3.

Money

What is money?
A medium of exchange of goods and services.
Why do we need money?
We need money in order to exchange goods and services with one another. This is because we aren’t self-
sufficient – we can’t produce all our wants by ourselves. Thus, there is a need for exchange.
In the past, barter system (exchanging a good or service for another good or service) prevailed. This had a
lot of problems such as the need for the double coincidence of wants (if the person wants a table and he has
a chair to exchange, he must find a person who has a table to exchange and is also willing to buy a chair),
the goods being perishable and non-durable, the indivisibility of goods, lack of portability etc.
Thus the money we use today is in the form of currency notes and coins, which are durable, uniform,
divisible (can be divided into 10’s, 50’s , 100’s etc), portable and is generally accepted. These are the
characteristics of what is considered ‘good money’.
The functions of money:
 Money is a medium of exchange, as explained above.
 Money is a measure of value. Money acts as a unit of account, allowing us to compare and state
the worth of different goods and services.
 Money is a store of value. It holds its value for a long time, allowing us to save it for future
purposes.
 Money is a means of deferred payment. Deferred payments are purchases on credit – where the
consumer can pay later for the goods or service they buy.

Banking

Banks are financial institutions that act as an intermediary between borrowers and savers. It is the money
we save at banks that is lent out as loans to other individuals and businesses.
Commercial banks are those banks that have many retail branches located in most cities and towns.
Example: HSBC. There is also a central bank that governs all other commercial banks in a country.
Example: The Reserve Bank Of India (RBI).
Functions of a commercial bank:
 Accept deposits in the form of savings.
 Aid customers in making and receiving payments via their bank accounts.
 Give loans to businesses and private individuals.
 Buying and selling shares on customers’ behalf.
 Provide insurance (protection in the form of money against damage/theft of personal property).
 Exchange foreign currencies.
 Provide financial planning advice.
Functions of a central bank:
 It issues notes and coins of the national currency.
 It manages all payments relating to the government.
 It manages national debt. Central banks can issue and repay public debts on the government’s
behalf.
 It supervises and controls all the other banks in the whole economy, even holding their deposits and
transferring funds between them.
 It is the lender of ‘last resort’ to commercial banks. When other banks are having financial difficulties,
the central bank can lend them money to prevent them from going bankrupt.
 It manages the country’s gold and foreign currency reserves. These reserves are used to make
international payments and adjust their currency value (adjust the exchange rate).
 It operates the monetary policy in an economy.(This will be explained in a later chapter)

3.2

Disposable income is the income of a person after all income-related taxes and charges have been
deducted.

Spending (Consumption)

The buying of goods and services is called consumption. The money spent on consumption is
called consumer expenditure.
People consume in order to satisfy their needs and wants and give them satisfaction.

Factors affecting consumption:

  Disposable income: the more the disposable income, the more people consume.
 Wealth: the more wealthy (having assets such as property, jewels, company shares) a person is, the
more he spends.
 Consumer confidence: if consumers are confident of keeping their jobs and their future incomes,
then they might be encouraged to spend more now, without worries.
 Interest rates: if interest rates provided by banks on saving are high, consumers might save more
so they can earn interest and thus consumer expenditure will fall.

Saving

Saving is income not spent (or delaying consumption until some later date). People can save money by
depositing in banks, and withdraw it a later date with the interest.
Factors affecting saving:
 Saving for consumption: people save so that they can consume later. They save money so that
they can make bigger purchases in the future (a house, a car etc). Thus, saving can depend on the
consumers’ future plans.
 Disposable income: if the amount of disposable income people have is high, the more likely that
they will save. Thus, rich people save a higher proportion of their incomes than poor people.
 Interest rates: people also save so that their savings may increase overtime with the interest
added. Interest is the return on saving; the longer you save an amount and the higher the amount,
the higher the interest received.
 Consumer confidence: if the consumer is not confident about his job security and incomes in the
future, he may save more now.
 Availability of saving schemes: banks now offer a variety of saving schemes. When there are
more attractive schemes that can benefit consumers, they might resort to saving rather than
spending.

Borrowing

Borrowing, as the word suggests, is simply the borrowing of money from a person/institution. The lender
gives the borrower money. The lender is usually the bank which gives out loans to customers.
Factors affecting borrowing:
 Interest rates: interest is also the cost of borrowing. When a person takes a loan, he must repay the
entire amount at the end of a fixed period while also paying an amount of interest periodically. When
the interest rates rise, people will be reluctant to borrow and vice versa.
 Wealth/Income: banks will be more willing to lend to wealthy and high-income earning people,
because they are more likely to be able to repay the loan, rather than the poor. So even if they would
like to borrow, the poor end up being able to borrow much lesser than the rich.
 Consumer confidence: how confident people feel about their financial situation in the future may
affect borrowing too. For example, if they think that prices will rise (inflation) in the future, they might
borrow now, to make big purchases now.
 Ways of borrowing: the no. of ways to borrow can influence borrowing. Nowadays there are many
borrowing facilities such as overdrafts, bank loans etc. and there are more credit (future payment)
options such as hire purchases (payment is done in installments overtime), credit cards etc.

Expenditure patterns between income groups

The richer people spend, save and borrow more amounts than the poor.
The poor spend higher proportions of their disposable income, especially on necessities, than the rich.
The poor save lesser proportions of their disposable income in comparison with the rich.

3.3

Labour Market

Labourers need wages to satisfy their wants and needs.

Payments for labour:

 Time-rate wage: wage given based on the no. of hours the employee has worked. Overtime
wages are given to workers who have worked extra no. of hours, which will usually be 1.5 times or
even twice the normal time rate.
 Piece-rate wage: wage given based on the amount of output produced. The more output an
employee produced, the more wage he/she earns. This is used in industries where output can be
easily measured and gives employees an incentive to increase their productivity.
 Salary: monthly payments made to workers, usually managers, office staff etc. usually in non-
manual jobs.
  Performance-related payments: payments given to individual workers or teams of workers who
have performed very well. Commissions given to salespersons for selling to a targeted no. of
customers is a form of performance-related pay.
What affects an individual’s choice of occupation?
 Wage factors: the wage conditions of a job/firm such as the pay rate, the prospect for performance-
related payments and bonuses etc. will be considered by the individual before he chooses a job.
 Non-wage factors: This will include:
 hours of work
 holiday entitlements
 promotion prospects
 quality of working environment
 job security
 fringe benefits (free medical insurance, company car, price discounts on company
products etc.)
 training opportunities
 distance from home to workplace
 pension entitlement
Labour demand is the number of workers demanded by firms at a given wage rate. Labour demand
is called ‘derived demand’, since the level of demand of a product determines that industry’s demand for
labour. That is, the higher the demand for a product, the more labour producers will demand to
increase supply of the product.
When the wage increases, the demand for labour contracts (and vice versa).
Labour supply is the number of workers available and ready to work in an industry at a given
wage rate. When the wage rate increases, the supply of labour extends, and vice versa.

We also know that as the number of hours worked increases, the

wage rate also increases. However, when a person get to a very high position and his wages/salary increases
highly, the number of hours he/she works may decrease. This can be shown in this diagram, called
a backward-bending labour supply curve. CEOs and executive managers at the top of the management
tend to have backward-bending labour supply curves.
Just like in a demand and supply curve analysis, labour demand and supply will extend and contract
due to changes in the wage rate. Other factors that cause changes in demand and supply of
labour will result in a shift in the demand and supply curve of labour.
Factors that cause a shift in the labour demand curve:
 Consumer demand for goods and services: the higher the demand for products, the higher the
demand for labour.
 Productivity of labour: the more productive labour is, the more the demand for labour.
 Price and productivity of capital: capital is a substitute resource for labour. If the price of capital
were to lower and its productivity to rise, firms will demand more of capital and labour demand will
fall (labour demand curve shifts to the left).
 Non-wage employment costs: wages are not the only cost to a firm of employing workers.
Sometimes, employment tax, welfare insurance for each employee etc. will have to be paid by the
firm. If these costs increase, firms will demand less labour.
Factors that cause a shift in the labour supply curve:
 Advantages of an occupation: the different advantages a job can offer to employees will affect the
supply of labour- the people willing to do that job. Example: if the number of working hours in the
airline industry increases, the labour supply there will shift to the left.
 Availability and quality of education and training: if quality training and education for a
particular job, say pilots, is lacking, then the labour supply for it will be low. When new education and
training institutes open, the labour supply will rise (labour supply curve shifts to the right).
 Demographic changes: the size and age structure of the population in an economy can affect the
labour supply. The labour supply curve will shift to the right when more people come into a country
from outside (immigration) and when the birth rate increases (more young people will be available
for work).
Why would a person’s wage rate change overtime?
As a beginner, the individual would have a low wage rate since he/she is new to the job and has no
experience. Overtime, as his/her experience increases and skills develop, he/she will earn a higher wage
rate. If he/she gets promoted and has more responsibilities, his/her wage rate will further increase. When
he/she nears retirement age, the wage rate is likely to decrease as their productivity and skills are likely to
weaken.

Wage Differentials
Why do different jobs have different wages?
 Different abilities and qualifications: when the job requires more skills and qualifications, it will
have a higher wage rate.
 Risk involved in the job: risky jobs such as rescue operation teams will gain a higher wage rate for
the risks they undertake.
 Unsociable hours: jobs that require night shifts and work at other unsociable hours are paid more.
 Lack of information about other jobs and wages: Sometimes people work for less wage rates
simply because they do not know about other jobs with higher wage rates.
 Labour immobility: the ease with which workers can move between different occupations and
areas of an economy is called labour mobility. If labour mobility is high, workers can move to jobs
with a higher pay. Labour immobility causes people to work at a low wage rate because they don’t
have the skills or opportunities to move to jobs with a higher wage.
 Fringe benefits: jobs which offer a lot of fringe benefits have low wages. But sometimes the
highest-paid jobs are also given a lot of fringe benefits, to attract skilled labour.

Why do wages differ between people doing the same job?

 Regional differences in labour demand and supply: for example, if the demand in an area for
accountants is very high, the wage rate for accountants will be high; whereas, in an area of low
demand for accountants, the wage rate for accountants will be low. Similarly, a high supply of
accountants will cause their wages to be low, while a low supply (scarcity) of accountants will cause
their wages to be high. It’s the law of demand and supply!
 Fringe benefits: some firms which pay a lot of fringe benefits, will pay less wages, while firms (in
the same industry) which pay lesser fringe benefits will have higher wages.
 Discrimination: workers doing the same work may be discriminated by gender, race, religion or
age.
 Length of service: some firms provide extra pay for workers who have worked in the firm for a long
time, while other firms may not.
 Local pay agreements: some trade unions may agree a national wage rate for all their members –
therefore all their members (labourers) will get a higher wage rate than those who do the same job
but are not in the trade union. This depends on the relative bargaining power of the trade union.
 Government labour policies: wages will be fairer in an economy where the government has set a
minimum wage policy. The government’s corporate tax policies can also influence the amount of
wage firms will be willing to pay out.
Other wage differentials:
 Public-private sector pay gap: public sector jobs usually have a high wage rate. But sometimes
public sector wages are lower than that of the private sector’s because low wages can be
compensated by the public sector’s high job security and pension prospects.
 Economic sector: workers in primary activities such as agriculture receive very low wages in
comparison to those in the other sectors because the value of output they produce is lower. Further
still, workers in the manufacturing sector may earn lesser than those in the services sector. But it
comes down to the nature of the job itself. A computer engineer in the manufacturing sector does
earn more than a waiter at a restaurant after all.
 Skilled and unskilled workers: Skilled workers have a higher pay than unskilled workers, because
they are more productive and efficient and make lesser mistakes.
 Gender pay gap: Men are usually given a higher pay than women. This is because women tend to
go for jobs that don’t require as much skill as that is required by men’s jobs (teaching, nursing,
retailing); they take career breaks to raise children, which will cause less experience and career
progress (making way for low wages); more women work part-time than full-time. Sometimes, even if
both men and women are working equally hard and effectively, discrimination can occur against
women.
 International wage differentials: developed countries usually have high wage rates due to high
incomes, large supply of skilled workers, high demand for goods and services etc; while in a less-
developed economy, wage rates will be low due to a large supply unskilled labour.

Division of Labour/Specialisation

Division of labour is the concept of dividing the production process into different stages enabling workers to
specialise in specific tasks. This will help increase efficiency and productivity. Division of labour is widely
used in modern economies. From the making of iPhones (the designs, processors, screens, batteries, camera
lenses, software etc. are made by different people in different parts of the world) to this very website (where
notes, mindmaps, illustrations, design etc. are all managed by different people).

Advantages to workers:
 Become skilled: workers can get skilled and experienced in a specific task which will help their
future job prospects
 Better future job prospects: because of the skill and training they acquire, workers will, in the
future, be able to get better jobs in the same field.
 Saves time and expenses in training
Disadvantages to workers:
 Monotony: doing the same task repetitively might make it boring and lower worker’s morale.
 Margin for errors increases: as the job gets repetitive, there also arises a chance for mistakes.
 Alienation: since they’re confined to just the task they’re doing, workers will feel socially alienated
from each other.
 Lower mobility of labour: division of labour can also cause a reduced mobility of labour. Since a
worker is only specialised in doing one specific task(s), it will be difficult for him/her to do a different
job.
 Increased chance of unemployment: when division of labour is introduced, many excess workers
will have to be laid off. Additionally, if one loses the job, it will be harder for him/her to find other jobs
that require the same specialisation.
Advantages to firms:
 Increased productivity: when people specialise in particular tasks, the total output will increase.
 Increased quality of products: because workers work on tasks they are best suited for, the quality
of the final output will be high.
 Low costs: workers only need to be trained in the tasks they specialise in and not the entire
process; and tools and equipment required for a task will only be needed for a few workers who
specialise in the task, and not for everybody else.
 Faster: when everyone focuses on a particular task and there is no need for workers to shift from
one task to another, the production will speed up
 Efficient movement of goods: raw materials and half-finished goods will easily move around the
firm from one task to the next.
 Better selection of workers: since workers are selected to do tasks best suited for them, division of
labour will help firms to choose the best set of workers for their operations.
 Aids a streamlined production process: the production process will be smooth and clearly
defined, and so the firm can easily adapt to a mass production scale.
 Increased profits: lower costs and increased productivity will help boost profits.
Disadvantages o firms:
 Increased dependency: The production may come to a halt if one or more workers doing a specific
task is absent. The production is dependent on all workers being present to do their jobs.
 Danger of overproduction: as division of labour facilitates mass production, the supply of the
product may exceed its demand, and cause a problem of excess stocks of finished goods. Firms need
to ensure that they’re not producing too much if there is not enough demand for the product in the
first place.
Advantages to the economy:
 Better utilisation of human resources in the economy as workers do the job they’re best at,
helping the economy achieve its maximum output.
 Establishment of efficient firms and industries, as the higher profits from division of labour will
attract entrepreneurs to invest and produce.
 Inventions arise: as workers become skilled in particular areas, they can innovate and invent new
methods and products in that field.
Disadvantages to the economy:
 Labour immobility: occupational immobility may arise because workers can only specialise in a
specific field.
 Reduces the creative instinct of the labour force in the long-run as they are only able to do a
single task repetitively and the previous skills they acquired die out.
 Creates a factory culture, which brings with it the evils of exploitation, poor working conditions,
and forced monotony.
Trade Unions are organizations of workers that aim at promoting and protecting the interest of
their members (workers). They aim on improving wage rates, working conditions and other job-related
aspects.
The functions of a trade union:
 Negotiating improvements in non-wage benefits with employers.
 Defending employees’ rights.
 Improving working conditions, such as better working hours and better safety measures.
 Improving pay and other benefits.
 Supporting workers who have been unfairly dismissed or discriminated against.
 Developing the skills of members, by providing training and education.
 Providing recreational activities for the members.
 Taking industrial actions (strikes, overtime ban etc.) when employers don’t satisfy their needs.
These are explained later in this topic.
Collective bargaining: the process of negotiating over pay and working conditions between trade
unions and employers.
When can trade unions argue for higher wages and better working conditions?
 Prices are rising (inflation): the cost of living increases when prices increase and workers will want
higher wages to consume products and raise their families.
 The sales and demand of the firm has increased.
 Workers in other firms are getting a higher pay.
 The productivity of the members has increased.

Industrial disputes
When firms don’t satisfy trade union wants or refuse to agree to their terms, the members of a trade union
can organize industrial disputes. Here are some:

Overtime ban: workers refuse to work more than their normal hours.
Go-slow: workers deliberately slow down production, so the firm’s sales and profits go down.
Strike: workers refuse to work and may also protest or picket outside their workplace to stop
deliveries and prevent other non-union members from entering. They don’t receive any wages during
this time. This will halt all production of the firm.
Trade union activity has several impacts:

Advantages to workers:
 Workers benefit from collective bargaining power by being able to establish better terms of
labour.
 Workers feel a sense of unity and feel represented, increasing morale.
 Lesser chance of being discriminated and exploited.
Disadvantages to workers:
 Workers might get lesser wages or none if they go on strike – as the output and profits of the
firm falls and they refuse to pay.
Advantages to firms:
 Time is saved in negotiating with a union when compared to negotiating with individuals workers.
 When making changes in work schedules and practices, a trade union’s cooperation can
help organise workers efficiently.
 Mutual respect and good relationships between unions and firms are good for business morale
and increases productivity.
Disadvantages to firms:
 Decision making may be long as there will be need of lengthy discussions with trade unions in
major business decisions.
 Trade unions may make demands that the firm may not be able to meet – they will have to
choose between profitability and workers’ interests.
 Higher wages bargained by trade unions will reduce the firm’s profitability.
 Businesses will have high costs and low output if unions organise agitations. Their revenue
and profits will go down and they will enter a loss. They may also lose a lot of customers to
competing firms.
Advantages to the economy:
 Ensures that the labour force in the economy is not exploited and that their interests are being
represented
Disadvantages to the economy:
 Can negatively impact total output of the economy.
 Firms may decide to substitute labour for capital if they can’t meet trade unions’ expensive demands,
and so unemployment may rise.
 Higher wages resulting from trade union activity can make the nation’s exports expensive and
thus less competitive in the international market
In modern times, the powers of trade unions have drastically weakened. Globalisation, liberalisation and
privatisation of economies are making markets more competitive. Firms have more incentive to reduce costs
of production to a minimum in order to remain competitive and profitable. Therefore, it is much harder for
unions to force employers to increase wages. Most unions operating nowadays are more focused on
bettering working conditions and non-monetary benefits.

3.4
Trade Unions are organizations of workers that aim at promoting and protecting the interest of
their members (workers). They aim on improving wage rates, working conditions and other job-related
aspects.
The functions of a trade union:
 Negotiating improvements in non-wage benefits with employers.
 Defending employees’ rights.
 Improving working conditions, such as better working hours and better safety measures.
 Improving pay and other benefits.
 Supporting workers who have been unfairly dismissed or discriminated against.
 Developing the skills of members, by providing training and education.
 Providing recreational activities for the members.
 Taking industrial actions (strikes, overtime ban etc.) when employers don’t satisfy their needs.
These are explained later in this topic.
Collective bargaining: the process of negotiating over pay and working conditions between trade
unions and employers.
When can trade unions argue for higher wages and better working conditions?
 Prices are rising (inflation): the cost of living increases when prices increase and workers will want
higher wages to consume products and raise their families.
 The sales and demand of the firm has increased.
 Workers in other firms are getting a higher pay.
 The productivity of the members has increased.

Industrial disputes
When firms don’t satisfy trade union wants or refuse to agree to their terms, the members of a trade union
can organize industrial disputes. Here are some:

 Overtime ban: workers refuse to work more than their normal hours.
 Go-slow: workers deliberately slow down production, so the firm’s sales and profits go down.
 Strike: workers refuse to work and may also protest or picket outside their workplace to stop
deliveries and prevent other non-union members from entering. They don’t receive any wages during
this time. This will halt all production of the firm.
Trade union activity has several impacts:

Advantages to workers:
 Workers benefit from collective bargaining power by being able to establish better terms of
labour.
 Workers feel a sense of unity and feel represented, increasing morale.
 Lesser chance of being discriminated and exploited.
Disadvantages to workers:
 Workers might get lesser wages or none if they go on strike – as the output and profits of the
firm falls and they refuse to pay.
Advantages to firms:
 Time is saved in negotiating with a union when compared to negotiating with individuals workers.
 When making changes in work schedules and practices, a trade union’s cooperation can
help organise workers efficiently.
 Mutual respect and good relationships between unions and firms are good for business morale
and increases productivity.
Disadvantages to firms:
 Decision making may be long as there will be need of lengthy discussions with trade unions in
major business decisions.
 Trade unions may make demands that the firm may not be able to meet – they will have to
choose between profitability and workers’ interests.
 Higher wages bargained by trade unions will reduce the firm’s profitability.
 Businesses will have high costs and low output if unions organise agitations. Their revenue
and profits will go down and they will enter a loss. They may also lose a lot of customers to
competing firms.
Advantages to the economy:
 Ensures that the labour force in the economy is not exploited and that their interests are being
represented
Disadvantages to the economy:
 Can negatively impact total output of the economy.
 Firms may decide to substitute labour for capital if they can’t meet trade unions’ expensive demands,
and so unemployment may rise.
 Higher wages resulting from trade union activity can make the nation’s exports expensive and
thus less competitive in the international market
In modern times, the powers of trade unions have drastically weakened. Globalisation, liberalisation and
privatisation of economies are making markets more competitive. Firms have more incentive to reduce costs
of production to a minimum in order to remain competitive and profitable. Therefore, it is much harder for
unions to force employers to increase wages. Most unions operating nowadays are more focused on
bettering working conditions and non-monetary benefits.

3.5

Trade Unions are organizations of workers that aim at promoting and protecting the interest of
their members (workers). They aim on improving wage rates, working conditions and other job-related
aspects.
The functions of a trade union:
 Negotiating improvements in non-wage benefits with employers.
 Defending employees’ rights.
 Improving working conditions, such as better working hours and better safety measures.
 Improving pay and other benefits.
 Supporting workers who have been unfairly dismissed or discriminated against.
 Developing the skills of members, by providing training and education.
 Providing recreational activities for the members.
 Taking industrial actions (strikes, overtime ban etc.) when employers don’t satisfy their needs.
These are explained later in this topic.
Collective bargaining: the process of negotiating over pay and working conditions between trade
unions and employers.
When can trade unions argue for higher wages and better working conditions?
 Prices are rising (inflation): the cost of living increases when prices increase and workers will want
higher wages to consume products and raise their families.
 The sales and demand of the firm has increased.
 Workers in other firms are getting a higher pay.
 The productivity of the members has increased.

Industrial disputes
When firms don’t satisfy trade union wants or refuse to agree to their terms, the members of a trade union
can organize industrial disputes. Here are some:

Overtime ban: workers refuse to work more than their normal hours.
Go-slow: workers deliberately slow down production, so the firm’s sales and profits go down.
Strike: workers refuse to work and may also protest or picket outside their workplace to stop
deliveries and prevent other non-union members from entering. They don’t receive any wages during
this time. This will halt all production of the firm.
Trade union activity has several impacts:

Advantages to workers:
 Workers benefit from collective bargaining power by being able to establish better terms of
labour.
 Workers feel a sense of unity and feel represented, increasing morale.
 Lesser chance of being discriminated and exploited.
Disadvantages to workers:
 Workers might get lesser wages or none if they go on strike – as the output and profits of the
firm falls and they refuse to pay.
Advantages to firms:
 Time is saved in negotiating with a union when compared to negotiating with individuals workers.
 When making changes in work schedules and practices, a trade union’s cooperation can
help organise workers efficiently.
 Mutual respect and good relationships between unions and firms are good for business morale
and increases productivity.
Disadvantages to firms:
 Decision making may be long as there will be need of lengthy discussions with trade unions in
major business decisions.
 Trade unions may make demands that the firm may not be able to meet – they will have to
choose between profitability and workers’ interests.
 Higher wages bargained by trade unions will reduce the firm’s profitability.
 Businesses will have high costs and low output if unions organise agitations. Their revenue
and profits will go down and they will enter a loss. They may also lose a lot of customers to
competing firms.
Advantages to the economy:
 Ensures that the labour force in the economy is not exploited and that their interests are being
represented
Disadvantages to the economy:
 Can negatively impact total output of the economy.
  Firms may decide to substitute labour for capital if they can’t meet trade unions’ expensive demands,
and so unemployment may rise.
 Higher wages resulting from trade union activity can make the nation’s exports expensive and
thus less competitive in the international market
In modern times, the powers of trade unions have drastically weakened. Globalisation, liberalisation and
privatisation of economies are making markets more competitive. Firms have more incentive to reduce costs
of production to a minimum in order to remain competitive and profitable. Therefore, it is much harder for
unions to force employers to increase wages. Most unions operating nowadays are more focused on
bettering working conditions and non-monetary benefits.

3.6

Demand for Factors of Production

Some factors that determine the demand of factors of production:

 The demand for the product: if more goods and services are demanded by consumers, more
factors of production will be demanded by firms to produce and satisfy the demand. That is, the
demand for factors of production is derived demand, as it is determined by the demand for the goods
and services (just like labour demand).
 The availability of factors: firms will also demand factors that are easily available and accessible
to them. If the firm is located in a region where there is a large pool of skilled labour, it will demand
more labour as opposed to capital.
 The price of factors: If labour is more expensive than capital, firms will demand more capital (and
vice versa), as they want to reduce costs and maximize profits.
 The productivity of factors: If labour is more productive than capital, then more labour is
demanded, and vice versa.
Labour-intensive and Capital-intensive production
Labour-intensive production is where more labourers are employed than other factors, say capital.
Production is mainly dependent on labour. It is usually adopted in small-scale industries, especially those
that produce personalised, handmade products. Examples: hotels and restaurants.
Advantages:

Flexibility: labour, unlike most machinery can be used flexibly to meet changing levels of consumer
demand, e.g., part-time workers.
 Personal services: labour can provide a personal touch to customer needs and wants.
 Personalised services: labourers can provide custom products for different customers. Machinery is
not flexible enough to provide tailored products for individual customers.
 Gives feedback: labour can give feedback that provides ideas for continuous improvements in the
firm.
 Essential: labour is essential in case of machine breakdowns. After all, machines are only as good as
the labour that builds, maintains and operates them..
Disadvantages:

 Relatively expensive: in the long-term, when compared to machinery, labour has higher per unit
costs due to lower levels of productivity.
 Inefficient and inconsistent: compared to machinery, labour is relatively less efficient and tends to
be inconsistent with their productivity, with various personal, psychological and physical matters
influencing their quantity and quality of work.
 Labour relation problems: firms will have to put up with labour demands and grievances. They
could stage an overtime ban or strike if their demands are not met.
Capital refers to the machinery, equipment, tools, buildings and vehicles used in production. It also means
the investment required to do production. Capital-intensive production is where more capital is employed
than other factors. It is a production which requires a relatively high level of capital investment compared to
the labour cost. Most capital-intensive production is automated (example: car-manufacturing).
Advantages:

 Less likely to make errors: Machines, since they’re mechanically or digitally programmed to do
tasks, won’t make the mistakes that labourers will.
 More efficient: machinery doesn’t need breaks or holidays, has no demands and makes no
mistakes.
 Consistent: since they won’t have human problems and are programmed to repeat tasks, they are
very consistent in the output produced.
  Technical economies of scale: increased efficiency can reduce average costs
Disadvantages:

 Expensive: the initial costs of investment is high, as well as possible training costs.
 Lack of flexibility: machines need not be as flexible as labourers are to meet changes in demand.
 Machinery lacks initiative: machines don’t have the intuitive or creative power that human labour
can provide the business, and improve production.

Production and Productivity

A firm combines scarce resources of land, labour and capital (inputs) to make (produce) goods and services
(output). Production is thus, the transformation of raw materials (input) to finished or semi-
finished goods and services (output).
In other words, production is the adding of value to inputs to create outputs. It is the production that gives
the inputs value.
Some factors that influence production:

Demand for product: the more the demand from consumers, the more the production.
Price and availability of factors of production: if factors of production are cheap and readily
available, there will be more production.
 Capital: the more capital that is available to producers, the more the investment in production.
 Profitability: the more profitable producing and selling a product is, the more the production of the
product will be.
 Government support: if governments give money in grants, subsidies, tax breaks and so on, more
production will take place in the economy.
Productivity measures the amount of output that can be produced from a given amount of input
over a period of time.
Productivity = Total output produced per period / Total input used per period
Productivity increases when:

more output or revenue is produced from the same amount of resources

the same output or revenue is produced using fewer resources.
(Labour productivity is the measure of the amount of output that can be produced by each worker in a
business).

Factors that influence productivity:

 Division of labour: division of labour is when tasks are divided among labourers. Each labourer
specializes in a particular task, and thus this will increase productivity.
 Skills and experience of labour force: a skilled and experienced workforce will be more
productive.
 Workers’ motivation: the more motivated the workforce is, the more productive they will be. Better
pay, working conditions, reasonable working hours etc. can improve productivity.
 Technology: more technology introduced into the production process will increase productivity.
 Quality of factors of production: replacing old machinery with new ones, preferably with latest
technologies, can increase efficiency and productivity. In the case of labour, training the workforce
will increase productivity.
 Investment: introducing new production processes which will reduce wastage, increase speed,
improve quality and raise output will raise productivity. This is known as lean production.

3.7

Costs of Production
Fixed costs (FC) are costs that are fixed in the short-term running of a business and have to be paid even
when no production is taking place. Examples: rent, interest on bank loans, telephone bills. These costs do
not depend on the amount of output produced.
Average Fixed Cost (AFC) = Total Fixed Cost (TFC) / Total Output

Variable costs (VC) are costs that are variable in the short-term running of a business and are paid
according to the output produced. The more the production, the more the variable costs are. Examples:
wages, electricity bill, cost of raw materials.
Average Variable Cost (AVC) = Total Variable Costs (TVC) / Total Output

Total Costs (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC)

This is a simple graph showing the relation between TC, FC and VC. The gap between
the TC and TVC indicates the TFC

Average cost or Average total Cost (ATC) is the cost per unit of output.
Average Total Cost (ATC) = Total Cost (TC) / Total Output or
Average Cost (AC) = Average Variable Cost (AVC) + Average Fixed Cost (AFC)

(Remember ‘average’ means ‘per unit’ and so will involve dividing the particular cost by the total output
produced. In the graphs above you will notice that the average variable costs and average total costs first
fall and then start rising. This is because of economies of scale and diseconomies of scale respectively. As
the firm increases its output, the average costs decline but as it starts growing beyond a limit, the average
costs rise).

Let’s calculate some costs in an example:

Suppose, a TV manufacturer produces 1000 TVs a month. The firm’s fixed costs in rent is $900, and variable
cost per unit is $500. What would its TFC, TVC, AVC, AFC, AC and TC be, in a month?

No. of units of TVs produced = 1000

Total Fixed Costs for one month = $900

Average Fixed Cost = $900 / 1000 = $0.9 per unit

Variable Cost of producing one unit of TV = $500

Total Variable Costs for producing 1000 TVs in a month = $500 * 1000 = $500,000
Average Variable Cost = $500,000 / 1000 = $500 (AVC is the same as VC per unit!)

Total Costs = Total Fixed Costs + Total Variable Costs ==> $900 + $500,000 = $500,900
Average Costs = Total Costs / Total Output ==> $500,900 / 1000 = $500.9
or Average Costs = AFC + AVC ==> $0.9 + $500 ==> $500.9

Revenue
Revenue is the total income a firm earns from the sale of its goods and services. The more the
sales, the more the revenue.
Total Revenue (TR) = No. of units sold (Sales) * Price per unit (P)
Average Revenue = Total Revenue (TR) / No. of units sold (Sales) (= Price per unit (P)!)
Suppose, from the example above, a TV is sold at $800 and the firm sells all the units it produces, what is
the firm’s Total Revenue and Average Revenue, for a month?
No. of units sold (Sales) in a month = No. of units produced in a month = 1000
Total Revenue = Sales * Price ==> 1000 * $800 = $800,000
Average Revenue = Total Revenue / Sales = $800,000 / 1000 = $800

Total Revenue – Total Cost = Profit

Objectives of Firms
Objectives vary with different businesses due to size, sector and many other factors. However, many
business in the private sector aim to achieve the following objectives.
  Survival: new or small firms usually have survival as a primary objective. Firms in a highly
competitive market will also be more concerned with survival rather than any other objective. To
achieve this, firms could decide to lower prices, which would mean forsaking other objectives such as
profit maximization.
 Profit: profit is the income of a business from its activities after deducting total costs from total
revenue. Private sector firms usually have profit making as a primary objective. This is because
profits are required for further investment into the business as well as for the payment of
return to the shareholders/owners of the business. Usually, firms aim to maximise their profits by
either minimising costs, or maximising revenue, or both.
 Growth: once a business has passed its survival stage it will aim for growth and expansion. This is
usually measured by value of sales or output. Aiming for business growth can be very beneficial. A
larger business can ensure greater job security and salaries for employees. The business can also
benefit from higher market share and economies of scale.
 Market share: market share can be defined as the sales in proportion to total market sales achieved
by a business. Increased market share can bring about many benefits to the business such as
increased customer loyalty, setting up of brand image, etc.
 Service to the society: Some operations in the private sectors such as social enterprises do not
aim for profits and prefer to set more social objectives. They aim to better the society by aiding
society financially or otherwise.
A business’ objectives do not remain the same forever. As market situations change and as the business
itself develops, its objectives will change to reflect its current market and economic position. For example, a
firm facing serious economic recession could change its objective from profit maximization to short term
survival.