating resources % change in quantity supplied
1. Price elasticity of supply (PES) =
1. The quantity producers are willing and able to supply at each % change in price
and every price, all other factors unchanged 2. The percentage change in quantity supplied is less than the
2. The quantity consumers are willing and able to buy at each percentage change in price
and every price, all other factors unchanged 3. Quantity supplied will increase by 2.5 × 5 = 12.5%
3. At the given price, the quantity demanded equals the 4. Any one from: extent to which there is capacity; ease of
quantity supplied increasing production; time period
4. The price adjusts acting as an incentive, a signal and a 5. Percentage change in quantity supplied = 0.5 × 2 = 1%.
rationing device to bring about equilibrium in a market New quantity supplied = 200 + (0.01 × 200) = 202 units
5. Changes in supply and demand conditions Market economic system
Demand 1. Business organisations that are owned by private individuals
1. It assumes that all other factors apart from price are held 2. Business organisations that are owned by the government
constant / remain unchanged 3. Government organisations may have social objectives and be
2. Any one from: the price of a substitute increases; the price less profit focused
of complement falls; there are more people in the buying 4. The economy has a private and a public sector
population; income increases (assuming it is a normal good) 5. Any one from: the profit motive may lead to efficiency as
3. Any one from: the price of a substitute decreases; the firms try to cut costs; innovation as firms try to gain more
price of complement increases; there are fewer people in customers; high levels of customer service as firms try to
the buying population; income decreases (assuming it is a sell more
normal good)

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 Market failure they are likely to reduce consumption spending,
1. A distortion in the market is preventing an efficient allocation which will reduce demand in the economy.
of resources Award up to 4 marks for logical reasons why a fall in
2. The benefit to society is greater than the perceived private property prices might impact on another group, e.g.
benefit; individuals do not fully appreciate the benefits of a • impact on firms – businesses may reduce investment
good or service if they regard the lower prices as evidence of less
3. The monopoly pushes up the price and reduces output demand in the economy; concerns over lower
compared to a competitive market; this can be bad for property prices may lead to less investment and
consumers less demand. [6 marks]
4. The production of a product may contribute to pollution, h) Award up to 4 marks for logical reasons why buying
congestion or other environmental damage; these are a house might be a good investment because of the
external costs, which means the social cost of production is potential increase in property prices.
greater than the private cost (to the firm) Award up to 4 marks for logical reasons why buying
5. Non-diminishable; non-excludable a house might not be a good investment, e.g. explain
how there are costs involved and interest payments, so
Mixed economic system it depends on what happens to the value of the asset
1. It will lead to excess quantity supplied, i.e. a surplus
relative to these costs; it also depends on whether
2. It will lead to an excess quantity demanded, i.e. a shortage
house prices rise or fall. [6 marks]
3. It may mean that social costs and benefits are taken into
9. a) A shortage shows that the quantity demanded at a given
account as the organisation is owned by the government
price is greater than the quantity supplied [1] meaning
4. Increases producer costs which, in the case of negative
there is excess demand [1]. [2 marks]
external costs, may increase private costs to become more
b) Logical explanation which might include:
equal to social costs
• bad weather [1] reducing the amount produced [1]
5. Indirect tax will increase costs and lead to a higher
• crop disease [1] reducing the output in a given
equilibrium price and lower equilibrium quantity
year [1]
Exam-style practice questions • an increase in number of producers [1] increasing
1. D [1 mark] output [1]
2. D [1 mark] • technology [1] increasing output [1]. [4 marks]
3. B [1 mark] c) Coherent analysis which might include:
4. B [1 mark] • accurately labelled supply and demand diagram [1]
5. B [1 mark] • a supply curve shifting inwards [1]
6. D [1 mark] • accurately shows the old equilibrium [1] and new
7. A [1 mark] equilibrium [1], with a new higher equilibrium price
8. a) If wages stay the same but prices increase, consumer [1] and higher equilibrium quantity [1]. [6 marks]
purchasing power will fall [1]; their money will buy less d) Explain when a maximum price has an effect and what
than it could before [1]. [2 marks] that is, i.e. a maximum price only has an effect if it is
b) There is a danger [1] that the borrowers will not be able below the equilibrium price and maximum price leads
to repay some or all of the amount borrowed [1]. to excess demand. Maximum price may be used by the
[2 marks] government to make sure that items are affordable,
c) Explanations which might include: e.g. housing.
• there seems to be a strong link between national Explain the problems of a maximum price, i.e. keeping
income growth and house prices [1] the price below equilibrium reduces the quantity
• this may be because, with more income, demand for supplied so less is available than in a free market. It
houses increases [1], given that supply cannot change is more affordable for those who get it but fewer
quickly [1] it leads to higher prices [1]. [4 marks] consume it. [8 marks]
d) House prices fell significantly [1]; the ‘increase’ in prices 10. a) It is a restriction on how low the price can go in a market
is negative – they are growing at a negative rate [1]. [1] that aims to keep price below the level it would be at
[2 marks] in the free market [1]. [2 marks]
e) Logical explanation which might include: b) Logical explanation which might include:
• number of households looking for accommodation [1] • the nature of the product, e.g. tobacco is
and businesses looking for office / factory space; more addictive [1], and so is likely to be price inelastic
looking leads to more demand [1] demand [1].
• cost and availability of finance [1]; lower cost of • the availability of substitutes such as e-cigarettes [1];
borrowing increases demand [1] the more the substitutes the more price elastic
• confidence in the future [1] – households may be demand is [1]
reluctant to spend heavily on property if they are • the degree of brand loyalty [1]; the more brand
worried about the future; businesses may be reluctant loyalty there is the more price inelastic demand is [1]
to spend on factory / office space if they are worried • the percentage of income spent on the product [1];
about the future [1]. [4 marks] the greater the percentage the more price elastic
f) Explanations which might include: demand will be [1]. [4 marks]
• use a diagram or diagrams to help explain that prices c) Coherent analysis which might include:
might be high due to: • an accurately labelled supply and demand diagram [1]
• high demand [1], e.g. due to confidence in the • the price fixed above equilibrium [1]
economy [1] • quantity supplied with minimum price shown [1] and
• limited supply [1], e.g. due to restrictions on the quantity demanded [1]; this leads to an excess
building [1]. [4 marks] supply [1]
g) Award up to 4 marks for logical reasons why a fall in • amount of excess supply marked on diagram [1].
property prices might impact on one group, for example: [6 marks]
• impact on consumers – with lower house prices,
consumers have fewer assets; with this fall in wealth

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 d) Explain the benefits to the government of Workers
understanding price elasticity of demand, for example: 1. Any two from: skills required; nature of job; wages
• understanding price elasticity of demand means 2. Higher wages
the government can anticipate the effect of, e.g. 3. Higher wages
introducing indirect taxes and minimum and 4. Limited government funds; often not profit making; may be
maximum prices on the quantity demanded offset by greater job security or better pensions
• this can help it decide on the level at which these 5. They may produce more output or higher value output for
should be set to achieve a desired impact on the the business and, therefore, can receive higher rewards
quantity demanded.
Explain that there are factors that limit the value of
Trade unions
1. An organisation to represent and protect employees
knowing the price elasticity of demand, for example:
2. Strike
• the effect in the market of a change in market
3. Work to rule
conditions may also depend on the extent of the
4. Redundancies
shift in demand and supply and the price elasticity of
5. Any one from: help understand an issue from employees’
supply
perspective; help gain the cooperation of employees; help
• the value of the price elasticity of demand will
find solutions to problems
change, e.g. over time the value of the price elasticity
of demand may vary. [8 marks] Firms
11. a) In a free market resources are allocated by supply and 1. Any one from: its sales (turnover), what it owns (assets), the
demand [1]. The price mechanism brings supply and number of employees
demand together [1]. [2 marks] 2. Primary sector: farming / extraction; secondary sector:
b) Explanations which might include: manufacturing
• that pollution is an external cost [1] which increases 3. A merger occurs when two or more firms join together to
the total costs to society [1] become one new business; a takeover occurs when one firm
• that pollution means that in the free market, where gains control of another
only private costs and benefits are considered, there is 4. Backward vertical integration occurs when one firm takes
over-production [1] which is inefficient [1]. [4 marks] over another firm in the same production process but closer
c) Coherent analysis which might include: to the suppliers; forward vertical integration occurs when
• taxes can be placed on production [1] to increase the one firm takes over another firm in the same production
private costs [1] to equal the social costs [1] process but closer to the consumers
• by increasing costs this will shift supply [1] reducing 5. These occur when unit costs fall as the scale of production
the equilibrium quantity in the market [1] increases
• if the tax matches the external cost [1] the level of 6. Any one from: to gain economies of scale; to gain market
output will be efficient thanks to this intervention [1]. power
[6 marks] Firms and production
d) Explain the effect of ‘tougher standards’ on emissions, 1. Land; labour; capital; enterprise
e.g. this will force producers to reduce output and this
output
be more efficient than producers ignoring external costs 2. Labour productivity =
number of employees
and over-producing.
Explain the case for taxation, e.g. taxation increases 400
3. Labour productivity = = 5 units
the private costs to force producers to take account of 80
the effects of pollution; taxation raises revenue for the 4. Any two from: quantity of capital equipment available;
government but raises the price for consumers; this may quality of capital equipment available; organisation of
affect people’s ability to travel, especially low income work; training received; motivation levels
groups. This may be seen as unfair and also affect, e.g. 5. High productivity means that more units can be produced
their ability to work. [8 marks] with the same inputs, which should increase sales and
revenue, or the same output can be produced with fewer
3 Microeconomic decision inputs, which should reduce costs
Firms’ costs, revenue and objectives
makers 1. Profit = total revenue – total costs
2. Costs that do not change with output
Money and banking 3. Costs that do change with output
1. Any three from: unit of account; medium of exchange; total cost
standard of deferred payment; store of value 4. Average cost = (average cost is total cost per unit)
output
2. Any two from: accept deposits; lend; provide efficient means 5. Used to reward owners; used to invest into the business
of payment (a source of funds)
3. To manage a country’s currency, money supply and interest
rates Market structure
4. To achieve an inflation target 1. Any two from: better service; better quality; wider range of
products
Households 2. A measure of the sales of one business as a percentage of
1. It is the cost of borrowing money and the reward for saving total market sales
2. Any two from: income; income tax; consumer confidence 3. One firm dominates the market; it has a high market share
3. Any two from: to save income for later life; to save for a 4. Any one from: it may push up prices; it may reduce quality
major purchase; to have a safety fund in a protected market; it may not innovate
4. Any one from: different income; different stage of life cycle; 5. Any one from: it may use abnormal profits to invest in
time of year research and development and innovate; it may encourage
5. An overdraft is a facility to borrow short term up to an other firms to be more innovative to remove the monopoly
agreed limit; a loan is when a fixed sum of money is
borrowed for a fixed term at agreed interest rates

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 Exam-style practice questions d) Explain what internal economies of scale are, e.g.
1. B [1 mark] technical, bulk buying, financial.
2. C [1 mark] Explain that a business might experience internal
3. D [1 mark] diseconomies of scale, e.g. due to problems with control,
4. A [1 mark] coordination and communication. [8 marks]
5. D [1 mark] 9. a) Answers may include: nature of the job [1], e.g. whether
6. A [1 mark] it is interesting and has variety [1], non-monetary
7. a) Market share measures the sales of one business [1] as a characteristics [1], e.g. working hours and conditions [1].
percentage of the total market sales [1]. [2 marks] [2 marks]
b) A monopoly is a seller that dominates a market [1]; it b) Explanations which might include:
has a high market share [1] (note: a pure monopoly is a • the minimum wage is the minimum wage rate that all
single seller in a market) [2 marks] employees must earn in the country [1]
c) Google was accused of abusing its market power [1] • this has an impact if employees would otherwise earn
because consumers did not have real choice [1] when less than this in the free market [1]; it will increase
they were searching for items; Google allegedly misled earnings [1]
them [1] so this was not in the public interest [1]. • however, at the BBC most employees will earn more
[4 marks] than this anyway [1]
d) Your answer should calculate $2.7 billion as a percentage • although they may feel their pay is low, it is higher
2.7 than the minimum by law so minimum wage would
of $ 89 billion, i.e. × 100 [1]; = 3.03% [1] [2 marks] not have an effect [1]. [4 marks]
89
e) Explanations which might include: c) Coherent analysis which might include:
• becoming a monopoly may mean the business can • how much the output can be sold for [1] – the more it
become a price maker [1] and charge more [1] is sold for the greater demand will be [1] and higher
• becoming a monopoly may mean the business the wage [1]
can earn higher (abnormal) profits [1] exploiting • how productive the employee is [1]; the more
consumers [1] productive they are the more output they produce
• becoming a monopoly may mean there is less and the more they will be paid [1]
competitive pressure [1] to innovate or improve • training period [1]; the longer the training period the
customer service [1]. [4 marks] lower the supply [1] and the higher the equilibrium
f) Coherent analysis which might include: wage [1]
• highly innovative [1] creating products others cannot • the skills required [1]; the more skills needed the
imitate [1] lower the supply [1] and the higher the equilibrium
• buy up competitors [1] removing rivals [1] wage [1]. [6 marks]
• strong brand loyalty [1] making it difficult for rivals to d) Explain the benefits of trade union membership, e.g.
win customers [1]. [4 marks] greater protection from exploitation and better working
g) Award up to 4 marks for logical reasons why taxing conditions.
monopolies may be desirable, e.g taxing these profits Explain the potential disadvantages of membership,
generates revenue for the government, which can be e.g. the costs of being a member, may lose the ability to
used for other purposes to benefit society; taxes may bargain individually. [8 marks]
help to reduce behaviours / external costs that are
against the public interest.
Award up to 4 marks for logical reasons why alternative
4 Government and macro
ways of controlling behavior may be desirable, e.g.
legislation or government taking control of business.
economy
[6 marks] The role and macroeconomic aims of government
h) Award up to 4 marks for logical reasons why a monopoly 1. The income of the economy increases
may be bad for consumers, e.g. using market power to 2. To increase the income of its country and the income per
push up price and potentially reduce quality. person
Award up to 4 marks for logical reasons why a monopoly 3. Because unemployment is a waste of resources and is
may be good for consumers, e.g. using abnormal profits inefficient
to invest in research and development; abnormal profits 4. It measures the value of a country’s transactions with the
may act as incentive to others to innovate to gain rest of the world
abnormal profits. [6 marks] 5. The organisations that are owned and run by the government
8. a) This is the service sector [1], e.g tourism, education and
finance [1]. [2 marks] Fiscal policy
b) Explanations which might include: 1. The use of government spending and taxation policies to
size of a business can be measured in different ways influence the economy
such as sales [1], i.e the value of what has been sold [1], 2. Progressive
assets [1], i.e the value of what it owns [1], number of 3. Direct tax is paid directly from earnings or profits; indirect
employees [1], i.e the total number of people who work tax is paid when a product is bought
for it [1]. [4 marks] 4. Government spending is greater than taxation revenue
c) Coherent analysis which might include: 5. Any three from: defence; healthcare; education; transport;
Small businesses justice
• can bring jobs [1] reducing unemployment in the
economy [1]
• can bring new products [1] creating more choice for
consumers [1]
• can innovate [1] leading to more choice and greater
efficiency [1]
• can provide greater competition for larger firms [1]
leading to more innovation or lower prices [1].
[6 marks]
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 Monetary policy 7. a) Gross domestic product is a measure of the value of
1. Attempts to control money supply and interest rates to income generated over a given time within a region [1];
influence the economy it is a measure of national income [1]. [2 marks]
2. The cost of borrowing money and the reward for savings b) Government spending exceeds its revenue [1]; over a
3. It might encourage borrowing by firms for investment period, typically a year [1]. [2 marks]
4. It might encourage borrowing by households (as it is c) The rate of tax paid increases [1] as income increases [1].
cheaper to borrow) and, therefore, increase consumption [2 marks]
5. It might encourage foreign investors to want to save in d) Explanations which might include:
the country; is likely to increase demand for currency and • that a deficit may be because of high levels of
increase the exchange rate government spending [1], e.g. on education or
defence [1] and / or low levels of tax revenue [1], e.g.
Supply-side policy low tax revenue [1]. [4 marks]
1. Policies designed to increase aggregate supply in the economy
e) Explanations which might include:
2. Any two from: lower tax rates to encourage work; lower
• high unemployment [1] so some have low incomes [1]
unemployment benefits; more training; providing information
• lack of training and skills [1] so some have poorly paid
about jobs available; assisting with relocation; improving
jobs [1]
healthcare; changing legislation around trade union power
• discrimination [1] so some are paid too little [1].
3. Increased investment by the government, e.g. into transport
[4 marks]
and communications
f) Explanations which might include:
4. Any one from: investment in targeted industries; incentives
• higher fuel duties will increase the price [1] and this
to encourage investment and innovation; protecting infant
may discourage consumption [1]
industries; encouraging greater competition (limiting
• fuel consumption can have external costs [1] so
takeovers and mergers); encouraging startups (reducing
reducing the consumption may lead to a more
bureaucracy involved)
efficient allocation of resources [1]
5. Any one from: changing regulations to make it easier for
• the demand for fuel is likely to be price inelastic [1]
financial organisation to set up; encouraging customers to
and so, by taxing this, the quantity demanded will fall
search for the best deal to encourage efficiency
less than the price increase (proportionately), which
Economic growth should lead to relatively large tax revenues for the
1. Gross domestic product; a measure of national income government [1]. [4 marks]
2. GDP adjusted for the effects of inflation to show the g) Award up to 4 marks for logical analysis of the possible
purchasing power of national income private consequences of unemployment for those who
3. Negative GDP growth for two successive quarters of the year are unemployed.
(i.e. 6 months) Award up to 4 marks for logical analysis of the possible
4. Any two from: investment in infrastructure; incentives consequences for society as a whole in South Africa.
for investment and innovation; lower interest rates to [6 marks]
encourage investment and spending; supply-side policies h) Award up to 4 marks for logical reasons why supply-side
5. An outward shift of the PPC policies might be a good way of increasing economic
Employment and unemployment growth, e.g. supply-side policies.
1. Any two from: can cause poverty; can lead to social divisions / Award up to 4 marks for logical reasons why supply-side
unrest; possible increase in time; wasted resources / inefficient policies might not be a good way of increasing economic
economy growth, e.g. depends on what policies they are, how
2. Individuals are unemployed because the industry they they are implemented. [6 marks]
worked in is no longer competitive and they do not have 8. a) The maximum output an economy can produce [1] given
the skills for other jobs its existing resources [1]. [2 marks]
3. Increasing aggregate demand to create jobs b) Explanations which might include:
4. Any one from: training; provide more information; help • lower incomes [1] because of not earning from
employees relocate work [1]
5. The level of unemployment measures the number of people • less spending [1] due to lower incomes [1]
who are willing and able to work but are not employed • possible social problems [1] due to frustration and
at the given wage rate at a given moment in time; the lack of money [1]. [4 marks]
unemployment rate is the number of people unemployed as c) Coherent analysis which might include:
a percentage of the total workforce • cyclical (demand deficient) [1] due to lack of demand
[1] leading to less need for employees [1]
Inflation and deflation • frictional [1] due to people being between jobs [1] so
1. A sustained increase in the general price level waiting for next job [1]
2. Inflation caused by excess demand • seasonal [1] due to seasonal patterns of demand [1]
3. Inflation caused by higher costs being passed on e.g. fruit farming [1]
4. Any two from: increase costs of inputs and, therefore, • structural [1] due to changes in the competitiveness
increase prices; uncertainty about economic conditions and, of industries [1], e.g. decline of an industry as costs
therefore, less investment; changes to menu costs; changes too high relative to competitors abroad [1]. [6 marks]
to shoe leather costs d) Explain how boosting demand may reduce
5. May increase uncertainty and reduce investment unemployment, e.g lower taxes and / or more spending
Exam-style practice questions boosting demand creating jobs. Explain how this is
1. C [1 mark] suitable for cyclical unemployment.
2. D [1 mark] Explain other ways of reducing unemployment, e.g. by
3. C [1 mark] boosting the demand in the economy (through fiscal
4. D [1 mark] and monetary policies) or providing information and
5. D [1 mark] training. The method used by the government should be
6. B [1 mark] linked to the cause of unemployment. [8 marks]

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 9. a) A budget deficit occurs when the revenue of the Population
government is less than its spending [1] over a given 1. The median age of the population is increasing
period [1]. [2 marks] 2. The difference between the number of people entering and
b) Explanations which might include: leaving the population of a country over a given period
• training increases productivity [1] 3. Any one from: healthcare; education; social provisions, e.g.
• providing more information [1] so more people are social care and clean water; environmental factors, e.g.
aware of the jobs available and can find jobs more natural disasters and pollution
easily [1] 4. Any one from: easing of regulations, e.g. relaxing visa
• increasing the incentive to work [1] so more people requirements; a higher perceived quality of life / standard of
can work and produce [1]. [4 marks] living
c) Coherent analysis which might include: 5. Any one from: higher taxes on those in work to provide for
• explain what is meant by fiscal policy [1] those not working; higher healthcare bills
• explain how changes in government spending and
taxation and benefit rates can affect unemployment [1]
Differences in economic development between countries
1. A developing economy has a low income per person; but is
• explain the impact on, e.g. demand deficient
growing fast
unemployment [1]. For example, more government
2. True
spending can increase demand for goods and services
3. True
[1], creating more demand for employees [1], and
4. True
reducing unemployment [1]. [6 marks]
5. By allowing trade so the developing economy can export
d) Explain how an increase in government spending can
more; with more exports the businesses in the developing
reduce unemployment, e.g. more spending can increase
economy can earn more and pay employees more; this can
demand for goods and services, creating jobs and
lead to further spending and demand in the economy
reducing unemployment.
Explain how reducing taxes can reduce unemployment, Exam-style practice questions
e.g. reducing income tax or corporation tax can increase 1. D [1 mark]
income and profits and increase demand, reducing 2. D [1 mark]
unemployment; reducing income tax can increase the 3. C [1 mark]
rewards from working, creating an incentive to work. 4. C [1 mark]
[8 marks] 5. A [1 mark]
6. a) A developing economy has a low income per person [1]
but is growing fast [1]. [2 marks]
5 Economic development b) The tertiary sector involves the provision of services [1];
e.g. education, healthcare and accounting [1]. [2 marks]
Living standards c) Per capita income is the total income of a country
1. National income per person adjusted for inflation divided by population [1]; it shows the average income
2. How the income in the country is divided between its per person [1]. [2 marks]
population d) Explanations which might include:
3. Any two from: does not necessarily reflect the quality • a large proportion of the population have low literacy
of goods and services; does not show how income is [1], e.g. this is likely to reduce productivity [1]
distributed; does not include income from non-marketed • still being an agricultural economy [1], e.g. dependent
output (e.g. barter) and unpaid work; does not reflect on products that are vulnerable to the weather,
quality of life (e.g. how many hours are worked); does not which can cause major shifts in supply and prices
include trade in the ‘shadow economy’ and incomes; reliant on imports of manufactured
4. Standard of living measures the income per person; cost of goods [1]. [4 marks]
living measures the price level in the economy e) Explanations which might include:
5. Any one from: by using supply-side policies to boost • economic growth leads to higher incomes [1]
economic growth / the capacity of the economy; by using • higher incomes can lead to a better standard of living
demand-side policies to increase demand, potentially for Ethiopian citizens [1]
leading to higher output and income; monetary and • a higher standard of living reduces poverty [1] and
fiscal policies can increase income more than population makes the government popular [1]. [4 marks]
increases, leading to an increase in income per person f) Explanations which might include:
Poverty • foreign firms might be attracted by low costs of
1. When incomes fall significantly below what is required to live factors of production in Ethiopia [1] because this
a modest but adequate existence can increase profits [1] and availability of labour in
2. When individual or household income falls below some Ethiopia [1] which reduces costs [1]
national average or median income • might be attracted by government policies [1], e.g
3. Any two from: unemployment; homelessness; low pay; grants for locating there [1]
addiction • that the location (near seaports) is a good base for
4. Any two from: loss of status and self-respect; health issues; exporting to other parts of the world [1] reducing
social exclusion / tension travel costs [1]. [4 marks]
5. Any two from: increase in national minimum wage; create g) Award up to 4 marks for logical reasons why income
more jobs; changes to taxation system; changes to benefits per person is a good measure of development, i.e. it
system; investment in education and healthcare; investment measures the standard of living.
in training people; encouraging startup businesses / business Award up to 4 marks for logical reasons why other
growth; subsidies for certain services measures might be better than income per person, e.g.
education levels, the health of the population, birth
rates and mortality rates. [6 marks]

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 h) Award up to 4 marks for logical reasons why greater
trade can be good for the economy, e.g. open up export 6 International trade and
markets and lead to more earnings for the country; can
mean more access to better and cheaper products for globalisation
Ethiopian citizens; can allow Ethiopian businesses to
access cheaper supplies. International specialisation
Award up to 4 marks for logical reasons why greater 1. When one country has a lower opportunity cost in the
trade might make it difficult for local businesses to grow production of a good or service compared to another country
(when facing international competitors). [6 marks] 2. True
7. a) This means that the percentage increase in national 3. Any one from: better resources; better technology; skills and
income each year [1] is relatively high [1]. [2 marks] experience
b) Explanations which might include: 4. More choice of goods at lower prices
• unemployment [1]; without a job, income falls [1] 5. Any one from: can import resources at a lower price than
• low pay [1], e.g. due to low skills [1] it can produce itself; can help keep costs down; can enable
• illness [1], preventing work [1]. [4 marks] faster economic growth
c) Coherent analysis which might include: Free trade and protection
• increase the financial burden on the government 1. Tariff
[1], e.g. more healthcare provision [1] which needs 2. Quota
investment [1] 3. Infant industries
• need to finance areas such as pensions and healthcare 4. When one government introduces protectionist measures in
[1]; this may increase the tax burden on those in work response to another government using them
[1] and this may reduce the incentive to work or make 5. Any one from: increases prices; allows inefficient domestic
profits [1] producers to continue in production; less choice for
• might affect consumption patterns [1], e.g. less consumers; a reduction in quality and customer service
demand for toys [1] leading to different output by
Foreign exchange rates
producers [1]. [6 marks]
1. The value of one currency in terms of another
d) Explain how a multinational might help reduce poverty,
2. Increase in demand for the currency, e.g. due to greater
e.g. by bringing investment, jobs and economic growth,
demand for the country’s goods and services or higher
which will create jobs within the multinational and also
interest rates
for suppliers of the business.
3. Appreciation
Explain that the effect depends on the behaviour of the
4. Any one from: fall in demand (e.g. less demand from
multinational, e.g. depends on level of investment, what
abroad for its goods and services); an increase in supply
jobs are offered, whether profits are reinvested into the
(e.g. increased demand for imports)
country, whether local staff are employed and how many
5. An appreciation of a currency decreases the price of imports,
local suppliers there are. [8 marks]
all other factors unchanged
8. a) GDP measures the national income of an economy
over a period of time [1]. The Human Development Current account of balance of payments
Index includes GDP [1] but also considers health [1] and 1. The sum of the balance of trade (goods and services exports
education [1]. [2 marks] less imports), primary income (net income from abroad) and
b) Logical explanation may include: secondary income (net current transfers)
• higher birth rate leads to higher population [1] 2. The value of money leaving the country on the current account
which can, over time, increase labour force [1], which is the greater than the value of money entering the country
increases factors of production [1] 3. Lack of international competitiveness; strong value of the
• this can lead to an increase in output [1] and income currency
in the economy [1] 4. Likely to reduce demand, reduce income, increase
• in short run it may mean more people without an unemployment, reduces inflation
increase in output [1] as there are more children [1] so 5. By reducing the value of its currency – this can make exports
GDP per head falls [1]. [4 marks] cheaper in foreign currency and imports more expensive
c) Coherent analysis which might include: domestically, reducing the deficit
• how GDP measures income [1] Exam-style practice questions
• that the Human Development Index is a summary 1. D [1 mark]
measure of average achievement of a number of 2. B [1 mark]
important dimensions [1], such as health, education 3. B [1 mark]
and standard of living [1] 4. C [1 mark]
• how these may change in different ways [1], e.g. they 5. a) Deficit [1 mark]
may have more income [1] but this does not necessarily b) The economic and political union between member
mean it is invested in education or health [1] European countries [1]; within the EU there is freedom
• that it is possible to have high incomes but the HDI to of movement of people, goods, services and money /
be relatively lower [1] – HDI measures a wider range there are common tariffs against imports from non-
of measures than just income [1]. [6 marks] member countries [1]. [2 marks]
d) Explain how the minimum wage might reduce poverty. c) No barriers to trade between countries [1]; e.g. no tariffs
If the minimum wage is higher than the free market or quotas [1]. [2 marks]
wage for low income earners it will raise their earnings d) Answers may include:
and bring some out of poverty. However, it will mean • favourable trade agreements [1] and trading
fewer are employed, so the unemployed will be conditions [1]
worse off. • Japanese consumers have strong preferences for EU
Explain other measures that may be used, such as efforts products [1]
to get more people into work, e.g. more training and • favourable exchange rates [1]. [4 marks]
more information, and investment in education.
[8 marks]

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 e) Logical explanation which might include: d) Explain why trade protection may be adopted, e.g. to
Businesses will need time to prepare for the new trading protect infant industry, retaliation, to protect strategic
conditions [1], e.g. European producers must have time industries
to ensure they can compete with producers from Japan Explain the benefits of free trade, e.g. more choice
[1]; the change may cause some businesses to close and of goods and services for consumers at lower prices,
lead to unemployment in some regions [1]; governments economic growth, consumption outside of the PPC.
will want to give businesses times to prepare for this to [8 marks]
reduce impact on industries [1]. [4 marks] 7. a) The price of one currency in terms of another [1], e.g.
total income $1 = £0.80 [1] [2 marks]
f) Average income =
number of people b) Explanations which might include:
• uncompetitive prices [1] making local goods more
$4 932 000 000 000
= [1] appealing [1]
127 000 000 • poor quality [1] reducing demand [1]
= $38 834.64 [1] [2 marks] • high income domestically [1] leads to more
imports [1]. [4 marks]
g) Logical explanation might include:
c) Coherent analysis which might include:
• the benefits of trade [1], e.g. can benefit from the
• protectionism may reduce quantity of goods available
skills and resources of other countries [1]
to consumers [1], e.g. through quotas [1] reducing
• that they may be different brands and models [1];
their choice [1]
trade gives consumers more choice [1]. [4 marks]
• protectionism may increase prices [1], e.g through
h) Logical explanation might include:
tariffs [1] and increase prices for consumers
• may be due to supply increasing [1]
• may make foreign inputs more expensive for
• more supply might push prices down [1]
businesses [1], e.g. with cost of tariff [1] increasing
• that it may be due to the power of the buyers, e.g.
costs [1] and reducing profits [1]
the big supermarkets [1] – they can force the price
• tariffs may raise revenue for the government [1]
down [1] as they are in a strong bargaining
giving more funds for investment elsewhere [1]
position [1]. [5 marks]
• may create or protect jobs in protected industries [1]
i) Award up to 4 marks for logical reasons explaining
which may win votes [1] but overall there may be
impact may be desirable for some groups, e.g lower
fewer jobs in the economy [1]. [6 marks]
prices and more choice for consumers.
d) Explain how a fall in the exchange rate is likely to
Award up to 4 marks for logical reasons explaining
reduce imports and increase exports, e.g. due to higher
impact may not be desirable for some groups, e.g some
export prices abroad and more expensive import prices
producers may face more competition. [6 marks]
in local currency, improving the current account deficit.
6. a) The value of money leaving the country on the current
Explain how this may change over time, e.g. as demand
account over a given time period [1] is greater than the
for exports and imports becomes more price sensitive
value of money entering the country [1]. [2 marks]
and consumers change their behaviours. [8 marks]
b) Logical explanation which might include
• tariffs [1] which involve placing a tax on foreign
goods and services making them less competitive [1]
• quotas [1] which involves a limit on the number of
foreign goods or services [1]. [4 marks]
c) Your answer should:
• Coherent analysis which might include:
Earnings from goods and services exported may
be less than spending on imports [1] due to lack of
competitiveness [1] such as higher costs [1] or lack of
productivity [1] or poor quality [1] or strong exchange
rate [1]. [6 marks]

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 Glossarry

Absolute advantage – when a Barter – the exchange of goods Claimant count – the number of
country can produce products at or services for others goods or people entitled to claim benefits
a lower cost than a competitor services (without using money) over a given time period
Absolute poverty – severe Basic economic problem – there Command (or planned) economy
deprivation of basic human are limited resources and unlimited – an economy in which the basic
needs, including food, safe human wants, so decisions have to economic questions are solved
drinking water, sanitation be made about what is produced, by the government allocating
facilities, health, shelter, how it is produced and who it is resources
education and information produced for
Commercial bank – high street
Ageing population – when the Birth rate – usually measured banks; banks that accept
median age of a population by the number of live births deposits, lend to households and
increases, e.g. due to a decline in per thousand people in the firms and provide an efficient
birth rates or an increase in life population per year means of payment
expectancy
Boom – occurs when output is Comparative advantage – when
Aggregate demand – the total growing faster than the average one country can produce a good
demand for goods and services in trend rate or service at a lower opportunity
an economy cost than another
Budget – measures the difference
Aggregate supply – the total between government spending Complement – a good that
supply of goods and services in and revenue over a given period is closely linked to another
an economy good, e.g. a printer and printer
Budget deficit – government
cartridges, so the demand for
Appreciation – an increase in spending is greater than taxation
and price of one product has a
value revenue
direct effect on the demand for
Average cost (AC) – unit cost; Budget position – the difference and price of the other
total cost divided by output between government spending
Conglomerate integration
and government revenue in a
Average revenue (AR) – a – when a firm acquires an
given period, usually a year
measure of the amount paid by unrelated business, e.g. a car
customers per item; the price of Budget surplus – government manufacturer acquires a hotel
a product spending is less than its revenue business
Backward vertical integration Buffer stock – stock bought by Consumer – households or
– a firm joins with another firm the government when there individuals; the end-users of
at an earlier stage of the same is excess supply and sold when products
production process, e.g. a car there is excess demand to help
Consumer Price Index (CPI)
manufacturer joins with a tyre stabilise prices in volatile markets
– a weighted index that
manufacturer
Capital – financial and material measures changes in the price
Balance of payments – a record wealth; goods used to produce of consumer goods and services
of all of a country’s financial other goods, e.g. equipment and purchased by households
transactions with the rest of the technology
Consumption – to consume;
world over a year
Capital goods – goods, such as the amount of an individual or
Balance of trade – the difference machines and equipment, which household’s income spent on
between the values of exports are an investment for the future goods and services
(money coming into the country
Central bank – manages a Consumption goods – goods for
from sales abroad) and imports
country’s currency, money supply immediate consumption, e.g.
(money leaving the country for
and interest rates on behalf of food
purchase abroad)
the government

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 Contraction – a decrease in Depression – occurs when there Employment – the number of
quantity demanded due to a is a fall in real GDP of more people in work
price rise / a decrease in supply than 10% from the peak of the
Enterprise – refers to the
due to a fall in price economic cycle to its lowest point
management expertise needed
of recession
Cooperative – organisations that to think of new products and
are jointly owned Derived demand – demand for a processes and combine resources
factor of production that occurs to set up a new project or
Cost of living – the amount
as a result of the demand for a business
of money needed to sustain
product or service
a certain level of living Entrepreneur – someone who
for a household, including Direct tax – a tax taken directly comes up with new ideas and
basic expenses such as from earnings, e.g. income tax takes the risk to develop new
accommodation, food and and corporation tax business opportunities
clothing
Disequilibrium – at the given Equilibrium – quantity supplied
Cost-push inflation – a rise in price, the quantity demanded equals quantity demanded at a
prices due to an increase in costs is greater than the quantity given price
supplied (there is a shortage) or
Death rate – usually measured Exchange rate – the price of one
the quantity supplied is greater
by the number of deaths currency in terms of another
than the quantity demanded
per thousand people in the
(excess supply) Export subsidy – a direct payment,
population per year
low-cost loan or tax relief for
Dissave – to spend a greater
Deficit – occurs when expenses exporters from the government to
amount of money than available
(outgoings) are higher than encourage export of goods
income, e.g. by using savings or a
income
pension fund Exports – goods and services sold
Deflation – a sustained fall in the abroad
Economic agents – the different
general price level over a given
groups within an economy, e.g. Extension – an increase in the
period
consumers, employees, producers quantity demanded due to a fall
Demand – the quantity of goods and government in price / an increase in supply
and services that buyers are due to a rise in price
Economic (business or trade)
willing and able to buy
cycle – the growth pattern of External economies of scale –
Demand curve – a graph showing an economy’s income over time, when unit costs decrease at every
the quantity that buyers are including boom, recession, slump level of output due to factors
willing and able to buy at each and recovery outside of the business itself
and every price, all other factors
Economic goods – a good that Factor mobility – refers to how
unchanged
can only be produced if resources easily factors can move from one
Demand-pull inflation – a rise are moved from the production business or industry to another
in price caused by an increase in of another good, i.e. production Factors of production – the
aggregate demand involves an opportunity cost inputs into the production
Demerit goods – goods that are Economic growth – a shift process: land, labour, capital and
worse for the individual that the outwards in the PPC; the total enterprise
individual may appreciate, e.g. amount of goods and services Fertility rate – the average
cigarettes and drugs that the economy can produce number of children a woman will
Dependency ratio – the increases give birth to over her lifetime
percentage of dependants in Embargo – a ban on trade in Financial intermediary – an
an economy compared to the particular goods and services organisation that provides a link
number of people of working with another country between savers and borrowers,
age
Employee – someone in work; e.g. banks, building societies,
Depreciation – a fall in value someone employed by another pension funds and insurance
economic agent companies

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 Finite resources – resources that Free rider problem – when Incidence of the tax burden –
are limited and will eventually people use a public resource or the division of the tax burden
run out good without paying their share between the consumers and the
of the cost producers
Firm – a business organisation; a
business or company Free trade – unrestricted trade Income – how much is earned
(occurs when there are no over a given period; a flow of
Fiscal drag – occurs when an
barriers to trade) earnings
increase in income means that
higher taxes have to be paid, so Geographical immobility – Income distribution – refers
the individual is no better off in employees cannot move to or to the way in which the total
real terms work in another region, e.g. due income of a country is distributed
to prohibitive housing prices / amongst its population
Fiscal policy – the means by
transport costs
which a government adjusts its Income inequality – when
spending levels and tax rates to Globalisation – integration of income is distributed unevenly,
monitor and influence a nation’s economies, industries, societies so that some individuals /
economy and cultures around the world households have significantly
more than others
Fixed cost (FC) – a cost that does Government – the means by
not change with output, e.g. rent which state policy is enforced Increasing returns – when
or interest on a loan output increases more than the
Gross domestic product (GDP) – a
proportional increase in inputs
Fixed (or managed) exchange measure of the income earned
rate – an exchange rate that is in an economy over a year, i.e. Indirect tax – a charge on
kept at a particular level by the the value of the output of final products that is payable by
government goods and services produced in producers to the government; it
a year may be a specific per unit tax or
Fixed-rate loan – a loan for
an ad valorem tax
which interest repayments are Gross national income (GNI) –
agreed at the start (are fixed) gross domestic product, plus Individual demand curve –
incomes earned by foreign shows the quantity an individual
Floating exchange rate – when
residents, minus income earned consumer is willing and able
the price of a currency is
in the domestic economy by non- to buy at each price, all other
determined by market forces, i.e.
residents factors unchanged
by the supply and demand of the
currency in the foreign currency Horizontal integration – when Individual supply curve – shows
markets a business joins with another the quantity an individual
at the same stage of the same producer is willing and able
Foreign exchange rate – the
process, e.g. one bank joins with to produce at each price and
price of one currency in terms of
another bank every price, all other factors
another
unchanged
Household – includes all the
Forward vertical integration
persons living together in one Inflation – a sustained increase
– when a business joins with
housing unit, e.g. a house or in the general price level over a
another at a stage nearer the
apartment period of time
customer, e.g. a manufacturer
buys a retailer Human Development Index Interest rate – the cost of
(HDI) – a measure of economic borrowing money and the
Free goods – goods that do not
development and social welfare, reward for saving
involve an opportunity cost
based on life expectancy,
Internal diseconomies of scale –
Free market economy – an education and standard of living
a rise in costs that occurs when
economy in which the basic
Imports – goods and services sold the scale of production increases
economic problem is solved
to people within a country that
by the decisions of firms and Internal economies of scale – a
are produced abroad
households in the private sector fall in costs that occurs when the
scale of production increases

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 International trade – when Market equilibrium – this occurs Monopoly power – occurs when
countries buy and sell goods and when the quantity supplied one business dominates the
services from each other equals the quantity demanded industry and has power over
and there is no incentive to others
Joint demand – when two
change
products are always brought Mortgage – a loan obtained to
together, so demand is the same Market failure – occurs in a free pay for property
market when the outcome of the
Labour – the human input into Movement along a demand
market is not satisfactory from a
production; refers to the size and curve – a change in the quantity
social point of view
skills of the workforce demanded due to a change in
Market share – a company’s sales price
Labour immobility – when it
as a percentage of the total sales
is difficult for labour to move Movement along a supply
in the industry
from one business or industry to curve – a change in the quantity
another, e.g. due to a difference Market supply curve – supplied due to a change in price
in skills or difficulty moving to a constructed by adding together
Multinational company (MNC)
different area the quantity supplied by all the
– a company that has bases in
different producers supply at
Land – a factor of production; more than one country
each price and every price
includes land and natural
Nationalisation – when assets
resources, such as oil Maximum price – set by the
are transferred from the private
government to limit the price
Level of unemployment – the sector to the public sector
that can be charged in a market
number of people who are
Net emigration – the number of
willing and able to work but are Menu costs – the costs incurred
people leaving a country exceeds
not employed at the given wage by a firm in order to change their
the number entering over that
rate at a given moment in time prices
period
Loan – a fixed amount that is Merger – when two or more
Net immigration – the number
borrowed and repaid at agreed businesses join together to create
of people entering a country
rates a new business
exceeds the number leaving over
Macroeconomics – a study of the Merit goods – goods that are that period
economy as a whole better for the individual than the
Net migration – the difference
individual may appreciate, e.g.
Market – made up of supply and between the number of people
education
demand; occurs when buyers and coming into a country and the
sellers come together to trade Microeconomics – the study number leaving a country over a
(exchange goods and services) of specific markets within an given period
economy
Market demand curve – Non-diminishable – refers to a
constructed by adding together Minimum price – set by the free good; if someone consumes
the quantity demanded by all government to limit how low the a product, it does not reduce the
the different consumers at each price can go in a market amount available for others
and every price, all other factors
Mixed economy – an economy Non-excludable – refers to a free
unchanged
with a private sector and a public good; non-paying consumers
Market disequilibrium – this sector cannot be prevented from
occurs when the quantity accessing it
Monetary policy – the central
demanded does not equal the
bank’s actions to influence Normal goods – goods for which
quantity supplied
interest rates, the supply of demand increases as income
Market economic system – this money and the exchange rate to increases
occurs when resources are affect the economy
Objectives – these are targets,
allocated by market forces of
Monopoly – occurs when there is e.g. to increase profits
supply and demand
a single seller in a market

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 Occupational immobility – Price elastic – a percentage Production possibility curve
employees cannot move from change in price leads to a more (PPC) – shows the maximum
one industry to another due to a than proportionate change in combination of goods and
lack of skills another factor services that an economy can
produce with its factors of
Opportunity cost – the alternative Price elasticity of demand (PED) –
production at a given moment
that is given up / sacrificed when the percentage change in
a decision is made about resource quantity demanded in relation Productive efficiency – all
allocation, e.g. if resources to percentage change in price, all resources are being fully utilised;
are allocated to produce more other factors unchanged more of one product can only
computer games they cannot also be produced if less of another is
Price elasticity of supply (PES)
be used for healthcare produced
– the percentage change in
Optimum population – the quantity supplied in response to Productive inefficiency – when
theoretical population size at a percentage change in price an economy is operating inside
which, working with all available the PPF, i.e. more of one product
Price inelastic – a percentage
resources, there would be the can be produced without
change in price leads to a less
highest standard of living for all producing less of another
than proportionate change (less
people in the country (resources are available)
than 1) in another factor
Overall poverty – insufficient Productivity – a measure of the
Price mechanism – the process
income and resources to output in relation to the inputs
whereby the price adjusts to
allow citizens a sustainable used to produce it
bring about equilibrium
livelihood, characterised by Profit – the difference between
hunger, ill health, limited access Primary income – income earned
revenue and costs
to education, unsatisfactory by a country’s citizens who
housing and social discrimination own assets overseas, including Profit maximisation – when
earnings, profits, dividends on a business earns the highest
Overdraft – a facility to borrow investments abroad and interest possible profit achievable
up to a certain amount from a
bank and only pay interest on Primary market (stock exchange) – Protection (protectionist
the amount actually borrowed where bonds and shares are sold measures) – barriers to trade;
for the first time measures to protect one
Overpopulation – when there country’s producers from foreign
are too many people in a country Primary sector – made up of the
competition
given the resources available farming and extractive industries,
such as oil and coal Public corporation –
Partnership – a type of business organisations that are state
organisation; two or more Private limited company (ltd) – a
owned, such as schools and
people working together in the company owned by shareholders;
hospitals
pursuit of profit shareholders have limited
liability; the shares cannot be Public goods – goods that are
Pattern of employment – refers advertised non-diminishable and non-
to the types of job that people excludable
within an economy do Private sector – made up of
businesses owned by private Public limited company (plc) – a
Population – the total number individuals company owned by shareholders;
of people in a country at a given shareholders have limited
moment Privatisation – when assets are
liability; shares can be sold to the
transferred from the public
Population structure – the way in general public
sector to the private sector
which the population is divided Public sector – made up of
up between males and females Producer – any business or firm
organisations that are owned by
of different age groups that produces a good or service
the government
Production – the total output of
Quota – a limit placed on the
a business
quantity of a good or service
allowed into a country

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 Real GDP per head (or per capita) – Shareholder – an individual or wealth available to a household
the value of gross domestic product firm that owns at least one share or socioeconomic group
(GDP) adjusted for inflation and in another company
Stock exchange – a market for
divided by the population size to
Shift in demand – more or less shares
give a value per person
is demanded at each and every
Strike – when employees
Real national income per price
withdraw their labour in protest
person – the value of gross
Shift in supply – more or less is / to force a decision from their
national income (GNI) adjusted
supplied at each and every price employer
for inflation and divided by the
population size to give a value Shoe leather costs – refers to Subsidy – a benefit, usually a
per person the opportunity cost of time cash payment or tax reduction,
and energy that a firm puts into given to a firm by the
Recession – a fall in national
trying to counteract the effects government to help remove
income (GDP) for two consecutive
of inflation some type of burden
quarters (i.e. six months) or more
Shortage – the quantity Substitute – a similar product,
Recovery – when real GDP picks up
demanded is greater than the which may replace another if
from the low point of the recession
quantity supplied market conditions change
Regulation – rules made by a
Slowdown – when the rate of Supply – the quantity that
government or other authority
income growth slows down, but producers are willing and able to
to control the way in which
the economy is still growing produce at each and every price,
something is done
all other factors unchanged
Slump – a sustained and major
Relative poverty – when
recession leading to a significant Supply curve – this shows the
individual or household income
fall in output quantity that producers are
falls below the national average
willing and able to produce at
or median income Social benefits – the total
each and every price, all other
benefits to society of producing
Renewable – resources that factors unchanged
a good or service, i.e. the private
can be replaced / come from a
plus the external benefits Supply-side policy – a government
sustainable source
policy with the aim of increasing
Social costs – the costs to society
Resources – inputs used to productivity and shifting
of producing a good or service,
produce goods or services; the aggregate supply to the right
e.g. pollution and / or congestion
factors of production
Surplus – the quantity supplied
Sole trader – a business set up
Revenue – the income of the is greater than the quantity
by an individual (the individual
business; equal to the spending (or demanded
is the business); the business has
expenditure) of consumers; price
unlimited liability Takeover – when a business gains
per unit × number of units sold
control of another, e.g. by buying
Savings – money from income Specialisation (international
the majority of its shares
that is not spent (is saved) trade) – when a country or
region specialises in producing Tariff – taxes on foreign goods
Secondary income – involves the product where it has a and services and increases to
money transfers between central comparative advantage their price
governments and grants
Specialisation (labour market) Taxation – charges imposed
Secondary market (stock – occurs when jobs are divided on households and firms to
exchange) – the trade of second- into smaller tasks and employees raise revenue for government
hand shares are trained to do one of these spending
Secondary sector – made up specific tasks
Tertiary sector – made up of
of the firms that take raw Standard of living – usually firms that provide services, e.g.
materials and process them, e.g. measured by real GDP per head or education and banking
manufacturing real national income per capita;
refers to the level of comfort and

Glossary 133

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 Total cost (TC) – fixed costs plus Unemployment rate – the economy has at a given moment
variable costs number of people unemployed in time
as a percentage of the total
Total revenue (TR) – the total Weighted price index – a list
workforce
expenditure by consumers; of prices that are weighted to
the total income of a business; Variable costs (VC) – costs that reflect the relative importance of
calculated by price multiplied by change with output, e.g. the the different goods and services,
quantity costs of materials e.g. essential foodstuffs and
services have a higher weighting
Trade union – an organisation Variable-rate loan – a loan for
than luxury goods
that represents employees and which the interest repayments
works to protect their rights vary as interest rates in the Work to rule – when employees
economy change do exactly what is in their
Underpopulation – when there
contract and no more
are too few people in an area Wealth – a stock concept; the
to use the resources effectively, stock of assets (e.g. shares and
given the level of technology property) a person, business or

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 Ackn
nowledgem
ments

Cover photo © photowind / Shutterstock

p.15 – Fig. 1 & 2: data © World Bank / OECD; p.15 – Fig. 3: data © MOTIE;
p.44 – Fig. 1 & 2: data © OECD; p.88 – Fig. 1: data © Stats SA;
p.101 – Fig. 1: data © World Bank / OECD; p.117 – Fig. 2: data © European Union, 1995–2017

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First published 2018

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Acknowledgements 135

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 Notes

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 8mm spine

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