UNIT 2.

1 ECONOMIC SYSTEMS

Determining what to produce?

1. What to produce
2. How to produce
3. Whom to produce

Market: An arrangement where consumers and producers of a good and service come and
exchange.

Price Mechanism: When the demand and supply determines the price of a commodity

Advantages of the market system:

1. Wide variety of goods

2. Firms respond quicker to change in consumer wants
3. Profit motives encourages firms to develop new products and efficient methods
4. No taxes

Market Failure: When markets fail to produce goods and services worthwhile , and decisions
of producers and consumers that result in wasteful or harmful activities

Market problems and how mixed economies solve market problems:

Market system Mixed system

Firms only produce profitable goods and Government provides public goods
services
Firms only supply goods to consumers who Government provides public and merit goods
can afford it at low cost/free
Resources only employed it its profitable Government can provide jobs in public
sectors and provide welfare payments to
unemployed or low incomes
Harmful goods may be produced if its Charge high taxes on such goods or ban it
profitable
Producers and consumers ignore the harmful Introduce laws and regulations to stop this
effects on the environment
Some firms may dominate the market supply Regulates or breaks up the monopolies

How government interventions can be bad?

1. Taxes can distort market signals and reduce work incentive

-Less money for hard work, increase prices
2. Laws and regulations increase production cost and reduces the supply
-Health, safety, employment, environmental, consumer protection increases
production cost
3. Public sector maybe be inefficient and produce poor quality goods and services
-No profits means less importance of production cost
4. Some government spending maybe be political or for personal gain
- Taking on big projects that are not necessary for publicity or using money to bribe
the public sector

Size of Mixed economy = public sector output + private sector output

Opportunity cost of public sector: Since public sectors money comes from taxes , the higher
the taxes and therefore less money for the private sector to spend

Public expenditure: Public expenditure is spending made by the government of a

country on collective needs and wants (Welfare payments, infrastructure, subsidies)

Capital expenditure: The cost of long -term improvements (schools, machinery,

medical equipment)

UNIT 2.2-PRICE MECHANISMS

Demand: The want or willingness of consumers to buy a good and service

Demand Curve:
-Downward sloping
-Price rises, demand falls
-Price and quantity move
in opposite directions
Extension of demand:
when quantity demanded
increases with a fall in
price, with no other factor
affecting demand
Contraction of demand:
Opposite of extension
Ceteris paribus: All other factors remain unchanged
An Increase in demand: Means
that consumers demand more of a
product at each and every price
then they did before
A fall In Demand: Opposite of
increase in demand.

Changes or shifts in consumer demand

and shifts in curves:

1. Changes in consumer incomes

2. Changes in tax on incomes
- Disposable income: Amount of income left to spend after taxes
3. Prices and availability of other goods and services
- Complementary goods are said to be in joint demands (butter and margarine)
4. Changes in taste habit and fashion
5. Population Change

Supply: The amounts of good and service producers are willing to make at different prices.

Factors that affect supply:

1. Changes in the cost of factors of production

2. Changes in the price and profitability of other goods and services
3. Technological advance Factors:
4. Business optimism and expectations
5. Global factors 1. Number of Substitutes
-Inelastic when there
Price Elasticity of Demand: The responsiveness of quantity demanded to changes in the
are fewer substitutes
price of a good or service
cause there is no
choice but to buy. Eg:
Medicine
2. The period of time
-More time consumers
have the more likely
they will find cheaper
substitutes
3. The proportion of
income spent on a
commodity
-If goods with low
prices like newspapers
were to increase it
Change in price would only be a little
Change in price
causes a small bit and won’t take
causes a big
change in quantity
change in quantity much out of a
PED<1
PED>1 person’s income
(inelastic) unlike the
Qn−Q o

1 oo
PED=
Pn−P o

1 oo

Price Elasticity of Supply

Qn−Q o
Factors:
1 oo
PES= 1. Time
Pn− P o -Takes more time to get more things
1 oo 2. Availability of Resources
Supply -If a production wants to expand it
needs more factors of production

Effect of tax on supply: Effect of subsidy on supply:

Indirect tax (can be seen as Reduces market price as subsides
additional cost of production, causes decrease production cost. However
demand to go down and producers to it can distorts competition, for
raise their supply to match the tax example the government can
price increase. subsidize its inefficient production.
This can cause other countries
production to fail
UNIT 2.3 SOCIAL COST

Private cost + External cost=Total social cost

Private benefits + External benefits=Total social benefits
An uneconomic resource is one that’s social cost exceeds its social benefits’
Market Failure and Government Intervention:

How the market fails: Whenever a use of resources creates external cost or benefits, the
market economic system will fail to allocate resources efficiently. This is because private
sector films will only make decisions based on their own private cost.

Government Intervention:

1. Laws and Regulations: Can be introduced by governments to ban or control activities

that create serious negative externalities and cost.(contamination of land by pollution)
2. Tax: If market prices fail to reflect the external cost of a productive activity then there
may be possible to impose a tax on product prices to make sure they do. Also reduces
consumer demand.(Cigarettes)
3. Subsidies: Private sector firms are not interested in producing external benefits for
other because they are not paid for them. Subsidies help to reduce their production
cost and thus make it profitable to produce the goods and services(buses)

Government policy and conflicts of Interest: Taxes, subsidies and laws and regulations can
also influence consumer demand where these have external cost and benefits (cigarette tax or
vaccine subsidies). However when government intervention occurs, it may create conflicts
of interest. (Higher taxes on income for subsidised buses good for middle income people, but
for high income people higher taxes are bad and they may not benefit as much from buses)

Arguments for and against conservation:

NO YES
Free market encourages the most efficient If prices are too low to cover external cost
use of resources through price mechanism; then taxes can help to raise prices and reduce
firms that waste resources face higher costs demand.
and are not able to compete with more
efficient ones.
Conserving resources leave them idle, thus Measures designed to conserve resources will
less jobs are created. not result in less goods and services, just
more efficient ways to use them.
In a free market prices will increase as Resources will be reallocated from the
resources deplete, therefore encouraging production of goods and services with high
conservation and waste reduction instead external cost to lower ones. For example
solar panels, as more is produced the price
will go down and demand for them will
increase
As resources run out their cost will rise, and
we will find cheaper alternatives
UNIT 3.1 MONEY

Problems with barter:

1. Fixing a rate of exchange

2. Finding someone to swap with
3. Trying to save

Functions of Money:

1. Medium of Exchange
2. Measure of Value
3. Store of Value
4. Means of deferred payment(Can pay later, credit cards)

What makes good money?

1. Acceptability
2. Durability
3. Portability
4. Divisibility
5. Scarcity

Money Supply- Cash or notes circulating and deposits in banks and other financial
institutions.

Types of banks:

Functions of Commercial banks:

1. Accepting deposits of money and savings

2. Helping customers make and receive payments
3. Making personal and commercial loans(Overdraft- over withdrawing and Mortgage-
long term loan on house)
4. Buying and selling shares for customers
5. Providing insurance
6. Operating pension funds
7. Providing financial and tax planning advice
8. Exchanging foreign currencies

Functions of Central banks:

1. It issues notes and coins for the nation’s currency

2. Manages payments to and from the government
3. It manages the national debt
4. It supervises the banking system, regulating the conduct of bank holding their
deposits and transferring funds between them
5. Lender of the last resort the banking system
6. Manages the nations gold and foreign gold reserve
7. Operates the government’s monetary policy

Functions of the stock exchange:

1. It helps companies sell their stocks or equities

2. This helps them to raise finance
3. It helps the public buy such stocks
4. This buying and selling of shares through the stock exchange will produce a market
price
5. It provides an indicator of how generally an economy is doing

UNIT 3.2 OCCUPATIONS AND EARNINGS

Payments for labour:

1. Time rate
2. Piece rate
3. Fixed annual rate
4. Performance related payment

Factors that can affect an individual’s choice of occupation:

1. wages/salaries
2. bonuses/commission
3. pension
4. holiday entitlement (fringe benefits)
5. proximity to home
6. promotion prospects
7. working conditions
8. Canteen/social facilities.
Advantages and disadvantages of Specialization for the individual:

Advantages Disadvantages
Allows individual to make the best use of his Relies on others to produce goods and
abilities services
Can improve their skills by repeated carrying Doing the job for many years can be boring
out the same task and stressful
Skilled employees earn more than unskilled Skills and occupations can become outdated
employees and have a higher demand for
skilled ones

Why firms may change their demand for labour:

1. Changes in consumer demand for goods and services

2. Changes in the productivity of labour
3. Changes in the price and productivity of capital
4. Changes in non-wage employment cost

Why labour supply may change?

1. Changes in the net advantages of an occupation

2. Changes in the provision and quality of education and training
3. Demographic changes(population)

Occupational wage differentials:

1. Different abilities and qualifications

2. “Dirty” jobs and unsociable hours
3. Job Satisfaction
4. Lack of information about jobs and wages
5. Labour mobility(Changing jobs)

Why earnings differ from people doing the same job:

1. Regional differences in labour demand and supply curves

2. Length of service
3. Local pay agreements(trade unions)
4. Non-monetary rewards differ
5. Discrimination

Why government intervene in labour markets:

1. Protect the rights of employees and employers

2. Outlaw and regulate restrictive practices that are used by trade unions or employers
3. Raise the wages of the lowest paid workers
4. To reduce unemployment
5. To outlaw discrimination

UNIT 3.3 TRADE UNIONS

Trade unions protect the rights and interests of their members and improve wages and
working conditions in exchange of a union membership fee to fund the organisation.

Functions:

1. Negotiate improvements in and other non-wage benefits

2. Defending employees’ rights and jobs
3. Improve working conditions
4. Improve pay and fringe benefits
5. Encourage workers participation in business and decision making
6. Support members who have been fired or are taking industrial actions(temp pay)
7. Developing the skills of union members
8. Provide social and recreational amenities for their members
9. Influencing the government policy and employment legislation(laws)

Types of Unions

1. General Unions (transport/commercial)

2. Industrial Unions (Factories)
3. Craft Unions ( Technicians/Carpenters)
4. Non-manual Unions (Journalist)

Collective bargaining:

When trade unions and employers negotiate

Trade unions will argue for improved wages and other working conditions when:

1. Price inflations is high and rising

2. Other groups of worker receive pay rises
3. New machinery or working practises has been introduced to the workplace
4. Labour productivity of members has increased
5. Profits of the employing organization have increased.
Union representation:

1. Closed shop: Employees must join a union as a condition for working there
2. Open shop: Can employ union or non-union members
3. Single Union agreement: An employer agrees to a single union representing all its
employees

-Advantages:

1. Time saved negotiating with only 1 union

2. Avoids disagreement with different unions
3. Easier to implement changes in only one union
4. Closer working relationship with the union and help reduce industrial disputes

What determines the strength of unions?

1. Unions represent all the employees in a firm

2. Union members provide essential products to the public
3. Union is able to support their members financially during strikes

Arbitration: When an outsider (government senior employee or lawyer) helps settles

disputes between unions and employers

UNIT 3.4 SPENDING, SAVINGS AND BORROWINGS

Reasons for spending:

1. Wealth
2. Consumer confidence in their jobs
3. Interest rates

Reasons for increasing consumptions trends:

1. Real incomes have risen

2. People work fewer hours than last time
3. Social attitudes have changed(Woman started working, less time looking after their
family, more demand for time saving appliances)
4. Couples are marrying later in life and having fewer children (More households, fewer
people in one)
5. People have become more health conscious
6. Concern for environment growing’s

7. Rapidly advancing technologies

Savings

Delayed consumption until some later time.

Why people save?

1. For consumption
2. High saving interest rates
3. Consumer confidence in jobs
4. Availability of saving schemes

What determines level of borrowing?

1. Interest rates
2. Wealth(more willing can easily repay)
3. Consumer confidence in job
4. Ways of borrowing and availability of credit
UNIT 4.1 TYPES OF BUSINESS ORGANISTION

Questions to think when starting a business:

1. Do I have enough money?

2. Can I do it alone?
3. Do I want to share ownerships and profits?
4. Am I prepared to risk everything I own(unlimited liability)

SOLE TRADER

Business owned by one person

ADVANTAGES DISADVANTAGES
Sole trader business organization is easy to Has unlimited liability
set up
Sole trader is very personal one( with A sole trader has full responsibility for
customers) managing the business
Sole trader has full control over the business Sole trader lack capital(Hard to expand, lack
of money)
Sole trader receives all the profits

PARTNERSHIPS

Legal agreements between 2-20 people to own, finance and run a business jointly, and share
all profits.

ADVANTAGES DISADVANTAGES
Easy to set up Partners can disagree
Partners bring new skills and ideas to the General partners have joint unlimited liability
business
Partners invest new capital into the business Partnerships lack capital
and finance expanse

JOINT STOCK COMPANIES (LIMITED COMPANIES, LLC)

Joint stock companies sell stocks to raise capital, the people who invest in shares becomes
owners or shareholders of the companies. Therefore joint-stock companies is jointly owned
by investors who bought the stock

Two types of joint-stock companies:

1. Private limited(one or more shareholders it can only sell shares known to the current
shareholders)
2. Public limited companies(can sell shares through the stock market)
1) Advantages and disadvantages of private limited

ADVANTAGES DISADVANTAGES
Popular form of organisation for sole traders Limited companies have to disclose financial
or partnerships looking to raise capital information(competitors find out and
expensive to make)
Company shareholders have limited They cannot sell their shares publicly(less
liability(only the money invested is at risk) money for expansion)
Shareholders have no management
responsibilities``
Companies have separate legal identities
form its owners

2) Advantages and Disadvantages of public limited companies

ADVANTAGES DISADVANTAGES
They can sell shares publicly (Raise more It is expensive to form a public limited
money) company
They can advertise their shares (Prospectus They are required to publish detailed annual
informs shareholders about their activities) reports and accounts
Public shareholders have to hold Annual
General meetings(AGM)(expensive and time
consuming
Management diseconomies(Communication
problems between different parts and layers
of the company)
Vulnerable to take overs(more than 50%
shares)
Divorce of ownership from control

MULTINATIONAL CORPORATIONS

Advantages:

1. Reach more consumers globally

2. Avoid trade barriers by setting up operations in countries that apply tariffs and quotas
to import some multinationals
3. Minimize transport cost by locating plants in different countries to be nearer to
consumers/suppliers
4. Minimize wage cost by putting factories in low wage countries
5. Raise significant capital for expansion, research and development and to employ
workers with the highest skills
6. Scale of productions allows it to lower average cost
Impact on economies:

1. Increase investment in new business premises and technologies.

2. Provides jobs for local workers
3. Brings new knowledge and skills into a country which can help domestic firms
improve their own productivity
4. Pay taxes on their profits which boost government revenues
5. Increase export earnings through international trade

Problems they create in host countries:

1. Exploit workers in low wage economies

2. Natural resources exploited and the environment damaged
3. Profits may be switched between countries to avoid taxes

COOPERATIONS

Firm owned, controlled, and operated by a group of users for their own benefit. Each
member contributes equity capital, and shares in the control of the firm on the basis of one-
member, one-vote principle (and not in proportion to his or her equity contribution).

Two main types:

1. Worker cooperatives
2. Consumer cooperatives

Worker Cooperatives (owned by workers)

ADVANTAGES DISADVANTAGES
Popular with workers because they are in Hard to raise capital, have to borrow from
charge, encourages them to work harder banks. Thus they remain small.
because they can take part in decision
making and running the business
Workers receive the profit they make, based May be badly run because workers running it
on dividends on the basis of equal share or have no business experience`
according to how much money they put in

Retail Cooperatives (Retailing businesses run for the benefit of their customers) (Managers
run the organization)

Principles:

1. Owned by their members

2. Members elect a board of directors
3. Each member has one vote regardless of number of shares
4. Profits shared between members
PUBLIC SECTOR

Types:

1. Central government authorities(Decisions on political, economic and other national

issues)
2. Local government authorities(Implement national policies)
3. Government agencies(Administration of government functions)
4. Public corporations(business like organization to operate under government control)

UNIT 4.2: ORGANIZATION OF PRODUCTION

Productivity: amount of output produced from a given amount of input

Increases if:

1. More output or revenue produced from same amount of resources

2. Same output produced using fewer resources

Output per period

Average product of labour=
Number of employees

Not all labour is involved in output (cleaners)

Revenue per period

Average revenue product of labour=
Number of employees

Quality is not measured

DIVISION OF LABOUR (Increase productivity)

ADVANTAGES DISADVANTAGES
More goods and services produced Work becomes boring
Full use of employees abilities Workers may feel alienated
Time is saved Products become too standardized
Allows use of machinery

Other ways firms increase labour productivity:

1. Train workers to improve existing skills

2. Rewarding increased productivity
3. Encourage employees to buy shares(more productivity, higher dividend)
4. Increase job satisfaction
5. Replace old machineries
6. Introduce new production process
Factors that affect labour or capital demanded:

1. Amount of goods and services consumers demand

2. Market prices of labour and capital
3. Productivity of labour and capital

CALCULATING COST AND REVENUE

Profit=Total revenue-cost

Fixed cost

Total variable cost=variable cost per unit x quantity demanded

Total cost=fixed cost +variable cost

Total cost
Average cost=
Total Output

Total Revenue= Price per unit x Quantity sold

Revenue earned
Average revenue per unit =
Number sold

Profit (loss) =total revenue-total cost

Profit (loss) per unit= average revenue-average cost

Breakeven=Total Revenue=Total cost

Total
Breakeven level of output =¿ cost ¿
Price per unit−Variable cost per unit
UNIT 4.3 GROWTH OF FIRMS

Size of firms:

1. Number of employees(small<50)
2. Organization(Different levels)
3. Capital employed
4. Market share

How firms grow:

1. Internal growth( buying new capital)

2. External Growth( Firms combining)
Types
1. Horizontal(Buying firms with similar production of goods and services)
2. Forward integration(Buying firms with a higher stage of production)w
3. Backward Integration( Buying firms with a lower stage of production)
4. Lateral Integration(Buying firms in different industries)

INCREASING SCALE OF PRODUCTION

1. Purchasing economies(Bulk buying)

2. Marketing economies(Purchasing its own distribution or advertisement)
3. Financial economies(Large firms can borrow more money and at lower interest rates)
4. Technical economies(Large firms have more money to invest in capital)
5. Risk-bearing economies(Large firms have more customers and countries to sell to,
means less risk)

DISECONOMIES OF SCALE (Firms grow too big)

1. Management diseconomies(Firms too large too manage)

2. Need vast quantities of materials
3. Unable to attract enough workers
4. Labour diseconomies(when workers get bored of doing repetitive tasks)
5. Harder to attract new customers(products too standardized)
6. Selling shares may lead to disagreements with the new shareholders
7. Agglomeration diseconomies(When firms takeover too many other stages of
production and cannot coordinate all of them)

Why some firms remain small:

1. Size of their market is small

2. Access to capital is limited
3. New technology has reduced the scale of production
4. Some business owners may simply choose to stay small
UNIT 4.4 COMPETITION

Why firms compete:

1. Increase customer base

2. Increase sales
3. Expand market share(Total market volume or value of sales)
4. Achieve product superiority
5. Enhance image
6. Maximize profits

Types of competition:

1. Price competition
2. Non-price competition(quality or advertising)

Advertising:

1. Involves the creation of consumer wants(Persuasive or informative)

2. Can create powerful brand images and consumer loyalties
3. Advertising can reduce competition

Is advertising wasteful:

1. Using resources for advertising is wasteful

2. Duplication of effort and resources are wasteful.

PRICING STRATEGIES

Factors that influence pricing decisions:

1. Level and strength of consumer demand

2. Amount of competition from rival producers to supply a market
3. Cost of production and level of profit required

Demand-based strategies:

1. Price skimming(Uses high price initially when it is a new or improved product,

charges high prices to recover development cost )
2. Penetration pricing(Setting prices low to encourage more consumers and increase
loyalty)

Competitive pricing strategies

1. Destruction pricing(Setting price often below cost in order to destroy sales of other
competitors)
2. Price Wars(continually reducing prices lower than competitors)
3. Price leadership(when the largest market share lowers or raises the price and everyone
else follows)
Cost-Based pricing

Price = (Total cost/Total output) + mark-up profit

MARKET STRUCTURES (characteristics of the market, usually on supply side)

Examining competition:

1. Amount of control a firm has over the total market supply

2. Amount of influence a firm has over market price
3. Freedom of new suppliers have to enter the market

Perfect Competition: No one firm or consumer has powers to influence market price, they
are all price takers and any firms that raise the price would lose to producers and go out of
business. Unable to lower price below either because it will lose too much money. (Does not
exist)

Features:

1. Price and non-price competition

2. Pursue different pricing strategies based on amount of competition
3. Product features and brand images will be highly differentiated and wide range of
product designs
4. Market share and profits of competing businesses will vary over time as new business
enters and inefficient firms are forced to close

Imperfect competition: when one firm has a degree of control over price

MONOPOLY

ADVANTAGES DISADVANTAGES
May be more efficient in production because Less consumer choice
of scale of production
Monopoly may still face competition from Lower output and higher prices
overseas
May still charge low prices as they fear new Lower product quality
firms may enter
May re-invest its profits in new inventions X-inefficiency(No competition therefore they
and better products use less effort to ensure resources are used in
the most efficient way)
Need for regulation
BARRIERS TO ENTRY (Things preventing firms from entering a market)

NATURAL ARTIFICIAL
Economies of scale(big firms reduce average Restriction on supplies
cost lower than other firms by producing
more)
Capital size(Product may require a large Predatory pricing
amount of capital to produce)
Historical reasons(First in the supply) Exclusive dealing
Legal considerations(patenting) Full line forcing

Ways government controls monopolies:

1. Break them up into smaller ones

2. Impose fines on firms that abuse market power
3. Regulating the prices and service levels of monopolies
UNIT 5.1-GOVERNMENT ECONOMIC POLICY

Capital Expenditures: Investments in long-lived assets by the government. For example

computers, roads, schools and healthcare.

Governments will use their spending to achieve a number of objectives:

1. Provide goods and services that are in the public interest(Merit and Public goods)
2. Invest in national infrastructure(Roads, railway, universities, public buildings)
3. Support agriculture and key industries (by providing financial assistance or subsidies
to firms to reduce their cost of production or make investments in staff training, new
machinery, research and development of new products, processes and materials.
4. Manage the macroeconomy(Increase public spending during a recession can boost
demand and reduce unemployment)
5. Reduce inequalities in incomes and help vulnerable people(Income support and
welfare payments)

Many private sectors benefit from public expenditure from their impact on consumer
demand. Such as:

1. Construction firms benefit from contracts to build schools and other buildings
2. Office equipment manufacturers benefit from spending on equipping public offices
3. Farms may benefit from agricultural subsidies to increase their production of food
4. Power companies earn revenue from electricity supplied for street lights
5. The defence industry benefits from orders for defence equipment
6. Public sector workers use their incomes to buy goods and services from businesses

Aggrega
Consumpti + Investmen + Governme +
( )
te = Exports-Imports
on ts nt
Demand
Spending
Macroeconomic objectives of the government:

1. Low and stable rate of inflation

2. High and stable level of employment
3. Economic growth in the total output
4. Stable of balance of international trade and payment
5. Reduce poverty and reduce inequalities in income and wealth
6. Reduce pollution and waste

Demand-side policies influence the level of AD in an economy using a number of policy

instruments. These are:

1. Total public expenditure

2. The overall level of taxation
3. The rate of interest

They can be effective for these reasons:

1. The amount consumers have to spend on goods and services depend on their level of
disposable income after income taxes have been deducted
2. Taxes on profits will affect the amount of money firms have to invest in new
productive capacity and their demand for labour
3. Increasing public expenditure can boost total demand and therefore stimulate higher
output and employment in a n economy
4. As interest rates rises consumers may save me and /or borrow less to spend on
consumer goods and services. This may also encourage investments from overseas. As
interest rates fall firms may borrow more to invest

Two types of demand-side policies: Fiscal and Monetary

Fiscal Policy

(Involves varying the overall level of public expenditure and/or taxation in an economy to
manage the AD and influence the level of economic activity)

Expansionary fiscal policy: If a government wants to increase AD in the economy to boost

employment and output it can increase its expenditure and/or reduce taxation.

This leads to:

Firms: Cutting taxes on profits provide firms with an incentive to increase output and
investments in new productive capacity.

People: Cutting taxes on personal income encourages people to participate and motivate them
to increase their productivity

Expansionary fiscal policies are implemented during a recession or economic downturn.

Budget: An expansionary fiscal policy usually means running or increasing a budget deficit.
If public expenditure exceeds total revenue the budget will be deficit and the government will
have to borrow money to finance it.

Contractional Fiscal Policy: Aims to reduce pressure on prices in the economy by cutting
aggregate demand through a reduction in public expenditure and/or by raisin g total taxation.

Effect: Fiscal policy can affect the distribution of income. Increased taxes may be placed on
those with the highest incomes and the money raised used to finance more public services
and increased welfare for the lowest incomes

Contractionary policy reduces employment and decreases growth in output

Budget: A budget deficit will be cut or may go into surplus if tax revenue exceeds public
spending
Problems with fiscal policy:

1. Fiscal policy is cumbersome to use (Hard to know exactly how much public spending
or cut taxes by during an economic downturn)
2. Increase in public expenditure crowds out private spending (Increasing public
spending or cutting taxation requires the government to borrow more money from the
private sector. The more money they borrow the less the private sector has to spend)
3. Increasing taxes on incomes and profits can reduce incentive to work and enterprise
(If taxes are too high people and firms may reduce their work effort. This leads to a
reduction in labour productivity, total output and profits. As cost of production in
firm’s increase they will be less able to compete on product and price quality against
other producers overseas. As a result demand goes down and unemployment may rise)
4. An expansionary fiscal policy creates expectations of inflation (Consumers and
produces may expect a rise in inflation following an expansionary fiscal policy. As a
result, employees push for higher wages to protect them from an increase in the cost
of living. Rising wages will increase production costs and reduce demand for labour.
This may cause a cost-push inflation and rising unemployment)

Monetary policy

(Involves changes in the money supply or the interest rate in an economy to influence the
level of AD and economic activity)

Main instrument of monetary policy is the minimum lending rate or rate of interest charged
by the central bank to loan money to the banking system. This will affect how the banks
charge businesses and personal customers to borrow money the rate of interest savers earns
on their saving account.

Expansionary monetary policy:

Involves a cut in interest rates and/or expansion in the money supply to boost AD. These
measures will often be taken when unemployment is rising and economic growth is falling or
has turned negative during an economic recession.

1) Interest rates↓ Borrowing↑Savings↓ Consu../Expen…Investment↑ Output/Employment↑

2) Quantitative easing (Using printed money to buy bank’s financial assets to lend more money)

Money supply↑ Dispo..Income↑ Consumption↑ Income↑ AD↑= Economic Growth(Inflation also)

Contractionary monetary policy:

This involves raising interest rates and/or cutting the money supply to reduce aggregate
demand if the economy is overheating and inflationary pressures are rising

1)Interest rates↑ Borrowing↓ /Money supply↓=Less spending(AD↓Employment↓Future EC↓)

Exchange rate policy

(Changes in interest rates can be used to influence the exchange rate of a national currency)
When exchange rate falls in one country, transactions with other international countries will
become more expensive. Therefore imported goods will become more expensive which will
negatively impact its country balance of international payments and cause inflation to occur.

To counter this, the government will raise its interest rates in order to raise the exchange rate.
This happens because wealthier residents from other countries will buy more of that country’s
currency to store money in that country’s bank.

If interest rates were lowered, it would reduce the cost of overseas residents buying goods
from their country which can increase exports and boost output and employment

SUPPLY SIDE POLICIES

Supply side policies target economic growth, they aim to boost productive potential and
increase the aggregate supply. Expanding AS will help to reduce inflationary pressures on
prices from rising AD, provide additional employment and boost production of goods and for
exports. Overall, supply side policies can help to achieve all the macroeconomic objectives of
a government at the same time

1) Selective tax incentives

-High rates on personal incomes reduce people incentives to work and entrepreneurs to start
new firms. Therefore cutting taxes on earnings and profits can positively impact on
productive efforts of workers and firms.

-Granting tax reliefs also encourages firms to invest in new plant and equipment to expand
their productive potential

2) Selective subsidies

-Financial assistance paid to businesses by a government to help meet cost. Helps expand
output and reduce market price. Often used to support faming, to fund investments in new
technologies and to help small business grow

3) Improving education and training

-In order for firms to be successful in competing in international markets they need to have
highly trained and skill workforce.

-A well-educated land trained workforce can raise labour productivity and will be better able
to adapt to new production methods and technologies. Governments can assist by providing
training programmes, funding universities and providing more accessible education.

4) Labour market reforms

-Restrictions on the supply of labour to an occupation will force up the market wage and
result in fewer jobs. Governments can introduce laws and regulations to reduce the power of
trade unions to strike and demand unreasonable wages

-Laws on minimum wages can be used to encourage people to work. Some firms cut jobs as
their cost of production increases

5) Competition policy

-Monopolies that dominate the market are large and powerful and may use their market
power to restrict competition, charge igh prices and earn excessibe profits. Laws and
regulations can be used to fine firms that are anti-competitive and force them to break up to
smaller firms

6) Removing trade barriers

-A national government may seek to protect its domestic firms and labour forced from
competition overseas

7) Privatization

- T ownership of a business, enterprise, agency, public service property from the public sector
(the state or government) to the private sector (businesses that operate for a private profit) or
to private non-profit organizations.

UNIT 5.2 TAXES

Uses:

1. To finance government expenditure. One of the most important uses of taxes is to

finance public goods and services, such as street lighting and street cleaning.
2. To reduce consumption of goods that creates negative externalities.
3. To control the amount of imported goods i.e. tariffs
4. Used as a part of fiscal policy to control aggregate demand in the economy.
5. To control income inequality
6. Protect the environment

DIRECT AND INDIRECT TAXES

Advantage and disadvantage of direct taxes.

ADVANTAGE DISADVANTAGE
High revenue yield Reduce work incentives
Used to reduce inequalities in incomes and Reduce enterprise incentives
wealth
Based on ability to pay(Family Tax Evasion
commitments/dependants)

ADVANTAGE DISADVANTAGE
Cost Effective Inflationary
Expand tax base Regressive
Used to target specific products and activities Revenues are less certain and predictable
Easy to adjust tax rates Encourage tax evasion(smuggling to avoid
tax)

UNIT 6.1-INFLATION

Inflation: A general and sustained rise in the level of prices of goods and services

How to measure inflation

Measured by

• CPI (Consumer Price Index)

• RPI (Retail Price Index)

1. A base year or starting point is chosen. This becomes the standard against which price
changes are measured.

2. A list of items bought by an average family is drawn up. This is facilitated by the Living
Costs and Food Survey.

3. A set of weights are calculated, showing the relative importance of the items in the average
family budget - the greater the share of the average household bill, the greater the weight.

4. The price of each item is multiplied by the weight, adjusting the item's size in proportion to
its importance.

5. The price of each item must be found in both the base year and the year of comparison (or
month).