Economics Revision Notes For Olevel

EconomicRevisionNoteforGr:08,09,10
http://www.dineshbakshi.com/igcsegcseeconomics
1.BASICECONOMICPROBLEM:
LEARNINGOUTCOMES:
At the end of this unit students will be able to:

define the nature of the economic problem (finite resources and unlimited wants);
define the factors of production (land, labour, capital, enterprise);
define opportunity cost and analyse particular circumstances to illustrate the concept;
evaluate the implications of particular courses of action in terms of opportunity cost.
1.1ProductionPossibilityCurve
:
Production Possibility
Curve/Production Possibility
Boundary/Production Possibility
Frontier
FromthepointofviewofanEconomy,thereisanopportunitycostofusingits
resources.ProductionPossibilitycurve(PPC)showsthemaximumcombinationsofgoodsand
servicesthatcanbeproducedbyaneconomyinagiventimeperiodwithitslimitedresources.

Inthegraph,ifalltheresourcesareusedtoproduceSchoolsthentherewillbenoHospitals.If
youmovetotheotherendthenalltheresourceswouldbeusedtoproduceHospitalsandnot
Schoolswillbethereintheeconomy.Governmenthastomovealongthiscurveanddecidethe
bestpossiblecombinationofgoodstoproduce.ForexampleZ,showsthepossible
combinationsofSchoolbuildingsandHospitals.Thus,itisimpossibletobuildmoreSchools
withoutalsobuildingfewerHospitals.
ResourceshavetobeswitchedfrombuildingmoreHosipitalstobuildingmoreSchools.Thisis
knownasrellocationofresources.Beforetherellocationofresourceswewillhavetoconsider
thecostsofrellocatingtheseresourcesbetweenuses.Thiscostswillincluderetrainingcostof
ourworkforceandthetimeconsumedinthisrellocation.
AnypointoutsidethecurveisunattainableunlessthereisanoutwardshiftofthePPC.Thiscan
onlybepossibleifthereisanimprovementinthequantityand/orqualityoffactorsof
production.Thisisknownaseconomicgrowth.Itisaprocessofincreasingtheeconomys
abilitytoproducegoodsandservices
1.2FACTORSOFPRODUCTION:
What are factors of Production?

Resourcesavailableonearthtomakegoodsandservicestosatisfyourneedsandwantare
limited.
Ineconomics,
factorsofproduction
(orproductive
inputs
)aretheresourcesemployedto
producegoodsandservices.Thesecanbecategorisedas
Land
:Allnaturalresourcesprovidedbynaturesuchasfields,forests,oil,gas,metalsandother
mineralresources.Thepaymentforlanduseandthereceivedincomeofalandownerisrent.
Labour:
Humaneffortusedinproductionwhichalsoincludestechnicalandmarketingexpertise.
Thepaymentforsomeoneelse'slabourandallincomereceivedfromonesownlabour
is
wages
.Labourcanalsobeclassifiedasthephysicalandmentalcontributionofanemployee
totheproductionofthegood(s).
Capital:
Humanmadegoods(ormeansofproduction)whichareusedintheproductionofother
goods.Theseincludemachinery,toolsandbuildings.
Enterprise:
Theskillandrisktakingabilityofthepersonwhobringstogetheralltheother
factorsofproductiontogethertoproducegoodsandservices.Usuallytheownerorfounderofa
business.
1.3
Scarcity, Choice and Opportunity cost:
Unlimited Wants
Humanbeings,inordertosurviveneedalotofthings.Someofthesethingsareveryimportant
forourexistence.Forexample,food,clothing,water,shelterandair.Thesethingscanbe
classifiedas
Needs
.Apartfromthistherearethingswhichareneededbyusbuttheyarenot
importantforoursurvivalandwecanlivewithoutthemalso.Forexample,goingonan
expensiveholiday,owninga57inchesPlasmaTV.Theseareknownas
Wants
.Thislistis
neverendingandiscontinuouslyincreasing.
Limited Resources
Ontheotherhand,wehavelimitedresourcestoproducethesegoodsandserviceswewant.
Therearenotenoughcarfactoriestoprovidecarstoeverybodyonearth.Everythingonthis
planethassomelimitsexceptforourWants.
Whenunlimitedwantsmeetlimitedresources,itisknownasScarcity.
2.ALLOCATIONOFRESOURCES/Howthe
marketandmarketfailure:
LEARNINGOUTCOMES:
At the end of this unit students will be able to:

describetheallocationofresourcesinmarketandmixedeconomicsystems
demonstratetheprincipleofequilibriumpriceandanalysesimplemarketsituationswith
changesindemandandsupply
describethecausesofchangesindemandandsupplyconditionsandanalysesuchchangesto
showeffectsinthemarket
definepriceelasticityofdemandandsupplyandperformsimplecalculations
demonstratetheusefulnessofpriceelasticityinparticularsituationssuchasrevenuechanges,
consumerexpenditure
describetheconceptofmarketfailureandexplainthereasonsforitsoccurrence
evaluatethemeritsofthemarketsystem
defineprivateandsocialcostsandbenefitsanddiscussconflictsofinterestinrelationtothese
costsandbenefitsintheshorttermandlongtermthroughstudiesofthefollowingissues:
conservingresourcesversususingresource
publicexpenditureversusprivateexpenditure
2.1 What is demand?

Demandisdefinedaswantorwillingnessofconsumerstobuygoodsandservices.In
economicswillingnesstobuygoodsandservicesshouldbeaccompaniedbytheabilitytobuy
(purchasingpower)andisreferredtoaseffectivedemand.
Types of demand
Compositedemand:
Itiswhenagoodisdemandedfortwoormoreuses.Forexampleoilmay
beusedtorunacarorasafuelinafactory.
Jointdemand
:Itiswhentwogoodsareboughttogether.Mouseisboughtwithamousepad.
Deriveddemand:
Itiswhendemandforonegoodoccursasaresultofdemandforanother.
Example,Ifmoregoodsaremade,morelabourisneeded.Hencedemandforlabourisderived
demand.
Law of demand
Itstatesthatwhenpriceincreases,theamountdemandedwillfallandwhenpricesfall,the
amountdemandedwillrise.
ThisphenomenonwhenplottedonagraphisknownasDemandCurve.
2.2
Changes in demand | extension, contraction, fall ,
rise
:
Movement along the demand

Curve
Extension of demand
Extensionofdemandistheincreaseindemandduetothefallinprice,allotherfactors
remainingconstant.
Contraction of demand
Contractionofdemandisthefallindemandduetotheriseinprice,allotherfactorsremaining
constant.
Shift in the demand curve

Usuallydemandcurvesaredrawnbasedontheassumptionexceptforpriceallotherfactors
remainthesame.Buttheremightbeinstanceswhendemandmaybeaffectedbyfactorsother
thanprice.Thiswillresultinthechangeindemandalthoughthepricewillremainthesame.This
changeindemandmaycausethedemandcurvetoSHIFTinwardsoroutwards.
ShiftofdemandcurveOUTWARDSshowsanincreaseindemandatthesamepricelevel.Itis
knownasINCREASEINDEMAND.
ShiftofdemandcurveINWARDSshowsthatlessisdemandedatthesamepricelevel.Itis
knownasaFALLINDEMAND.
2.3
Factors affecting demand:
Factors affecting demand:
Changeinpeoplesincome:
Morethepeopleearnthemoretheywillspendandthusthe
demandwillrise.Afallinincomewillseeafallindemand.
Changesinpopulation:
Anincreaseinpopulationwillresultinariseindemandandvice
versa.
Changeinfashionandtaste:
Commoditiesorwhichthefashionisoutarelessindemandas
comparedtocommoditieswhichareinfashion.Inthesameway,changeintasteofpeople
affectsthedemandofacommodity.
ChangesinIncomeTax:
Anincreaseinincometaxwillseeafallindemandaspeoplewill
havelessmoneyleftintheirpocketstospendwhereasadecreaseinincometaxwillresultin
increaseofdemandforproductsandservicesbecausepeoplenowhavemoredisposable
income.
ChangeinpricesofSubstitutegoods:
Substitutegoodsorservicesarethosewhichcan
replacethewantofanothergoodorservice.Forexamplemargarineisasubstituteforbutter.
Thusariseinbutterpriceswillseeariseindemandformargarineandviceversa.
ChangeinpriceofComplementarygoods:
Complementarygoodsorservicesaredemanded
alongwithothergoodsandservicesorjointlydemandedwithothergoodsorservices.Demand
forcarsisaffectedthechangeinpriceofpetrol.Sameway,demandforDVDplayerswillriseif
thepricesofDVDsfall.
Advertising:
Asuccessfuladvertisingcampaignmayaffectthedemandforaproductor
service.
Climate:
Changesinclimateaffectsthedemandforcertaingoodsandservices.
Interestrates:
AfallinInterestratewillseeariseindemandforgoodsandservices.
2.4
What is supply
:
What is Supply?
Supplyreferstotheamountofgoodsandservicesfirmsorproducersarewillingandabletosell
inthemarketatapossibleprice.
Law of Supply
Itstatesthatwhenthepriceofacommodityrises,thesupplyforitalsoincreases.
Thehigherthepriceforthegoodorservicethemoreitwillbesuppliedinthemarket.The
reasonbehinditisthatmoreandmoresupplierswillbeinterestedinsupplyingthosegoodor
servicewhosepricesarerising.
2.5
Changes in supply
:
Movement along the Supply

Curve
Extension of supply
Itreferstotheincreaseinsupplyofacommoditywiththeriseinprice,otherfactorsremaining
unchanged.
Contraction of supply
Itreferstothefallinsupplyofacommoditywhenitspricesfall,otherfactorsremaining
unchanged.
Shift in Supply Curve

Whenfactorsotherthanpriceaffectthesupplyitresultsintheshiftofsupplycurve.Thesupply
curvemaymoveinwardoroutward.
Ashiftofsupplycurveoutwardstotherightwillmeananincreaseinsupplyatthesameprice
level.
Whenthesupplycurvemovesinwardstotheleftitmeansthatlessisbeingsuppliedatthe
samepricelevel.
2.6
Factors affecting supply
:
Factors affecting Supply

Priceofthecommodity:
Ariseinpricewillresultinmoreofthecommoditybeingsuppliedto
themarketandviceversa.
Pricesofothercommodities:
ForexampleifitismoreprofitabletoproduceLCDTVsthen
producerswillproducemoreLCDTVsascomparedtoPLASMATVs.Thusthesupplycurvefor
PLASMATVswillshiftinwardsi.e.afallinsupply.
Changeincostofproduction:
Increaseinthecostofanyfactorofproductionmayresultin
thedecreaseinsupplyasreducedprofitsmightseeproducerslesswillingtoproducethat
commodity.
Technologicaladvancement:
Improvementintechnologyresultsinloweringofcostof
productionandmoreprofitsfortheproducerandthusmoresupplyofthatcommodity.
Climate:
Climateandweatherconditionsaffectthesupplyofcommoditiesespeciallyagricultural
goods.
2.7
Market Equilibrium | price determination:
Market Price-Equilibrium Price

Equilibriumpricecanbedefinedasthepriceatwhichthequantitydemandedisequaltothe
quantitysupplied.
MarketPricecanbedefinedasthepriceprevailinginthemarket.Pricesaredeterminedby
supplyanddemandforces.
ItisnotnecessarythatMarketPriceisequivalenttoEquilibriumprice.
Inthegraphbelowthepointatwhichthedemandcurvemeetsthesupplycurveisthe
equilibriumprice.
Effect of change in Demand and

Supply
Demand Supply Equilibrium Equilibrium
price
quantity
Increase
Unchanged
Rise
Rise
Decrease
Unchanged
Fall
Fall
Unchanged
Increase
Rise
Rise
Unchanged
Decrease
Rise
Fall
2.8
Price Elasticity of demand:
Price Elasticity of demand

Theresponsivenessofquantitydemanded,orhowmuchquantity
demandedchanges,givenachangeinthepriceofgoodsorserviceis
knownasthepriceelasticityofdemand.
%changeinquantitydemanded
PriceElasticityofdemand(PED)=
%Changeinprice
Negative sign
Themathematicalvaluewhichisderivedfromthecalculationisnegative.Anegativevalue
indicatesaninverserelationshipbetweenpriceandthequantitydemanded.However,the
negativesignisignored.
Range of PED
ThevalueofPEDmightrangefrom0to?
LetstakealookatvarioustypesofPED.
Perfectly Inelastic demand
InthiscasethePED=0Thatmeans,anychangeinpricewillnothaveanyeffectonthe
demandoftheproduct.Orinotherwords,thepercentagechangeindemandwillbeequalto
zero.Itishypotheticalsituationanddoesnotexistinrealworld.
PerfectlyelasticdemandInthiscasethePED=?
Thedemandchangesinfinitelyataparticularprice.Anychangeinpricewillleadtofallof
demandtozero.Itishypotheticalsituationanddoesnotexistinrealworld.
HoweverNormalgoodshavevalueofPEDbetween0and?.Thesecanbeclassifiedas
InelasticdemandWhenaproducthasaPEDlessthan1andgreaterthan0,itissaidtobe
haveaninelasticdemand.Thepercentagechangeindemandislessthanthepercentage
changeinpriceoftheproduct.
Demandforaproductissaidtobe
ELASTIC
ifthepercentagechangeisdemandismorethan
thepercentagechangeinprice.
ThevalueofPEDismorethan1.

Whenthereisasmallerpercentagechangeinquantitydemandedascomparedtothe
percentagechangeinitsprice,theproductissaidtoprice
INELASTIC
.
ThevalueofPEDislessthan1.
Unitary Elastic Demand

Whenthepercentagechangeindemandisequaltothepercentagechangeinprice,theproduct
issaidtohaveUnitaryElasticdemand.Inshort,PED=1
2.9
Cross elasticity of demand
:
Cross price elasticity of demand

(XED)
Crosselasticityofdemandis
theeffectonthechangeindemandofonegoodasaresultofachange
inpriceofrelatedtoanotherproduct.
Ineconomics,itisdenotedbythesymbolXED.
Theformulaforcrosselasticityofdemandis
%changeinquantitydemandedofgoodX
Crosselasticityofdemand=
%ChangeinpriceofgoodY
InXEDitisimportanttohavethepositive/negativesigninfrontofthevalue.
IfthevalueofXEDispositive,thismeansthatthetwogoodsbeingconsideredaresubstitute
goods.
Closesubstituteshavehighpositivevalue.Example:butterandmargarine.
Iftwogoodsarecomplements,anincreaseinthepriceofonewillleadtoareductioninthe
demandfortheothertheXEDisnegative.
Veryclosecomplementshavealowernegativevalue.
Iftwogoodsareunrelated,achangeinthepriceofonewillnotaffectthedemandforthe
othertheXEDiszero.
2.10
Income elasticity of demand
:
TheIncomeElasticityofDemand(YED)measurestherateofresponseofquantitydemanddue
toaraise(orlowering)inaconsumersincome.
Incomeelasticityofdemand=
%changeinquantitydemanded
%ChangeinIncome
Normalgoods:
anincreaseinincomeleadstoanincreaseinconsumption,demandshiftsto
theright.ThusYEDispositivefornormalgoods.
Inferiorgoods:
Incomeelasticityisactuallynegativeforinferiorgoods,thedemandcurveshifts
leftasincomerises.Asincomerises,theproportionspentoncheapgoodswillreduceasnow
theycanaffordtobuymoreexpensivegoods.Forexampledemandforcheap/genericelectronic
goodswillfallaspeopleincomerisesandtheywillswitchtoexpensivebrandedelectronic
goods.
{xtypo_info}Distinguish,withreferencetoYED,betweennecessity(incomeinelastic)goodsand
luxury(incomeelastic)goods.{xtypo_info}
Basicornecessitygoodshavealowincomeelasticityi.e.,0<?<1.Quantitydemandedwillnot
increasemuchasincomeincreases(incomeelasticityforfood=0.2)
Luxurygoodshavehighincomeelasticityi.e.?>1.Quantitydemandedrisesfasterthan
income.Forrestaurantmealsincomeelasticityishigherthanforfood,becauseoftheadditional
restaurantservice.
Indifferenttypesofeconomies,thedemandforgoodsandservicesaredeterminedbythe
incomeelasticity.Aseconomiesgrow,firmswillwanttoavoidproducinginferiorgoods.The
reasonbeingasincomeincreasesmoreandmorepeoplewillswitchfrominferiorgoodsto
superiorgoods.
2.11
What is an economic system
:
What is an Economic System?

Becauseofthefactthatthereisscarcityofresourcesandunlimitedwants,itisalwaysa
problemtoallocateresourcesinanefficientmanner.Weareconstantlyfacingthreebasic
questions.Theseare:
Whattoproduce?
Howtoproduce?
Forwhomdoweproduce?
Everycommunityorcountrymustchooseanddevelopitsownwayofsolvingtheseproblems.
Thewayacountrydecideswhattoproduce,howtoproduceandforwhomtoproduceiscalled
itEconomicSystem.
ThethreeEconomicSystemsexistingare:
MarketEconomicsystem
PlannedEconomicSystem
MixedEconomicSystem
Note:
TherearenoPUREcommandeconomies
TherearenoPUREmarketeconomies
Insteadthereisacontinuumofdifferentcharacteristics
2.12
Market economic system | features, advantages
and disadvantages
:
Thecentralthoughtofthissystemisthatitshouldbetheproducersandconsumerswhodecide
howtoutilisetheresources.Thus,themarketforcesdecidewhattoproduce,howmuchto
produceandforwhomtoproduce.
Features
Allresourcesareprivatelyownedbypeopleandfirms.
Profitisthemainmotiveofallbusinesses.
Thereisnogovernmentinterferenceinthebusinessactivities.
Producersarefreetoproducewhattheywant,howmuchtheywantandforwhomtheywantto
produce.
Consumersarefreetochoose.
PricesaredecidedbythePricemechanismi.e.thedemandandsupplyofthegood/service.
Advantages
Freemarketrespondsquicklytothepeopleswants:
Thus,firmswillproducewhatpeople
wantbecauseitismoreprofitablewhereasanythingwhichisnotdemandedwillbetakenoutof
production.
WideVarietyofgoodsandservices:
Therewillbewidevarietyofgoodsandservices
availableinthemarkettosuiteverybodystaste.
Efficientuseofresourcesencouraged:
Profitbeingthesolemotive,willdrivethefirmsto
producegoodsandservicesatlowercostandmoreefficiently.Thiswillleadtofirmsusinglatest
technologytoproduceatlowercosts.
Disadvantages
Unemployment:
Businessesinthemarketeconomywillonlyemploythosefactorsof
productionwhichwillbeprofitableandthuswemayfindalotofunemploymentasmore
machinesandlesslabourwillbeusedtocutcost.
Certaingoodsandservicesmaynotbeprovided:
Theremaybecertaingoodswhichmight
notbeprovidedforbytheMarketeconomy.Thosewhichpeoplemightwanttousebutdont
wanttopaymaynotbeavailablebecausethefirmsmaynotfinditprofitabletoproduce.For
example,Publicgoods,suchas,streetlighting.
Consumptionofharmfulgoodsmaybeencouraged:
Freemarketeconomymightfindit
profitabletoprovidegoodswhichareindemandandignorethefactthattheymightbeharmful
forthesociety.
IgnoreSocialcost:
Inthedesiretomaximiseprofitsbusinessesmightnotconsiderthesocial
effectsoftheiractions.
2.13
Planned economy | features, advantages and
disadvantages
:
Inaplannedeconomy,the
factorsofproductionareownedandmanagedbythe
government
.ThustheGovernmentdecideswhattoproduce,howmuchtoproduceandfor
whomtoproduce.
Features:
Allresourcesareownedandmanagedbythegovernment.
ThereisnoConsumerorproducersovereignty.
Themarketforcesarenotallowedtosetthepriceofthegoodsandservices.
Profitinnotthemainobjective,insteadthegovernmentaimstoprovidegoodsandservicesto
everybody.
Governmentdecideswhattoproduce,howmuchtoproduceandforwhomtoproduce.
Advantages
Pricesarekeptundercontrolandthuseverybodycanaffordtoconsumegoodsandservices.
Thereislessinequalityofwealth.
Thereisnoduplicationastheallocationofresourcesiscentrallyplanned.
Lowlevelofunemploymentasthegovernmentaimstoprovideemploymenttoeverybody.
Eliminationofwasteresultingfromcompetitionbetweenfirms.
Disadvantages
Consumerscannotchooseandonlythosegoodsandservicesareproducedwhicharedecided
bythegovernment.
Lackofprofitmotivemayleadtofirmsbeinginefficient.
Lotoftimeandmoneyiswastedincommunicatinginstructionsfromthegovernmenttothe
firms.
Examples of Planned economies
NorthKorea
Cuba
Turkmenistan
Myanmar
Belarus
Laos
Libya
Iran
Iraq(until2003)
2.14
Mixed economy | features, advantages and
disadvantages
:
Mixed Economy
A
mixedeconomy
isaneconomicsystemthatincorporatesaspectsofmorethanone
economicsystem.Thisusuallymeansaneconomythatcontainsbothprivatelyownedand
stateownedenterprisesorthatcombineselementsofcapitalismandsocialism,oramixof
marketeconomyandplannedeconomycharacteristics.Thissystemovercomesthe
disadvantagesofboththemarketandplannedeconomicsystems.
Features
Resourcesareownedbothbythegovernmentaswellasprivateindividuals.i.e.coexistenceof
bothpublicsectorandprivatesector.
Marketforcesprevailbutarecloselymonitoredbythegovernment.
Advantages
Producersandconsumerhavesovereignty
tochoosewhattoproduceandwhattoconsume
butproductionandconsumptionofharmfulgoodsandservicesmaybestoppedbythe
government.
Socialcostofbusinessactivitiesmaybereduced
bycarryingoutcostbenefitanalysisby
thegovernment.
AscomparedtoMarketeconomy,amixedeconomy
mayhavelessincomeinequality
dueto
theroleplayedbythegovernment.
Monopolies
maybeexistingbut
underclosesupervision
ofthegovernment.
2.15
What is Market Failure
:
What is Market Failure?

Inamarketwherethereisequilibrium,theresourcesareallocatedinthebestpossiblemanner
andthereis'allocativeefficiency'.
AllocativeefficiencyiswhensituationwhereMarginalcostisequaltoMarginalrevenue.
However,thisisnotpossibleintherealworld.Marketfailureexistswhentheresourcesarenot
allocatedefficiently.Communitysurplusisnotmaximisedandthusthereismarketfailure.From
acommunity'spointofview,producersurplusisnotequaltoconsumersurplus.

Marketfailureisthuscausedby
Abuseofmonopolypower
Lackofpublicgoods
Underprovisionofmeritgoods
Overprovisionofdemeritgoods
Environmentaldegradation
Inequalityindistributionofwealth
Immobilityoffactorsofproduction
Problemsofinformation
Shorttermism
2.16
Social cost and Social benefit
:
Social Cost and benefits

Everybusinessactivitywhichtakesplacehassomebenefitsandcostsattachedtoit.The
benefitsgobothtotheownersofthefirmaswellastoexternalstakeholders.Inthesameway
theownersandtheexternalstakeholdershavetopayacostfortheactivitiesofthebusiness.
Talkingabout
Private cost
Itisthecostofsettingupthebusiness.Theowner(s)payforthehireofmachinery,buyingof
materials,paymentsofwages.ThisistermedasPrivateCost.
Private benefit
Themonetarybenefitsi.e.therevenueearnedbythefirmisabenefitfortheownerandis
termedasPrivatebenefit.
External Cost
Theproblemsthattheexternalstakeholdershavetobearduetothefirmsactivityareknownas
externalcost.Example:cleaningariverwhichhasbeenpollutedbyafirmswasteproducts.
Privatefirmsusuallyignoreexternalcost.
External benefits
Somefirmscancauseexternalbenefits.Thesearethebenefitstotheexternalstakeholdersdue
totheactivityoffirm.Forexample,afirmmaytrainworkers,whichmightgetthembetterwages
inotherfirms.Theseexternalbenefitsarefree.
Socialcostisthetotalcostpaidforbythesocietyduetotheactivitiesofafirm.Itisthesumof
alltheexternalcostandprivatecost.
Socialbenefitisthetotalbenefitarisingduetotheproductionofgoodsandservicesbyafirm.
Thisisequaltothetotalofprivatebenefitsandexternalbenefits.
3.
Individual as producer, consumer & brrower:
LEARNINGOUTCOMES:
describethefunctionsofmoneyandtheneedforexchange
describethefunctionsofcentralbanks,stockexchanges,commercialbanks
identifythefactorsaffectinganindividualschoiceofoccupation(wagefactorsandnonwage
factors)
describelikelychangesinearningsovertimeforanindividual
describethedifferencesinearningsbetweendifferentoccupationalgroups(male/female
skilled/unskilledprivate/publicagricultural/manufacturing/services)
describetradeunionsandtheirroleinaneconomy
describethebenefitsanddisadvantagesofspecialisationfortheindividual
analysethedifferentmotivesforspending,savingandborrowing
discusshowandwhydifferentincomegroupshavedifferentexpenditurepatterns(spending,
savingandborrowing).
3.1
What is money?
Money
isanythingthatisgenerallyacceptedaspaymentforgoodsandservicesand
repaymentofdebts.
Functions of Money
A medium of exchange
Moneyovercomestheproblemofneedingadoublecoincidenceofwants.Itcanbeusedto
exchangeandisthereforeacomparativeobject,a
tertiumcomparationis
("athirdcomparative
unit").
A unit of account
Moneyactsasameasuringunitforvalue.Thusdifferentcommoditiescanbeexpressedin
termsofmoneyuniformly.Thissimplifiesthecomparisonofthevalueoftwoproductsor
services.
A store of value
Moneycanbeusedtostorevalue.Unlikebartersystemwherethecommoditiescouldnotbe
savedovertime,moneycanbestoredasitdoesnotlosevalueovertime.
A standard of deferred payment

Moneycanbeusedtopayovertimeforcommodities.Goodsandservicescanbepaidforin
instalmentsoveraperiodoftimee.ghirepurchase.Thiswasmuchmoredifficultand
complicatedinthebartersystem.
3.2
Qualities of good money:
Followingarethequalitiesofgoodmoney:
General acceptance
Theessentialqualityofgoodmoneyisthatitshouldbeacceptabletoall,withoutanyhesitation
intheexchangeforgoodsandservices.
Portability
Itisalsoanimportantqualityofgoodmoneythatisshouldbeeasilytransferablefromoneplace
toanotherfordoingbusinessandmakingpayment.Thepapermoneyiseasiertocarrybecause
ithasminimumpossiblewaitthanmetallicmoney.
Storability
Moneyshouldbestorableanditshouldnotbedepreciatewithtime.Ifthemoneyusedis
perishableitwillloseitsvalueinfewdays.Papermoneyhasthisqualityofstorability.
Divisibility
Goodmoneyisthatwhichcouldbedividedintosmallunitswithoutlosinganyvalue.
Durability
Moneyshouldbedurable.Itshouldnotloseitsvaluewiththepassageoftime.Thegoldand
silvercoinsdonotwearoutquicklyandqualityofmoneyremainsthesame.
Economy
Itisimportantqualityofgoodmoneythatitshouldbemadeeconomically.Ifthereisheavycost
onissuingmoremoneythatisnotgoodmoney.Goodmoneyisthathaslowcostandmore
supply.Papermoneyhasthisqualityofeconomy.
3.3
Functions of Central Bank:
Central Banks
CentralBanksarechargedwithregulatingthesizeofanationsmoneysupply,theavailability
andcostofcredit,andtheforeignexchangevalueofitscurrency.Regulationoftheavailability
andcostofcreditmaybedesignedtoinfluencethedistributionofcreditamongcompetinguses.
Theprincipalobjectivesofamoderncentralbankincarryingoutthesefunctionsaretomaintain
monetaryandcreditconditionsconducivetoahighlevelofemploymentandproduction,a
reasonablystablelevelofdomesticprices,andanadequatelevelofinternationalreserves.
Function of a Central Bank

Acentralbankusuallycarriesoutthefollowingresponsibilities:
Implementationofmonetarypolicy.
Controlsthenation'sentiremoneysupply.
TheGovernment'sbankerandthebankers'bank("LenderofLastResort").
Managesthecountry'sforeignexchangeandgoldreservesandtheGovernment'sstock
register
Regulationandsupervisionofthebankingindustry
Settingtheofficialinterestratesusedtomanagebothinflationandthecountry'sexchangerate
andensuringthatthisratetakeseffectviaavarietyofpolicymechanisms
3.4
Video Series | Role of Central Bank
:
TheprimaryobjectiveoftheECBsmonetarypolicyistomaintainpricestability.TheECBaims
atinflationratesofbelow,butcloseto,2%overthemediumterm.Theoperationalframeworkof
theEurosystemconsistsofthefollowingsetofinstruments:
Open market operations

Openmarketoperationsplayanimportantroleinsteeringinterestrates,managingtheliquidity
situationinthemarketandsignallingthemonetarypolicystance.
ClickhereonmoreinformationonOpenmarketoperations
Standing facilities
Standingfacilitiesaimtoprovideandabsorbovernightliquidity,signalthegeneralmonetary
policystanceandboundovernightmarketinterestrates.Twostandingfacilities,whichare
administeredinadecentralisedmannerbytheNCBs,areavailabletoeligiblecounterpartieson
theirowninitiative.
MoreinformationonStandingfacilities
Minimum reserve requirements

Theintentoftheminimumreservesystemistopursuetheaimsofstabilisingmoneymarket
interestrates,creating(orenlarging)astructuralliquidityshortageandpossiblycontributingto
thecontrolofmonetaryexpansion.
3.5
Commercial Bank
:
Commercialbanksprovidebankingservicestobusinessesandconsumers.Theseareprofit
motivatedbusinesseswiththepowertomakeloansandacceptdeposits
fromcustomers.
Thenamecommercialbankwasfirstusedtoindicatethattheloansextendedwereshortterm
loanstobusinesses,thoughloanslaterwereextendedtoconsumers,governments,andother
nonbusinessinstitutionsaswell.Mostcommercialbanksofferavarietyofservicestotheir
customers,includingsavingsdeposits,safedepositboxes,andtrustservices.
Functions of Commercial banks

Commercialbanksareusuallyengagedinthefollowingactivities:
processingofpaymentsbywayoftelegraphictransfer,EFTPOS,internetbankingorother
means
Issuingbankdraftsandbankcheques.
acceptingmoneyontermdeposit
lendingmoneybywayofoverdraft,installmentloanorotherwise
providingdocumentaryandstandbyletterofcredit,guarantees,performancebonds,securities
underwritingcommitmentsandotherformsofoffbalancesheetexposures
safekeepingofdocumentsandotheritemsinsafedepositboxes
Currencyexchange.
Sale,distributionorbrokerage,withorwithoutadvice,ofinsurance,unittrustsandsimilar
financialproductsasafinancialsupermarket.
3.6
Stock exchange | Its role in the economy
:
Stock Exchange
Itisanorganizedmarketforthesaleandpurchaseofsecuritiessuchas
shares,stocksandbonds.
Stockexchangesarelikemarketswherebuyersandsellersofshares,stocksandbondmeet.
Theseareknownassecondarymarket.
Oncesharesareissuedbycompanies,thesecanagainbeboughtorsoldthroughaStock
exchange.
Role of Stock exchanges

Stockexchangeshavemultiplerolesintheeconomy,thismayincludethefollowing:
Raising capital for businesses

TheStockExchangeprovidescompanieswiththefacilitytoraisecapitalforexpansionthrough
sellingsharestotheinvestingpublic.
Mobilizing savings for investment

Whenpeopledrawtheirsavingsandinvestinshares,itleadstoamorerationalallocationof
resourcesbecausefunds,whichcouldhavebeenconsumed,orkeptinidledepositswith
banks,aremobilizedandredirectedtopromotebusinessactivitywithbenefitsforseveral
economicsectorssuchasagriculture,commerceandindustry,resultinginastrongereconomic
growthandhigherproductivitylevelsandfirms.
Facilitating company growth

Companiesviewacquisitionsasanopportunitytoexpandproductlines,increasedistribution
channels,hedgeagainstvolatility,increaseitsmarketshare,oracquireothernecessary
businessassets.Atakeoverbidoramergeragreementthroughthestockmarketisoneofthe
simplestandmostcommonwaysforacompanytogrowbyacquisitionorfusion.
Redistribution of wealth
Stocksexchangesdonotexisttoredistributewealth.However,bothcasualandprofessional
stockinvestors,throughdividendsandstockpriceincreasesthatmayresultincapitalgains,will
shareinthewealthofprofitablebusinesses.
Corporate governance
Byhavingawideandvariedscopeofowners,companiesgenerallytendtoimproveontheir
managementstandardsandefficiencyinordertosatisfythedemandsoftheseshareholders
andthemorestringentrulesforpubliccorporationsimposedbypublicstockexchangesandthe
government.
Creating investment opportunities for small

investors
Asopposedtootherbusinessesthatrequirehugecapitaloutlay,investinginsharesisopento
boththelargeandsmallstockinvestorsbecauseapersonbuysthenumberofsharestheycan
afford.ThereforetheStockExchangeprovidestheopportunityforsmallinvestorstoownshares
ofthesamecompaniesaslargeinvestors.
Government capital-raising for development

projects
Governmentsatvariouslevelsmaydecidetoborrowmoneyinordertofinanceinfrastructure
projectssuchassewageandwatertreatmentworksorhousingestatesbysellinganother
categoryofsecuritiesknownasbonds.ThesebondscanberaisedthroughtheStockExchange
wherebymembersofthepublicbuythem,thusloaningmoneytothegovernment.
Barometer of the economy

Atthestockexchange,sharepricesriseandfalldepending,largely,onmarketforces.Share
pricestendtoriseorremainstablewhencompaniesandtheeconomyingeneralshowsignsof
stabilityandgrowth.Aneconomicrecession,depression,orfinancialcrisiscouldeventuallylead
toastockmarketcrash.Thereforethemovementofsharepricesandingeneralofthestock
indexescanbeanindicatorofthegeneraltrendintheeconomy.
3.7
Labour market | demand and supply of labour
:
What are wages?
WagesaretherewardtothefactorofproductionLabour.Wagesarealsoregardedasthe
Priceoflabour.Wagesarepaymentsmadetolabour.Priceoflabourisdeterminedbythe
marketforcesi.e.demandandsupply.
Demand for labour

Thedemandforlabourisaderiveddemand.Itmeansthatthedemandforlabourislinkedwith
theproductsorservicestheyproduce.Ifthedemandforthosecommoditiesrisesthedemand
forlabouralsorises.
Factors affecting the demand for

labour
Derived demand
Thedemandforlabourisalwaysderivedfromthedemandforthegoodorserviceitproduces.
Thusifthedemandforaparticulargoodsorserviceincreaseitwillleadtoariseindemandfor
labourusedtoproducethosecommodities.Recentlytherehasbeenanincreaseddemandfor
softwareprofessionalsduetotheincreaseddemandforITproducts.
Wage rates
Afallinwageswillcauseanextensioninthedemandforlabourwhileariseinwagespaidto
workswillcauseacontractionindemand.
Technology used
Inindustrieswherethereisimprovedtechnologycanbeused,thedemandforlabourwilltendto
fallasproducerswillreplacelabourwithsophisticatedmachinery.
Supply of labour
Supplyoflabourincreaseswiththeriseinwagerate.Thesupplycurveoflabournormally
slopesupwardtotheright.
Factors affecting the supply of labour

Wage rate
Inmostcasesthesupplyoflabourwillincreasewiththeincreaseinwages.Thisisbecause
moreworkerswillbeattractedbyahigherwagerateandmoreovertheexistingworkforcemay
bewillingtoworkovertimeatahigherwagerate.
Size of the population

Anincreaseinpopulationwillleadtoanincreaseinsupplyoflabour.
Social factors
Withmoreandmorewomenenteringthelabourmarketthesupplyoflabourhasincreasedin
therecenttimes.
Working age
Loweringtheworkingageofwillincreasethesupplyoflabour.Anincreaseintheretirementage
willincreasethesupplyoflabour.
Educational requirement
Jobswhichneedspecialtrainingoreducationalqualificationswillseelesssupplyoflabouras
comparedtojobswhichdontneedhighlevelofeducationalqualification.
3.8
Wage rate determination
:
How to wage rate is determined?

Thewagerateinaparticularindustryisdeterminedbythemarketforcesi.e.demandand
supply.
Thepointatwhichthedemandandsupplyoflabourwillintersectwilldeterminethewagerate
forthatparticularindustry.
A rise in the demand for labour will

lead to a rise in the equilibrium wage
rate.
A fall in the supply of labour will result

in a rise in the equilibrium wage rate.
3.9
Substitution and Income effect:
Substitution and Income effect

Asthepriceofagoodisraiseditssupplyalsoincreases.Thuswegetanormalupwardsloping
curve.Inthesameway,ahigherwageratewillinfluencepeopletoworkformorehours.This
wouldmeanthattheworkerwillspendlessonleisurebecausethepriceofleisurehasgoneup,
intermsofopportunitycost.Thisisknownas
Substitutioneffect.
Asaresult,thesupplycurvewillbeslopingupwards.Butwhenthehourlyraterisesabovea
certainlevelaworkermaywishtoworkfewerhoursperweek,becausehecanearnhigher
incomewithinashorterperiodoftime.Thisisknownas
Incomeeffect.
Thiswillresultinthe
supplycurvebendingbackward.
Thisisillustratedinthediagrambelow.
3.10
Changing jobs at same wages:
Why workers change jobs at

same wages?
Therearemanytimeswhenaworkerdecidestomovetoanotherjobatthesamerateofpay
Thereasonsmightbe:
Sometimesworkersmovefromonejobtoanotheratthesamerateofpaybecausetheir
workingconditionsarenotgoodoracceptabletothemandtheyprefertochangejobeven
thoughtheyarenotpaidmore.
Theremaybetimeswhentheworkermayfindproblemsduetoextremeweatherconditionsor
geographicalfactors.
Workersalsochangejobsinexpectationofbetterprospectsofpromotionorprofessional
development,thoughtheyarenotgettinghigherwages.
Manyworkersmightfindthejourneytoworkverytiringandwouldprefertoworkclosetotheir
homes.
Someworkersmightrelocatetoalocationwhichtheypersonallylikeeventhoughtheymight
getthesamewages.
Workinginlargecompanyisconsideredasastatussymbolbymanyworkersandtheymight
changejobtoworkinalargecompany.
ManybusinessesdontpayhighwagesbutcarefortheiremployeesbyprovidingFringe
benefitssuchassubsidisedmeals,healthscheme,leisureactivities.Thismayalsoinfluencea
workertomovetothesebusinesses.
3.11
Why work at low wages?
Theremaybetimeswhenaworkerwouldbepreparedtoworkforverylowwages?
Thereasonsmightbe
Theworkermightnotbeabletogetanotherjobandhastocontendwithlowwagestillhefinds
abetterpayingjob.
Lowskilledjobsusuallyhavelowwages.Theworkermightnotbetrainedtodoskilledjoband
thusgetlowwages.
Theworkermightchoosetoworkparttimeanddoesnotmindlowpay.Forexample,astudent
workingdoingaparttimejobtoearnhispocketmoneymaynotnegotiatetoomuchforhigher
wages.
Inthesameway,aworkermightviewthejobasatemporarymeasureuntilabetterjobis
availableandmaynotnegotiateforbetterwages.
Lackofinformationisalsoanimportantfactor.Workerswhodonotknowofalternativejobs
usuallylandupgettinglowerwages.
Agemaybeafactorwhichlimitstheworkertogethigherwages.
3.12
Factors affecting individual's choice of job:
Factors affecting individual's

choice of job
Anindividualmightbeinfluencedbymanyfactorswhilechoosingajob.Thesefactorsare
dividedintowagefactorsandnonwagefactors.
Non-wage factors
Herearesomeofthenonwagefactorswhichmightinfluenceanindividual'schoice.
length/numberofholidays
workingconditions/environment
hoursofwork
promotion/careerprospects
travellingdistance
sizeofcompany
social/canteenfacilities
provisionofinsurancescheme
companycar.
3.13 Why wages differ?

Reasonsfordifferencesinremuneration:
Skills/training:
Jobsrequiringhigherlevelofskillsandtrainingusuallyfetchhigher
remuneration
Education/qualifications:
Againjobsrequiringhigherlevelofeducation/qualificationarepaid
higherremunerations.
Experience:
Peoplewithvastexperiencewillgethigherremunerationascomparedtoaperson
withlesserexperience.
Levelofresponsibility:
Jobswithgreaterresponsibilitiesareusuallypaidmore.
Geographicalarea:
Jobslocatedinurbanareasareusuallycarryinghigherremunerations
becauseofhigherlivingcostsincities.Peopleworkingintrecherousgeographicalareasmay
getextraremunerationintheformofadditionalallowances.
Tradeunionmembership:
TradeUnionmembersmightendupnegotiatingbetter
remunerationsthennontradeunionmembers.
Demandfactors:
Firmsproducinggoodsandserviceswhicharehighindemandusuallypay
betterremunerationstotheirworkers.
Supplyfactors:
Industrieswherethereisashortageofworkerswillusuallypayhigher
remunerationtoattractworkers.
3.14
Factors affecting individual expenditure
Factors affecting individual

expenditure
Level of income/wealth
Anindividualwithhighincomewillusuallyspendmorethanapersonwhoseincomeisless.
Family size and commitments

Anindividualwithalargefamilywillendupspendingmorefromhisincome.
Rates of interest
Wheninterestratesarehighpeopleusuallyspendlessassavingareamoreattractiveoption.
Availability of/knowledge about

savings schemes
Availabiliyandknoweledgeofsavingschemeswillresultinindividualsspendinglessandsaving
more.
Confidence in banking system

Astrongbankingsystemwillattractmoresavingsandhencelessspending.
Personal needs/lifestyle
Lifestyleofanindividualisamajordeterminentofhowmuchisspent.Individualsfollowing
lavishlifestyleswillendupsavinglessandspendingmore.
Health care
Individualshavinghealthissuesorpayingheavyhealthinsurancepremiumisoughttohave
moreexpenditureascomparedtoapersonhavinglessornohealthissuesornohealth
insurancepremiumliabilties.
Education
Peopleusuallywithhighereducationwillendupspendingmorecomparedtoalesseducated
person.Theprimereasonbeinganeducatedpersonwillhavevariedinterests.
Future expectations
Individualswhofeelmoreinsecuredabouttheirfuturewillsavemoreforthe'rainydays'and
hencehavewillspendless.
3.15
Savings | Factors affecting savings
Saving
Savingisincomenotspent,ordeferredconsumption.
Factors affecting savings
Interestrates:
Higherinterestrateswillencouragepeopletosavemore.
Availabilityofappropriatesavingsschemes:
Withmoreoptionstosavemoneypeoplewill
beattractedtosavemore
Advertising
of/knowledgeaboutwhatisavailableatfinancialinstitutions
Confidence
/trustinfinancialinstitutions
Sizeofrealdisposableincome:
Disposableincomeistheincomeleftafterpayingtaxes.Thus
moremoneyleftinpocketswillencouragepeopletosavemore.
Rateofinflation:
wheninflationishighpeoplehavelessmoneyleftwiththemtosavebecause
amajorpartoftheirdisposableincomewillbespenttosatisfytheirneedsandwants.
Saveforafuturepurchase:
Peoplemightsavewiththemotivetocarryoutafuturepurchase
e.g.ahouse
Precautionaryfactors:
Peoplemightbesavingforarainyday
Tastesandpreferencesofconsumers:
Italsodependsonaindividualspreference.Some
peoplesavemorethanothers.
Consumerconfidence
/expectationsaboutfuturechangesintheeconomy,e.g.risk
ofunemploymentmayleadtopeoplesavingmore
3.16
Specialisation | Divsion of labour
Throughyears,productionhasdevelopedintoacomplicatedprocessandthusbrokendown
intoaseriesofhighlyspecialisedtask.Eachtaskisthenperformedbyaworker.Thisisknown
asDivisionofLabour.
Advantages of Division of Labour
Practisemakesperfect:
Workerspecialisesinaparticulartaskandgivesinthebest,thus
producinggoodsfasterandlesswastageofmaterial.
Useofmachinery:
Specialisedmachinerycanbeusedwhichisfurtherincreasethe
productivity.
IncreasedOutput:
withimprovementinefficiencyanduseofmachineryoutputisincreased.
Savestime:
Thereisnotimewastedinswitchingofjobsandthusthemomentumofproduction
canbemaintainedwhichleadstolesswastageoftime.
Disadvantages of Division of Labour
Boredom:
Performingthesametaskoverandoveragainmayleadtoboredomfortheworkers.
Lackofvariety:
Thoughthenumberofgoodsproducedincreasesbuttheyareidenticalor
standardized.
Lowmotivationforworker:
Repeatedlyperformingthesametaskmayleadtolowmotivation
levelfortheworker.Theworkermightnothavethesenseoffulfillingacompletetaskasheis
performingonlyapartofthejob.
Lackofmobility:
Duetospecialisationworkersmightfinditdifficulttoswitchbetween
occupations.
3.17
What is a trade union ?
A
tradeunion
or
labourunion
isanorganizationofworkerswhohavebandedtogetherto
achievecommongoalsinkeyareassuchaswages,hours,andworkingconditions.Thetrade
union,throughitsleadership,bargainswiththeemployeronbehalfofunionmembersand
negotiateslabourcontractswithemployers.Thismayincludethenegotiationofwages,work
rules,complaintprocedures,rulesgoverninghiring,firingandpromotionofworkers,benefits,
workplacesafetyandpolicies.
ArallyofthetradeunionUNISONin
Oxfordduringastrike
Copyright
2006KaihsuTai
3.18
Why do workers join trade union?
Workersmightjoinatradeunionbecause
Theybelievethatthereisstrengthinnumberandtheywillbelistenedtowhentheyinagroup.
Tonegotiateabetterpay,moreholidaysandlesshoursofwork.
Topressurisetheemployertoprovidethemwithahealthierandsaferworkingenvironment.
Improvedbenefitsforretrenchedworkers
Togetthebenefitsofadvice,financialsupportandwelfareactivitiescarriedoutbyTrade
Unions.
Manyworkersmayalsojoinatradeunionbecausethereisa
closedshop
policy.
Closed Shop
Itiswhereallemployeesmustbeamemberofthesametradeunion.
Single Union agreement

Itisanagreementbetweenthemanagementandworkers,wherethemanagementdealswith
onlyonetradeunionandnoother.
Collective bargaining
Itmeansthenegotiationsbetweenoneormoretradeunionsandoneormoreemployersonpay
andconditionsofemployment.
Productivity agreement
Itisanagreementbetweenthemanagementandworkerswherebythemanagementagreesto
increasethebenefitsforworkersinreturnforanincreaseinproductivity.
3.19
Types of industrial actions
Strike:
whenemployeesrefusetowork
Picketing:
Whenemployeesstandoutsidetheworkplaceandpreventthesmoothfunctioningof
thefirm.E.g.theymaystopthemovementofLorriesinandoutoffactory.
WorktoRule:
Itiswhenworkerspurposelyfollowalltherulesinordertodelaytheprogressof
work.
Goslow:
Itiswhentheemployeesworkataveryslowpace.
Noncooperation:
Itinvolvesworkersrefusingtofollowanewprocedureorrule.
Overtimeban:
Itiswhentheemployeesrefusetoworkovertimeorforadditionalhoursofwork
apartfromtheirnormalworkinghours.
4.
Private firm as producer and employer:
Learning outcomes
Attheendofthisunitstudentswillbeableto:
describethetypeofbusinessorganisationinthepublicandprivatesectors:soleproprietors,
partnerships,privatecompanies,publiccompanies,multinationals,cooperatives,public
corporations
describeandevaluatetheeffectsofchangesinstructureofbusinessorganisations
describewhatdeterminesthedemandforfactorsofproduction
definetotalandaveragecost,fixedandvariablecostandperformsimplecalculations
analyseparticularsituationstoshowchangesintotalandaveragecostasoutputchanges
definetotalandaveragerevenueandperformsimplecalculations
describetheprincipleofprofitmaximisationasagoal
describepricingandoutputpoliciesinperfectcompetitionandmonopoly
describethemainreasonsforthedifferentsizesoffirms(sizeofmarket,capital,organisation)
describeandevaluateintegration,economiesanddiseconomiesofscale
discusstheadvantagesanddisadvantagesofmonopoly
4.1
What is a sole trader?
Thesoletraderiistheoldestandmostpopulartypeofbusiness.Itisaformofbusinesswhere
thereisonlyoneownerwhomanagesandcontrolsthebusiness.
Asoleproprietorship,isatypeofbusinessentitywhichlegallyhasnoseparateexistencefrom
itsowner.Hence,thelimitationsofliabilityenjoyedbyacorporationandlimitedliability
partnershipsdonotapplytosoleproprietors.Alldebtsofthebusinessaredebtsoftheowner.It
isa"sole"proprietorinthesensethattheownerhasnopartners.
Asoleproprietorshipessentiallymeansapersondoesbusinessinhisorherownnameand
thereisonlyoneowner.Asoleproprietorshipisnotacorporationitdoesnotpaycorporate
taxes,butratherthepersonwhoorganizedthebusinesspayspersonalincometaxesonthe
profitsmade,makingaccountingmuchsimpler.Asoleproprietorshipneednotworryabout
doubletaxationlikeacorporateentitywouldhaveto.
Asoleproprietormaydobusinesswithatradenameotherthanhisorherlegalname.Insome
jurisdictions,forexampletheUnitedStates,thesoleproprietorisrequiredtoregisterthetrade
nameor"DoingBusinessAs"withagovernmentagency.Thisalsoallowstheproprietortoopen
abusinessaccountwithbankinginstitutions.
Advantages to a Sole Proprietor

Anentrepreneurmayoptforthesoleproprietorshiplegalstructurebecausenoadditionalwork
mustbedonetostartthebusiness.Inmostcases,therearenolegalformalitiestoformingor
dissolvingabusiness.
Asoleproprietorisnotseparatefromtheindividualwhatthebusinessmakes,sodoesthe
individual.Atthesametime,alloftheindividual'snonprotectedassets(e.ghomesteador
qualifiedretirementaccounts)areatrisk.Thereisnotnecessarilybettercontrolorbusiness
administrationpossiblewithasoleproprietorship,onlyincreasedrisks.Forexample,asingle
membercorporationorlimitedcompanystillonlyhasoneowner,whocanmakedecisions
quicklywithouthavingtoconsultothers,buthastheadvantageoflimitedliability.
Furthermore,inmostjurisdictions,asoleproprietorshipfilessimplertaxreturnstoreportits
businessactivity.Typicallyasoleproprietorshipreportsitsincomeanddeductionsonthe
individual'spersonaltaxreturns.Incomparison,anidenticalsmallbusinessoperatingasa
corporationorpartnershipwouldberequiredtoprepareandsubmitaseparatetaxreturn.
Asoleproprietorshipoftenhastheadvantageoftheleastgovernmentregulation.
Disadvantages to a Sole Proprietor

Abusinessorganizedasasoletraderwilllikelyhaveahardtimeraisingcapitalsincesharesof
thebusinesscannotbesold,andthereisasmallersenseoflegitimacyrelativetoabusiness
organizedasacorporationorlimitedliabilitycompany.
Itcanalsosometimesbemoredifficulttoraisebankfinance,assoleproprietorshipscannot
grantafloatingchargewhichinmanyjurisdictionsisrequiredforbankfinancing.
Hiringemployeesmayalsobedifficult.
Thisformofbusinesswillhaveunlimitedliability,sothatifthebusinessissued,theproprietoris
personallyliable.
Thelifespanofthebusinessisalsouncertain.Assoonastheownerdecidesnottohavethe
businessanymore,ortheownerdies,thebusinessceasestoexist.
Incountrieswithoutuniversalhealthcare,suchastheUnitedStates,asoleproprietorisalso
responsibleforhisorherownhealthinsurance,andmayfinddifficultyfindinganyifoneofthe
familymemberstobecoveredhasaprevioushealthissue.
Anotherdisadvantageofasoleproprietorshipisthatasabusinessbecomessuccessful,the
risksaccompanyingthebusinesstendtogrow.Tominimizethoserisks,asoleproprietorhas
theoptionofformingacorporation.IntheUnitedStates,asoleproprietorcouldalsoforma
limitedliabilitycompany,orLLC,whichwouldgivetheprotectionoflimitedliabilitybutwouldstill
betreatedasasoleproprietorshipforincometaxpurposes.
4.2
Partnership | features, advantages,
disadvantages
:
What is a Partnership?
A
partnership
isatypeofbusinessentityinwhich
partners
(owners)sharewitheachotherthe
profitsorlossesofthebusinessundertakinginwhichallhaveinvested.Partnershipsareoften
favoredovercorporationsfortaxationpurposes,asthepartnershipstructuredoesnotgenerally
incurataxonprofitsbeforeitisdistributedtothepartners(i.e.thereisnodividendtaxlevied).
However,dependingonthepartnershipstructureandthejurisdictioninwhichitoperates,
ownersofapartnershipmaybeexposedtogreaterpersonalliabilitythantheywouldas
shareholdersofacorporation.
Advantages of Partnership
Easy
tosetup
Morecapital
canbebroughtintothebusiness.
Partnersbring
newskills
andideastoabusiness
Decisionmaking
canbemucheasierwithmorebrainstothinkaboutaproblem.
Partners
shareresponsibilities
anddutiesofthebusiness.
Divisionoflabour
ispossibleaspartnersmayhavedifferentskills.
Disadvantages of Partnership
Thereis
unlimitedliability
:Allthepartnersareresponsibleforthedebtsofthefirmandifthe
businessgoesbankrupt,allthepartnerswillhavetoclearthedebtseveniftheyhavetosellof
theirpersonalbelongings.
Disagreement
amongthepartnerscanleadtoproblemsforthebusiness.
Thereisa
limittothecapital
invested.Becauseofthefactthatmaximum20membersare
allowed,thebusinessmayfinditdifficulttoexpandafteracertainlimit.
Thereis
nocontinuity
ofexistence.Partnershipisdissolvedifoneofthepartnersdieor
resignsorbecomesbankrupt.
4.3
Partnership Deed
:
Beforestartingapartnershipbusiness,allthepartnershavetodrawupalegaldocumentcalled
a
PartnershipDeedofAgreement
.
Itusuallycontainsthefollowinginformation:
Namesofincludedparties
includesallnamesofpeopleparticipatinginthiscontract
Commencementofpartnership
includeswhenthepartnershipshouldbegin.Thedateofthe
contractisassumedasthisdate,ifnoneisgiven.
Durationofpartnership
includeshowlongthepartnershipshouldlast.Itisautomatically
assumedthatthedeathofoneofthecontractingpartiesbreaksthecontract,unlessotherwise
stated.
Businesstobedone
includesexactlywhatwillbedoneinthispartnership.Thissection
shouldbeveryparticulartoavoidconfusionandloopholes.
Nameoffirm
includesthenameofthebusinessentity.
Initialinvestments
includeshowmucheachpartnerwillinvestimmediatelyorbyinstallments.
Divisionofprofitsandlosses
includeswhatpercentagesofprofitsandlosseseachpartner
willreceive.Ifitisnotalimitedpartnership,thenthereisunlimitedliability(eachpartneris
responsibleforallpartners'debts,includingtheirown).
Endingofthebusiness
includeswhathappenswhenthebusinesswindsdown.Usuallythis
includesthreeparts:1)Allassetsareturnedintocashanddividedamongthemembersina
certainproportion2)onepartnermaypurchasetheothers'sharesattheirvalue3)allproperty
isdividedamongthemembersintheirproperproportions.
Dateofwriting
includessimplythedatethatthecontractwaswritten.
4.4
Limited Companies | types, features and
advantages
Alsoknownas
Jointstockcompanies
.Thesearebusinesswhereanumberof
owner(shareholder)poolintheirresourcestodoacommonbusinessandtosharetheprofits
andlossesproportionally.
Inalimitedcompany,thedebtsofthecompanyareseparatefromthoseoftheshareholders.As
aresult,shouldthecompanyexperiencefinancialdistressbecauseofnormalbusinessactivity,
thepersonalassetsofshareholderswillnotbeatriskofbeingseizedbycreditors.Ownershipin
thelimitedcompanycanbeeasilytransferred,andmanyofthesecompanieshavebeenpassed
downthroughgenerations.
Difference between Limited companies and

partnership
Limitedcompaniescan
issueshares
whereaspartnershipbusinesscannot.
Shareholdersenjoy
limitedliability
inLimitedcompanies.Itmeansthatifthecompany
experiencefinancialdistressbecauseofnormalbusinessactivity,thepersonalassetsof
shareholderswillnotbeatriskofbeingseizedbycreditors.Whereaspartnershipbusinessdoes
nothavelimitedliabilityexceptforlimitedpartnerships.
SeparateIdentity:
Limitedcompaniesareconsideredashumanbeingsintheeyesofthelaw.
Theyarebornanddieintheeyesoflaw.Theycansueandgetsuedontheirownname.
Continuity:
Thereiscontinuityofexistenceinlimitedcompaniesandaretheirexistenceisnot
affectedbythedeath,bankruptcyorsicknessoftheirowner.ThisisnotthecaseinPartnership
orsoletraderbusinesses.
TherearetwomaintypesofLimitedcompanies.Theseare:
PrivateLimitedCompany
PublicLimitedCompany
4.5
Private limited company | features, advantages,
disadvantages
Private limited Companies

Thesearecloselyheldbusinessesusuallybyfamily,friendsandrelatives.
Privatecompaniesmayissuestockandhaveshareholders.However,theirsharesdonottrade
onpublicexchangesandarenotissuedthroughaninitialpublicoffering.
Shareholdersmaynotbeabletoselltheirshareswithouttheagreementoftheother
shareholders.
Advantages
LimitedLiability:
Itmeansthatifthecompanyexperiencefinancialdistressbecauseofnormal
businessactivity,thepersonalassetsofshareholderswillnotbeatriskofbeingseizedby
creditors.
Continuityofexistence:
businessnotaffectedbythestatusoftheowner.
Minimumnumberofshareholdersneedtostartthebusinessareonly2.
Morecapitalcanberaisedasthemaximumnumberofshareholdersallowedis50.
Scopeofexpansion
ishigherbecauseeasytoraisecapitalfromfinancialinstitutionsandthe
advantageoflimitedliability.
Disadvantages
Growthmaybelimitedbecause
maximumshareholders
allowedareonly50.
Thesharesinaprivatelimitedcompany
cannotbesoldortransferred
toanyoneelsewithout
theagreementofothershareholders.
4.6
Public Limited Companies and Stock Exchange
please visit this link to study more about 4.6 (
https://youtu.be/GnJCOof2HJk
)
4.7
Public Limited company | features, advantages,
disadvantages
LimitedcompanieswhichcansellshareonthestockexchangearePublicLimitedcompanies.
ThesecompaniesusuallywritePLCaftertheirnames.Minimumvalueofsharestobeissued(in
UK)is50,000.
Advantages
Thereis
limitedliability
fortheshareholders.
Thebusinesshas
separatelegalentity.
Thereiscontinuityevenifanyoftheshareholdersdie.
Thesebusinessescan
raiselargecapital
sumasthereisnolimittothenumberof
shareholders.
Thesharesofthebusinessare
freelytransferable
providingmoreliquiditytoitsshareholders.
Disadvantages
Therearelotof
legalformalities
requiredforformingapubliclimitedcompany.Itiscostlyand
timeconsuming.
Inordertoprotecttheinterestoftheordinaryinvestorthereare
strictcontrolsand
regulations
tocomply.Thesecompanieshavetopublishtheiraccounts.
Theoriginalownersmay
losecontrol.
PublicLimitedcompaniesarehugeinsizeandmayface
managementproblems
suchasslow
decisionmakingandindustrialrelationsproblems.
4.8
Franchsing | features, advantages, disadvantages
What is franchising?
Theterm"franchising"candescribesomeverydifferentbusinessarrangements.Itisimportant
tounderstandexactlywhatyou'rebeingoffered.
Franchiseoccurswhentheownerofabusiness(thefranchisor)grantsalicencetoanother
personorbusiness(thefranchisee)tousetheirbusinessideaofteninaspecificgeographical
area.
Thefranchiseesellsthefranchisor'sproductorservices,tradesunderthefranchisor'strade
markortradenameandbenefitsfromthefranchisor'shelpandsupport.
Inreturn,thefranchiseeusuallypaysaninitialfeetothefranchisorandthenapercentageofthe
salesrevenue.
Thefranchiseeownstheoutlettheyrun.Butthefranchisorkeepscontroloverhowproductsare
marketedandsoldandhowtheirbusinessideaisused.
WellknownbusinessesthatofferfranchisesofthiskindincludeProntaprint,DynoRod,
McDonald'sandCoffeeRepublic.
Advantages and disadvantages of

franchising
Buyingafranchisecanbeaquickwaytosetupyourownbusinesswithoutstartingfrom
scratch.Buttherearealsoanumberofdrawbacks.
Advantages
Yourbusinessisbasedona
provenidea.
Youcancheckhowsuccessfulotherfranchisesare
beforecommittingyourself.
Youcanusearecognised
brandname
and
trademarks
.Youbenefitfromanyadvertisingor
promotionbytheownerofthefranchisethe"franchisor".
Thefranchisorgivesyou
support
usuallyincludingtraining,helpsettingupthebusiness,a
manualtellingyouhowtorunthebusinessandongoingadvice.
Youusuallyhave
exclusiverights
inyourterritory.Thefranchisorwon'tsellanyother
franchisesinthesameregion.
Financing
thebusinessmaybeeasier.Banksaresometimesmorelikelytolendmoneytobuy
afranchisewithagoodreputation.
Riskisreduced
andissharedbythefranchisor.
Ifyouhaveanexisting
customerbase
youwillnothavetoinvesttimelookingtosetoneup.
Relationshipswith
suppliers
havealreadybeenestablished.
Disadvantages
Costs
maybehigherthanyouexpect.Aswellastheinitialcostsofbuyingthefranchise,you
paycontinuingroyaltiesandyoumayhavetoagreetobuyproductsfromthefranchisor.
Thefranchiseagreementusuallyincludes
restrictions
onhowyourunthebusiness.Youmight
notbeabletomakechangestosuityourlocalmarket.
Thefranchisormightgo
outofbusiness,
or
change
thewaytheydothings.
Otherfranchiseescouldgivethebranda
badreputation
.
Youmayfinditdifficultto
sell
yourfranchiseyoucanonlysellittosomeoneapprovedbythe
franchisor.
Reducedriskmeansyoumight
notgenerate
largeprofits
.
4.9
Cooperatives | features, types, advantages,
disadvantages
What is a Co-operative?
Acooperativeisdefinedasanautonomousassociationofpersonsunitedvoluntarily
tomeettheircommoneconomic,social,andculturalneedsandaspirationsthrough
ajointlyownedanddemocraticallycontrolledenterprise
.
Acooperativemayalsobedefinedasabusinessownedandcontrolledequallybythe
peoplewhouseitsservicesorwhoworkatit.
Therearedifferenttypesofcooperatives:
Housing cooperative
Ahousingcooperativeisalegalmechanismforownershipofhousingwhereresidentseither
ownsharesreflectingtheirequityinthecooperative'srealestate,orhavemembershipand
occupancyrightsinanotforprofitcooperativeandtheyunderwritetheirhousingthrough
payingsubscriptionsorrent.
Building cooperative
Membersofabuildingcooperative(inBritainknownasaselfbuildhousingcooperative)pool
resourcestobuildhousing,normallyusingahighproportionoftheirownlabour.Whenthe
buildingisfinished,eachmemberisthesoleownerofahomestead,andthecooperativemay
bedissolved.
Retailers' cooperative
Aretailers'cooperative(knownasasecondaryormarketingcooperativeinsomecountries)is
anorganizationwhichemployseconomiesofscaleonbehalfofitsmemberstogetdiscounts
frommanufacturersandtopoolmarketing.Itiscommonforlocallyownedgrocerystores,
hardwarestoresandpharmacies.Inthiscasethemembersofthecooperativearebusinesses
ratherthanindividuals.
Utility cooperative
Autilitycooperativeisapublicutilitythatisownedbyitscustomers.Itisatypeofconsumers'
cooperative.IntheUS,manysuchcooperativeswereformedtoprovideruralelectricaland
telephoneservice.
Worker cooperative
Aworkercooperativeorproducercooperativeisacooperativethatisownedanddemocratically
controlledbyits"workerowners".Therearenooutsideownersina"pure"workers'cooperative,
onlytheworkersownsharesofthebusiness,thoughhybridformsinwhichconsumers,
communitymembersorcapitalistinvestorsalsoownsomesharesarenotuncommon.
Membershipisnotcompulsoryforemployees,butgenerallyonlyemployeescanbecome
members.However,inIndiathereisaformofworkers'cooperativewhichinsistsoncompulsory
membershipforallemployeesandcompulsoryemploymentforallmembers.Thatistheformof
theIndianCoffeeHouses.ThissystemwasadvocatedbytheIndiancommunistleaderA.K.
Gopalan.
Consumers' cooperative
Aconsumers'cooperativeisabusinessownedbyitscustomers.Employeescanalsogenerally
becomemembers.Membersvoteonmajordecisions,andelecttheboardofdirectorsfrom
amongsttheirownnumber.AwellknownexampleintheUnitedStatesistheREI(Recreational
EquipmentIncorporated)coop,andinCanada:MountainEquipmentCoop.
Theworld'slargestconsumers'cooperativeistheCooperativeGroupintheUnitedKingdom,
whichoffersavarietyofretailandfinancialservices.TheUKalsohasanumberofautonomous
consumers'cooperativesocieties,suchastheEastofEnglandCooperativeSocietyand
MidcountiesCooperative.
MigrosisthelargestsupermarketchaininSwitzerlandandkeepsthecooperativesocietyasits
formoforganization.
CoopisanotherSwisscooperativewhichoperatesthesecondlargestsupermarketchainin
SwitzerlandafterMigros.
Agricultural cooperative
Agriculturalcooperativesarewidespreadinruralareas.
IntheUnitedStates,therearebothmarketingandsupplycooperatives.Agriculturalmarketing
cooperatives,someofwhicharegovernmentsponsored,promoteandmayactuallydistribute
specificcomodities.Therearealsoagriculturalsupplycooperatives,whichprovideinputsinto
theagriculturalprocess.
InEurope,therearestrongagricultural/agribusinesscooperatives,andagriculturalcooperative
banks.Mostemergingcountriesaredevelopingagriculturalcooperatives.
4.10
Multinational businesses
What are Multinational

Businesses?
Businesseswhichhavetheiroperations,factoriesandassemblyplantsinmorethan
onecountryareknownasMultinationalBusiness.Theyarealsoknownas
Transnationalbusinesses.
Advantages of being a Multinational
Multinationalcansetuptheirbusinessoperationsincountrieswherethe
labourandraw
materialischeaper
,whichcangivethemcostadvantageintheinternationalmarket.
Multinationalhaveaccesstomanymarketswhich
spreadstheriskoffailure
.Ifanyproduct
maynotbesuccessfulinaparticularmarket,itmightbesuccessfulinanother.
MNCsproduceinlargequantitiesthusachievinggreater
economiesofscales.
Amultinationalbusinessis
lessvulnerabletotradebarriers
.MNCssetuptheirlocal
operationsincountrieswherethereispotentialmarketforthemandgetawaywithimportduties
andrestrictions.
MNCscanlocatetheiroperationsnearthepotentialmarketwhichresultsin
lower
transportationcost
.
Advantages of Multinational to the host

country
Multinationalscreate
employment
.
Theybring
newtechnologyandtechniques
ofproduction.
MNCsusuallyprovide
training
totheirworkerwhichresultsinbetterskillsforthecountrys
workforce.
Multinationalbusinessesusuallyproduceinlargequantitiesandexporttoothercountrieswhich
canresultinvaluable
foreignexchange
forthehostcountry.
Theypayhuge
taxestothegovernment
whichcanbeusedforthedevelopmentofthehost
country.
4.11
Sources of finance
Abusinessmighthaveaccesstovarioussourcesoffinancingitsneeds.Thesesourcesof
financecanbeclassifiedas:
Internal and external
Internal:
thisismoneyraisedfrominsidethebusiness.Itincludes
Salesofassets
:Businessmightselloffold,obsoleteassetswhicharenolongerusedbythe
businesstoraiseadditionalcashforthebusiness.
Advantage
Betteruseofcapital
Disadvantage
Anewbusinessmightnothaveany
oldorobsoleteassets
Retainedprofits:
Businesses(especiallylimitedcompanies)usuallykeepsomepartofthe
profiteveryyearforfutureuse.Thisisalsoknownasploughedbackprofit.Overaperiodof
timeitcantotaluptoahugeamountwhichcanbeusedforfinancingthebusiness.
Advantage Disadvantage
Doesnotincrease
liabilities
Noneedtopayinterest
Notavailabletonewbusinesses
Reductioninworkingcapital
:Cuttingthestocklevelscanalsohelpthebusinesstoraise
additionalcash.
Advantage Disadvantage
Costsrelatedtostorageof Mayleadtoshortageofstock
stockisreduced
andlossofsales
4.12
External sources of finance | Long term, medium
and short term
External sources of finance

External:Thisisthemoneyraisedfromoutsidethebusiness.Itincludes
Short Term
Bankoverdraft:
Bankoverdraftisafacilitygivenbybankstoitsbusinesscustomers,people
havingcurrentaccounts.Throughthisfacilitythecustomerscanoverdrawtheiraccountstoa
greatervaluethanthebalanceintheaccount.Tooverdrawnamountisagreedinadvancewith
thebankmanager.Thebankassignsalimittooverdrawfromtheaccountandthebusinesscan
meetitsshorttermliabilitiesbywritingchequestotheextentoflimitallowed.
Advantage
Noneedforcollateralsorsecurity.
Moreflexibleandtheoverdraft
amountcanbeadjustedevery
monthaccordingtoneeds.
Disadvantage
Interestratesareusuallyvariable
andhigherthanbankloans
Cashflowproblemscanariseifthe
bankasksfortheoverdrafttobe
repaidatashortnotice.
TradeCredit:
Usuallyinbusinessdealingsuppliergiveagraceperiodtotheircustomerstopay
forthepurchases.Thiscanrangefrom1weekto90daysdependinguponthetypeofbusiness
andindustry.
Advantage
Disadvantage
Nointeresthastobepaid.
Thebusinessmaynotgetcash
discounts.
Bydelayingthepaymentofbillsforgoodsorservicesreceived,abusinessis,ineffect,
obtainingfinancewhichcanbeusedformoreimportantexpenditures.
Factoringofdebts:
Itinvolvesthebusinesssellingitsbillsreceivabletoadebtfactoring
companyatadiscountedprice.Inthiswaythebusinessgetaccesstoinstantcash.
Medium Term
Hirepurchase:
Itinvolvespurchasinganassetpayingforitoveraperiodoftime.Usuallya
percentageofthepriceispaidasdownpaymentandtherestispaidininstallmentsforthe
periodoftimeagreedupon.Thebusinesshastopayaninterestontheseinstallments.
Leasing:
Leasinginvolvesusinganasset,buttheownershipdoesnotpasstotheuser.
Businesscanleaseabuildingormachineryandaperiodicpaymentismadeasrent,tillthetime
thebusinessusestheassets.Thebusinessdoesnotneedtopurchasetheasset.
Advantage
Disadvantage
Thebusinesscanbenefitfromtheasset Thetotalcostofleasingmayendup
withoutpurchasingit.
higherthanthepurchasingofasset
Usuallythemaintenanceoftheassetis
donebytheleasingfirm.
Mediumtermbankloan:
Abankloanfor1yearto5years.
Longterm
LongtermBankloan:
borrowingfrombankforalimitedperiodoftime.Thebusinesshasto
payaninterestontheborrowing.Thisinterestmaybefixedorvariable.Businessestakingloan
willoftenhavetoprovidesecurityorcollateralfortheloan.
Issueofshare:
Itisapermanentsourceoffinancebutonlyavailabletolimitedcompanies.
Publiclimitedcompaniescansellfurthersharesuptothelimitoftheirauthorizedsharecapital.
Privatelimitedcompaniescansellfurthersharestoexistingshareholders.
Advantage
Permanentsourceofcapital.
Incaseofordinarysharesbusinesswill
onlypaydividendsifthereisaprofit.
Disadvantage
Dividendshavetobepaidtothe
shareholders.
Debentures:
A
debenture
isdefinedasacertificateofacceptanceofloanswhichisgiven
underthecompany'sstampandcarriesanundertakingthatthedebentureholderwillgetafixed
return(fixedonthebasisofinterestrates)andtheprincipalamountwheneverthedebenture
matures.Itisissuedforalongperiodsoftime.Debenturesaregenerallyfreelytransferrableby
thedebentureholder.Debentureholdershavenovotingrightsandtheinterestgiventothemis
achargeagainstprofit.
Salesandleaseback:
thisinvolvesafirmsellingitsassetsorpropertytoaninvestment
companyandthenleasingitbackoveralongperiodoftime.Thebusinessthuscanusethe
assetwithoutpurchasingitandcanusetherevenueearnedfromitssaleforotherpurposes.
4.13
What are resources
Resourcesofaneconomyarethefactorsofproductionortheinputswhichareusedtoproduce
anoutputi.e.goodsandservices.Thesecanbeclassifiedintofourcategories.
Land
Landincludesallresourcesfoundintheseaandonland.Theyarealsoknownasnatural
resources.Landissaidtobeimmobileandislimitedinsupply.Landissubjecttothelawof
diminishingreturns.
Lawofdiminishingreturnsstatesthatgivenafixedfactor,variablefactorsaddedtoitwill
eventuallyleadtoafallinmarginalproduct.
Labour
Labourreferstoinputofhumanefforts,bothphysicalandmental.However,onlythosehuman
effortsareconsideredineconomicsaslabourwhichhasthesolepurposeofreceivingrewards.
Anykindoflabourdoneforpleasureiscannotbeconsideredaslabour.
Labourhasgreatermobilitythanlandbutislessmobilethancapitalandcannotbestored.
Mobility of labour
Itreferstothemovementoflabour.Therearetwotypesoflabourmobility.Theseare:
Geographicalmobility
Itisthemovementoflabourfromplacetoanother.Buttherearemanybarrierstogeographical
mobilitywhichareasfollows:
1. Workersmayhaveinsufficientinformationorunawarenessoftheopportunitiesexistingin
differentplaces.
2. Sometimesagemaybeafactor.Olderworkersaremoreimmobilethanyoungerones.
3. Socialtiesorsentimentalreasonmaydiscourageworkerstomovetootherplaces.
Occupationalmobility
Itreferstothewillingnessandmobilityofworkertochangefromoneoccupationtoanother.
1. Labourmaylacknecessaryskillsandqualificationsneededtorelocatetoanotherjob.
2. Certainoccupationmayhaveentryrequirementsandrestrictions.
3. Personallikingoftheoccupationmaydiscourageaworkertomovetootheroccupations.
4. Someworkersmaybetoocautiousintakingriskandmovingtoanotheroccupation.
Capital
Thesearemanmaderesourceswhichhelptoproducemanyothergoodsandservices.
Itcanbeclassifiedas:
Fixedcapital
Thesearephysicalassetswhichdonotvaryasthelevelofoutputvariesanditsformdoesnot
changeinthecourseofproduction.Examplesincludefactories,machines,anddockyardsand
soon.
Workingcapital
Itconsistsofstocksofrawmaterialsandstocksofsemifinishedandfinishedgoodsawaiting
purchaseofconsumers.Itvarieswiththelevelofoutput.Thus,whenoutputincreases,the
workingcapitalalsoincreases.
Entrepreneur
Entrepreneuristhepersonwhobringsallthefactorsofproductiontogetherandorganisesthem
toproducegoodsandservices.Anentrepreneurdecideswhattoproduce,howtoproduceand
forwhomtoproduce.
4.14
Location decisions
Factors affecting the choice of

location of a firm
Near to the Market
Themostimportantfactoraffectingthelocationofafirmisthenearnesstothemarket.Every
businesswantstobeneartoitscustomers.Thisisespeciallytrueforretailbusinesses.
Near to the raw materials

Incaseofmanufacturingfirmitismoreeconomicaltolocateneartothesourceofrawmaterial.
Thisresultsinlowtransportationcost.Iftheoutputofthefirmsismoreexpensivetotransport
thanitsinput,itisabulkdecreasingindustryandismorelikelytolocateneartothemarket.For
example,brewingindustrieslocateneartothemarketbecauseitisexpensivetotransport
finishedproduct.
Ontheotherhand,iftherawmaterialusedbythefirmisbulkyandexpensivetotransport,itisa
bulkdecreasingindustry.Inthiscase,thefirmwouldlocateneartotherawmaterial.
Supply of labour
Ifafirmrequiresskilledlabour,thanthelocationdecisionmightbeaffectedbyavailabilityof
skilled,cheaplabour.ManymultinationalfirmsarelocatingtheirproductionfacilitiesinSouth
EastAsiancountriesjustbecausethelabourischeapinthesecountries.
Availability of cheap land

Firmswhichneedlargeareasoflandmightconsidercostoflandbeforelocating.Automobile
manufacturingplantsneedlargechunksofland.
Traditional locations
Locatinginanareathatcontainssimilarbusinesses,suppliersandmarketsmayalsobea
considerableadvantage.InIndonesia,mostofthewoodcraftbusinessesprefertolocateinBali
becauseofitslongreputationofproducingexcellentwoodcraft.
Amenities
Basicamenitiessuchasgas,electricity,water,wastedisposalanddrainagemayalsobe
considered.
Climate
Manyproductionprocessesmaybeaffectedbytheclimaticconditionsalso.Chipmanufacturers
prefertolocateindryareas,e.g.SiliconValley.
Safety requirements
Someproductsmaybehazardousforthecommunityandthusneedtobelocatedawayfrom
highdensitypopulation.Forexample,Nuclearpowerplants,Chemicalplants.
Managements Preference
Inmanycasesthelocationofafirmmaybeinfluencedbythelikesanddislikesofits
management.
Governments Influence
Governmentalsoinfluencesthelocationdecisionsofthefirms.Governmentmaygivespecial
incentivestofirmswhichlocateinunderdevelopedorhighunemploymentareasofthecountry.
TheseincentivesmaybeintheformofTaxholidays,subsidies,cheaplandetc.Afirminorder
toharnesstheseincentivesmaylocateintheseregions.
4.15
Capital Intensive and Labour Intensive
Capital Intensive Vs. Labour

Intensive
Abusinessis
capitalintensive
ifitrequiresheavycapitalinvestmentinbuyingassetsrelative
tothelevelofsalesorprofitsthatthoseassetscangenerate.
Acapitalintensivebusinesswilltypicallyhavesomemixtureofthefollowingcharacteristics:
highdepreciationcosts
highbarrierstoentry
largeamountsoffixedassetsonthebalancesheet.
A
labourintensivebusiness
isoneinwhichthemaincostisthatoflabour,anditishigh
comparedtosalesorvalueadded.
Justacapitalintensivebusinessmayattempttoreduceoperationalgearingby,forexample,
leasingorrentingassets,alabourintensiveonemaytrytoreduceoperationalgearingby
outsourcingorautomation.
4.16
Meaning of Productivity
What is meant by Productivity?

Productivityistheratioofoutputstoinputs.Itreferstothevolumeofoutputproducedfroma
givenvolumeofinputsorresources.Ifthefirmbecomesmoreproductive,thenithasbecome
moreefficient,sinceproductivityisanefficiencymeasure.Productivitycanbe:
Labour productivity
Totaloutputinagiventimeperiod
= Outputperworker
Quantityoflabouremployed
Capital productivity
Totaloutputinagiventimeperiod
= Outputpercapitalinput
QuantityorValueofCapitalemployed
How to improve productivity?

Productivitycanbeimprovedby:
Raisingtheskillleveloftheworkersthroughtraining
Usingmoretechnologicallyadvancedequipmentintheproductionprocess.
Improvingthemotivationleveloftheemployees
Bymanagingtheavailableresourceinamoreefficientway.
4.17
Types of cost | Fixed, variable, average, marginal
cost
What is Cost?
Allpaymentsmadebyafirmintheproductionofagoodorservicearecalledthecostof
production.Thesecostscanbeclassifiedindifferentways.
Types of costs
Fixed Cost and Variable cost
Fixedcosts
areexpensesthatdonotchangeinproportiontotheactivityofabusiness,
within
therelevantperiodorscaleofproduction
.Forexample,aretailermustpayrentandutilitybills
irrespectiveofsales.
Variablecostsbycontrastchangeinrelationtotheactivityofabusinesssuchassalesor
productionvolume.Intheexampleoftheretailer,variablecostsmayprimarilybecomposedof
inventory(goodspurchasedforsale),andthe
costofgoods
isthereforealmostentirely
variable.
Inmanufacturing,directmaterialcostsareanexampleofavariablecost.Anexampleof
variablecostsisthepricesofthesuppliesneededtoproduceaproduct.
Acompanywillpayforlinerentalandmaintenancefeeseachperiodregardlessofhowmuch
powergetsused.Andsomeelectricalequipment(airconditioningorlighting)maybekept
runningeveninperiodsoflowactivity.Theseexpensescanberegardedasfixed.Butbeyond
this,thecompanywilluseelectricitytorunplantandmachineryasrequired.Thebusierthe
company,themoretheplantwillberun,andsothemoreelectricitygetsused.Thisextra
spendingcanthereforeberegardedasvariable.
Alongwithvariablecosts,fixedcostsmakeuponeofthetwocomponentsoftotalcost.Inthe
mostsimpleproductionfunction,totalcostisequaltofixedcostsplusvariablecosts.
Itisimportanttounderstandthatfixedcostsare"fixed"onlywithinacertainrangeofactivityor
overacertainperiodoftime.Ifenoughtimepasses,allcostsbecomevariable.
Inretailthecostofgoodsisalmostentirelyavariablecostthisisnottrueofmanufacturing
wheremanyfixedcosts,suchasdepreciation,areincludedinthecostofgoods.
Althoughtaxationusuallyvarieswithprofit,whichinturnvarieswithsalesvolume,itisnot
normallyconsideredavariablecost.
Variablecosts
areexpensesthatchangeinproportiontotheactivityofabusiness.Alongwith
fixedcosts,variablecostsmakeupthetwocomponentsoftotalcost.
DirectCosts
,however,
arecoststhatcanbeassociatedwithaparticularcostobject.Notallvariablecostsaredirect
costs,howeverforexample,variablemanufacturingoverheadcostsarevariablecoststhatare
notadirectcosts,butindirectcosts.
Forexample,amanufacturingfirmpaysforrawmaterials.Whenactivityisdecreased,lessraw
materialisused,andsothespendingforrawmaterialsfalls.Whenactivityisincreased,more
rawmaterialsisusedandspendingthereforerises.
Average cost per unit

Averagecost
isequaltototalcostdividedbythenumberofgoodsproduced.
Total cost/output
Itisalsoequaltothesumofaveragevariablecosts(totalvariablecostsdividedbyOutput)
Marginal cost
Marginalcost
isthechangeintotalcostthatariseswhenthequantityproducedchangesby
oneunit.Ingeneralterms,marginalcostateachlevelofproductionincludesanyadditional
costsrequiredtoproducethenextunit.So,themarginalcostsinvolvedinmakingonemore
woodentablearetheadditionalmaterialsandlabourcostincurred.
4.18
Production in Short run
Shortrunisaperiodoftimewhenatleastoneofthefactorsofproductionisfixed.Usually
labouristheeasiestfactortochange.Thusinshortrunafirmcanincreaseproductiononlyby
employingmorelabourbecausenomorelandorcapitalisavailable.Thus,labouristhevariable
factorintheshortrun.
'Shortrun'forvariousfirmsisdifferent.Itmaybefewdaysforsomeindustriesandmaybe
yearsforsomeindustries.
Production function
Itistheequationthatexpressestherelationshipbetweenthequantitiesofproductivefactors
(suchaslabourandcapital)usedandtheamountofproductobtained.Itstatestheamountof
productthatcanbeobtainedfromeverycombinationoffactors,assumingthatthemostefficient
availablemethodsofproductionareused.
Principlesofeconomics,LibbyRittenberg
Law of increasing returns

Thisstatesthatasmoreunitsofvariablefactorareaddedtoafixedfactor,outputwillfirstrise
morethanproportionately.Thus,thefirmexperiencesincreasingreturns.
Law of diminishing returns

Thelawstatesthatasmoreunitsofavariablefactorareaddedtoafixedfactor,therewillcome
apointwhenoutputwillriselessthanproportionately.Thefirmexperiencesdiminishingreturns.
Principlesofeconomics,LibbyRittenberg
Thisgraphshowsfirm'stotalproductcurvewiththerangesofincreasingmarginalreturns,
diminishingmarginalreturns,andnegativemarginalreturnsmarked.Thisfirmexperiences
increasingmarginalreturnsbetween0and3unitsoflaborperday,diminishingmarginalreturns
between3and7unitsoflaborperday,andnegativemarginalreturnsbeyondthe7thunitof
labor.
Marginal product
Marginalproductoflabouristhechangeintotaloutputwhenonemoreworkerisemployed.
Itcanbecalculatedas
Changeintotalproduct
Changeinnumberofworkers
Average product
Averageproductoflabouristhetotalproductdividedbythenumberofworkersproducingit.In
otherwords,outputeachworker.
Totalproduct
Numberofworkers
4.19
Diagrams |Cost curves in short run
Total Fixed Cost
Totalfixedcostwillremainconstanteventhoughoutputchanges.
Average Fixed Cost

Averagefixedcostwillfallasoutputincreases.
Total Variable cost

Asoutputincreases,totalvariablecostwillincreases.
Average Variable Cost

TheaveragecostcurveisUshaped.Asoutputincreases,averagevariablecostfallsbecause
ofspreadingofcost.
Total Cost
Itcanbedefinedastotalvariablecostplustotalfixedcost.
Marginal Cost
Marginalcostwillinitiallyfall,reachtheminimumandfinallyrise.
4.20
Production in the Long run | Cost curves
Production in the Long run
Inthelongruntherearenofixedfactorsofproduction.Allfactorsarevariable,andfirmsare
thereforeabletoadjusttheirinputofallfactorsofproduction.Theprocessofchangeofinputof
allfactorsofproductionisthechangeinthe
scaleofproduction
.
Whenafirmchangesitinputsbutthechangeinoutputismorethanthechangeinput,thefirms
issaidtobeexperiencing
increasingreturnstoscale.
Ontheotherhand,whenafirmsoutput
experiencesalessproportionateincreaseascomparedtotheincreaseininput,itissaidto
be
diminishingreturnstoscale
.
Afirmexperiencinganincreasedreturntoscalewillfinditsaveragecostsfalling.Thisistermed
as
economiesofscale
.Whereas,ariseinaveragecostofproductionduetodiminishingreturn
toscalearetermedas
diseconomiesofscale.
Long run cost curves

InthelongrunallthefactorsofproductionareVariableandafirmcanexpandordecreasethe
levelofoutputbyvaryingitsvariablefactors.
Thereisnotimedimensionastodeterminewhetheritisshortrunorlongrun.Whenthefirm
canalteritfixedfactors,itissaidtobealongrun.
Long run Total Cost (LRTC)

Itisthetotalcostincurredasaresultofproducingacommodityinthelongrun.Itcanstartfrom
0asthereisnotfixedcost.
Longruntotalcostwillinitiallyincreaseatadecreasingrateandthenatanincreasingratedue
tolawofreturntoscale.
Long run Average Cost (LRAC)

ItisUshaped.Inthelongrun,asoutputincrease,theaveragecostwillfallduetointernal
economiesofscale.Asoutputincreasesfurther,averagecostwillremainconstantandifthe
outputisincreasedfurther,theaveragecostwillincreaseagainduetointernaldiseconomiesof
scale.
4.21
Economies of scale
What are economies of scale?

Economiesofscalearethecostadvantagesthatenterprisesobtaindue
tosize,withcostperunitofoutputgenerallydecreasingwith
increasingscaleasfixedcostsarespreadoutovermoreunitsofoutput.
Type of economies of scale

Thesecanbeclassifiedintofivecategories:
Purchasing economies:
Whenbusinessbuysinlargequantities,theyareabletogetdiscountsandspecialprices
becauseofbuyinginbulk.Thisreducestheunitcostofrawmaterialsandafirmgetsan
advantageoverothersmallerfirms.
Marketing economies:
Thecostofadvertisinganddistributionrisesatalowerratethanrisesinoutputandsales.In
proportiontosales,largefirmscanadvertisemorecheaplyandmoreeffectivelythantheir
smallerrivals.
Financial economies:
Alargercompanytendstopresentamoresecureinvestmenttheyfinditeasiertoraise
finance.Banksandotherlendinginstitutionstreatlargefirmsmorefavorablyandthesefirmsare
inapositiontonegotiateloanswithpreferentialinterestrates.Further,largecompaniescan
issuesharesandraiseadditionalcapital.
Managerial economies:
Alargecompanybenefitsfromtheservicesofspecialistfunctionalmanagers.Thesefirmscan
employanumberofhighlyspecializedmembersonitsmanagementteam,suchas
accountants,marketingmanagerswhichresultsinbetterdecisionbeingtakenandreductionin
overallunitcosts.
Technical economies:
Inlargescaleplantsthereareadvantagesintermsoftheavailabilityanduseofspecialist,
indivisibleequipmentwhicharenotavailabletosmallfirms.Largemanufacturingfirmsoftenuse
flowproductionmethodsandapplytheprincipleofthedivisionoflabour.Thisuseofflow
productionandthelatestequipmentwillreducetheaveragecostsofthelargemanufacturing
businesses.
4.22
Diseconomies of Scale
Diseconomies of Scale
Thesearethedrawbacksofbeingabigbusiness.Inotherwords,allthefactorsthoseleadtoan
increaseinaveragecostsasabusinessgrows.
Diseconomiesincludethefollowing:
Human relations
Itisdifficulttoorganizelargenumberofemployees.Thebusinessmightfinditselfspendingtoo
muchoncommunication.Theremightbelongchainsofcommandandinstructionswilltakea
longtoreachthedesireddestination.Moreovertheremightbedistortioninthemessage.There
willbelesspersonalcontactbetweendecisionmakersandstaff,whichcanleadtolowlevelof
morale,lackofmotivationandultimatelyindustrialrelationsproblems.
Decisions and co-ordinations

Therecouldbecoordinationproblems.Withalargerhierarchy,boththequalityofinformation
reachingfromthemanagementtotheworkersandviceversacouldleadtopoordecision
making.Therewouldbeconsiderablepaperworkandmanymeetings.
External diseconomies
Recently,consumershavebecomemoreconsciousoftheactivitiescarriedoutbybigfirms.
Therefore,bigfirmshavetospendalotofmoneyonenvironmentalissuesandsocial
responsibilityact.Theseultimatelyleadtohigheraveragecostperunit.
4.23
What is revenue ?
What is revenue?
Itisthevalueofsalesofafirmsproducts.Itistheincomefromsalesofgoodsandservices.
QuantitysoldXPrice
TotalRevenue
isalsoknownasturnover.
Averagerevenuereferstotherevenueofthefirmbysellingperunitcommodity.Itiscalculated
as:
Totalrevenue/numberofproductssold
MarginalRevenue
isthechangeinthetotalrevenuefromthesaleofanadditionalunit.
Itiscalculatedas
Changeintotalrevenue/changeinquantity
4.24
Perfect Competition | Characteristics, Merits and
Demerits
Perfect Competition
Asituationwheretherearemanyfirmscompetinginthemarket,thereislotofcompetitionand
thefirmproducingthebestqualitygoodsandservicesatlowestpricewillbesuccessful.
Characteristics of Perfect Competition

Homogeneous products
Allfirmsproducetheidenticalproducts.
Many buyers in the market

Thoughtherearemanybuyersinthemarkettheycannotcontroltheprices.Theyareprice
takers.Thepricesaresetthroughthepricemechanism.
Many sellers in the market

Therearemanysellersinthemarket.Thereisnodominatingfirm.Allfirmsareusuallysmall
andarepricetakers.
Perfect information
Allbuyersandsellershaveperfectknowledgeaboutthepricesinthemarket.
Freedom of entry and exit

Therearenobarrierstoentryandexitforfirms.Firmsarefreetoenterorexitthemarketattheir
discretion.Ifafirmismakingprofitotherfirmsmayenterthemarkettemptedbytheprofits.
No preferential treatment
Thereisnopreferencegiventoanyfirmbygovernmentoranybody.Allfirmsareequally
treated.
Merits of Perfect Competition
Thereisoptimalallocationofresourcesinthelongrun.
Maximumeconomicefficiencyasnosinglefirmcancontrolprices.Thereisnowastefulexcess
capacity.
Advertisingandpromotionalexpensesareeliminatedbecauseproductishomogeneousand
thereisperfectknowledgeamongtheconsumers.
Demerits of Perfect Competition
NoResearchandDevelopmentundertakenastheproductsarehomogeneous.
Pricesinperfectcompetitionarecontrolledbythepricemechanism.Itmayleadtoinstable
incomeandpricesduetofrequentchangeinequilibriumprices.
4.25
Monopoly | features, advantages, disadvantages
Monopoly
Monopolymeansamarketwherethereisonlyonesellerofaparticulargoodorservice.
Characteristics
Onlyonesinglesellerinthemarket.Thereisnocompetition.
Therearemanybuyersinthemarket.
Thefirmenjoysabnormalprofits.
Thesellercontrolsthepricesinthatparticularproductorserviceandisthepricemaker.
Consumersdonthaveperfectinformation.
Therearebarrierstoentry.Thesebarriersmanybenaturalorartificial.
Theproductdoesnothaveclosesubstitutes.
Advantages of monopoly
Monopolyavoidsduplicationandhencewastageofresources.
Amonopolyenjoyseconomicsofscaleasitistheonlysupplierofproductorserviceinthe
market.Thebenefitscanbepassedontotheconsumers.
Duetothefactthatmonopoliesmakelotofprofits,itcanbeusedforresearchanddevelopment
andtomaintaintheirstatusasamonopoly.
Monopoliesmayusepricediscriminationwhichbenefitstheeconomicallyweakersectionsof
thesociety.Forexample,Indianrailwaysprovidediscountstostudentstravellingthroughits
network.
Monopoliescanaffordtoinvestinlatesttechnologyandmachineryinordertobeefficientandto
avoidcompetition.
Disadvantages of monopoly
Poorlevelofservice.
Noconsumersovereignty.
Consumersmaybechargedhighpricesforlowqualityofgoodsandservices.
Lackofcompetitionmayleadtolowqualityandoutdatedgoodsandservices.
5. Role of government in an economy
Learning Outcomes
Attheendofthisunitstudentswillbeableto
describethegovernmentasaproducerofgoodsandservicesandasanemployer
describetheaimsofgovernmentpolicies,suchasfullemployment,pricestability,economic
growth,redistributionofincome,balanceofpaymentsstability
discussthepossibleconflictsbetweengovernmentaims
describethetypesoftaxation(direct,indirect,progressive,regressive,proportional)andthe
impactoftaxation
discussthegovernmentsinfluence(regulation,subsidies,taxes)onprivateproducers.
5.1
Economics objectives of Government
Mostofthegovernmentsroundtheworldhavefourmainobjectives.Theseare
Keepinflationundercontrol
Maintainalowlevelofunemployment
Achieveahighlevelofeconomicgrowthrate
Maintainahealthybalanceofpayments.
5.2
Government spending or expenditure
Governmentspending
or
governmentexpenditure
isclassifiedbyeconomistsintothree
maintypes.
Governmentpurchasesofgoodsandservicesforcurrentuseareclassed
as
government
consumption.
Governmentpurchasesofgoodsandservicesintendedtocreatefuturebenefits,suchas
infrastructureinvestmentorresearchspending,areclassedas
governmentinvestment
.
Governmentexpendituresthatarenotpurchasesofgoodsandservices,andinsteadjust
representtransfersofmoney,suchassocialsecuritypayments,arecalled
transferpayments
.
5.3
Why do government spend
Therearemanyreasonsforgovernmentspending.Thesecanbe
To Provide Public goods

Publicgoodisthatgood,
consumptionbyoneindividualdoesnotreduceavailabilityofthe
goodforconsumptionbyothersandthatnoonecanbeeffectivelyexcludedfromusingthe
good.Thesegoodsareofimportancetothegeneralpublicandhenceareprovidedbythe
government.Exampledefence,streetlightingetc.
To provide Merit goods

A
meritgood
isacommoditywhichisjudgedthatanindividualorsocietyshouldhaveonthe
basisofanorm.Thegovernmentfeelsthateverybodyshouldenjoythesegoodsirrespectiveof
theirincomeForexample,healthandeducation.Inmostoftheeconomies,governmentsspend
amajorpartoftheirexpenditureonhealthandeducation.
To maintain and promote economic growth

Publicspendinghasanimportantroletoplayin
maintainandpromotingeconomicgrowth
in
theeconomy.Increasesingovernmentspendingonstateprovidedgoodsandservicesaddto
totaldomesticdemandandcanhavemultipliereffectsonthefinallevelofequilibriumnational
income.
Ensure welfare of the state

Oneofthegovernmentsmainobjectiveistoprovidereducethegapbetweenrichandpoorand
thusgovernmentprovidesserviceslikehealthandeducationtotheeconomicallyweaker
sectionsofthesocietyfreeofcostoratasubsidisedrates.The
socialsecuritysystem
also
triestoprovidea
safetynet
forthosewhosufferunexpectedfallsinincomearisingfrom
unemployment,separationandbereavement.
5.4
Taxation | Purpose of taxation
Taxation
ATaxisafinancialchargeorotherlevyimposedonanindividualoralegalentitybyastateora
functionalequivalentofastate.Taxesconsistofdirecttaxorindirecttax.
Ataxmaybedefinedasa"pecuniaryburdenlaiduponindividualsorpropertytosupportthe
government[]apaymentexactedbylegislativeauthority."
Purposes of Taxation
Financing government spending:
Taxesarejustifiedastheyfundgovernmentexpenditureandactivitiesthatarenecessaryand
beneficialtosociety.
Reduce gap between rich and poor

Progressivetaxationcanbeusedtoreduceinequalityinasociety.Accordingtothisview,
taxationinmodernnationstatesbenefitsthemajorityofthepopulationandsocialdevelopment.
Progressivetaxsystemwherehigherincomegroupshavetopaymoretaxisaneffectivewayof
reducinginequalityofincome.
Reduce consumption of demerit Goods

Taxescanbeusedasaneffectivetooltoreducetheconsumptionofdemeritgoodslikealcohol
andtobacco.Highertaxesonthesegoodsreducetheconsumption.Examplesincludecigarette
taxandexciseduty.
Control Inflation
Oneofthecausesofinflationis
toomuchmoneychasingtoofewgoods
.Governmentcan
takeawaytheextradisposableincomeofthepeoplethroughhighertaxesandthusreducethe
aggregatedemandintheeconomyandresultinginlowinflationrate.
Balance of payments
Tariffsaretaxesonimports.Governmentcancorrectanunfavourablebalanceofpayment
situationbyincreasingthetariffs.Thiswillresultinimportsbecomingexpensiveandwillcausea
fallindemandfortheimportedgoods.
Protecting local industries

Governmentusestaxesasameantoprotectlocal/infantindustries.Increasingtariffsonimports
andcharginglowertaxestolocal/infantindustriesmayboostthedemandforgoodsand
servicesproducedbydomesticindustry.
5.5
Classificationoftaxes|progressive,
regressive,proportional
Classificationoftaxes
Progressivetaxes
A
progressivetax
isataximposedsothatthetaxrateincreasesastheamountsubjectto
taxationincreases.Insimpleterms,itimposesagreaterburden(relativetoresources)onthe
richthanonthepoor.Itcanbeappliedtoindividualtaxesortoataxsystemasawhole.
Progressivetaxesattempttoreducethetaxincidenceofpeoplewithalowerabilitytopay,as
theyshifttheincidencedisproportionatelytothosewithahigherabilitytopay.Theresultis
peoplewithmoredisposableincomepayahigherpercentageofthatincomeintaxthando
thosewithlessincome.
ExampleofProgressivetaxinNew
Zealand
Income(NewZealandDollar)
Taxrate(%)
Upto38,000
19.5
3800160,000
33
Above60,001
49
ExampleofProgressivetaxinAustralia
Income(AustralianDollar)
Taxrate(%)
Upto6000
600125000
15
2500175000
30
75001150000
40
Above150000
45
RegressiveTax
Theoppositeofaprogressivetaxisa
regressivetax
,wherethetaxratedecreasesasthe
amountsubjecttotaxationincreases.Itimposesagreaterburden(relativetoresources)onthe
poorthanontherich.Regressivetaxesattempttoreducethetaxincidenceofpeoplewith
higherabilitytopay,astheyshifttheincidencedisproportionatelytothosewithlower
abilitytopay.
Forexample,ifJanehas$10andJohnhas$5,ataxof$1onapurchasewouldresultina
differentpercentageoftotalincomeappliedtotaxation,20%forJohnand10%forJane.Thus,a
taxthatisfixedtothevalueofthegood/servicewouldlikely,ineffect,resultinahigherburden
oftaxationtopeoplewithlessmoney.
ProportionalTax
Aproportionaltaxisonethatimposesthesamerelativeburdenonalltaxpayersi.e.,wheretax
liabilityandincomegrowinequalproportion.Insimpleterms,itimposesanequalburden
(relativetoresources)ontherichandpoor.Proportionaltaxesmaintainequaltaxincidence
regardlessoftheabilitytopayanddonotshifttheincidencedisproportionatelytothosewitha
higherorlowereconomicwellbeing.
5.6
Directtaxes|typesofdirecttaxes
Directtaxes
Taxeswhicharecollecteddirectlyfromincomeandwealthareknownasdirecttaxes.
TypesofDirecttaxes
Incometax
Incometax
iscollectedonallincomesreceivedbyprivateindividualsaftercertainallowances
aremade.InmostoftheeconomiesIncometaxisamajorsourceofGovernmentrevenue.
Corporationtax
Thistaxisleviedonprofitsearnedbycompanies.Itisaproportionaltaxwhichisleviedatthe
constantrate.
Petroleumrevenuetax
Itisataxleviedontheprofitsofcompaniesinvolvedindrillingofoilandgas.Thistaxmayor
maynotexistinothercountries.
Capitalgainstax
Capitalgainstaxischargedontheprofitrealizedonthesaleofanoninventoryassetthatwas
purchasedatalowerprice.Themostcommoncapitalgainsarerealizedfromthesaleofstocks,
bonds,preciousmetalsandproperty.Notallcountriesimplementacapitalgainstaxandmost
havedifferentratesoftaxationforindividualsandcorporations.
PropertyTax
ManycountrieshavePropertytax,ormillagetax.Itisthetaxwhichtheownerpaysonthevalue
ofthepropertybeingtaxed.
Thetaxingauthorityrequiresand/orperformsanappraisalofthemonetaryvalueofthe
property,andtaxisassessedinproportiontothatvalue.Formsofpropertytaxusedvary
betweencountriesandjurisdictions.
Stampduty
Stampduty
isaformoftaxthatisleviedondocumentsrelatingtoimmovableproperty,stocks
andshares.Apartfromtransfersofsharesandsecurities,stampdutiesarealsochargedonthe
issueofbearerinstrumentsandcertaintransactionsinvolvingpartnerships.
5.7
Indirecttaxes|Valueaddedtax,exciseduty
IndirectTaxes
Indirecttax(suchassalestax,
valueaddedtax(VAT),
or
goodsandservicestax(GST))
isa
taxcollectedbyanintermediary(suchasaretailstore)fromthepersonwhobearstheultimate
economicburdenofthetax(suchasthecustomer).Theintermediarylaterfilesataxreturnand
forwardsthetaxproceedstogovernmentwiththereturn.Anindirecttaxmayincreasetheprice
ofagoodsothatconsumersareactuallypayingthetaxbypayingmorefortheproducts.
Exampleswouldbefuel,liquor,andcigarettetaxes.Anexcisedutyonmotorcarsispaidinthe
firstinstancebythemanufacturerofthecarsultimatelythemanufacturertransferstheburden
ofthisdutytothebuyerofthecarinformofahigherprice.Thus,anindirecttaxissuchwhich
canbeshiftedorpassedon.
AllIndirectTaxesareregressiveinnature.Thepoorwillfeelthepinchmorethantherich.
TypesofIndirectTaxes
ValueaddedTax
Valueaddedtax(VAT),orgoodsandservicestax(GST),isaconsumptiontaxleviedon
value
added
.Incontrasttosalestax,VATisneutralwithrespecttothenumberofpassagesthatthere
arebetweentheproducerandthefinalconsumerwheresalestaxisleviedontotalvalueat
eachstage,theresultisacascade(downstreamtaxesleviedonupstreamtaxes).
ExportsareconsumedabroadandareusuallynotsubjecttoVATVATchargedundersuch
circumstancesisusuallyrefundable.Thisavoidsdownwardpressureonexportsandultimately
exportderivedrevenue.
AVATisanindirecttax,inthatthetaxiscollectedfromsomeonewhodoesnotbeartheentire
costofthetax.
Exciseduties
Excise
dutyisatypeofindirecttaxchargedongoodsproducedwithinthecountry.
Lists
ofsuch
goodsarereadilyprovidedbygovernments.
5.8
Fiscal policy and how it works
Fiscalpolicy
referstogovernmentpolicythatattemptstoinfluencethedirectionofthe
economythroughchangesingovernmenttaxesorthroughsomespending.
Thetwomaininstrumentsoffiscalpolicyare
governmentspending
and
taxation
.
Changesinthelevelandcompositionoftaxationandgovernmentspendingcanimpactonthe
followingvariablesintheeconomy:
Aggregatedemandandthelevelofeconomicactivity.
Thepatternofresourceallocation.
Thedistributionofincome.
How Fiscal Policy works?

Scenario one: High rate of Inflation
Highrateofinflationiscausedbytoomuchaggregatedemandintheeconomy.Government
willusedeflationaryfiscalpolicy.Governmentwilltrytoinfluenceaggregatedemandby
reducingitspublicspending.Thegovernmentwillspendlessonconstructionofroads,bridges
andotherpublicspendingandthusaggregatedemandwillfall.Ontheotherhand,Government
mayincreasethetaxrates.Anincreaseintaxrateswilltakeawaytheextradisposableincome
outpeoplespocketresultinginalowerdemand.
Scenario two: Low rate of Inflation

Inaneconomicrecession,aggregatedemand,outputandemploymentalltendtofall.Nowthe
Governmentwantstoincreaseemploymentintheeconomy,itcanattempttodosoby
increasingaggregatedemand.TheGovernmentwillincreasethepublicspendingresultingina
riseinaggregatedemand.Governmentmayreducethetaxratessothatpeoplehavemore
disposableincometospendandinstigatedemandintheeconomy.
5.9
Problems with Fiscal Policy
Reduce incentive to work
Raisingtaxesonincomeandprofitsreduceworkincentives,employmentandeconomicgrowth.
Anefforttoreduceaggregatedemandmaycausedisincentivestowork,ifthisoccurstherewill
beafallinproductivityandAggregatesupplycouldfall.
Adverse effect of lowering Public Spending

ReducedgovtspendingtoIncreaseAggregatedemandcouldadverselyaffectpublicservices
suchaspublictransportandeducationcausingmarketfailureandsocialinefficiency.
Crowding out effect

Withanincreaseingovernmentexpenditure,therewillbegreatercompetitionforlimited
resources.Thiswilloffsetprivateinvestmentsresultinginshrinkingoftheprivatesector.
Inaccurate forecasting
IftheGovernmentsestimateorforecastingiswrongorinaccuratetheFiscalpolicywillsuffer.
Forexample,ifarecessionisexpectedandthegovernmentpractisesdeficitbudget,andyetthe
recessionturnsouttobeaboom,thiswillcauseinflation.
Implementation of the Policy

Planningforthespendingisdoneoncebymostofthegovernments.Ifthereisadelayinthe
implementationofthefiscalpolicy,itmightreducetheeffectivenessofthepolicy.Thusthetime
lagisimportant.
5.10
Monetary Policy
Monetarypolicy
istheprocessbywhichthegovernment,centralbank,ormonetaryauthorityof
acountrycontrols
1. thesupplyofmoney,
2. Availabilityofmoney,and
3. Costofmoneyorrateofinterest,
inordertoattaingrowthandstabilityoftheeconomy.
Monetarypolicyisgenerallyreferredtoaseitherbeinganexpansionarypolicy,ora
contractionarypolicy.
An
expansionarypolicy
increasesthetotalsupplyofmoneyintheeconomyandistraditionally
usedtocombatunemploymentinarecessionbyloweringinterestrates.
Contractionarypolicy
decreasesthetotalmoneysupplyandinvolvesraisinginterestratesin
ordertocombatinflation.
Itisarguedthatanincreaseinthemoneysupplycausesanincreaseintherateofinflation.
Maintainingalowandstableinflationisoneofthemainmacroeconomicobjectivesofthe
Government.Governmentdoessobycontrollingthesupplyofmoneytotheeconomy.This
policyisknownas
monetarypolicy.
Monetarypolicyisconcernedwithcontrollingthesupplyofmoneyandtheinterestratesinthe
economy.Thegovernmentcannotcontrolboththesupplyofmoneyandinterestratesatthe
sametime.
MonetarypolicyinanycountryisusuallycontrolledbytheCentralBankofthatcountry.The
Centralbankalterstheinterestratesintheeconomyafterassessingtheinflationarypressures
inthemarket.
Evaluation of Monetary Policy

Monetarypolicyisconsideredtobemoresuccessfulduringinflationarytimesbecausean
increaseininterestratesreducestheborrowingsandthusstabilisestheprices.Whereas,
duringdeflation,Monetarypolicymaynotbeaseffective.Duringdeflationorrecession,thereis
uncertaintyinthemarketwhichdiscouragesentrepreneursandproducerstotakerisk.
5.11
Interest rates affect on economy
How a change in Interest rates

affects economy?
Controllingtheinterestratesaffectstheaggregatedemand,inflationrateandtheexchange
rate.
Scenario one: Increasing the interest rates

Anincreaseintheinterestrateswillreducethedemandforborrowingfromcustomersandfirms.
Iftheyborrowlessmoney,theywillhavelessmoneytospendandtheaggregatedemandwill
fallorrisemoreslowly.Moreover,individualswillbeencouragedtosavemoreduetohigh
interestrates.
Higherinterestratewillalsoraisethevalueofthecountrysexchangerateasmoreinternational
investorswillbeinterestedininvestingtheirmoneyinthecountry,togetbetterinterestrates.
Scenario one: Reducing the interest rates

Reducingtheinterestrateswillencouragepeopleandfirmstospendmoremoney.Asloans
becomecheaper,morepeoplewillbeinterestedintakingloansandpurchasinghousesand
cars.Evenfirmswillbeencouragedtoexpandasthecostofcapitalischeap,theywillfindit
easiertoraisefunds.Thiswillfueltheaggregatedemandintheeconomy.
5.12
How the supply of money affects the economy
How the supply of money affects

the economy?
IftheGovernmentreducesthesupplyofmoney,banksandmoneylenderswillfindtheyhave
lessmoneytolendtopeopleandfirms.Thisshortageofthesupplyofmoneywillleadthemto
chargehigherinterestrate.Moreover,inordertoobtainmoremoneytheywillincreasethe
interestratestoattractsaverstoputmoneyindepositaccounts.Alltheseactionswillleadto
loweringtheaggregatedemandandthepriceswillcomedown.
Ontheotherhand,iftheGovernmentincreasesthesupplyofmoneytobanks,theywilllower
theinterestratesinordertoencouragepeopleandfirmstoborrowmore.Moreindividualsand
firmswillborrowthusboostingtheaggregatedemandandtheoutputoftheeconomy.Butifthe
increaseinsupplyisnotcalculatedproperlyitcanresultininflation.
5.13
How government controls the money supply
Moneysupplyincludesallthenotesandcoinsincirculationwiththepublicplusthemoneywith
banks.Italsoincludesthedepositsinbanksandbuildingsocieties.Thelaterismoresignificant
supplyofmoneyandisusuallythetargetofGovernmentsmonetarypolicy.Thewaysthrough
whichGovernmentcontrolsthemoneysupplyare:
Open market operations

Governmentusuallysellstreasurybillsandbondstoraisemoney.Privateindividualsinvestin
thesebondsandbillsinordertogetahealthyrateofinterest.Thisreducesthedepositswith
banksandthemoneysupply.
Variation of legal reserve requirements

Usually,thecommercialbankshavetomaintainacertainpercentageoftheirassetsasdeposit
withtheCentralBank.WhentheCentralBankwantstoreducemoneysupplyitwillincreasethe
limitofthedepositkeptbythebanks.Thecommercialbanksareleftwithlessmoneytolendto
theircustomers.
5.14
Supply side policies
Mostsupplysidepoliciesaimtoenablethefreemarkettoworkmoreefficientlyandattemptto
promoteemployment,lowinflationandeconomicgrowth.ThemainideabehindSupplyside
policiesistoreduceGovernmentinterference.
Supplysidepoliciesinclude
Privatisation
Privatisationisthesellingofstateownedbusinessestoprivateindividualsandgroups.This
increasestheefficiencyoftheseorganisationsastheyfacemorecompetition.Profitmotive
increasestheincentivetoutilisetheresourcesinthebestpossibleway.
Deregulation
Deregulationinvolvesreducingbarrierstoentryinordertomakethemarketmorecompetitive.It
doesawaywithunnecessaryrulesandregulationsonbusinesswhichresultsinreducedcost,
increasedoutputandlowerprices.Moreover,itincreasesthecompetitionintheeconomy,
leadingtohigherefficiencyforbusinesses.
Increased education and training

Improvingthelevelofeducation,trainingandskillsoftheworkforcewillraisethelabour
productivityandincreasetheaggregatesupply.Governmentsusuallygivealotofimportanceto
educationandencouragemoreandmorepeopletoattenduniversitiesandcollegesand
enhancetheskillsoftheworkforce.
Labour Markets reforms

BycontrollingtheactionsofthetradeunionstheGovernmentcanensurethatthereisleast
disruptioninthebusinessactivities.
6. Economic indicators:
Learning outcomes
AttheendofthisUnitstudentswillbeableto
With regards to prices
describehowtheretailpriceindexiscalculated
discussthecausesandconsequencesofinflation.
With regards to employment
describethechangingpatternsandlevelsofemployment
discussthecausesandconsequencesofunemployment.
With regards to output
defineGrossDomesticProduct(GDP)
describesimplemeasuresandindicatorsofcomparativelivingstandards,suchasGDPper
head,HumanDevelopmentIndex(HDI).
6.1 Inflation:
Measuring Inflation
The Retail price Index (RPI)
This is a price index that shows the general change in prices over
time as a %.
A hypothetical basket of goods and services which represents a
normal households spending.
The items are weighted to reflect the % of income spent on them.
Each month the prices of the goods & household spending patterns
are monitored and the RPI is calculated.
The index has a base year and the % change is measured from
this.
Causes of Inflation
Cost-Push Inflation
Increases in wages & raw material costs push production costs up

and result in higher prices.
If increases in wages are matched by an increase in worker

productivity then unit costs should not rise.
A wage spiral may occur when workers demand higher wages
leading to higher prices & so workers then demand higher wages
again & so on.
Demand-Pull Inflation
Excess demand (an increase in demand without an equal increase

in supply) pulls prices higher.
Usually output can be increased to match demand but if there is full
employment then extra workers cannot be employed to increase
output. It could also be a shortage of a raw material that limits
supply.
Monetary
Increases in the money supply that are greater than increases in

output (more money chasing same output).
Can be classed as demand-pull inflation.
Effects of Inflation
The value of money falls (each $ buys less). Hyperinflation may lead
to loss in confidence of the currency.
Redistribution of income:
o
savers lose out as their savings lose real value & borrowers
gain as they repay less in real terms than they borrowed.
People on fixed incomes (pensioners, students) see their real
income fall unless it is index-linked (linked to the changes in
the rate of inflation).
Increased costs for firms: changing prices, labels, working out

future costs.
Balance of Payments: increased prices make a countrys exports

less desirable & imports seem comparatively cheaper. This can
lead to further issues such as unemployment.
6.2 Unemployment:
Measuring Unemployment
Measured as the % of the labour force who are willing & able to work and
looking for a job.
Methods for measuring unemployment vary & generally the official rate is
lower than the actual number of people looking for work.
Types of Unemployment
Frictional unemployment
: people between jobs - tends to be short
term.
Structural unemployment
: industrial change over the long term
can leave sectors of the labour force with skills that the economy
no longer demands.
Seasonal unemployment
: labour only demanded at certain times
of the year (fruit pickers/ tour guides).
Cyclical unemployment
: high unemployment in times of recession.
Immobility of labour
: workers are generally fairly immobile (home,
family) & only seek work in their region.
Technology
: increases in technology have replaced some jobs and
reduced number of workers in others.
Minimum wage
: increased labour costs may force employers to
hire less workers.
Effects of Unemployment
Increases in unemployment lead to higher costs for the

Government (support & benefits) & at the same time less income for
the Government (income tax). This could mean higher taxes for the
working population or reduced spending on
schools/hospitals/emergency services etc.
Increased unemployment means less output & so less goods and

services for people to share.
Increased costs to society through higher crime rates, higher health
bills (alcoholism/depression), increased rates of divorce.
6.3 Economic Growth:

Measuring Output
Gross Domestic Product (GDP)

Definition: The total value of the goods and services produced in an
economy over a given time period.
This is the standard measurement but there are several variations that
are used to provide a clearer picture of what is happening in the
economy.
Nominal GDP
: GDP valued using the current prices (no inflation
consideration).
Real GDP
: GDP that has had the effect of inflation removed.
Real GDP per capita

: average Real GDP per person in the country.
This allows any changes in the population size to be reflected.
Measuring Quality of Life

Human Development Index (HDI)
This is an index that takes into account 3 factors (each is an index itself):
Life expectancy index
Education index
Income index
It generates a score between 0 and 1. The closer to 1 the higher the

quality of life.
It is considered a better measure of overall development then GNI or
GDP because it takes into account social factors aswell as purely
economic ones.
7. Developed and developing economies
Learning outcomes
At the end of this Unit students will be able to

describe why some countries are classified as developed and others are not;
recognise and discuss policies to alleviate poverty;
describe the factors that affect population growth (birth rate, death rate, fertility rate,
net migration) and discuss reasons for the different rates of growth in different countries;
analyse the problems and consequences of these population changes for countries at
different stages of development;
describe the effects of changing size and structure of population on an economy;
discuss differences in living standards within countries and between countries, both
developed and developing.
7.1
Difference between developed and developing
economy
Difference between developed

economy and less developed economy
Developed
Less
economy developed
economy
Population
lowbirthrate
higherlifeexpectancy
lowdeathratedueto
bettermedicalfacilities
agingpopulation
Developingcountries
havehigherrateof
naturalincrease.Death
rateshavefallenfaster
thanbirthratesbirth
ratesaresignificantly
higherthanin
developedcountries,
whereasdeathratesare
onlysomewhathigher
thanindeveloped
countries.Tradition,lack
ofcontraception,
povertyandlackof
educationarethemain
causesofhigh
populationgrowthrate.
Education
Highlevelofliterary,
Highlytrainedworkforce.
Workersarepaidhigh
ratesofwages.
Lowlevelofliteracywith
lowskilllevelsofthe
workforceresultsinlow
wagesoftheworkforce.
Governmentisthemain
providerofeducation
servicesandhavelow
percentageofpublic
expenditureallocated
foreducation.
Economic
structure
Theseeconomies
usuallyhavealarger
tertiarysectorandmost
oftheworkforceis
engagedinservice
industries.Thecountry
producesandexports
hightechnologyproducts
orhighvalueadded
goods.
Primarysectoristhe
majorcontributortothe
GDPofthecountry.Low
GDPpercapitaisthere.
Usuallyexports
agriculturalgoodsor
naturalresourcesand
importsvalueadded
goodsfromdeveloped
countries.
7.2
Characteristics of a less developed economy
What are developing countries?

Thedevelopmentofacountryismeasuredwithstatisticalindexessuchasincomepercapita
(perperson)(GDP),lifeexpectancy,therateofliteracy.Countriesarecategorisedasless
developedbecauseoftheirpovertyandlowaverageincomes,theirlackofgoodhuman
resourcesandtheirlowlevelofeconomicdiversification.
HOTQUESTION:
Explainwhatislikelytobetheoccupationaldistributionofthepopulationina
lessdevelopedcountry?
SUGGESTEDANSWER:
Mostoftheworkforceisengagedinagricultureandotherprimary
industries,withsomeinmanufacturingandsomeinserviceindustries.Manyofthesejobswill
bepoorlypaid.
Developingcountriesareingeneralcountrieswhichhavenotachievedasignificantdegreeof
industrializationrelativetotheirpopulations,andwhichhave,inmostcasesamediumtolow
standardofliving.Thereisastrongcorrelationbetweenlowincomeandhighpopulationgrowth.
Othertermssometimesusedarelessdevelopedcountries(LDCs),leasteconomically
developedcountries(LEDCs)
Characteristics of a less developed

economy
Theseeconomiesaremarkedbya
highbirthrate,
relativelyhighdeathrateand
alowlifeexpectancy
highpopulationgrowth
Highdependencyratio
LowGDPpercapita.
Lowerproportionofpopulationisenrolledineducation
Lowleveloflivingstandard
Poorhealthduetopoornutrition,lackofaccesstofacilitiessuchascleanwaterandproper
sanitation.
Healthcareprovisionsareofoftenpoor.
Structure of the Economy

Theseeconomiesaremorereliantonprimarysector.
Theyexportcertainprimarycommodities,agriculturalgoodsandlowtechnologyproducts.
Advancedeconomies
Emerginganddevelopingeconomies(notleastdeveloped)
Emerginganddevelopingeconomies(leastdeveloped)
7.3
Example of Population Pyramid
The Population Pyramidwhat it

is and how it works
Bargraphsareahandywaytoillustratenumbers.Forexample,ifweweretographthenumber
ofmalesandfemalesinCanadaforvariousagegroupsaccordingtothe1961Census,the
resultwouldbetheillustrationsbelow.
(Clickonimagetoenlarge)
Ifweweretodisplaythesegraphshorizontally,makeamirrorimageoftheoneforwomen,and
thenjointhemtogether,wewouldhavea
populationpyramid
exactlyasseenbelow.

ThispopulationpyramidshowsataglancethedistributionoftheCanadianpopulationin1961.
Youcanseethatthepyramidnarrowstowardthetop.Thisisbecausethedeathrateishigher
amongolderpeoplethanamongyoungerpeople.
Therearealsoafewbulgesandnarrowerpartsinthemiddlepartofthepyramid.Forexample,
therearenotasmanypeopleintheir20sasintheir30sinCanadain1961.Thepeopleintheir
20sin1961werebornduringtheDepression,atimeofeconomichardshipinCanadawhen
peoplewerehavingfewerchildren.
In1961,thepyramidhadawidebase.Infact,whenweaddthepercentagesforthethree
lowestagegroups,wefindthat35%ofthepopulationwasunder15.Thesearethebaby
boomers,alargegroupofpeoplebornbetween1947and1966whentheeconomywas
growingandprospering.
Byanalysingpopulationpyramidsandidentifyingtrends,wecanlearnalotaboutoursociety.
Thesestatisticsgivegovernmentsandothersoneofthetoolstheyneedtomakeinformed
decisionsthatwillaffectourlivestodayandinthefuture.
StatisticsCanadainformationisusedwiththepermissionofStatisticsCanada.Usersare
forbiddentocopythedataandredisseminatethem,inanoriginalormodifiedform,for
commercialpurposes,withoutpermissionfromStatisticsCanada.Informationonthe
availabilityofthewiderangeofdatafromStatisticsCanadacanbeobtainedfromStatistics
Canada'sRegionalOffices,itsWorldWideWebsiteat
www.statcan.gc.ca,
anditstollfree
accessnumber18002631136.
What is a developed economy?

Countrieswitheconomiesinwhichthetertiaryandquaternarysectorsofindustrydominateare
knownasdevelopedeconomies.Thislevelofeconomicdevelopmentisusuallydeterminedon
thefollowingfactors:
High income per capita

"
Highincomeeconomies"
aredefinedbytheWorldBankascountrieswithaGrossNational
Incomepercapitaof$11,456ormore.AccordingtotheUnitedNationsdefinitionsomehigh
incomecountriesmayalsobedevelopingcountries.Thus,ahighincomecountrymaybe
classifiedaseither
developed
or
developing
.
High Human Development Index (HDI)
The
HumanDevelopmentIndex
(
HDI
)isanindexcombiningnormalizedmeasuresoflife
expectancy,literacy,educationalattainment,andGDPpercapitaforcountriesworldwide.The
basicuseofHDIistorankcountriesbylevelof"humandevelopment",whichusuallyalso
impliestodeterminewhetheracountryisadeveloped,developing,orunderdevelopedcountry.
High gross domestic product (GDP) per

capita
Traditionally,CanadaandtheUnitedStatesinNorthAmerica,JapaninAsia,AustraliaandNew
ZealandandmostcountriesinNorthernEuropeandWesternEuropehavebeenconsidered
"developedcountries".TheseeconomiesgenerallyhaveapercapitaGDPinexcessof$10,000.
MapofDevelopedCountriesaccordingtotheCIAWorldFactbook2008
7.4
Population
Pyramid
What is a Population pyramid?

A
populationpyramid
,alsocalled
agesexpyramid
and
agestructurediagram
,isa
graphicalillustrationthatshowsthedistributionofvariousagegroupsinapopulation(typically
thatofacountryorregionoftheworld),whichnormallyformstheshapeofapyramid.
Ittypicallyconsistsoftwobacktobackbargraphs,withthepopulationplottedontheXaxisand
ageontheYaxis,oneshowingthenumberofmalesandoneshowingfemalesinaparticular
populationinfiveyearagegroups(alsocalledcohorts).Malesareconventionallyshownonthe
leftandfemalesontheright,andtheymaybemeasuredbyrawnumberorasapercentageof
thetotalpopulation.
Young population
Generallyapopulationpyramidthatdisplaysapopulationpercentageofages114over30%
andages75andaboveunder6%isconsidereda"youngpopulation".
Thispatterngenerallyoccursindevelopingcountries,withahighagriculturalworkforce.
Ageing population
Apopulationpyramidthatdisplaysapopulationpercentageofages114under30%andages
75andaboveover6%isconsideredan"agingpopulation".
Usuallyfoundindevelopedcountrieswithadequatehealthservices,e.g.Australia).
Acountrythatdisplaysallornoneofthesecharacteristicsisconsideredneither.
Uses of Population pyramid
Populationpyramidscanbeusedtofindthenumberofeconomicdependentsbeingsupported
inaparticularpopulation.
Populationpyramidscanbeusedtoobservethenaturalincrease,birth,anddeathrate.
7.5
Optimum Population
Optimum Population
Itisthenumberofpeoplethatwillproducethehighestpercapitaeconomicreturngiventhe
resourcesavailable,andtheirfullutilization.Shouldthepopulationriseorfallfromtheoptimum
theoutputpercapita,andstandardofliving,willfall.
Acountryissaidtobeunderpopulatedifithasinsufficientpeopletomakefulluseofthe
resourcesavailable.Ontheotherhandacountryisoverpopulatediftherearetoomanypeople
andfewresources.Therewillbediminishingreturns.
7.6
Factors affecting population | Birth rate, death
rate, net migration
Factors affecting the population

The Birth Rate
Itistheaveragenumberofthechildrenborninacountrycomparedtotherestofthepopulation.
Inotherwords,itisthenumberofbirthsforevery1000peopleinthecountry.
Numberoflivebirths
Birthrate=
X1000
Totalpopulation
Factors affecting the birth rate in a country
Existingagesexstructure
Availabilityoffamilyplanningservices
Socialandreligiousbeliefsespeciallyinrelationtocontraceptionandabortion
Femaleemployment
Economicprosperity(althoughintheorywhentheeconomyisdoingwellfamiliescanaffordto
havemorechildreninpracticethehighertheeconomicprosperitythelowerthebirthrate).
Povertylevelschildrencanbeseenasaneconomicresourceindevelopingcountriesasthey
canearnmoney
InfantMortalityRateafamilymayhavemorechildrenifacountry'sIMRishighasitislikely
someofthosechildrenwilldie.
Conflicts
Typicalageofmarriage
The Death Rate

Thenumberofpeoplewhodieeachyearcomparedtoevery1000peopleinthepopulationis
knownasdeathrate.
Death
rate=
numberof
deaths
X1000
Totalpopulation
Factors affecting Death rate in a country
Medicalfacilitiesandhealthcare
Nutritionlevels
Livingstandard
Accesstocleandrinkingwater
Hygienelevels
Levelsofinfectiousdiseases
Socialfactorssuchasconflictsandlevelsofviolentcrime
Net Migration
Emigration
iswhenapersonmovesoutofthecountry.
Immigration
iswhenapersonmovesintoacountry.
NetMigrationisthedifferencebetweenemigrationandimmigration
.
Ifnetimmigrationispositiveitwillleadtoapopulationincrease,anegativenetimmigrationwill
leadtoafallinpopulationofthecountry.
Dependency Ratios
Itisthenumberofpeopleinworkwiththetotalpopulationofthecountry.
Dependencyratio
=
TotalPopulation
Numberofpeopleinwork
DependentPopulationusuallyconsistsofchildren,students,housewives,theunemployedand
oldagepensioners.
Affects of increase in dependent population

Lowerstandardofliving
Anincreaseinthedependentpopulationwillmeanthatpeopleinworkhavemorepeopleto
supportandthusthelivingstandardofthecountrywillfall.
Balanceoftrade
Ifthepeopleinworkcannotproduceenoughgoodsandservicestosatisfytheneedofthe
growingdependentpopulationthenthecountryhastospenditsincomeonimportingthese
goodsandservices,whichwillleadtoanunfavourablebalanceoftrade.
Changes in Population pattern as a

country becomes more developed
Asaneconomybecomesmoredevelopedthefollowingcharacterisiticsmightbenoticedinits
populationstucture.
ChangeinOccupationalstructure
primarysectorwillcontinuetofall
secondarysectorwillfirstrise,andthenfall
tertiarysectorwillcontinuetorise.
Agestructure
averageageofthepopulationwillrise
therewillbeanageingpopulation
BirthrateandDeathratewillfall
Geographicalstructure
therewillbeamovementoutoftheruralareasandintotheurbanareas.
7.7
Introduction to population
Changes in world Population

The
worldpopulation
isthetotalnumberoflivinghumansonEarthatagiventime.AsofJuly
2008,theworld'spopulationisestimatedtobejustover
6.684billion.
Inlinewithpopulation
projections,thisfigurecontinuestogrowatratesthatwereunprecedentedbeforethe20th
century,althoughtherateofincreasehasalmosthalvedsinceitspeakof2.2percentperyear,
whichwasreachedin1963.Theworld'spopulation,onitscurrentgrowthtrajectory,isexpected
toreachnearly9billionbytheyear2042.
Further Research
WorldPopulationProspects
YearbyYearWorldPopulationEstimates:10,000B.C.to2007A.D.
WorldPopulation
ThePopulationProject
OptimumPopulationTrust
StateofWorldPopulation2007report
7.8
Barriers to growth
Barriers to growth of less

developed economies
RapidpopulationgrowthneutralisesgrowthinGDP.TheultimateeffectisthatGDPpercapita
remainsthesameorcomesdown.
Humanresources:
Lackoftrainingandhighlevelskillsmakestheworkforcelessproductive.
Lackofnaturalresources:
Ifthecountryislackinginnaturalresources,growthcanbedifficult.
Moreover,ifthecountryhasgoodnaturalresources,buttheyarenotmanagedproperlythen
therewillbelessdevelopment.
Inefficientuseofresources:
Ifthereisnooptimumutilisationofworkforce,orifthefirmsare
inefficientduetolackofcompetition.
Toomuchdependenceonagriculturalproducts:
Developedcountrieswhichimportthese
productsfromlessdevelopedcountriesusuallypayverylowpricesforit.Moreover,theyfurther
processtheseproductsandsellitforhigherpricestoLDCs.
Poorinfrastructure:
Lackofinfrastructuresuchaspoortransportandcommunicationis
anotherreasonwhichhindersgrowthforLDCs.
8. International aspects
Learning outcomes
At the end of this unit students will be able to

describe the benefits and disadvantages of specialisation at regional and national levels;
describe the structure of the current account of the balance of payments;
define exchange rates;
discuss the causes and consequences of exchange rate fluctuations;
describe methods of protection;
discuss the merits of free trade and protection
8.1
Exchange rate | revaluation, devaluation,
appreciation, depreciation
Exchange Rate
Exchangerateistherateatwhichonecountryscurrencycanbeexchangedforanother
countryscurrency.
How is exchange rate determined?

Fixed Exchange Rate
Afixedexchangeratesystemreferstothecasewheretheexchangerateissetandmaintained
atsamelevelbythegovernmentirrespectiveofthemarketforces.
Floating Exchange Rate

Floatingexchangeratesystemmeansthattheexchangerateisallowedtofluctuateaccording
tothemarketforceswithouttheinterventionoftheCentralbankorthegovernment.
Appreciation and Depreciation

Theexchangerateforanycurrencyusuallyfluctuates.Whenthevalueofthecurrencygoesup
ascomparedtoothercurrencyitisknownas
appreciation
.Whenthevalueofcurrencyfallsas
comparedtoothercurrencyitisknownas
depreciation
.
Usuallytheexchangeratesaredeterminedbythedemandandsupplyofthatcurrencyinthe
internationalmarket.
Demandforanycountryscurrencyontheforeignexchangemarketisdeterminedbydemand
forthatcountrysexportsofgoodsandservicesandbychangesinforeigninvestmentinthat
country.Thisisbecausewhenforeignersbuyanothercountrysexportsofgoodsorservices
theymustpayfortheseinthecurrencyoftheexportingcountry.
InthesamewaySupplyofanycountryscurrencyontheforeignexchangemarketis
determinedbythatcountrysimportsofgoodsandservicesandbyitsinvestmentinother
countries.
Thuswhenthedemandforacurrencyrisesitspricegoesupanditbecomescostlier.
Revaluation and Devaluation

Itreferstoofficialchangesinthepriceofacurrencyinafixedexchangeratesystem.
Devaluation
iswhenthepriceofthecurrencyisofficiallydecreasedinafixedexchangerate
system.
Revaluation
istheofficialincreaseinthepriceofthecurrencywithinafixedexchangerate
system.
What causes the fluctuation in

currency value?
Changes in the imports and exports of the
country
Anincreaseinexportsofacountrywillleadtoanincreaseindemandforthecurrencyandthus
thevaluerises.
Changes in Interest rate

Higherinterestratewillattractmoreforeigninvestorstoinvestinthecountryandthusthe
demandforcurrencywillrise,resultinginappreciationinvalueofthecurrency.
Changes in Inflation rate

Higherinflationratewillmakethecountryuncompetitiveintheinternationalmarket.Theexports
willfallresultingindecreaseddemandforthecurrencyandhencelowervalue.
8.2
Balance of Payment | Current, Capital and
financial account
Balance of Payments
Itshowsallthepaymentsandreceiptsbetweenonecountryandalltheothercountriesittrades
with.BalanceofPaymentisclassifiedintothreecategories.Theseare:
The current account

Itincludes
Allthevisibleandinvisibletradeofthecountry
Wagesreceivedbycountriescitizensworkingoutsideinothercountriesorpaidtoforeign
workersworkinginthecountry.
Interestpayments,profitsanddividendsonshares
Taxesreceivedandpaidbythegovernmentfromforeignsources.
The Capital account

Itincludesflowofmoneyinandoutofthecountrybecauseof:
Changeofownershipoffixedassets
Saleoffixedassets
The financial account

Itrecordstheflowofmoneyinandoutofacountrybecauseof:
Investmentincapital,sharesandloans.
Directinwardinvestment.
Portfolioinvestments
BalanceofPaymentcanbefavourableorunfavourable(deficit).
8.3
Exports and Imports | Visible trade and invisible
trade
Exports & Imports

Exportsarethemovementofgoodsorcommoditiesoutofthecountry.
Importsarethemovementofgoodsorcommoditiesintothecountry.
Visible Trade
Visibletradeinvolvestradingofgoodswhichcanbetouchedandweighed.Examplesinclude
tradeingoodssuchasOil,machinery,food,clothesetc.
VisibleTradeconsistsof
Visibleexports:
Sellingoftangiblegoodswhichcanbetouchedandweighedtoother
countries.
Visibleimports:
Buyingoftangiblegoodswhichcanbetouchedandweighedfromother
countries.
Balance of trade
Itisthedifferencebetweenthevalueofvisibleexportsandvalueofvisibleimportsofacountry.
IfthevalueofvisibleexportsismorethanvisibleimportsthecountrywillhaveaSurplus
balanceoftrade.
IfthevalueofvisibleimportsismorethanvisibleexportsthecountrywillhaveanUnfavourable
balanceoftrade.
Invisible trade
Invisibletradeinvolvestheimportandexportofservicesratherthangoods.Exampleinclude
servicessuchasinsurance,banking,tourism,education.
IfaUKstudentcomestoSingaporetostudy,itwouldbeinvisibleexportforSingaporeasitis
earningforeignexchangebyprovidingeducationalservices.
IfaSingaporecitizentravelstoUKforaholiday.ItwillbeinvisibleimportforSingaporeand
invisibleexportforUK.
Balance of invisible trade

Itisthedifferencebetweenthevalueofinvisibleexportsandvalueofinvisibleimportsofa
country.
8.4
Comparative advantage | Theory and example
Thetheoryofcomparativeadvantagestatesthatacountryshouldspecialiseintheproductionof
goodorserviceinwhichithasloweropportunitycostanditshouldimportcommoditieswhich
haveahigheropportunitycostofproduction.
Example
Supposeforexamplewehavetwocountries
ofequalsize,
Northland
and
Southland
.Both
produceandconsumetwogoods,
Food
and
Clothes
.Theproductivecapacitiesand
efficienciesofthecountriesaresuchthatifbothcountriesdevotedalltheirresourcestoFood
production,outputwouldbeasfollows:
Northland:100tonnes
Southland:200tonnes
Ifalltheresourcesofthecountrieswereallocatedtotheproductionofclothes,outputwouldbe:
Northland:100tonnes
Southland:100tonnes
Assumingeachhas
constantopportunitycostsofproduction
betweenthetwoproductsand
botheconomieshavefullemployment
atalltimes.
Allfactorsofproduction
aremobilewithin
thecountries
betweenclothingandfoodindustries,butare
immobilebetweenthe
countries
.
Thepricemechanismmustbeworkingtoprovideperfectcompetition
.
SouthlandhasanabsoluteadvantageoverNorthlandintheproductionofFood.Bothcountries
areequallyefficientintheproductionofclothes.Thereseemstobenomutualbenefitintrade
betweentheeconomies.The
opportunitycosts
showsotherwise.Northland'sopportunitycost
ofproducingonetonneofFoodisonetonneofClothesandviceversa.Southland'sopportunity
costofonetonneofFoodis0.5tonneofClothes.TheopportunitycostofonetonneofClothes
is2tonnesofFood.Southlandhasacomparativeadvantageinfoodproduction,becauseofits
loweropportunitycostofproductionwithrespecttoNorthland.Northlandhasacomparative
advantageoverSouthlandintheproductionofclothes,theopportunitycostofwhichishigherin
SouthlandwithrespecttoFoodthaninNorthland.
Toshowthesedifferentopportunitycostsleadtomutualbenefitifthecountriesspecialize
productionandtrade,considerthecountriesproduceandconsumeonlydomestically.The
volumesare:
Food
Clothes
Northland
50
50
Southland
100
50
Worldtotal
150
100
Production and consumption before trade

Thisexampleincludesnoformulationofthepreferencesofconsumersinthetwoeconomies
whichwouldallowthedeterminationoftheinternationalexchangerateofClothesandFood.
Giventheproductioncapabilitiesofeachcountry,inorderfortradetobeworthwhileNorthland
requiresapriceofatleastonetonneofFoodinexchangeforonetonneofClothesand
SouthlandrequiresatleastonetonneofClothesfortwotonnesofFood.Theexchangeprice
willbesomewherebetweenthetwo.Theremainderoftheexampleworkswithaninternational
tradingpriceofonetonneofFoodfor2/3tonneofClothes.
Ifbothspecializeinthegoodsinwhichtheyhavecomparativeadvantage,theiroutputswillbe:
Food
Clothes
Northland
100
Southland
200
Worldtotal
200
100
Production after trade

Worldproductionoffoodincreased.Clothingproductionremainedthesame.Usingthe
exchangerateofonetonneofFoodfor2/3tonneofClothes,NorthlandandSouthlandareable
totradetoyieldthefollowinglevelofconsumption:
Food
Clothes
Northland
75
50
Southland
125
50
Worldtotal
200
100
Consumptionaftertrade
Northlandtraded50tonnesofClothingfor75tonnesofFood.Bothbenefited,andnow
consumeatpointsoutsidetheirproductionpossibilityfrontiers.
AssumptionsinExample2
Twocountries,twogoods
thetheoryisnodifferentforlargernumbersofcountriesand
goods,buttheprinciplesareclearerandtheargumenteasiertofollowinthissimplercase.
Equalsizeeconomies
again,thisisasimplificationtoproduceaclearerexample.
Fullemployment
ifoneorotheroftheeconomieshaslessthanfullemploymentoffactorsof
production,thenthisexcesscapacitymustusuallybeusedupbeforethecomparative
advantagereasoningcanbeapplied.
Constantopportunitycosts
amorerealistictreatmentofopportunitycoststhereasoningis
broadlythesame,butspecializationofproductioncanonlybetakentothepointatwhichthe
opportunitycostsinthetwocountriesbecomeequal.Thisdoesnotinvalidatetheprinciplesof
comparativeadvantage,butitdoeslimitthemagnitudeofthebenefit.
Perfectmobilityoffactorsofproductionwithincountries
thisisnecessarytoallow
productiontobeswitched
withoutcost.
Inrealeconomiesthiscostwillbeincurred:capitalwill
betiedupinplant(sewingmachinesarenotsowingmachines)andlabourwillneedtobe
retrainedandrelocated.Thisiswhyitissometimesarguedthat'nascentindustries'shouldbe
protectedfromfullyliberalisedinternationaltradeduringtheperiodinwhichahighcostofentry
intothemarket(capitalequipment,training)isbeingpaidfor.
Immobilityoffactorsofproductionbetweencountries
whyaretheredifferentratesof
productivity?Themodernversionofcomparativeadvantage(developedintheearlytwentieth
centurybytheSwedisheconomistsEliHeckscherandBertilOhlin)attributesthesedifferences
todifferencesinnations'factorendowments.Anationwillhavecomparativeadvantagein
producingthegoodthatusesintensivelythefactoritproducesabundantly.Forexample:
supposetheUShasarelativeabundanceofcapitalandIndiahasarelativeabundanceof
labor.Supposefurtherthatcarsarecapitalintensivetoproduce,whileclothislaborintensive.
ThentheUSwillhaveacomparativeadvantageinmakingcars,andIndiawillhavea
comparativeadvantageinmakingcloth.Ifthereisinternationalfactormobilitythiscanchange
nations'relativefactorabundance.Theprincipleofcomparativeadvantagestillapplies,butwho
hastheadvantageinwhatcanchange.
NegligibleTransportCost
Costisnotacauseofconcernwhencountriesdecidedtotrade.It
isignoredandnotfactoredin.
Assumethathalftheresourcesareusedtoproduceeachgoodineachcountry.
This
takesplacebeforespecialization
Perfectcompetition
thisisastandardassumptionthatallowsperfectlyefficientallocationof
productiveresourcesinanidealizedfreemarket.
8.5
Absolute advantage | definition and Examples
Acountryhasan
absoluteadvantage
overanotherinproducingagood,ifitcanproducethat
goodusingfewerresourcesthananothercountry.
ForexampleifoneunitoflaborinAustraliacanproduce80unitsofwoolor20unitsofwine
whileinFranceoneunitoflabormakes50unitsofwoolor75unitsofwine,thenAustraliahas
anabsoluteadvantageinproducingwoolandFrancehasanabsoluteadvantageinproducing
wine.
AustraliacangetmorewinewithitslaborbyspecializinginwoolandtradingthewoolforFrench
wine,whileFrancecanbenefitbytradingwineforwool.
Example
Example1
CountryAcanproduceonewidgetusingoneunitoflabour.
CountryBcanproduceonewidgetusingtwounitsoflabour.
CountryAhasanabsoluteadvantageoverCountryBinproducingwidgets.
Example2
CountryAhas100unitsoflabor.Ituses20toproduce80unitsofParachutes,and80to
produce20unitsofBarbiedolls.
CountryBhas100unitsoflabor.Ituses40toproduce100unitsofBarbiedolls,and60to
produce20unitsofParachutes.
Ifthecountriesmaximizedtheirpotential,CountryAcouldproduce400unitsofParachutes,and
countryBcouldproduce250unitsofBarbiedolls.Throughtrade,thetwocountrieswould
achieveamoreefficientallocationofresourcesandincreasetheirprosperity.
8.6
Free trade | Benefits of free trade
What is Free Trade?
Freetradeisasystemoftradepolicythatallowstraderstotradeacross
nationalboundarieswithoutinterferencefromtherespective
governments.
Reasons for Free Trade

DomesticNonavailability:A
nationtradesbecauseitlackstherawmaterials,climate,
specialistlabour,capitalortechnologyneededtomanufactureaparticulargood.Tradeallowsa
greatervarietyofgoodsandservices.
Costeffectiveness:
Itischeapertobuyfromothercountriesratherthanproducingthemselves.
Benefits of Trade
Lowerpricesforconsumers:
Whenthereisfreetrade,consumerscanfreetobuygoodsfrom
theproducerwhoiswillingtosellatthelowestprices.Henceconsumersgainfromlowerprices.
Greaterchoiceforconsumers:
Withfreetrade,consumershaveaccesstovarietyofgoods
andservicesfromdifferentproducersacrosstheglobe.Thismeansmorechoice.
Abilityofproducersto
benefitfromeconomiesofscale:
Producershaveaccesstoalarger
marketthustheycanproducemoreatlowercostandbenefitfromeconomiesofscale.
Abilityto
acquireneededresources:
Throughfreetradeproducerscannotonlysellinalarge
marketbutalsogainfrompurchasingfromsuppliersacrosstheworld.
More
efficientallocationofresources:
Whenthereisfreetrade,themostefficientproducers
gettheopportunitytoproduceduetotheircostefficiency.Thisleadstoproductiveefficiency.
Increasedcompetition:
Infreetradeproducersfromdifferentregionscancompetewitheach
otherintermsofprice,qualityandvariety.Increasedcompetitionleadstoefficientallocationof
resources.
Sourceofforeignexchange:
Freetradeinvolvesthetransactionofgoodsandservices
betweennations.Inordertopurchasegoodsfromabroad(imports),weneedforeigncurrency.
Thisispossiblethroughexportingofgoodstoothercountries.
Free Trade diagrams
8.7
Protectionism | Meaning and Methods
Protectionism
Policyofprotectingdomesticindustriesagainstforeigncompetitionbymeansoftariffs,
subsidies,importquotas,orotherhandicapsplacedonimports.Thechiefprotectionist
measures,governmentleviedtariffs,raisethepriceofimportedarticles,makingthemless
attractivetoconsumersthancheaperdomesticproducts.Importquotas,whichlimitthe
quantitiesofgoodsthatcanbeimported,areanotherprotectionistdevice.
Methods of Protectionism
Tariffs
Atariffisataxonforeigngoodsuponimportation.Tariffratesvaryaccordingtothetypeof
goodsimported.Importtariffswillincreasethecosttoimporters,andincreasethepriceof
importedgoodsinthelocalmarkets,thusloweringthequantityofgoodsimported.
Quotas
An
importquota
isatypeofprotectionistthatsetsaphysicallimitonthequantityofagoodthat
canbeimportedintoacountryinagivenperiodoftime.Thisleadstoareductioninthequantity
importedandthereforeincreasesthemarketpriceofimportedgoods.Quotas,likeothertrade
restrictions,areusedtobenefittheproducersofagoodinadomesticeconomyattheexpense
ofallconsumersofthegoodinthateconomy.
Administrative Barriers
Countriesaresometimesaccusedofusingtheirvariousadministrativerules(eg.regardingfood
safety,environmentalstandards,electricalsafety,etc.)asawaytointroducebarrierstoimports.
Embargo
An
embargo
istheprohibitionofcommerceandtradewithacertaincountry,inordertoisolateit
andtoputitsgovernmentintoadifficultinternalsituation,giventhattheeffectsoftheembargo
areoftenabletomakeitseconomysufferfromtheinitiative.
Subsidies
Governmentsubsidies(intheformoflumpsumpaymentsorcheaploans)aresometimesgiven
tolocalfirmsthatcannotcompetewellagainstforeignimports.Thesesubsidiesarepurportedto
"protect"localjobs,andtohelplocalfirmsadjusttotheworldmarkets.
Anti-dumping legislation
Supportersofantidumpinglawsarguethattheyprevent"dumping"ofcheaperforeigngoods
thatwouldcauselocalfirmstoclosedown.However,inpractice,antidumpinglawsareusually
usedtoimposetradetariffsonforeignexporters.

Economics Revision Notes For Olevel

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What are the factors of production?

What are the factors of production?

What is a production possibility curve?

What is a production possibility curve?

EconomicRevisionNoteforGr:08,09,10

At the end of this unit students will be able to:

What are factors of Production?

At the end of this unit students will be able to:

2.1 What is demand?

Movement along the demand

Shift in the demand curve

Movement along the Supply

Shift in Supply Curve

Factors affecting Supply

Market Price-Equilibrium Price

Effect of change in Demand and

Price Elasticity of demand

Perfectly Inelastic demand

Unitary Elastic Demand

Cross price elasticity of demand

What is an Economic System?

Examples of Planned economies

What is Market Failure?

Social Cost and benefits

A standard of deferred payment

Function of a Central Bank

Open market operations

Minimum reserve requirements

Functions of Commercial banks

Role of Stock exchanges

Raising capital for businesses

Mobilizing savings for investment

Facilitating company growth

Creating investment opportunities for small

Government capital-raising for development

Barometer of the economy

What are wages?

Demand for labour

Factors affecting the demand for

Factors affecting the supply of labour

Size of the population

How to wage rate is determined?

A rise in the demand for labour will

A fall in the supply of labour will result

Substitution and Income effect

Why workers change jobs at

Factors affecting individual's

3.13 Why wages differ?

Factors affecting individual

Family size and commitments

Availability of/knowledge about

Confidence in banking system

Factors affecting savings

Advantages of Division of Labour

Disadvantages of Division of Labour

Single Union agreement

Advantages to a Sole Proprietor

Disadvantages to a Sole Proprietor

Difference between Limited companies and