Chapter 1: Economics and Economies PDF

A Part Introduc...

A Part Introduction 1 Economics and Economies 2 This opening part of the book introduces you to economics – what it is and why it is a great subject to study. Eco- nomics is not a set of facts or theories to be memorised; it is both more interesting and more useful than that. Studying economics enables you to think about the world in a different way; it helps you to make sense of the decisions people make: decisions about what to buy or what job to do; decisions governments make about how Copyright © 2022. Pearson Education, Limited. All rights reserved. much to tax or what to spend those taxes on; decisions businesses make about what to produce, what prices to charge and what wages to pay. This makes economics relevant for everyone, not only those who are going on to further study. And it is about some of the biggest issues that face society, such as poverty and inequality, health and wellbeing, the environment, biodiversity and sustainability, the relationships between nations and how we trade and how money gets moved around the world, economic recessions and unemployment, and how individuals and govern- ments can help to tackle these issues. By studying economics, you will gain a ‘toolkit’ of concepts, ideas and theories that will enable you to think about and analyse these issues. You will be able to apply this ‘way of thinking’ to your life both now and in the future. You will be able to think more analytically and to problem-solve more effectively; this helps explain why economics graduates are so highly valued by employers. Studying economics therefore opens up a variety of career opportunities. Sloman, John, et al. Economics, Pearson Education, Limited, 2022. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/city/detail.action?docID=6824443. M01 Economics 05339.indd 1 10/11/2021 14:15 Created from city on 2024-12-15 18:23:55.  1 Chapter Economics and Economies We start by looking at two of the biggest issues of our CHAPT E R M AP time – the COVID-19 pandemic and global warming. These have had profound effects on societies around the world 1.1 Economics and global issues 3 and, in the case of global warming, will do for decades to COVID-19 and the global health emergency 3 come. But they are not just issues studied by health and The environment and the global climate emergency 4 climate scientists. They are forcing us and our govern- 1.2 The core of economics 6 ments to make choices. Studying these choices is central The problem of scarcity 6 to economics. Economists can analyse them and present Demand and supply 7 us with policy alternatives. They can help us come to the Dividing up the subject 7 best decisions in the light of the information presented Macroeconomics 8 by scientists. Microeconomics 9 Illustrating economic issues: the production Economics contains some core ideas. These ideas are possibility curve 14 simple, but can be applied to a wide range of economic Illustrating economic issues: the circular problems. We start examining these ideas in this chap- flow of goods and incomes 16 ter. We begin on the journey to help you to ‘think like an 1.3 Different economic systems 18 economist’ – a journey that we hope you will find fascinat- The classification of economic systems 18 ing and will give you a sound foundation for many possible The command economy 19 future careers. Assessment of the command economy 20 In this chapter, we will attempt to answer the ques- Copyright © 2022. Pearson Education, Limited. All rights reserved. The free-market economy 20 Assessment of the free-market economy 24 tion, ‘What is economics about?’, and give you greater The mixed economy 25 insight into the subject you are studying. We will see how the subject is divided up and distinguish between the 1.4 The nature of economic reasoning 27 two major branches of economics: microeconomics and Economics as a science 27 macroeconomics. Economics as a social science 29 Economics and policy 29 We will also look at the ways in which different types of economy operate, from the centrally planned economies of the former communist countries to the more free-market economies of most of the world today. We will ask just how ‘markets’ work. Sloman, John, et al. Economics, Pearson Education, Limited, 2022. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/city/detail.action?docID=6824443. M01 Economics 05339.indd 2 10/11/2021 14:15 Created from city on 2024-12-15 18:23:55.  1.1 ECONOMICS AND GLOBAL ISSUES 3 1.1 ECONOMICS AND GLOBAL ISSUES Economists study very many of the issues we face, whether Individual choices as individuals, families, firms and employees, local groups, People had to decide whether to follow the rules and advice societies, central and local government, and internationally about behaviour (e.g. whether to wear a face mask or socially through institutions and meetings of governments. Some of distance). Some decided to follow lockdowns; others were these issues are small everyday ones, such as what to buy in ready to break or bend the rules. Economics studies people’s the supermarket or how much to save. Others are global in behaviour – and how it impacts on economic decisions and scale, requiring solutions at a whole range of levels from the the economy. We look at such behaviour in Chapters 2 to 5. international to actions by individuals. For example, early on in the pandemic, many people stock- Two of the greatest issues to confront society in recent piled various items, such as hand sanitiser, toilet rolls and times have been the coronavirus pandemic and the climate dried foods. This caused many shops to run out, which only crisis. further encouraged panic buying. Some shops responded by As COVID-19 swept across the world in early 2020, it left a raising prices to increase their profit margins. trail of deaths and lost livelihoods in its wake. Everyone had The lockdowns affected firms’ profits. Some sectors were to adjust their way of living, faced with lockdowns, working particularly hard hit, such as hospitality, leisure and tourism. from home, or jobs lost or furloughed. As scientists rushed to Many suppliers found that their sales revenues had dried up develop vaccines and health authorities rushed to distribute as they were forced to close down, while others adjusted by them, so governments were faced with the seeming dilemma trying to sell more online. Firms had to choose whether to of how much to prioritise saving lives versus how much to give up or carry on. prioritise saving livelihoods through keeping the economy On the plus side, some of their costs had fallen, such as going. Or would prioritising saving lives and locking down heating and lighting and staff costs; we call these ‘variable allow the economy to bounce back more quickly later on costs’. Other costs, however, such as rent, rates and interest with the virus sooner under control? charges generally did not fall; we call these ‘fixed costs’. The other issue is the climate emergency, with scientific Profits would have become losses if the government had evidence becoming clearer of the devasting effect of global not provided substantial support, which was still not enough warming. Melting ice caps causing rising sea levels that dev- to prevent many firms going out of business. Some managed astate low-lying lands; a change in long-term rainfall totals, to defer fixed costs, but these would have to be paid later – with some areas becoming drier and others wetter, affecting another difficult choice whether or not to give up. long-term crop yields and livelihoods and forcing people to And the pandemic hastened the move to online sales and migrate to survive; more frequent droughts, fires, floods and away from the High Street, leading to the demise of many hurricanes causing death and destruction; a loss of biodiversity large chains of shops such as Arcadia, Laura Ashley and as species are wiped out and as humans take more desperate Debenhams. Others, such as John Lewis, closed a number steps to survive, such as cutting down forests and farming more of branches. Across the UK, some 17 500 chain-store outlets intensively – activities that compound environmental damage. were permanently closed in 2020. In contrast, sales of online We examine each of these two issues and see how econo- retailers such as Boohoo and Asos boomed. mists can contribute to understanding them and their conse- We examine costs, revenues and profits in Chapters 6 to quences and what can be done about them. As we shall see, 9. We see how some firms are better protected against mar- economists have played a major part and will continue to do so. ket forces than others, especially if they have a large market Copyright © 2022. Pearson Education, Limited. All rights reserved. share and resulting market power. As far as employees were concerned, some were easily COVID-19 and the global health emergency able to work from home with a separate room to work in The COVID-19 pandemic dominated our lives during 2020 and a good Internet connection. They also saved money and 2021 and beyond. People and governments struggled on commuting costs. Others with childcare responsibilities to cope with illness and death, and the damage to lives and and shared working spaces and/or devices struggled to work livelihoods. The impact on developing countries was par- efficiently from home. Some found their incomes constant ticularly harsh. According to the World Bank, in 2020 alone or even rising; others saw a fall or had to rely on furlough the pandemic may have pushed around 100 million people money from the government. Most had little power in such into extreme poverty.1 a situation and had to accept the wages determined by the Everyone was faced with choices and these affected changing market environment. behaviour. Most of these had an economic dimension. Then vaccines began to be rolled out. Most people Indeed, economics studies the choices we make as individu- embraced getting jabbed to protect them and their loved als, firms, societies or governments. ones. Others were suspicious for various reasons. But here was 1 Poverty and Shared Prosperity 2020: Reversals of Fortune, p. 11, World Bank (2020, revised 2021), https://openknowledge.worldbank.org/bitstream/handle/10986/34496/9781464816024.pdf Sloman, John, et al. Economics, Pearson Education, Limited, 2022. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/city/detail.action?docID=6824443. M01 Economics 05339.indd 3 10/11/2021 14:15 Created from city on 2024-12-15 18:23:55.  4 CHAPTER 1 ECONOMICS AND ECONOMIES a classic problem in economics: what we do for ourselves often spend now and pay later – an easy choice at the time, but a dif- has spillover effects on others. If we are not protected, we are ficult one later, especially for governments facing re-election. more likely to catch the disease and pass it on to others, even if Policy choices such as these are examined in Chapter 22. we only get infected mildly or are largely asymptomatic. Many It was not just governments that were trying to keep actions we take affect others – either beneficially or adversely. their economies going. Central banks, such as the Federal These can be as simple as whether to wear a face mask. So Reserve in the USA, the European Central Bank for the euro- should the government constrain our actions? This is another zone and the Bank of England for the UK, were also playing key choice that has to be made and economists can help ana- their part. The general approach was to create more elec- lyse these choices and identify their costs and benefits. tronic money, through a process of ‘quantitative easing’. If there was more money circulating through the banking Government choices system, people would borrow and spend more, helping to The pandemic did not just affect individuals and firms; it had boost businesses. major effects on whole economies. With many firms being But when you turn on the ‘money tap’ like this, you have forced to shut down, even if only temporarily, and some sec- to choose how much money to create and when to turn the tors, such as public transport, facing a collapse in demand, tap off. Too little money and the recession may persist; economies around the world went into recession – economic too much money and prices may be pushed up by soaring growth was negative. spending. This ‘inflation’, as it is called, creates other prob- The UK was particularly badly hit at first, partly from lems for the economy, and central banks are keen not to the choice made by the government to delay locking down. let it go above 2 per cent per annum. The role of money in National output (known as ‘gross domestic product’ or the economy is examined in Chapter 18 and subsequent ‘GDP’) fell by nearly 10 per cent in 2020. Unemployment chapters. rose. The government responded by massively increasing spending by supporting individuals through the furlough Give some other examples of choices that governments had scheme, whereby 80 per cent of the wages of those temporar- to make during the pandemic. To what extent were they economic choices? ily laid off were covered by the government and distributed through their employers. Other support was given to busi- Getting all these economic choices right was a hard thing for nesses and to the self-employed. This prevented unemploy- individuals, businesses and governments. Economists had ment from rising much further. a crucial role in analysing the effects of these choices and Other longer-term measures for recovery included large- advising on the best courses of action. scale spending on physical infrastructure, such as public transport, roads, green energy and broadband, and on public services, such as health and education. In the USA, President The environment and the global climate Biden introduced a $3 trillion programme of infrastructure emergency spending to boost a green recovery. This followed a $1.9 tril- lion programme of support for vulnerable people and busi- So can economists play a central role in addressing the cli- nesses to survive the pandemic. mate emergency? The answer is ‘yes’ at many levels. Climate We look at issues such as growth and unemployment in scientists can model the causes and effects of global warm- the second half of the book from Chapter 15 onwards. ing. However, to address the problem and cut emissions But the massive support came at a cost. Government to reach carbon neutrality and stop global warming – or spending on support schemes plus a decline in tax revenues at least limit it to 1.5°C above pre-industrial levels, which meant that government borrowing soared. In the UK, annual is the objective of the Intergovernmental Panel on Climate Copyright © 2022. Pearson Education, Limited. All rights reserved. public-sector net borrowing rose from 2.6 per cent of GDP Change (IPCC) – then choices have to be made. in 2019 to nearly 17 per cent in 2020, so adding to the total As we saw when looking at the coronavirus pandemic in stock of public-sector debt, pushing it up from 84.4 per cent the context of vaccination, people’s actions affect others. in 2019 to just over 100 per cent in 2020 – and forecast to rise Perhaps nowhere is this more crucial than with the environ- to nearly 110 per cent by 2023 (see Figure 22.3 on page 697). ment. When people burn fossil fuels in their boilers or their The government has to finance the borrowing through cars, or buy goods which have travelled half way across the paying interest from taxes (or even more borrowing). So the world on fossil-fuel hungry ships and planes, this affects oth- government was faced with a choice about when to start ers; not just themselves. raising taxes or cutting government spending to reduce the At an individual level, therefore, people need to think level of borrowing. This was a hard choice and the plan, and behave ‘green’. But what are the mechanisms for announced in the 2021/22 Budget, was to raise taxes on achieving this? Apart from education and developing business profits (‘corporation tax’) and to freeze income tax greater social responsibility, pricing is key. If renewable thresholds from April 2023. Similar dilemmas were faced by energy were cheaper and fossil fuels were more expensive, governments around the world. The general approach was to then people would be more willing to switch to low-carbon Sloman, John, et al. Economics, Pearson Education, Limited, 2022. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/city/detail.action?docID=6824443. M01 Economics 05339.indd 4 10/11/2021 14:15 Created from city on 2024-12-15 18:23:55.  1.1 ECONOMICS AND GLOBAL ISSUES 5 consumption. Indeed, pricing is a central issue in econom- International action ics. We look at pricing in Chapters 2 and 3 and later in We live in an interdependent world. Actions in one part Chapters 7 and 8. of the globe affect lives in others. If the rich countries are But how can prices be altered? They can be reduced by gov- big carbon emitters, this affects people in poor countries ernment subsidies and raised by taxes. We look at green taxes too. Their lives may be more vulnerable to climate change and subsidies in Chapters 12 and 13. There are other methods and its impact on the weather and harvests. Economists too by which pricing can be used. One of these is emissions play a large role in studying the trading between nations trading. This is where permits to emit CO2 are allocated or and how economic power affects patterns of trade and auctioned to businesses, which can then trade them in mar- investment. kets. Low emitters will not have to pay so much, thereby giv- Multinational companies often drive intensive farm- ing them a cost advantage over high emitting companies, ing and mining in developing countries, and the effects which will require more permits and hence have to pay more. on the environment in these countries can be devastating. Economists have played a key role in developing emissions Rainforests are cut down for mining, ranching or growing trading in markets such as the EU Emissions Trading Scheme monocrops, such as palm oil plantations. And not only (EU ETS). is the devastation confined to these countries: as well as hugely diminishing biodiversity, they contribute to global The issue of fairness warming as the ‘lungs of the world’ are destroyed. From One of the key issues in economics is how to achieve a fair 2010 to 2019, in Brazil’s Amazon basin 16.6 billion tonnes distribution of income and wealth, both today and over of CO2 were released into the atmosphere from burning or time. One area where this is vitally important is the environ- destroying forest, or replacing it with plantations. Yet only ment. How can the world fairly share the costs and benefits 13.9 billion tonnes were drawn down through photosyn- of creating a low-carbon economy? If it fails, politicians will thesis and new growth.2 face a backlash from people who see their jobs and incomes Actions by the global community can help but very under threat. Young people will blame the old for taking often there are international games being played, with more than their fair share and degrading the environment countries often unwilling to commit to carbon-reducing in the process. measures unless they can be convinced that other coun- The problem is that change normally involves gainers tries are playing their part too. Economists study these and losers – a central dilemma in economics. Green invest- types of ‘games’. Indeed there is a major branch of econom- ment may create jobs in alternative energy generation but ics called ‘game theory’, which looks at effective ways of result in jobs being lost in coal mining and heavy industry. incentivising people, firms and governments to behave in And when there are groups of losers, populist politicians can co-operative ways. use the resulting anger to drive wedges in society and turn people against tackling climate change – something that is 2 Xiangming Xiao et al., ‘Carbon loss from forest degradation exceeds that from easier if they can deny its existence. deforestation in the Brazilian Amazon’, Nature Climate Change (29 April 2021), www.nature.com/articles/s41558-021-01026-5 CASE STUDIES AND BOX 1.1 WHAT’S THE LATEST ECONOMICS NEWS? APPLICATIONS The UK cannot retain the benefits of the EU’s single market Lack of training helps to explain low levels of Copyright © 2022. Pearson Education, Limited. All rights reserved. or customs union now it has left the EU. productivity. Researchers suggest that the long-term economic effects Oil prices set to remain low for many years as more and from the COVID-19 pandemic may be less serious than more countries engage in fracking and as more investment those from the financial crisis of 2007–8. takes place in green energy. Severe droughts cause crops to fail across sub-Saharan The economy grows more rapidly and economists pre- Africa: higher grain prices expected soon. dict that interest rates will rise; house prices likely to There is concern that American trade policies will hurt stop rising. both US consumers and producers, while reducing global Government raises taxes to tackle soaring public-sector debt. growth. Unemployment falls and economic growth accelerates, 1. What is it that makes each one of the above news items leading to expectations of higher interest rates. an economics item (we explore this question in the The age at which UK workers can draw their state pension next section)? is raised further. Many predict that those currently under 2. In each case identify two different individuals or 30 will be working until at least the age of 70. groups who might be affected by the news item. Sloman, John, et al. Economics, Pearson Education, Limited, 2022. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/city/detail.action?docID=6824443. M01 Economics 05339.indd 5 10/11/2021 14:15 Created from city on 2024-12-15 18:23:55.  6 CHAPTER 1 ECONOMICS AND ECONOMIES For what reasons may governments want other governments recognition of the environmental impact of trade. Econo- to stick to tough climate or emissions targets and yet be not mists study these conditions and can advise governments willing to do so themselves? on trade policy. This and other international issues are the subject of the final three chapters of the book. Trade can make everyone better off. Countries can spe- cialise in what they are good at and export these products, and then import products in which they are less efficient. All these economic issues stem from a core set of problems. But this only works if certain conditions hold, including It is to this core that we now turn. 1.2 THE CORE OF ECONOMICS Many people think that economics is about money. Well, In a poor country ‘wants’ might include clean water, educa- to some extent this is true. Economics has a lot to do with tion and suitable housing. In richer nations ‘wants’ might money: with how much money people earn; how much involve a second car, longer holidays and more time with they spend; what various items cost; how much money firms friends and family. As countries get richer, human wants make; the total amount of money there is in the economy. may change but they don’t disappear. Wants are virtually But, as we shall see later in the book, money is only impor- unlimited. tant because of what it allows us to do; money is a tool and Yet the means of fulfilling wants are limited. At any point, economics is more than just the study of money. the world can only produce a finite amount of goods and It is concerned with the following: services because the world has a limited amount of resources. These resources, or factors of production as they are often The production of goods and services: how much an econ- called in economics, are of three broad types: omy produces, both in total and of individual items; how much each firm or person produces; what techniques of Human resources: labour. The labour force is limited in production are used; how many people are employed. number, but also in skills. This limits the productivity of The consumption of goods and services: how much peo- labour: i.e. the amount labour can produce. ple spend (and how much they save); how much people Natural resources: land and raw materials. The world’s buy of particular items; what individuals choose to buy; land area is limited, as are its raw materials. how consumption is affected by prices, advertising, fash- Manufactured resources: capital. Capital consists of all ion, people’s incomes and other factors. those inputs that have themselves had to be produced. The world has a limited stock of factories, machines, transportation and other equipment. The productivity of Could production and consumption take place without money? If you think they could, give some examples. this capital is limited by the current state of technology. But we still have not got to the bottom of what economics is about. Is there one crucial ingredient that makes a prob- Definitions lem an economic one? The answer is that there is a central Production The transformation of inputs into outputs problem faced by all individuals and all countries, no matter by firms in order to earn profit (or to meet some other how rich. It is the problem of scarcity – an issue underlying objective). Copyright © 2022. Pearson Education, Limited. All rights reserved. all other economic problems. For an economist, scarcity has Consumption The act of using goods and services to a very specific definition. satisfy wants. This will normally involve purchasing the goods and services. Before reading on, how would you define ‘scarcity’? Must Factors of production (or resources) The inputs into goods be at least temporarily unattainable to be scarce? the production of goods and services: labour, land and raw materials, and capital. Labour All forms of human input, both physical and The problem of scarcity mental, into current production. Land and raw materials Inputs into production that are Ask people if they would like more money, and the vast provided by nature: e.g. unimproved land and mineral majority would answer ‘Yes’. But they don’t want more deposits in the ground. money for its own sake. Rather they want to be able to buy Capital All inputs into production that have themselves more goods and services, either today or in the future. These been produced: e.g. factories, machines and tools. ‘wants’ will vary according to income levels and tastes. Sloman, John, et al. Economics, Pearson Education, Limited, 2022. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/city/detail.action?docID=6824443. M01 Economics 05339.indd 6 10/11/2021 14:15 Created from city on 2024-12-15 18:23:55.  1.2 THE CORE OF ECONOMICS 7 Could each of these types of resources be increased in quan- will exceed potential supplies. Society has to find some way tity or quality? Is there a time dimension to your answer? of dealing with this problem, to try to match demand with supply. This applies at the level of the economy overall: total or ‘aggregate’ demand needs to be balanced against total So this is the fundamental economic problem: human or aggregate supply. In other words, total spending in the wants are virtually unlimited, whereas the resources avail- economy should balance total production. It also applies able to meet those wants are limited. We can thus define at the level of individual goods and services. The demand scarcity as follows: and supply of cabbages should balance, and so should the demand and supply of cars, houses, tablets and holidays. But if potential demand exceeds potential supply, how KEY Scarcity is the excess of human wants over what can IDEA are actual demand and supply made equal? Either demand actually be produced. Because of scarcity, various 1 has to be reduced, or supply has to be increased, or a combi- choices have to be made between alternatives. nation of the two. Economics studies this process. It studies how demand adjusts to available supplies, and how supply If we would all like more money, why does the government adjusts to consumer demands. not print a lot more? Could it not thereby solve the problem of scarcity ‘at a stroke’? Dividing up the subject Of course, we do not all face the problem of scarcity to the Economics is traditionally divided into two main branches – same degree. A poor family who may not be able to afford macroeconomics and microeconomics, where ‘macro’ means enough to eat, or a decent place to live, will hardly see it as big and ‘micro’ means small. a ‘problem’ that a rich family cannot afford a second ski- Macroeconomics is concerned with the economy as a ing holiday. But economists do not claim that we all face whole. It is concerned with aggregate demand and aggre- an equal problem of scarcity. In fact this is one of the major gate supply. By ‘aggregate demand’ we mean the total issues economists study: how resources are distributed, amount of spending in the economy, whether by con- whether between different individuals, different regions of sumers, by customers outside the country for our exports, a country or different countries of the world. by the government, or by firms when they buy capital This economic problem – limited resources but limitless equipment or stock up on raw materials. By ‘aggregate wants – makes people, both rich and poor, behave in certain supply’ we mean the total national output of goods and ways. Economics studies that behaviour. It studies people at services. work, producing goods that people want. It studies people as Microeconomics is concerned with the individual parts of consumers, buying the goods that they want. It studies gov- the economy. It is concerned with the demand and supply ernments influencing the level and pattern of production of particular goods, services and resources such as cars, but- and consumption. It even studies why people get married ter, clothes, haircuts, plumbers, accountants, blast furnaces, and what determines the number of children they have! In computers and oil. short, it studies anything to do with the process of satisfying human wants. Demand and supply Definitions We have said that economics is concerned with consump- Copyright © 2022. Pearson Education, Limited. All rights reserved. Scarcity The excess of human wants over what can actu- tion and production. Another way of looking at this is in ally be produced to fulfil these wants. terms of demand and supply. Demand and supply and the Macroeconomics The branch of economics that studies relationship between them lie at the very centre of econom- economic aggregates (grand totals): e.g. the overall level ics. How does this relate to the problem of scarcity? of prices, output and employment in the economy. Demand is related to wants. If every good and service were Aggregate demand The total level of spending in the economy. free, people would simply demand whatever they wanted. In total, such wants are likely to be virtually boundless, perhaps Aggregate supply The total amount of output in the economy. only limited by people’s imaginations. Supply, on the other Microeconomics The branch of economics that studies hand, is limited. It is related to resources. The amount that KI 1 firms can supply depends on the resources and technology individual units: e.g. households, firms and industries. p7 It studies the interrelationships between these units in available. determining the pattern of production and distribution Given the problem of scarcity – that human wants of goods and services. exceed what can actually be produced – potential demands Sloman, John, et al. Economics, Pearson Education, Limited, 2022. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/city/detail.action?docID=6824443. M01 Economics 05339.indd 7 10/11/2021 14:15 Created from city on 2024-12-15 18:23:55.  8 CHAPTER 1 ECONOMICS AND ECONOMIES Which of the following are macroeconomic issues, which are buy more imports. So part of the extra spending will go on microeconomic ones and which could be either depending goods from overseas, such as Japanese TVs, Chinese com- on the context? puters, German cars, etc. Also, if the rate of inflation is high, (a) Inflation. home-produced goods will become uncompetitive with (b) Low wages in certain sectors. foreign goods. We are likely to buy more foreign imports (c) The rate of exchange between the pound and the euro. (d) Why the prices of fresh fruit and vegetables fluctuate and people abroad are likely to buy fewer of our exports. more than those of cars. If aggregate demand is too low relative to aggregate sup- (e) The rate of economic growth this year compared with ply, unemployment and recession may well result. last year. (f) The decline of traditional manufacturing industries. Recession is where output in the economy declines for (g) Immigration of workers. two successive quarters or longer. In other words, dur- ing this period growth becomes negative. Hence, not all Macroeconomics periods during which the economy contracts are termed ‘recessions’. It is the duration and persistence of the con- Because scarcity exists, societies are concerned that their traction that distinguishes a recession. Recessions are KI 1 resources should be used as fully as possible and that over time associated with low levels of consumer spending. If peo- p7 their national output should grow. ple spend less, shops are likely to find themselves with Why should resources be used as fully as possible? If unsold stock. Then they will buy less from the manufac- resources are ‘saved’ in one time period, surely they can turers; they will cut down on production; and buy fewer be used in the next time period? The answer is that not all capital goods such as machinery. resources can be saved. For example, if a worker doesn’t go Unemployment is likely to result from cutbacks in produc- to work one week then that resource is lost: labour can’t be tion. If firms are producing less, they will need to employ saved up for the future. fewer people. Why do societies want growth? To understand this, think back to the discussion of endless wants: if our output grows, Macroeconomic policy, therefore, tends to focus on the then more of our wants can be satisfied. Individuals and soci- balance of aggregate demand and aggregate supply. It can ety can be made better off. be demand-side policy, which seeks to influence the level of The achievement of growth and the full use of resources spending in the economy. This in turn will affect the level of are not easy. This is demonstrated by periods of high unem- production, prices and employment. Or it can be supply-side ployment and stagnation that have occurred from time to policy. This is designed to influence the level of production time throughout the world (for example, in the recessions of directly: for example, by trying to create more incentives for the 1930s, the early 1980s and following the financial crisis firms to innovate. of 2007–8 and COVID-19 pandemic of 2020). Furthermore, attempts by governments to stimulate growth and employ- ment can result in inflation and rising imports. Economies have often experienced business cycles where periods of Definitions growth alternate with periods of recession, such periods Inflation A general rise in the level of prices throughout varying from a few months to a few years. the economy. Macroeconomic problems are closely related to the bal- (Annual) Rate of inflation The percentage increase in ance between aggregate demand and aggregate supply. the level of prices over a 12-month period. If aggregate demand is too high relative to aggregate sup- Balance of trade Exports of goods and services minus Copyright © 2022. Pearson Education, Limited. All rights reserved. ply, inflation and trade deficits are likely to result. imports of goods and services. If exports exceed imports, there is a ‘balance of trade surplus’ (a positive figure). If Inflation refers to a general rise in the level of prices imports exceed exports, there is a ‘balance of trade defi- throughout the economy. If aggregate demand rises cit’ (a negative figure). substantially, firms are likely to respond by raising their Recession A period where national output falls for two prices. If demand is high, they can probably still sell as or more successive quarters. much as before (if not more) even at the higher prices, and Unemployment The number of people of working make higher profits. If firms in general put up their prices, age who are actively looking for work but are currently inflation results. By comparing price levels between dif- without a job. (Note that there is much debate as to who should officially be counted as unemployed.) ferent periods we can measure the rate of inflation. Typically, the rate of inflation reported is the annual Demand-side policy Government policy designed to alter the level of aggregate demand, and thereby the level rate of inflation: the percentage increase in prices over a of output, employment and prices. 12-month period. Supply-side policy Government policy that attempts to Balance of trade deficits are the excess of imports over alter the level of aggregate supply directly. exports. If aggregate demand rises, people are likely to Sloman, John, et al. Economics, Pearson Education, Limited, 2022. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/city/detail.action?docID=6824443. M01 Economics 05339.indd 8 10/11/2021 14:15 Created from city on 2024-12-15 18:23:55.  1.2 THE CORE OF ECONOMICS 9 CASE STUDIES AND BOX 1.2 LOOKING AT MACROECONOMIC DATA APPLICATIONS Assessing different countries’ macroeconomic performance Rapid economic growth, low unemployment, low inflation and various economies, the success of governments’ macroeco- the avoidance of current account deficits1 are major macro- nomic policies seems decidedly ‘mixed’. economic policy objectives of most governments around the The table shows data for the USA, Japan, Germany2 and world. To help them achieve these objectives they employ the UK from 1961 to 2022. economic advisers. But when we look at the performance of Macroeconomic performance of four industrialised economies (average annual figures) Unemployment Inflation Economic growth Balance on current account (% of workforce) (annual %) (annual %) (% of national income) USA Japan Germany UK USA Japan Germany UK USA Japan Germany UK USA Japan Germany UK 1961–70 4.8 1.3 0.6 1.7 2.4 5.6 2.7 3.9 4.2 10.1 4.4 3.0 0.5 0.6 0.7 0.2 1971–80 6.4 1.8 2.2 3.8 7.0 8.8 5.1 13.2 3.2 4.4 2.8 2.0 0.9 0.5 1.1 −0.7 1981–90 2.5 2.5 6.0 9.6 4.5 2.2 2.5 6.2 3.2 3.9 2.3 2.6 −1.7 2.3 2.6 −1.4 1991–2000 3.3 3.3 7.9 7.9 2.2 0.4 2.3 3.3 3.3 1.5 1.9 2.4 −1.6 2.5 −0.7 −1.5 2001–07 5.3 4.6 9.2 5.2 2.8 −0.1 1.9 1.9 2.1 1.0 2.3 2.5 −4.8 3.3 3.8 −2.1 2008–11 8.4 4.7 7.0 7.3 2.1 −0.2 1.6 3.4 0.4 −0.6 0.8 −0.3 −3.2 2.9 5.9 −3.3 2012–19 5.5 3.3 4.3 5.5 1.6 0.7 1.3 1.8 2.4 1.1 1.4 1.9 −2.2 2.6 7.5 −4.3 2020 8.1 2.8 4.2 4.5 1.2 0.0 0.4 0.9 −3.5 −4.8 −4.9 −9.9 −3.1 3.3 7.1 −3.9 2021–22 5.0 2.6 4.1 6.1 2.3 0.4 1.7 1.7 5.0 2.9 3.5 5.2 −3.5 3.4 7.3 −3.9 Note: Years 2021 and 2022 are based on forecasts. Sources: Statistical Annex of the European Economy (Commission of the European Communities, various tables and years) and World Economic Outlook (IMF, April 2021), www.imf.org/en/Publications/WEO/weo-database/2021/April 1. Has the UK generally fared better or worse than the Economists have based their advice on inaccurate other three countries? statistics or incorrect forecasts. 2. Was there a common pattern in the macroeconomic Governments have not listened to the advice of econo- performance of each of the four countries over these mists. This could be for political reasons, such as the elec- 60 years? toral cycle. If the government does not have much success in There is little else that governments could have done: the managing the economy, it could be for the following reasons: problems were insoluble or could not have been predicted. 1 The current account balance is the trade balance plus any incomes earned Economists have incorrectly analysed the problems and from abroad minus any incomes paid abroad. These incomes could be wages, hence have given the wrong advice. investment incomes or government revenues (see section 15.7 for details). Economists disagree and hence have given conflicting advice. 2 West Germany from 1961 to 1991. Microeconomics renewable resources such as wind farms or a mixture of these? Copyright © 2022. Pearson Education, Limited. All rights reserved. Microeconomics and choice For whom are things going to be produced? In other words, Because resources are scarce, choices have to be made. There how will the country’s income be distributed? After all, KI 1 are three main categories of choice that must be made in p7 the higher your income, the more you can consume of any society: the total output. What will be the wages of shop workers, MPs, footballers and accountants? How much will pen- What goods and services are going to be produced and sioners receive? How much of the country’s income will in what quantities, since there are not enough resources go to shareholders or landowners? to produce everything people want? How many electric cars, how much coffee, how much healthcare, how many All societies have to make these choices, whether they smartphones, etc. will be produced? are made by individuals, groups or the government. They How are things going to be produced? What resources can be seen as microeconomic choices, since they are con- are going to be used and in what quantities? What tech- cerned not with the total amount of national output, but niques of production are going to be adopted? Will cars with the individual goods and services that make it up: be produced by robots or by assembly-line workers? Will what they are, how they are made, and who gets to con- electricity be produced from coal, oil, gas, nuclear fission, sume them. Sloman, John, et al. Economics, Pearson Education, Limited, 2022. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/city/detail.action?docID=6824443. M01 Economics 05339.indd 9 10/11/2021 14:15 Created from city on 2024-12-15 18:23:55.  10 CHAPTER 1 ECONOMICS AND ECONOMIES Choice and opportunity cost The opportunity cost of any activity is the sacrifice KEY Choice involves sacrifice. The more food you choose to buy, IDEA made to do it. It is the best thing that could have the less money you will have to spend on other goods. The 2 been done as an alternative. more food a nation produces, the fewer resources there will be for producing other goods. In other words, the produc- tion or consumption of one thing involves the sacrifice of concepts, which we shall be exploring throughout the book. TC 1 alternatives. This sacrifice of alternatives in the production Once you have grasped these concepts and seen their sig- p10 (or consumption) of a good is known as its opportunity cost. nificance, they will affect the way that you understand and If the workers on a farm can produce either 1000 tonnes analyse economic problems. They will help you to ‘think like of wheat or 2000 tonnes of barley, then the opportunity cost an economist’. of producing 1 tonne of wheat is the 2 tonnes of barley for- gone. The opportunity cost of buying a textbook is the new pair of jeans that you have had to go without. The opportu- Definition nity cost of saving for your old age is the consumption you sacrifice while younger. Opportunity cost The cost of any activity measured in Opportunity cost as the basis for choice is the first of terms of the best alternative forgone. our ‘threshold concepts’. There are 15 of these threshold THINKING LIKE AN THRESHOLD CONCEPT 1 CHOICE AND OP