IGCSE®/OLevelEconomics1.1ThebasiceconomicproblemS1FactorsofproductionNaturalresources=landMan-maderesources=capitalHumanskillsandeffort=labourBusinessknow-how=enterpriseProductionUsinginputs(resources)tomakeoutputs(goodsandservices)tosatisfytheneedsandwantsofconsumersConsumptionUsingupgoodsandservices(products)tosatisfyconsumers’needsandwantsThebasiceconomicproblemHumanwantsareunlimitedbutresourcesarescarceSo,weallhavetomakechoicesThereisalimitedamountofresourcessuchasrawmaterials,machines,factoriesandskilledworkers.Butthereareanumberofdifferentwaysinwhichtheycanbeused.ResourceallocationthereforeinvolvesdecidinghowbesttousescarceresourcestosatisfyasmanyneedsandwantsaspossibleCHOICECHOICEChoiceSimilarly,peopleandgovernmentsonlyhavealimitedamountofmoneybuthavemanyneedsandwantstosatisfy$100Food?Entertainment?Clothing?Defence?Healthcare?Roads?$100bnOpportunitycostOpportunitycostisthecostofchoiceWhatwouldyoubuywithUS$10?HowshouldthegovernmentspendUS$250million?(Or,shouldthegovernmentcuttaxesbyUS$250million?)Whatoccupationwillyouchoosewhenyoufinishyourstudies?HowshouldanewbusinessinvestUS$20million?Shouldweconservemorenaturalresources?…andwhatarethenextbestalternativesforegone?ProductionpossibilitycurvesAfirmproducingcarsandtrucksWhatistheopportunitycostofproducing20moretrucks?AneconomyproducingconsumergoodsandcapitalgoodsWhatistheopportunitycostofproducing15moretonnesofconsumergoods?ProductionpossibilitycurvesProductionpossibilitycurvesProductionpossibilitycurves(PPCs)showthemaximumcombinedoutputoftwoormoreproductsafirmoranentireeconomycanproducewithitsavailableresourcesResourcesarebeingusedefficientlyiftheyareproducingtheirmaximumoutputBut,becauseresourcesarelimited,producingmoreofoneproductmeansproducinglessofanotherPPCsarethereforeausefulwayofshowingtheopportunitycostofproducingmoreofoneproductintermsofhowmuchofanothermustbegivenupIGCSE®/OLevelEconomics2.1EconomicsystemsS2ResourceallocationBecauseproductiveresourcesarescarcerelativetohumanwantswemustdecide:Whattoproduce?Howtoproduce?Whotoproducefor?Shouldweuseresourcestoproduceasmanyconsumergoodsaspossibleorallocatesomeresources,forexample,tobuildnewroadsortoprovidebetterhealthcare?Whattoolsandmachinerywillbeneeded?Howmanyworkerswillberequiredandwhatskillswilltheyneed?Isitcheapertoemploymorelabourormoremachinery?Shouldpeopleinthegreatestneedgetthegoodsandservicestheyrequire?Orshouldtheybeproducedforpeoplewhocanpaythemostforthem?Whatpriceshouldtheypay?EconomicsystemsWhoinaneconomydecideswhatgoodsandservicestoproduce,howtoproducethemandwhotoproducethemfor,andhowarethesedecisionsaremade?MarketeconomyMixedeconomyPlannedeconomyWho?PrivatesectorfirmsandconsumersHow?ThepricemechanismWho?Privatesectorfirmsandconsumers,andagovernmentHow?ThepricemechanismandgovernmentplanningWho?GovernmentHow?GovernmentplanningEconomicsystemsChinaCubaNorthKoreaDenmarkFranceItalySwedenUKManydevelopedeconomiesArgentinaMauritiusNepalParaguayBahamasSingaporeThemarketeconomicsystemPrivatesectorproducersConsumersGoodsandservicesMoneyProductionExchangeConsumptionInafreemarketeconomicsystemalldecisionsaretakenbyprivatesectororganizationsandindividuals.Thereislittleornoroleforgovernmentorapublicsectorandthereforelittleornotaxationorpublicspending.ThepricemechanismAmarketisanysetofarrangementsthatbringstogetheralltheproducersandconsumersofagoodorservicesothattheycanengageinexchange.PrivatefirmsproducegoodsandservicestomaximizetheirprofitsConsumersconsumegoodsandservicestomaximizetheirutility(satisfaction)AsconsumerdemandforaproductrisesProductionbecomesmoreprofitable,soproducersincreaseoutputProductionbecomeslessprofitable,soproducersreduceoutputMarketpriceandquantitytradedMARKETPRICERISESMARKETPRICEFALLSAsconsumerdemandforaproductfallsWhat’sgoodaboutthemarketsystem?AwidevarietyofgoodsandserviceswillbeproducedtosatisfyconsumerwantsFirmsrespondquicklytochangesinconsumerwantsandspendingpatternsTheprofitmotiveoffirmsencouragesthemtodevelopnewproductsandusethemostefficientmethodsofproductionTherearenotaxesProfitscanbeincreasedbyincreasingsalesand/orreducingcostsofproductionIfconsumerdemandisrising,priceswillriseandproductionbecomesmoreprofitable.EntrepreneurswillallocateresourcestotheirmostprofitableusesThereisnopublicsectorinatotallyfreemarketeconomicsystemHowthemarketsystemcanfailMarketfailure:whenfreemarketsfailtoproducegoodsandservicesthatareworthwhileorwhenthedecisionsofproducersorconsumersresultinwastefulorharmfulactivitiesFirmswillonlyproducegoodsandservicesiftheyareprofitableFirmswillonlysupplyproductstoconsumerswhoareabletopayforthemResourceswillonlybeemployedifitisprofitabletodosoNATIONALPARKHowthemarketsystemcanfailMarketfailure:whenfreemarketsfailtoproducegoodsandservicesthatareworthwhileorwhenthedecisionsofproducersorconsumersresultinwastefulorharmfulactivitiesHarmfulgoodsmaybeproducedifitisprofitabletodosoSomeproducersandconsumersmayignoretheharmfuleffectsoftheiractivitiesonothersandtheenvironmentSomefirmsmayrestrictcompetition,misleadconsumersandchargethemveryhighpricesThemixedeconomicsystemInamixedeconomyagovernmentcaninterveneindifferentmarketsinanattempttocorrecttheworstmarketfailures:ItcanprovideusefulandessentialgoodsandservicesItcanprovidegoodsandservicesforpeopleinthegreatestneedItcanemploypeopleinpublicsectororganizationsandprovidefinancialsupporttoprivatesectorfirmstoboostoutputandemploymentItcanoutlawtheproductionofharmfulgoodsanddangerousactivitiesItcanoutlawbusinesspracticesthatrestrictcompetitionormisleadconsumersThemixedeconomicsystemAmixedeconomythereforecombinestheadvantagesofamarketeconomicsystemwith:governmentownershipandcontrolofsomescarceresourcesgovernmentinterventionstoregulatetheactionsofprivatesectorfirmsandconsumersinsomemarketsHowmixed?Governmentintervention:someproblemsBycorrectingfailuresinsomemarkets,agovernmentmaydistorttheallocationofresourcesandcauseproblemsinothers:HightaxesonpeopleandfirmscandistortmarketpricesignalsandreduceworkincentivesLandregulationscanincreaseproductioncostsandthereforereducetheprofitabilityandsupplyofsomegoodsandservicesPublicsectororganizationsmaybeinefficientandproducepoor-qualitygoodsandservicesbecausetheydonothavetomakeaprofitSomegovernmentspendingmaybeforpoliticalorevenpersonalgainIGCSE®/OLevelEconomics2.2HowmarketsworkS3Whatisamarket?ThemarketforagoodorserviceconsistsofallthoseproducerswillingandabletosupplyitandallthoseconsumerswillingandabletodemanditdemandgoodsandservicestosatisfytheirneedsandwantssupplygoodsandservicestoearnprofitsHowmanyfizzydrinks?Ifcanswere$5eachManyproducersFewconsumersIfcanswere10centseachFewproducersManyconsumersDemandThewantorwillingnessofconsumerstobuyaproductTobeaneffectivedemandaconsumermusthaveenoughmoneytobuytheproductAspricerises,thequantitydemandedbyconsumerscontractsAspricefalls,thequantitydemandedbyconsumersextendsAdemandcurveslopesdownwardsSubstitutesandcomplementsSubstitutescansatisfythesamewantComplementsareinjointdemandorororMarketdemandThesumofallindividualconsumerdemandsforaparticularproductAriseindemandThemarketdemandcurveshiftsoutwardsPossiblecausesare:anincreaseindisposableincomesaftertaxariseinthepriceofsubstitutesafallinthepriceofacomplementtastesandfashionfavourtheproductanincreaseinadvertisingariseinthepopulationotherfactors,e.g.hotweatherincreasesdemandforcolddrinksandsuncreamsMarketdemandThesumofallindividualconsumerdemandsforaparticularproductAfallindemandThemarketdemandcurveshiftsinwardsPossiblecausesare:afallindisposableincomesaftertaxafallinthepriceofsubstitutesariseinthepriceofacomplementtastesandfashionfavourotherproductsareductioninadvertisingafallinthepopulationotherfactors,e.g.hotweatherreducesthedemandforwindercoatsNo,iftheproductisaninferiorgoodAsincomerises,consumersbuylessastheyswitchtheirdemandtoothermorepreferableproductsYes,iftheproductisanormalgoodAsincomerises,consumersarewillingandabletobuymoreIncomeanddemandButwillariseinconsumerincomealwaysleadtoanincreaseindemandforaproduct?SupplyThewillingnessandabilityoffirmstomakeaproductavailabletoconsumersAspricerises,thequantitysuppliedbyproducersextendsbecauseproductionbecomesmoreprofitableAspricefalls,thequantitysuppliedbyproducerscontractsbecauseproductionbecomeslessprofitableAsupplycurveslopesupwardsMarketsupplyThesumofallindividualproducers’decisionsaboutthesupplyofaparticularproductAriseinsupplyThemarketsupplycurveshiftsoutwardsPossiblecausesare:otherproductsbecomelessprofitabletoproduceafallinthecostoffactorsofproductionanincreaseinthesupplyofresourcestechnicalprogressandimprovementsinproductionprocessesandmachineryanincreaseinbusinessoptimismandexpectationsofprofitthegovernmentsubsidizesproductionand/orcutstaxesonprofitsotherfactors,e.g.goodweatherboostscropharvestsMarketsupplyAfallinsupplyThemarketsupplycurveshiftsinwardsPossiblecausesare:otherproductsbecomemoreprofitabletoproduceariseinthecostoffactorsofproductionafallinthesupplyofresourcestechnicalfailures,suchasacutinpowersuppliesormechanicalbreakdownsafallinbusinessoptimismandprofitexpectationsthegovernmentwithdrawssubsidiesand/orincreasestaxesonprofitsotherfactors,e.g.warsandnaturaldisastersThesumofallindividualproducers’decisionsaboutthesupplyofaparticularproductMarketequilibriumPriceperunitQuantitytradedperperiodDDSSEquilibriumquantitytraded(Qe)Marketprice(Pe)0AmarketisinequilibriumwheremarketdemandequalsmarketsupplyAttheequilibriummarketpricethequantityconsumerswishtobuyisexactlyequaltothequantityproducerswishtosellIfamarketisinequilibriumtherearenopressurestochangethemarketpriceMarketdisequilibriumPriceperunitQuantitytradedperperiodDDSSPe0AmarketisindisequilibriumifthequantityconsumerswishtobuyisnotmatchedbythequantityproducerswishtosellP1P2AtpriceP1thereisanexcesssupply.Pricewillneedtofalltopersuadeconsumerstobuymoreandforproducerstocontracttheirsupply.AtpriceP2thereisanexcessdemand.Pricewillneedtorisetoreduceconsumerdemandandtoencourageproducerstosupplymore.AnincreaseinmarketpriceIfmarketdemandrisesORIfmarketsupplyfallsPriceperunitQuantitytraded0DSDD1D1SP1PQQ1Quantitytraded0DSDSP1Q1QPriceperunitS1S1PAdecreaseinmarketpriceIfmarketdemandfallsORIfmarketsupplyrisesPriceperunitQuantitytraded0D1SD1DDSPP1Q1QQuantitytraded0DS1DS1PQQ1PriceperunitSSP1Howresponsiveisdemandtochangesinprice?$1percanNowonly90centsAfter…Before…IfdemandisrelativelyelasticasmallchangeinpricecausesarelativelylargechangeinquantitydemandedHowresponsiveisdemandtochangesinprice?After…Before…asmallchangeinpricecausesonlyarelativelysmallchangeinquantitydemandedNowonly$2$2.20IfdemandisrelativelyinelasticPriceelasticityofdemandHowresponsiveconsumerdemandistoachangeinprice,andthereforehowrevenuesmayrespondfollowingachangeinpricePercentagechangeinprice=$1/$5=20%Percentagechangeinpassengernumbers=5/100=5%Priceelasticityofdemand=20%/5%=4Percentagechangeinprice=$0.5/$2.00=25%Percentagechangeinpassengernumbers=10/50=20%Priceelasticityofdemand=20%/25%=0.8ELASTICINELASTICDemandforaproductwillbepriceelasticif:Why?Because:theproducthasmanyclosesubstitutesconsumerscanbuyinsteadifthepricerises,e.g.differentwashingdetergentstheproductisexpensive,suchasmanyluxuryitems,soevenasmallincreaseinpricemaybeunaffordableconsumersdonotneedtopurchasetheproductfrequentlysotheyhavetimetosearchforalternativesifpricerisesPriceelasticityofdemand10%off%changeinquantitydemandedisgreaterthanthe%changeinprice>PED>1Demandforaproductwillbepriceinelasticif:Why?Because:theproducthasveryfewclosesubstitutesforconsumers,e.g.electricitytheproductisalow-costitem,e.g.adailynewspaperorboxofmatchestheproductisanessentialitemandneededregularly,e.g.manybasicfooditemssuchasbread,riceandvegetablesPriceelasticityofdemand10%off
1SupplyispriceinelasticWhenthe%changeinquantitysuppliedislessthanthe%changeinpricePES<1Forexample,ittakestimetogrowcornsosupplywillbecomemoreelasticovertimeIndirecttaxescanbeaddedtothepricesofgoodsandservicesButwhydogovernmentswanttoincreasethepricesandrestrictthesupplyofsomeproducts?todiscouragetheirconsumptionbecauseitcanbeharmful,e.g.cigarettestoreducetheirproductionbecauseitcanbeharmful,e.g.theburningofoilandgasreleasesharmfulemissionstoconservelimitednaturalresources,e.g.taxesonenergyandwateruseSubsidiescanbepaidtoproducerstowardstheircostsofproductionButwhydogovernmentswanttoincreasethesupplyandreducethepricesofsomeproducts?tomakeproductsmoreaffordableforthoseonthelowestincomes,e.g.basicfoodstuffstoencouragetheirconsumptionbecauseitcanbebeneficial,e.g.medicinestoencouragetheirdevelopmentandproductionbecauseitisbeneficialandcreatesemployment,e.g.windturbinesandsolarenergypanelsTaxes,subsidiesandmarketoutcomesTheeffectofanindirecttaxObjective:toreduceharmfulexhaustemissionsbythereducingtheconsumptionofpetrolBeforetaxof40centsperlitre:600millionlitresofpetrolaretradedeachmonthatthemarketpriceof80centsperlitreAftertaxof40centsperlitre:500millionlitresofpetrolaretradedeachmonthatanewmarketpriceof$1perlitreButwhydoesn’tthemarketpricerisefrom80centsto$1.20perlitre?Becausedemandcontractsaspricerises,sopetrolproducersenduphavingtopaysomeofthetaxtogovernmentTheeffectofasubsidyObjective:toencouragetheproductionandconsumptionofbiofuelBeforeasubsidyof$20perbarrel:40millionbarrelsofbiofuelaresuppliedandtradedeachmonthatthemarketpriceof$60perbarrelAfterasubsidyof$20perbarrel:50millionbarrelsofbiofuelaresuppliedandtradedeachmonthatanewmarketpriceof$50perbarrelButwhydoesn’tthemarketpricefallfrom$60to$40perbarrel?BecausedemandextendsaspricefallssoproducersdonothavetopassonthefullamountofthesubsidyIGCSE®/OLevelEconomics2.3SocialcostsandbenefitsS4PrivatecostsandbenefitsPrivatesectorfirmsConsumersAimtomaximizetheirprofitsPrivatecosts=wages,rents,components,insurancepremiums,telephonebills,electricity,etc.Privatebenefits=revenuefromthesaleofproductstoconsumersAimtomaximizetheirutility(orsatisfaction)Privatecosts=paymentsforgoodsandservicesPrivatebenefits=satisfactionfromconsumingtheproductstheybuySomeproducersandconsumersmayignoretheharmfuleffectsoftheirproductionandconsumptiondecisionsandactivitiesonotherconsumers,firmsandtheenvironmentbecausetheyareonlyconcernedwiththeirownprivatecostsandbenefitsMarketfailureExternalcostsSocialcostsTotalsocialcost=privatecosts+externalcostsExternalbenefitsSocialbenefitsTotalsocialbenefit=privatebenefits+externalbenefitsAneconomicuseofresources?Iftotalsocialbenefit>totalsocialcostIftotalsocialcost>totalsocialbenefitEconomicwelfarecanbeimprovedbyreducingproductionandconsumptionEconomicwelfarecanbeimprovedbyencouragingmoreproductionandconsumptionTaxonlandfilltoincreaseby20%asthegovernmentattemptstoreducetheamountofwastethatendsupintheground.CorrectingmarketfailureHowcanagovernmentinamixedeconomyensurethatfirmsandconsumerstakeaccountoftheexternalcostsandbenefitsoftheirdecisionsandactions?IndiatoenforcenewregulationstocurbnoisepollutionSouthAfricabansplasticbagstoreducelitterRetailerscaughthandingoutthebagsnowfaceafineof100,000rand($13,800)ora10-yearjailsentenceTheChinesegovernmentannounces18recyclingprojectsaretoreceivegovernmentsubsidiescoveringupto50%oftotalinvestmentcostsTheAustraliangovernmenthasbannedlivecattleexportstoIndonesiauntilsafeguardsareadoptedtoendthebrutalslaughterofanimalsGovernmentunveilsplantotaxthecarbonemissionsoftheworstpollutersCorrectingmarketfailuresToreduceexternalcostsRaisetaxesonfirmswithactivitiesthatcreateexternalcoststoreducethosefirms’after-taxprofits,e.g.taxesonemissionsfromtheuseoffossilfuels,onlandfillwasteandmineralextractionIncreaseindirecttaxesonproductsthatareconsideredharmfultoraisetheirpricesanddiscouragetheirconsumption,e.g.taxesoncigarettes,petrol,plasticbagsUseregulationsandfinestodiscouragetheproductionorconsumptionofproductsoractivitiesthatareharmful,e.g.smokingbans,planningcontrols,legallimitsonairandwaterpollutants,anti-litterlawsToincreaseexternalbenefitsEnsurepublicsectorprovisionofsociallyandeconomicallydesirablegoodsandservices,e.g.providingfreevaccinationsandeducation,publicparks,publictransportandroadsProvidesubsidiestoprivatesectorfirmstoreducethecostofactivitiesandproductsthathaveexternalbenefits,e.g.subsidiesforrecycling,renewableenergy,organicfarmingUseregulationstoencouragefirmstochangetheirproductionmethods,e.g.rulestophaseouttraditionallightbulbstoencourageaswitchtolow-energylightbulbs,healthandsafetyregulations,animalwelfarelawsIGCSE®/OLevelEconomics3.1MoneyandfinanceS5Whydoweneedmoney?Toexchangeforthosegoodsandservicesweeachneedandwantbutareunabletoproduceforourselves,becausewearenotself-sufficient(individuallywecannotproduceeverythingweneedandwant)wespecializeinthosetasksandproductiveactivitieswearebestabletodoandthereforeneedtotradewithproducersofotherproductsBarterBarterinvolvesexchanginggoodsandservices,i.e.‘payment’foroneproductismadewithanotherProblemswithbarterare:findingsomeonetoswapwith(theremustbeadoublecoincidenceofwants)►◄howtoagreevalues(howmanyapplestoonecow,andhowmuchcheeseforoneapple?)ThefunctionsofmoneyamediumofexchangeagoodstoreofvalueameasureofvalueameansofdeferredpaymentToovercometheproblemsofbarteramoneymustbe:PricesChoosingagoodmoneyAgoodmoneymustbe:acceptabletoothersinpaymentforgoodsandservicesdurablesothatitisnotworndownordamagedeasilythoughfrequentuseportablesothatitiseasytocarryarounddivisibleintosmallerunitsandvaluesscarce,otherwiseifitisfreelyavailableitwillbeoflittleornovaluetoothersWhatismoney?Notesandcoins+bankdepositsBankdepositsare‘nearmoney’becausetheycanbewithdrawntoprovidecashtomakepaymentsreasonablyquicklyFinancingeconomicactivityBankslendmoneytopeople,firmsandgovernmentorganizationstofinancetheirspendingStockcanbesoldonthestockmarkettoprovidelong-termfinanceforcompaniesandgovernmentsThebankingsystemBanksarefinancialintermediaries:theybringtogethercustomerswhowanttosavetheirmoneywithcustomerswhowanttoborrowitSAVINGMONEYBanksneedmoneytomakeloansBanksoffersaversinteresttoencouragethemtosavetheirmoneyinsavingsaccountsTheinterestrateisarewardforsavingmoneySaversmaybeofferedhigherinterestratesforlong-termsavingsThepriceofmoney…istheinterestrate(expressedasa%perunitofmoney)Thebaserateofinterestinaneconomyissetbythecentralbankorthegovernment.Itistheratewhichthecentralbankwillchargebanksforlendingthemmoneyiftheyrunshortofcash.Forexample:toattractsavings,abankoffersitscustomersannualinterestof3%apersonwhosaves$1,000inasavingsaccountforoneyearwillreceive$30ininterestattheendofthatyearThepriceofmoneyForexample:asmallfirmborrows$10,000repayableinoneyeartheinterestrateis5%peryearthetotalrepayableattheendoftheyear=$10,500BORROWINGMONEYTheinterestrateisthecostofborrowingmoneyLendingmoneytopeopleandfirmsinvolvesadministrativecostsandrisksofnon-repayment.BanksmustcoverthesecoststomakeaprofitThelongerthetermoftheloanandthegreatertheriskofnon-repaymentthehighertheinterestratechargedInterestchargesalsocompensatebanksforpriceinflationwhichwillreducethevalueofthemoneytheyhavetiedupinloansTheroleofacentralbankThecentralbankisatthecentreofthebankingsysteminmosteconomiesThemainfunctionofacentralbankistomaintainthestabilityofthenationalcurrencyandthemoneysupplyTheBankofEnglandTHEBANKERS’BANKSupervisesthebankingsystemandregulatestheconductofbanksHoldstheaccountsofbanksandtransfersmoneybetweenthemIslenderofthelastresorttobanksiftheyrunshortofmoneyTheroleofacentralbankTheCentralBankofIndonesiaTHEGOVERNMENT’SBANKIssuesnotesandcoinsManagesthenationaldebtManagespaymentstoandfromthegovernmentManagesthenation’sgoldandforeigncurrencyreservesOperatesthegovernment’smonetarypolicyIssuingstockStockisthenameusedtodescribemoneyraisedbyajointstockcompanyorcorporation,oragovernment.Jointstockcompaniessellsharestoraisepermanentcapital.Sharesneverhavetoberepaid.Thepeopleandorganizationsthatbuysharesbecometheownersorshareholdersofjointstockcompanies.Eachshareheldinacompanyentitlesitsownertoashareofanycompanyprofits.Thispaymentfromprofitsiscalledadividend.Agovernmentsellsloanstocksorbondstoraisemoneyforafixedperiodoftime,sometimesupto25yearsormore.Bondsarerepaidwithinterestattheendoftheirterm.ThestockmarketAstockexchange,orbourse,isabusiness