IGCSE Economics homepage

The Economic Problem

The basic economic problem is that people have unlimited wants but there are are limited resources to satisfy these wants.

Factors of Production

Land

The land for farming and building on, but it also includes the resources under the land (coal, minerals, metals etc), the resources on the land (forests, lakes etc) and the fish stocks in the sea.

The supply of land does not really change but the resources in/on the land can change significantly due to mining, forestry, fishing etc.

Labour

Labour is the human effort that is used to produce an item, both mentally & physically.

The supply of labour is determined by how many workers are available & how long they can work for. Factors affecting this include:

  • retirement age
  • school leaving age
  • length of working day (varies between countries)
  • holiday entitlement (varies between countries)

Capital

Capital is anything that is used to produce other goods & services rather than being used for its own sake (machinery, tools, offices etc).

There are 2 main categories of capital:

  • Working Capital - which is used up in the process of production (seeds, raw materials).
  • Fixed Capital - long lasting & not used up in production (machinery, warehouse etc).

The supply of capital generally increases as machinery is replaced/updated or factories expand their premises.

Enterprise

This is the decision making and risk bearing in business by an entrepreneur. An entrepreneur has to organise the factors of production and decide what & how much to produce.

Some risks can be insured against (fire, theft etc), but others such as increases in costs of production & increased competition cannot

Opportunity Cost

This is the cost of the best alternative that is given up when a decision is made. This can be applied to products that we buy, the jobs that we undertake and the products firms decide to make. Private firms generally base their decisions according to which product will maximise their profit.

The Production Possibility Curve (PPC)

Production Possibility Curve

This indicates the points at which factors of production are being used most efficiently. It is sometimes also known as the Production Possibility Frontier (PPF).

Any point to the left of the curve means that resources are not being used to their potential (uemployed labour, land not being used etc).

The curve can be moved outwards to the left through the discovery of new resources, new technologies that increase efficiency or increases in the quality of the factors of production.

It is also known as the Opportunity Cost Curve as it shows the opportuntiy cost of producing more of one product.

Allocation of Resources

Demand Curves

demand curve

Movement along the Demand Curve (Price)

demand contractions and expansions

A change in price causes a movement along the curve

Shift of the Demand Curve

demand curve shifts

A shift of the demand curve represents an increase or decrease of demand at a given price level. This may be because of:

Movement along the Supply Curve (Price)

supply curve contractions & expansions

A change in price causes a movement along the curve The higher the price of a product, the more suppliers will produce.. If the price rises then supply will rise, this is known as an extension in supply. The lower the pice of a product the less will be supplied. If the price falls then supply will fall, this is known as an contraction in supply.

Shift of the Supply Curve

supply curve shifts

A shift of the supply curve represents an increase or decrease in the quantitiy supplied at each & every price. Causes of shifts in supply:

Equilibrium

equilibrium

The equilibrium price is the point at which demand and supply are equal (where they cross on the diagram). It is also called the market clearing price since it is the point at which all the items supplied are demanded - therefor clearing the market of all the stock.

Consumers want low prices & suppliers want higher prices, this leads to adjustments in the price of products until the equilibrium point is reached.

Excess Supply

excess supply

This situation occurs when the price level is too high which results in a larger quantity supplied than quantity demanded.

Suppliers want to sell the extra stock that they have before it goes bad or out of season so they will lower the price. This leads to an expansion in the quantity demanded and a contraction in the quantity supplied bringing the market back into equilibrium.

Excess Demand

excess demand

This occurs when the price is set too low which result in a larger quantity being demanded than there is available from the suppliers.

Suppliers realise that they can charge a higher price and still sell more products so the price level rises which leads to a contraction in demand (some people wont buy at the higher price) and an extension in supply, bringing the market back into equilibirum.

Social Costs

When considering the cost of production or offering a service we need to take into account more than just the cost to the company. There are wider costs that affect society such as air polltion that are not accounted for on the price.

Private costs: these are the costs to individuals of consuming a product, often the monetary value, but sometimes a health cost such as smoking. They are also the costs to a firm (fixed and variable costs) of production.

Private benefits: the benefit to an individual from consuming a product, often satisfaction, more knowledge etc. In the case of a firm these are likely to be the profits that are made.

External costs: the costs of production or consumption of an item to a third party - litter, air pollution, water pollution are exmaples, these are often called externalities.

External benefits: the benefits of production or consumption to a third party - other firms & society may benefit from the skills that workers learn through their jobs such as first aid, it skills etc.

To establish the total cost or benefit to society the total value of the private costs and eternal costs needs to be calculated. The sum of the private and external benefits need to be calculated. If the social cost is greater than the social benefit then the resources & factors of production should be used ot produce something else that is more socially beneficial.

Individuals Choices

Money

Money has allowed us to develop systems of trade that do not rely on barter. In an economy based on barter some products and commodities may perish & lose value, be difficult to transfer to another owner or to divide into small amounts.

Functions of Money

  • Medium of exchange: exchangeable for other goods & services.
  • Measure of value: common measurement of the value of goods and services.
  • Store of value: money should not lose its value over time (inflation devalues money).
  • Deferred payment: money allows the true value of a transaction to be paid at a later date.

Characteristics of money

  • Acceptable
  • Durable
  • Portable
  • Divisible
  • Scarce

Types of Money

  • notes & coins (cash)
  • bank accounts - money transferred through cheques & direct debits

Banking

Central Banks

The government’s bank:

  • taxes paid in & gov spending paid out.
  • holds foreign currency & gold reserves
  • used for monetary policy (interest rates and control of the money supply).
  • Issues bank notes & coins.
  • Emergency lender to banks.
  • Regulates the banking system.

Commercial Banks

  • Private sector & profit orientated.
  • Accept deposits & lend to the public.
  • Typical services offered:
    • current/checking account
    • (instant access).
    • savings/deposit account (notice period for withdrawal or penalty).
    • overdraft (borrow money instantly).
    • loans (set amount & repayments).
    • cheques, debit & credit cards.

Stock Exchange

  • Organisation facilitating the buying & selling of shares.
  • Stock exchange traders are called stock brokers.
  • Only public limited companies can trade shares on the stock exchange.
  • Strict regulations for listed/quoted companies protect share buyers.
  • Share price indicies give an indication of the performance of the economy.
  • Most share deals are done electronically nowadays.
  • People buy shares for capital gains (rising values) or dividend payments.

Employment

Wage Factors

  • The higher the wage the more attractive the job is.
  • Form of payment:
    • Salary: an agreed annual amount paid monthly regardless of hours worked.
    • Wage: an hourly rate so hours worked become important.
    • Piece Rate: worker paid according to their output (fruit picking).
  • Overtime pay Jobs offering lots or regular overtime opportunities may be attractive to workers looking to supplement their income.
  • Bonuses Jobs that have bonus payments related to performance are attractive to workers. It encourages workers to be increasingly productive.
  • Commission Associated with jobs in sales industries & based on employees getting a % of the value of a sale they make. Succesful sales people can earn large commissions.

Non-Wage Factors

  • Working conditions: jobs in a pleasant environment, with regular breaks are attractive.
  • Working hours: jobs that require evening/night time and weekend work may be unattractive, especially to people with families.
  • Job satisfaction: people often highly value being satisfied at work.
  • Location: jobs that are close to home reduce travelling time. It is difficult for many people to move for a job.
  • Holidays: jobs that offer more holiday are attractive (teaching).
  • Pensions: the type and generosity of pension provision by an employer can vary.
  • Fringe benefits: company car, health insurance, free meals etc.

Differences in Earnings

There is a wide range in the amount that individuals get paid for the work they do. Various reasons exist:

  • Supply & demand of labour: if workers are highly demanded and in low supply then firms will offer high wages to attract workers. The opposite is also true.
  • Skill level: highly skilled workers are likely to earn high wages as few people can do what they do (doctors, vets etc).
  • Experience: workers that remain in a job generally recieve higher pay as they gain more experience.
  • Geographical location: some workers recieve higher wages to make up for a higher costs of living some parts of a country (London)
  • Danger factor: jobs that have risks associated often pay higher wages (firemen, soldiers etc).
  • Trade Union influence: workers that can bargain collectively (teachers unions etc) can demand higher wages.
  • Government policy: some governments impose minimum wage levels.
  • Gender: Men often get paid more than women & obtain the higher level jobs in companies.
  • Industrial sector: Agricultural jobs often pay lower wages than manufacturing and service jobs.

Trade Unions

Specialisation

Specialisation of labour focuses workers on a single task or small range of tasks. Firms hope that specialisation will lead to lower costs:

Individuals Spending

Individuals spend to buy the goods and services that they want or require. There are several factors that affect peoples spending choices:

Individuals Savings

People save money in various ways and for different reasons:

Reasons for saving

Factors affecting saving

The Private Firm

Business Organsiation

Sole Trader

  • Owned by one person
  • Low set up costs & small in size
  • Owner gets profits or liable for all losses
  • Limited financial capacity
  • Owner may lack some skills
  • Builders, carpenters, mechanics

Partnership

  • Minimum of 2 partners
  • Increased financial capacity
  • Increased skill set
  • Partners share profits/losses
  • Accountants, architects, solicitors

Co-operatives

  • Jointly owned by members
  • Run for benefit of members
  • Bulk-buy to allow low prices
  • Workers co-ops: share profits & decision making.
  • Housing co-ops buy & manage housing

Private Limited Companies (Ltd.)

  • financial capital divided as shares
  • Shares sold privately not on stock market
  • Share holders only have limited liability
  • Shares often sold to friends & family
  • limited ability to raise finance due to shares being limited to private sale

Public Limited Companies (Plc)

  • Financial capital divided as shares
  • Shares sold to public on stock exchange
  • Can raise large amounts of finance through share sales
  • Often large in size.
  • Admin costs of initial prospectus & sending annual accounts reports to shareholders.
  • Owned by shareholders,
  • Controlled by Board of Directors

Costs and Revenue

Fixed Costs

fixed costs

These are the costs that don’t vary with output such as rent, interest on loans etc. This means that the Total Fixed Cost (TFC) line is straight.

The Average Fixed Cost (AFC) line is sloped. TFC/output = AFC.

If fixed costs are $10 and 1 item is produced then the AFC is $10, however if 2 items are produced then the AFC is $5.

Variable Costs

variable costs

These are the costs that change as output changes such as raw materials, wages, utility bills. As output increases Total Variable Costs (TVC) increase.

Average Variable Costs (AVC) initially fall as productivity of workers increase and the firm benefits from economies of scale but these diminish & may reverse with increased output. TVC/output = AVC.

Total Costs

Total Costs

Fixed Costs + Variable Costs = Total Costs.

The total cost line starts at the level of the fixed cost line since these costs must be paid despite no production. Average Costs = total cost/output

Revenue

This is the total amount of money a firms recieves from selling goods (before costs are deducted).

Average Revenue = Total revenue/output

Integration and Mergers

Firm Size

Indicators of a firms size:

  • Number of employees
  • Value of output produced
  • Financial capital it has Internal Growth
  • Expansion in the current market
  • Increasing market share
  • Diversifying into other products

Horizontal Integration

  • Merging of firms at same stage of production
  • May benefit from increased economies of scale
  • Rationalisation of staff and capital to increase efficiency

Vertical Integration

  • Merging of firms producing same product but at different stages
  • Backward vertical integration: merging with a firm that supplies your raw materials/components
  • Forward vertical integration: merging with a firm that sells your product/commodity

Size Advantages

  • Small firms can be more personal, flexible, specialised
  • Large firms have more financial capital, benefit from economies of scale, can attract highly skilled employees.
  • Firms often start on a small scale & may then expand if that is the owners ambition & the market is big enough

Role of Government

The Circular Flow of Income

circular flow of income

Leakages

Injections

Aggregate Demand

This is the total demand in the economy.

It is made up of:

Aggregate Supply

This is the total supply in the economy.

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Levels of Development

Categories of countries

Less Developed Country (LDC)

LDC Characteristics

Factors Affecting Development

Environmental: Climate, Fertile soils, Natural disasters, Natural resources

Political: Corruption, High military spending

Historical: Colonial debt legacy, Unfair trade deals, Slave trade

Measuring Devlopment

Benefits of Devlopment

Problems of Development

Population Indicators

Causes of Population Growth

Population Pyramids & Changing Structures

LDC Population Structures

Developing country population pyramid

LDC pyramids typically have wide bases due to high birth rates. A classic pyramid shape due to a high death rate at all ages. They are short due to relatively low life expectancy.

Youthful Populations

Many LDCs have large proportions of their population who are young. This creates problems:

MDC Population Structures

Developed country population pyramid

MDC pyramids tend to be narrow at the base (low birth rate) and remain a similar shape up to the ages of 65+ due to a low death rate through these ages. The pyramid is often tall due to long life expectancy.

Aging Populations

Many MDCs have large proportions of their population who are elderly. This creates problems:

Migration & Development

  • LDCs often have large numbers of emmigrants who leave to seek higher wages and a better quality of life in MDCs (who subsequently have high levels of immigration).
  • The emmigrants are often of working age and so are a loss to the productive capacity of LDCs. They often send remittence payments back to their home country though which boosts the economy there.
  • Immigration for MDCs can be considered both good and bad. The increased supply of cheap labour allows firms to keep costs lower. Howevere it places extra pressure on housing and services such as health and education.

International Aspects

Why do Countries Trade?

Balance of Payments

Balance of Payments = current account + capital account + financial account + official reserves

Current Account

This shows the income and spending from trade with other countries. The main parts are:

Key terms

Specialization

Why Specialize?

If countries focus on producing what they are best at & then trade with other countries for the products they need, it should result in all the countries having more goods & services to share in total.

Absolute Advantage

This is the ability of a country to produce more of a certain good than other countries can with the same amount of resources.

Therefore countries should specialise in what they have an absolute advantage in & then trade.

Comparative Advantage

Protectionism

Why use Protectionist Measures?

Methods of Protectionism

Benefits and Problems of Protectionist Measures

Economic Indicators

Measuring Output

Gross Domestic Product (GDP)

The total value of the goods and services produced in an economy.

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.

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). It 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:
    • 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 country’s exports less desirable & imports seem comparatively cheaper. This can lead to further issues such as unemployment.

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.

Causes & 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.

Measuring Development/ Quality of Life

Human Development Index (HDI)

This is an index that takes into account 3 factors (each is an index itself):

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.