Cambridge International AS & A Level Economics PDF

Economics for Cambridge International AS & A Level COURSEBOOK Colin Bamford & Susan Grant Contents How to use this series How to use this book Introduction Introduction to command words Getting started with Cambridge International AS & A Level Economics 1 Basic economic ideas and resource allocation (AS Level) 1 Scarcity, choice and opportunity cost 2 Economic methodology 3 Factors of production 4 Resource allocation in different economic systems 5 Production possibility curves 6 Classification of goods and services End-of-unit exam-style questions 2 The price system and the microeconomy (AS Level) 7 Demand and supply curves 8 Price elasticity, income elasticity and cross elasticity of demand 9 Price elasticity of supply 10 The interaction of demand and supply 11 Consumer and producer surplus End-of-unit exam-style questions 3 Government microeconomic intervention (AS Level) 12 Reasons for government intervention in markets 13 Methods and effects of government intervention in markets 14 Addressing income and wealth inequality End-of-unit exam-style questions 4 The macroeconomy (AS Level) 15 National income statistics 16 Introduction to the circular flow of income 17 Aggregate demand and aggregate supply analysis 18 Economic growth 19 Unemployment 20 Price stability End-of-unit exam-style questions 5 Government macroeconomic intervention (AS Level) 21 Government macroeconomic policy objectives 22 Fiscal policy 23 Monetary policy 24 Supply-side policy End-of-unit exam-style questions 6 International economic issues (AS Level) 25 The reasons for international trade 26 Protectionism 27 Current account of the balance of payments 28 Exchange rates 29 Policies to correct imbalances in the current account of the balance of payments End-of-unit exam-style questions 7 The price system and the microeconomy (A Level) 30 Utility 31 Indifference curves and budget lines 32 Efficiency and market failure 33 Private costs and benefits, externalities and social costs and benefits 34 Types of cost, revenue and profit, short-run and long- run production 35 Different market structures 36 Growth and survival of firms 37 Differing objectives and policies of firms End-of-unit exam-style questions 8 Government microeconomic intervention (A Level) 38 Government policies to achieve efficient resource allocation and correct market failure 39 Equity and redistribution of income and wealth 40 Labour market forces and government intervention End-of-unit exam-style questions 9 The macroeconomy (A Level) 41 The circular flow of income 42 Economic growth and sustainability 43 Employment and unemployment 44 Money and banking End-of-unit exam-style questions 10 Government macroeconomic intervention (A Level) 45 Government macroeconomic policy objectives 46 Links between macroeconomic problems and their interrelatedness 47 Effectiveness of policy options to meet all macroeconomic objectives End-of-unit exam-style questions 11 International economic issues (A Level) 48 Policies to correct disequilibrium in the balance of payments 49 Exchange rates 50 Economic development 51 Characteristics of countries at different levels of development 52 Relationship between countries at different levels of development 53 Globalisation End-of-unit exam-style questions 54 Preparing for assessment Appendix: Key formulae Acknowledgements Copyright How to use this series How to use this book Throughout this coursebook, you will notice recurring features that are designed to help your learning. Here is a brief overview of what you will find. LEARNING INTENTIONS Learning intentions open each chapter. They help with navigation through the coursebook and indicate the important concepts in each topic. ECONOMICS IN CONTEXT Economics in context introduces you to the content in a chapter. These place some of the key ideas contained in the chapter into a real-world economics context. They raise important issues for discussion, with questions that allow you to look in more detail at the topic. KEY TERMS Key vocabulary and formulae are highlighted in the text when they are first introduced. An accompanying definition explains the meanings of these words and phrases. You will also find definitions of these words in the glossary at the back of this book. There is also a separate appendix for all key formulae. TIPS Tips are provided throughout this coursebook to help with your learning. The tips might cover how to avoid common errors or misconceptions, advice on essay-writing, evaluation and analysis, or guidance on how answers are arrived at. KEY CONCEPT LINKS These links explain how the coursebook’s topics are integrated with the key concepts in the Cambridge International AS & A Level Economics syllabus. ACTIVITY There are various activities throughout this coursebook. These include short case studies with evaluative or analytic questions, as well as opportunities to produce your own work either individually, in pairs or in groups. REFLECTION Reflection questions direct you to look back on an activity and encourage you to think about your learning. You will reflect on and assess the process that you used to arrive at your answers. THINK LIKE AN ECONOMIST Think like an economist provides you with an opportunity to apply economic principles to current events in various international settings. You will look at your life through an economics lens, and also apply your analysis skills and use evidence to look at the world of work. Designed to encourage group discussion, the short case studies and accompanying questions will help you to make connections between employment and studying economics. SELF-EVALUATION CHECKLIST At the end of each chapter, you will find a series of statements outlining the content that you should now understand. You might find it helpful to rate how confident you are for each of these statements when you are revising. You should revisit any topics that you rated ‘Needs more work’ or ‘Almost there’. EXAM-STYLE QUESTIONS Each chapter contains a set of multiple-choice questions. You can use these to assess the knowledge you have gained in this section of your course. In addition, each unit ends with a set of more demanding data response and essay questions. These can be used to assess what you have learnt across several chapters of the coursebook. You can find the answers to the activities and exam-style questions in the digital coursebook. Note: Throughout the text, dollars ($) refer to US dollars, unless otherwise stated. Introduction Who is this book for? Congratulations on obtaining a copy of this new coursebook. This fourth edition has been written to provide in-depth support for the new Cambridge International AS & A Level Economics (9708) syllabus. Structured to follow the order of the syllabus, the coursebook will prove useful for both learners and teachers of economics. The book will also be of benefit to learners and teachers of other A Level or equivalent economics courses. In addition, it will help university students who are new to economics and who want an introduction to the subject. What makes this book different? This coursebook includes a range of features that make economics relevant to the real world and bring the subject up to date. These features are designed to develop your skills as an economist. There is a chapter devoted to each of the 53 topics covered in the syllabus. Each chapter starts with a real-world case study that provides a focus for discussions with other learners on key issues in economics. Each chapter also contains a number of key terms, a variety of activities, key concepts, tips, a ‘Think like an economist’ feature, multiple-choice exam-style questions and a self-evaluation checklist. At the end of each unit, there are exam-style data response and essay questions. All of these features are designed to build up your understanding of economics, encourage you to think for yourself and to develop your skills on how to make meaningful judgements. How to use this book You can use this book to support and develop your learning as you progress through your course. The key terms will help you understand the main concepts. The activities will ensure that you can use the knowledge and skills you have gained in a variety of ways to enhance what you have learnt from the coursebook. The key concepts feature shows how aspects of the topic can be related to the key concepts identified in the syllabus. The tips will help you avoid common mistakes and provide some guidance on writing answers. The ‘Think like an economist’ feature will provide you with the opportunity to apply the skills you are gaining to issues that economists are currently exploring. The self-evaluation checklists can be used to check your level of understanding after completing each topic. The exam-style questions throughout the coursebook enable you to regularly assess the understanding that you have gained and monitor your progress. You can also use the accompanying Cambridge International AS & A Level Economics Workbook to develop your skills. The workbook provides more questions, activities and sample answers, and includes advice on enhancing your answer-writing skills. Economics is fascinating subject. We hope that this book will help you enjoy the subject and provide you with success on your course. Colin Bamford and Susan Grant Introduction to command words The command words and definitions in this section are taken from the Cambridge International AS & A Level Economics (9708) syllabus for examination from 2023. You should always refer to the appropriate syllabus document for the year of your examination to confirm the details and for more information. The syllabus document is available on the Cambridge International website at www.cambridgeinternational.org. The purpose of command words is to make it clear how you should approach answering a question. It is important that you understand what each command word is asking you to do. These are the command words used in the Cambridge International AS & A Level Economics (9708) syllabus and in the exam-style questions in this coursebook. In time and with practice, you will find that you can understand what skills you have to demonstrate in your answers to particular questions. Command What it means Guidance word Analyse examine in detail to show You should write an meaning, identify elements answer that shows how the and the relationship between points in your answer link them together, avoiding unnecessary detail. Assess make an informed You should write about judgement both sides of a particular issue and then come to a supported conclusion about which, if any, is best. Calculate work out from given facts, You should give a clear figures or information answer that includes the units involved e.g. $US. Comment give an informed opinion You should give a view on a particular issue based on evidence and not unsupported opinion. Compare identify/comment on You should make sure that similarities and/or your answer really does differences compare two things in terms of their similarities and differences and not just state what these things are. Consider review and respond to given You should make a brief information point that contains some evaluation. Define give precise meaning You should make sure that any definition is correct. Demonstrate show how or give an You should clearly show example that your answer is drawn on evidence. Describe state the points of a topic / You should give give characteristics and appropriate knowledge of main features a particular topic or issue. Discuss write about issue(s) or You should give a topic(s) in depth in a balanced account of both structured way sides, for and against, an issue or argument. Evaluate judge or calculate the You should aim to make a quality, importance, amount, reasoned judgement and or value of something include a supported conclusion on the merits or otherwise of something. Explain set out purposes or reasons / You should write an make the relationships answer that contains between things evident / clearly identifiable provide why and/or how and reasons; you may have to support with relevant draw upon data or other evidence information to make your explanation clear. Give produce an answer from a You should provide an given source or answer from memory or recall/memory from a source that is familiar to you. Identify name/select/recognise You should be precise about what you have identified. Justify support a case with You should be confident evidence/argument that your justification is supported by relevant evidence. Outline set out main points You should write a clear answer avoiding detail. State express in clear terms You should give an uncomplicated yet valid factual statement. Getting started with Cambridge International AS & A Level Economics The guidance in this section has been written by the authors. References to assessment and/or assessment preparation are the publisher’s interpretation of the syllabus requirements and may not fully reflect the approach of Cambridge Assessment International Education. You have selected to study a subject that is highly regarded by universities and employers. Many learners who have started economics at AS Level gain interesting and meaningful jobs. Many learners decide to study economics at university and then go on to successful jobs in industry, finance and government. Economics can change people’s lives. The advice of economists is well- respected. For instance, it helps to reduce unemployment, to raise living standards and to improve the quality of life. Economists are also at the heart of organisations that are seeking to combat climate change and poverty. An economist has a keen interest in world events, a logical mind and good communication skills. Many students of AS Level and A Level Economics are new to the subject. This book will introduce you to the subject and will develop the knowledge and skills you need. If you have studied Cambridge TM IGCSE or O Level Economics you will have knowledge of some of the topics that will be covered in this course. However, you will have to analyse these topics in more depth, cover some new topics and develop stronger analytical and evaluative skills. How different is AS Level and A Level from Cambridge IGCSE and O Level? Some topics are covered in more depth at AS Level and A Level than at Cambridge IGCSE and O Level. For example, not only will you need to know how unemployment is measured but you will also need to consider the possible difficulties in its measurement. You will encounter a number of new topics at AS Level and A Level. For example, you will learn about consumer surplus and the terms of trade. The skills required at AS Level and A Level are the same. These are knowledge and understanding, analysis and evaluation. The same emphasis is put on analysis but there is more emphasis placed on evaluation at A Level and less on knowledge and understanding. So, the key differences between this course and Cambridge IGCSE and O Level Economics are: more depth of subject content more breadth of subject content with new topics covered more emphasis on evaluation. What is the difference between AS Level and A Level Economics? In subject terms, you study both microeconomics and macroeconomics at AS Level and A Level. What you have learned at AS Level serves as a foundation for A Level; the topics at A Level involve more depth and in many areas, there is more emphasis on real world applications. This is particularly the case in macroeconomics. The ways in which you are assessed are very similar at AS Level and at A Level, with multiple- choice, data response and essay questions. Studying AS Level and A Level Economics is a continuous process. You will need to be aware that although A Level questions are drawn from the A Level syllabus, knowledge of material from the AS Level syllabus is assumed. What will you need? Among the resources you will need are: a copy of the syllabus – as you progress through your course, you should check that you understand each topic on that part of the syllabus this coursebook and the Cambridge International AS & A Level Economics Workbook – these will help you understand the topics and develop your skills past examination papers – these will be useful for you to see the types of questions you might come across in an examination and will provide you with an opportunity to get practice in answering the questions; as the syllabus has been revised recently, these papers will not fully reflect the new question papers a way of keeping your notes, assignments and other written resources – you may decide to keep these on paper in a file or you may decide to use a laptop or tablet computer access to economics news reports, reliable websites and economic blogs a calculator to use on your assignments, activities and questions in the coursebook, workbook and past examination questions a ruler to use when drawing diagrams. How mathematical is economics? At AS Level and A Level, the key mathematical skills you will need are numeracy, data interpretation, and the ability to draw diagrams. The key specific skills are: calculating and interpreting percentages and percentage changes calculating and interpreting ratios calculating averages calculating and interpreting index numbers using and interpreting formulae interpreting tables of data, scatter diagrams, pie charts, line graphs and bar charts drawing a range of diagrams. It is recommended that learners starting this course have studied Cambridge IGCSE (Extended) or Cambridge O Level in Mathematics or equivalent. What other skills will you need? These include the following: Research skills: You will need to keep up to date with changes in economic events and investigate economic issues such as the causes of poverty. Decision-making skills: You will need to develop the ability to assess both sides of an argument, come to a judgement and support it. Oral communication skills: The coursebook will provide you with the opportunity to debate economic issues with other learners. Some of these opportunities will be in pairs and some in larger groups. Expressing your ideas and informed views, and listening to the ideas and informed views of others, will strengthen your knowledge and understanding, your analytical and evaluative skills. Written communication skills: You will have to answer essay questions. At AS Level these will be in two parts and at A Level in one part. In both cases, it is important that you write clearly. See the section below on ‘Introduction to economics essay writing skills’. The information in the following two sections is taken from the Cambridge International AS & A Level Economics (9708) syllabus for examination from 2023. You should always refer to the appropriate syllabus document for the year of your examination to confirm the details and for more information. The syllabus document is available on the Cambridge International website at www.cambridgeinternational.org. How will you be assessed? As part of your course, it will be useful to consider the syllabus’s assessment objectives: Knowledge and understanding (AO1) Show knowledge of syllabus content, recalling facts, formulae and definitions. Demonstrate understanding of syllabus content, giving appropriate explanations and examples. Apply knowledge and understanding to economic information using written, numerical and diagrammatic forms. Analysis (AO2) Examine economic issues and relationships using relevant economic concepts, theories and information. Select, interpret and organise economic information in written, numerical and diagrammatic form. Use economic information to recognise patterns, relationships, causes and effects. Explain the impacts and consequences of changes in economic variables. Evaluation (AO3) Recognise assumptions and limitations of economic information and models. Assess economic information and the strengths and weaknesses of arguments. Recognise that some economic decisions involve consideration of factors such as priorities and value judgements. Communicate reasoned judgements, conclusions and decisions, based on the arguments. What are the key concepts in economics? The syllabus identifies six paired key concepts and one singular concept. These are: scarcity and choice the margin and decision-making equilibrium and disequilibrium time efficiency and inefficiency the role of government and the issues of equality and equity progress and development. You are obviously aware of the concept of time. Economists often distinguish between the short-run and long-run effects of economic events and policy changes. Some of the other terms may not mean much to you now but you will become familiar with them as you progress through your course. The coursebook regularly highlights where some of these concepts apply. Introduction to economics essay writing skills To write a strong answer, the following are important: Plan your answer: This does not have to be a detailed plan. You may just want to jot down some ideas but a plan can help you structure your answer, avoid you forgetting points and ensure that you focus on the specific question set. Be clear and precise in your writing: Use words you understand and when using technical terms, be specific. This is because economics has many terms that are very similar. Write impersonally: In other words, do not use ‘I’ or ‘we’ in your essays. This applies particularly when you are asked to make an evaluation of an economic issue or argument. Take care with sentences and punctuation: In general, try to write in short sentences, to the point and containing words you understand and know how to use. Use one idea per paragraph and develop your ideas: This makes it easier for someone reading your work to know what your answer is about and see how your idea has been developed. Support the statements you make: Develop the points you make and the arguments you put forward. Do not jump stages. For example, do not just write that an increase in wages may reduce poverty – explain why it might. If you are asked to ‘assess, evaluate or discuss’, come to a conclusion, making a judgement: This judgement should be supported by analysis you have provided in your answer. (Also see the third tip below). Tips on becoming an effective learner Here are some tips that can help you as you progress through your course: 1 Be prepared. 2 Think like an economist. 3 Base evaluation on sound analysis. 4 Use real world examples. 1 Be prepared After each lesson, you should review what you have learnt. Make sure you engage in active learning. This involves you taking part in the learning process by doing something with information on economic topics. This will reinforce your understanding and can help you see the links between topics. This book will help you with this. As mentioned earlier, you can complete the activities and answer the multiple-choice questions at the end of each of the chapters. This should be done on a regular basis. There are also the full data response questions and structured essay questions at the end of each of the eleven units. The activities in each chapter, which are designed for you to work with other learners, will develop your confidence and understanding of the subject matter of economics. You can also do a variety of other activities including writing your own multiple-choice questions and producing mind maps. 2 Think like an economist Good economists have a range of skills. They are able to analyse and evaluate economic issues, interpret and use diagrams and have an awareness of what is happening now and in the past in the domestic and global economy. They also have an understanding of what is likely to happen in the future and use and interpret data to make economic forecasts. Good economists think logically. They base their comments on sound economic analysis, considering both sides of an argument, rather than uninformed opinions. 3 Base evaluation on sound analysis An important aspect of studying AS and A Level Economics is that what you learn should allow you to evaluate economic issues. To do this effectively, your evaluation should be based on a foundation of sound economic analysis. Questions that contain command words such as ‘Consider’, ‘Discuss’, ‘Assess’ and ‘Evaluate’ are asking you to examine arguments for and against a topic; in the case of some essay questions, you will need to make a final judgement. 4 Use real-world examples It is beneficial to use real-world examples to illustrate the points you are making in your answers. Some of these can be drawn from markets in your economy or from your economy’s macroeconomic performance. For example, in answering a question on changes in equilibrium price, you might be able to mention how a period of bad weather has pushed up the price of an agricultural product in your country. In answering a question on the effectiveness of using fiscal policy to reduce unemployment, your answer could be strengthened by exploring how recent changes in taxation and government spending have affected unemployment in your country. To provide good examples, keep up to date with what is happening in your economy and major economies such as China, Germany and the USA. The next step Having considered some of the features of the syllabus and the nature of economics, you are now ready to start this course. You will find it challenging but also interesting and rewarding. Economics is a subject that most learners become more confident in as they progress through their course. This is because some of the same terms and concepts are used when covering different topics. You will learn to think like an economist and you will build up what is sometimes called the economist’s toolkit. This is the term used to describe the skills and techniques economists have available to analyse economic problems and issues. We wish you the best of luck in your studies. Unit 1 Basic economic ideas and resource allocation (AS Level) UNIT INTRODUCTION This unit provides you with an introduction to studying economics. The chapters introduce you to terms and concepts that form part of ‘the economist’s tool kit’. You will find these terms and concepts invaluable as your study of economics progresses. The subject of economics has grown out of the fundamental economic problem. When resources such as an individual’s income are limited, choices have to be made. A simple model, the production possibility curve, is used to show how the fundamental economic problem applies in an economy. The unit explains why governments find it necessary to provide some goods and services for us. Chapter 1 Scarcity, choice and opportunity cost LEARNING INTENTIONS In this chapter you will learn how to: explain the fundamental economic problem of scarcity explain the need for individuals, firms and governments to make choices define the meaning of opportunity cost explain how opportunity cost results from the need to make choices explain the basic questions of resource allocation. ECONOMICS IN CONTEXT The economist’s role in a changing world This is certainly an interesting time to be studying economics given all the problems in the global economy. As the 2019 joint Nobel Prize economist, Esther Duflo, has said, ‘Economists have something to contribute’. Let us look at the topic of climate change, where this is undoubtedly true. Figure 1.1: In 2019, the French–American economist Esther Duflo was jointly awarded the Nobel Prize in Economic Sciences with economists Abhijit Banerjee and Michael Kremer for ‘their experimental approach to alleviating world poverty’ Few would now disagree that the effects of climate change can no longer be ignored. Issues to be addressed include: Should we fly less? Should we source more of our needs locally? Should we eat less meat and fewer animal products? Should high-income countries do more to help other countries? The list does not stop here. In all these issues, economists have something to contribute. Discuss in a pair or a group: Is there anything you could do to reduce your carbon footprint? What do you think economists could suggest to help combat climate change? 1.1 The fundamental economic problem The fundamental economic problem arises because resources (inputs used to produce goods and services) are scarce while people’s wants are unlimited. Wants are unlimited because there is always likely to be something else that a person wants whatever their income. For an individual on a low income, a want may be a car; for a millionaire a want may be a personal jet aircraft. Both wants are unobtainable on each individual’s current amount of income. It is important not to confuse wants and needs. Needs are things like food, shelter and clothing that are needed for survival. The fundamental economic problem means that individuals, firms and governments have to make choices due to the scarcity of resources. Making a choice involves taking decisions on how to allocate scarce resources between many competing uses. Figure 1.2 shows the fundamental economic problem. TIP In economics, a need is not the same as a want. Learners often confuse need and want. An individual may not have the income required to satisfy all their wants. A need tends to be more important than a want because needs are required for survival. Figure 1.2: The fundamental economic problem KEY CONCEPT LINK Scarcity and choice: The fundamental problem in economics is that wants are unlimited, but resources are scarce. This means a choice always has to be made between competing uses for resources. There will be an opportunity cost each time a choice is made. Look out for the theme of scarcity and choice in economics. ACTIVITY 1.1 1 a Write a list of ten wants starting with your most important want first. Do not discuss your list with other learners. Ask your teacher to make their own list too. Once everyone has completed their list, share the results in class. b What did you find? You probably agreed on the first few choices, but it is likely you saw a big variation in your choices further down the list. 2 In a group, discuss how your list compares to lists compiled by others with very different life experiences, such as your economics teacher. 3 Discuss whether there is likely to be an end to your list if you are not limited to ten choices. Remember that wants are continually expanding, developing and changing. 1.2 Unlimited wants There are certain basic needs that must be satisfied if we are to stay alive. These include the essentials items of food, shelter and clothing. Also, you might identify wants that seem less essential but that improve the quality of life, for example television, cars and trips to the cinema. These wants are sometimes called luxuries, but remember that what is a luxury for one individual may be considered an essential for others. This is because everyone has a scale of preference, on which you place your more urgent wants at the top and the less urgent ones at the bottom. Each individual’s scale of preference is a product of a set of influences, including culture, upbringing and life experiences. Together these influence your likes and dislikes. Unsurprisingly, scales of preference may vary widely between individuals. Some wants expand as we grow older and make different life choices. Imagine how an individual’s needs may change as they move from a single-person household to a family household (for example, how their wants may change from a small car with two doors to a large, family car with five doors). Some wants may develop and expand when individuals see others enjoying particular goods and services and so desire to have those goods as well. Sometimes wants change as a result of new experiences (for example, people may want to improve their fitness after seeing a TV programme about obesity). All of this points to the fact that people will always have wants. While businesses are continually finding new, more efficient ways to produce more and more goods and services with the resources available, society is still faced with the fundamental economic problem of limited resources and unlimited wants. 1.3 Choice and opportunity cost Given limited resources and unlimited wants, individuals, firms and governments have to choose which wants to satisfy. They have to make a choice between alternative wants. The true cost of any choice made between alternatives is expressed by economists in terms of opportunity cost. Opportunity cost is the cost of the choice in terms of the next best alternative. For example, suppose you have $15 to spend on yourself. You can either buy a video game that costs $15 or two paperback books for $7.50 each. You cannot buy both the video game and the books. You have to choose between the alternatives. You decide to buy the video game. The next best alternative is the books. Therefore, the opportunity cost of the video game is the two books. Opportunity cost shows you the real cost of your choices. It can be applied in a variety of contexts and is helpful for decision-makers such as individuals, firms and governments. TIP Opportunity cost is a recurring topic throughout the syllabus. Remember to consider opportunity cost whenever you are studying situations where choices have to be made. ACTIVITY 1.2 Air transport is one of the biggest contributors to the emission of greenhouse gases. In a group, consider the opportunity costs involved if the future growth of air transport is restricted. Produce a poster for your classroom wall to show all the points that need to be considered. REFLECTION In your answer to Activity 1.1, you ranked your top ten ‘wants’ in order. Why do you think people might have to do this in real life? How does this increase your understanding of the concept of ‘wants’? Have you ever thought about how you might put your own ‘wants’ in rank order? 1.4 What to produce, how to produce and for whom to produce? The fundamental economic problem leads to three important questions. The three questions are related to the allocation of resources. All economies have to answer these questions. What to produce? How to produce? For whom to produce? What to produce? Economies cannot produce everything, so they must decide what to produce and in what quantities. For example, firms and governments have to choose whether to produce lots of goods and services, such as food, clothing and vehicles, to improve the standard of living, or whether to produce lots of military equipment to improve national defence. The evidence for this is that some countries spend a lot more than others on their national defence. How to produce? Firms have to consider how resources are used so that they achieve the best outcome. Firms need to consider how they can get the maximum use out of the resources available. Sometimes firms need to consider issues other than purely economic concerns when deciding how to produce. It may be that an economy could produce more goods and services by using cheap labour, but there may be moral objections to the use of cheap labour. Crop yields could be increased through more intensive methods of cultivation. Also, better use might be made of underground water supplies, as seen in Egypt where potatoes and other crops are grown in the Sahara desert. For whom to produce? Governments have to decide whether everyone is going to have a more or less equal share of what is produced or whether some will have more than others. Some economies aim to create a more equal society through policies that redistribute wealth and income from the rich to the poor. This could be achieved through the use of taxation. There are other economies, by contrast, that have extreme inequalities of income and wealth, often based upon inheritance. Inequality is a significant issue in most emerging economies where there is a widening gap between rich people and people living in poverty. ACTIVITY 1.3 In 2019, 28% of Japan's population was aged 65 years and over; by 2050, this figure is estimated at 38%. Total population is also projected to fall from 125m in 2019 to 100m in 2050. Suggest the likely effect of these changes on a what to produce b how to produce c for whom to produce. KEY CONCEPT LINK Scarcity and choice: The three fundamental economics questions are typical of a trade-off between economic freedom for firms and individuals and a government that desires greater social equality and fairness. THINK LIKE AN ECONOMIST Healthcare funding issues in Africa Figure 1.3: Healthcare in the Democratic Republic of the Congo The World Health Organization (WHO) has warned that a lack of funding is hindering the fight to improve healthcare in Africa. Governments in Africa spend just 1% of the world’s financial resources on healthcare but bear 24% of the global burden of diseases. Spending by individual governments varies greatly – spending is highest in Namibia and South Africa, both of which spend 10 times more per head than in Kenya and Tanzania and at least 20 times more per head than in Ethiopia and the Democratic Republic of the Congo, according to the WHO study. The data can be misleading since the World Bank, the private sector and charities such as the Gates Foundation spend huge sums on funding healthcare, especially in Sub-Saharan Africa. Total funding is not the only challenge. Because not all wants can be satisfied, funding has to be directed to those areas of healthcare where there is most need. Figure 1.4 shows how spending on different types of healthcare varies greatly from country to country. Figure 1.4: Healthcare spending by type for selected African countries ($ million) 2016 Funding for healthcare in Africa is inadequate in relation to what is needed. Imagine you are an economist employed by the WHO. 1 Consider how you might obtain more funding for healthcare in Africa. 2 How could the additional funds be allocated to give maximum benefit? EXAM-STYLE QUESTIONS: MULTIPLE CHOICE 1 The fundamental economic problem exists because: A resources are scarce in relation to unlimited wants. B a business does not know how much it can sell. C resources are scarce in relation to needs. D we cannot always have what we want. 2 Wants are unlimited because: A there will always be something we would like to have. B there will always be something we need. C our income is limited. D we are never aware of what we might want in the future. 3 A government has limited resources to fund the wants of its population. This means that: A the government has to make choices. B the government is unable to provide any goods free of charge. C the government has to cut the pay of government workers. D the government is unable to borrow more funds. 4 A teacher usually marks examination papers during the school break. She receives $900. Instead, this time, she has decided to do some maintenance work on her apartment. To get someone to do the work would cost $600. What is the opportunity cost if the teacher decides to do the maintenance work herself rather than mark examination papers? A $300 B $600 C $900 D $1500 5 You are a student preparing for an assessment. A friend calls round and asks you to play a game of football. You decide to stay at home to prepare your assessment. What is the opportunity cost? A Your friend’s team loses the football match. B You save money on bus fares by not playing. C The healthy exercise you will get by playing football. D A higher mark for your assessment. 6 Which of these questions is not one an economy has to address? A how resources are used B for what resources are used C where resources are used D for whom resources are used SELF-EVALUATION CHECKLIST After studying this chapter, complete a table like this: You should be able to: Needs Almost Ready more there to move work on Understand why the fundamental economic problem of scarcity occurs Understand why individuals, firms and governments have to make choices because resources are scarce Understand that opportunity cost results from the need to make choices and is the next best alternative that is foregone Analyse why the fundamental economic problem requires all economies to answer three important questions: what to produce, how to produce, for whom to produce Chapter 2 Economic methodology LEARNING INTENTIONS In this chapter you will learn how to: explain why economics is a social science differentiate between facts and opinions (positive and normative statements) explain why economists use the term ceteris paribus explain when to refer to a time period such as ‘short run’, ‘long run’ and ‘very long run’. ECONOMICS IN CONTEXT Why economics is important Economics covers a wide range of issues like the ones in the media headlines in Figure 2.1. You are likely to learn about economics issues in newspapers, on television and through the internet. Figure 2.1: These media headlines from around the world show the sorts of issues and concerns that interest economists Economists have developed their own language of terms and concepts that they use to explain and evaluate the issues that affect our world and everyday lives. In this book you will learn the terminology used by economists. Some of the words may seem familiar, for example ‘demand’, ‘market’, ‘unemployment’, ‘inflation’ and so on. Other terms will be new to you. By the end of your AS Level studies, you should be able to use these words and terms in a useful way to enable you to think like an economist. The words in colour in the headlines are in general everyday use. The words have very specific meanings when used in economics, as you will see as you study this book. Discuss in a pair or a group: Look at two or three recent newspapers. Identify any key economic terms you can find. Select one article. Summarise the main points. State why these points may be of interest to economists. 2.1 What is economics? Think back to Section 1.1 and your understanding of the fundamental economic problem. You can use your understanding to write a simple definition of economics, for example ‘the study of how to allocate scarce resources in the most efficient way’. TIP Try to read the business section of a good newspaper at least once a week. You might be surprised by how much economics it usually contains. The study of economics is divided into two parts: microeconomics and macroeconomics, as shown in Figure 2.2. Figure 2.2: The study of economics is divided into microeconomics and macroeconomics. Nowadays, the division of economics between microeconomics and macroeconomics is less clear cut. For example, some aspects of the operation of markets affect the macroeconomy, such as an increase in demand for cars could affect an economy’s export and import trade. TIP The division of economics between microeconomics and macroeconomics is not always a clear one. You need to remember this when answering questions. 2.2 Economics as a social science Economics is a social science. The ‘social’ aspect is because economics looks at human behaviour, particularly in relation to satisfying human needs and wants. Economics is also a ‘science’. This is because of the way that economists put forward and investigate theories in the same way as scientists. Like scientists, economists put forward new ideas that seek to explain the ever and rapidly changing global economy in which we all work and live. Figure 2.3 shows a simplified view of how the scientific process comes about. Figure 2.3: Economics as a science The theories put forward by economists are often referred to as models. Models are a simplified representation of what has actually taken place and are usually explained mathematically. The value of models is that they can be used over and over again to test a theory in many different contexts. 2.3 Positive and normative statements Economists may analyse facts without making any value judgements. For example, an economist might make these statements: A fall in supply of petrol leads to an increase in its price. A 10% increase in tourist numbers in Mauritius has created 10% more employment. An increase in taxation on cars results in fewer cars being sold. The inflation rate in 2021 is 8%. All of the above statements refer to what will happen, based on actual evidence or observation. The economist does not give their opinion or make a value judgement. Statements like these are known as positive statements. When an economist expresses an opinion or makes a value judgement within their analysis, the statement can no longer be proven. Statements that express a value judgement are referred to as normative statements. For example, each of the normative statements below contains a value judgement within the analysis: A fall in the supply of petrol should lead to an increase in its price. A 10% increase in tourist numbers in Mauritius is likely to create at least 15% more jobs in the tourist industry. An increase in taxation on cars might result in a fall in demand for new cars. The inflation rate of 8% in 2021 was the worst in 10 years. Figure 2.4: A street market in Mauritius ACTIVITY 2.1 1 Convert each of the normative statements below into positive statements: a The price of onions should increase due to prolonged drought. b An increase in government spending on the railways is the best way to increase employment in India. c It is wrong to always assume a more equal distribution of income in a planned economy compared to a market economy. 2 Discuss in a pair: What difference does this make to an economist’s explanation of each statement? 2.4 Meaning of the term ceteris paribus Ceteris paribus is a Latin term widely used by economists to refer to a situation where ‘other things remain equal’ or are unchanged. Ceteris paribus allows economists to simplify a situation by assuming that apart from a single change of circumstances, everything else is unchanged. In this way, economists can model the effects of one change at a time. For example, when analysing the reasons why consumers purchase a product, there may be many reasons. The most important reason is usually price. In analysing the effect of a change in price, it is understood that all other factors that determine consumer demand are ceteris paribus. In other words, they are not subject to change. TIP As you study economics, you will realise the importance of the term ceteris paribus when explaining change. Ceteris paribus simply means ‘other things equal’. Remember to include the term in any written answers where relevant. The margin Like ceteris paribus, ‘the margin’ is another tool economists use to simplify a situation. Many aspects of microeconomics involve analysing decisions ‘at the margin’. By this, economists mean that a small change in one variable, such as consumer income, will lead to further (small) changes in other variables, such as consumer spending and imports. Using the margin to analyse issues enables economists to predict what the likely impact of change might be. KEY CONCEPT LINK The margin and decision-making: Decision-making by consumers, firms and governments is based on choices at the margin. For example, firms will produce up to the point where the revenue generated by an extra unit of output is equal to the cost of producing it. This concept – like scarcity and choice – can be applied in many different situations that economists study. REFLECTION Do you think that you are beginning to understand some of the topics that are part of economics? If not, what can you do to improve your understanding? 2.5 The importance of time periods We live in a world of change. Change is all around us – in daily life, at home, at work, and in the ways in which economies function. Economists take change into account in their analysis of situations. They use time periods to assess how, over time, change can influence the concepts that economists seek to model and explain. For example, the following time periods are often used when economists discuss the factors of production (resources or inputs that are used in the production of goods and services – land, labour, capital, enterprise): The short run is a time period in which it is possible to change only some inputs. Typically, it is when labour, a variable resource or factor of production, can be increased or decreased to change what is produced. So, with all other factors of production such as capital resources remaining the same (ceteris paribus), a firm taking on more workers may be able to increase the quantity of goods it produces. In the long run, it is possible for all factors of production or resources to change. So, in the long run, a firm may improve the quality and quantity of its capital by building a new factory to increase its output. This will usually allow the firm to be more efficient since it has had time to assess the best way to achieve its objectives. The very long run is where not only are all factors of production variable but all other key inputs are variable. Key inputs can include technology, government regulations and social concerns. The key concept ‘Time’ may be used to show where the distinction between the short run and the long run is an important consideration. TIP Time periods do not have an exact timescale such as three months or one year. Remember that the timescale depends on whether any or all of the factors of production can be changed. ACTIVITY 2.2 In pairs, look again at the newspaper article you selected at the start of this chapter, or choose another news story. Prepare a short presentation in which you explain the points that would interest economists in the article. You may use a presentation app if you wish. Make your presentation to the class. THINK LIKE AN ECONOMIST Are economists' models flawed? Figure 2.5: Japanese consumers Most economists agree that low interest rates provide a monetary stimulus whereby firms increase their investments in the business and consumers spend more. In taking this position, economists have developed models of the relationship and tested the models in the real world; governments worldwide have applied this policy when faced with a situation in which their economy needs to expand. Since the financial crisis of 2008, interest rates have been drastically cut to record low levels such as the UK’s 0.25% from 2016 to 2018. Japan has even had a negative interest rate of –0.1% since 2016. The reality does not match what the economist’s models say should happen. Firms are holding back from investing in new capital and consumers are reluctant to spend even though the financial return on savings is negligible or, in the case of Japan, negative. So, what is happening? Divide into two groups. One group should consider the situation from the viewpoint of the UK, the other group should consider the situation from the viewpoint of Japan. Imagine you are: 1 yourself, as a consumer 2 the chief executive of a large firm 3 a government finance minister. Discuss what you would do in each case. Why might you believe that the economists’ models are flawed? Each group should prepare a short presentation to give to the other group. EXAM-STYLE QUESTIONS: MULTIPLE CHOICE 1 Which of these is a positive statement? A Wages in Indonesia are likely to be unevenly distributed. B In 2019, the average wage in Indonesia was 3.8 million Indonesian Rupiah per month. C The average hourly wage rate in Jakarta should be higher than elsewhere in Indonesia. D The average wage in Indonesia depends on how it is measured. 2 Insert the correct words into this sentence. A … (1) … statement in economics is one that is subjective and …(2)… be tested by using real world evidence. 1 2 A normative cannot B normative can C positive cannot D positive can SELF-EVALUATION CHECKLIST After studying this chapter, complete a table like this: You should be able to: Needs Almost Ready more there to move work on Understand why economics is a social science Understand the difference between positive statements and normative statements Use the term ceteris paribus to describe a situation where ‘other things remain equal’ or unchanged Understand the importance of time periods to assess how over time, change can influence the concepts that economists seek to model and explain Chapter 3 Factors of production LEARNING INTENTIONS In this chapter you will learn how to: define the meaning of the factors of production: land, labour, capital and enterprise explain the importance of the factors of production describe the rewards to the factors of production explain the difference between human capital and physical capital explain the division of labour and specialisation explain the role of the entrepreneur in the organisation of the factors of production in 21st century economies and as a risk taker. ECONOMICS IN CONTEXT James Dyson, entrepreneur Figure 3.1: James Dyson James Dyson is a well-known global entrepreneur. An entrepreneur is someone who seeks out new business opportunities and is willing to take risks. Dyson’s range of products such as vacuum cleaners, fans and hand dryers are used around the world in homes, hotels, factories, offices and airports. James Dyson is best known for his bagless vacuum cleaner. As an engineer, the idea for the cleaner developed from a new industrial dust extractor that Dyson built for his small engineering company. By the early 1980s, Dyson had a working prototype of his vacuum cleaner, but it took a further 10 years for it to go on sale as a commercial product, and left him heavily in debt. Launched in 1993, the Dyson bagless vacuum cleaner became a best seller. Dyson moved production of the vacuum cleaner from the UK to Malaysia in 2002. At the time, the move was controversial as it would result in job losses in the UK. Once the patent expired, other manufacturers copied Dyson’s design. More recently, Dyson’s company has developed and manufactured a range of hand dryers, hair dryers, fans and lights using the latest Dyson technology. His revolutionary washing machine was not successful. His latest project has been to build an electric car at a new factory in Singapore. Despite a huge investment, Dyson has been forced to abandon the project as it would not be commercially viable. It is likely there will be other new ventures to follow but this shows the risks involved even for an experienced and highly successful entrepreneur. In 2019, the US business magazine Forbes estimated James Dyson’s net worth to be over $5 billion. Discuss in a pair or a group: What qualities do you think a successful entrepreneur like James Dyson is likely to have? Why might Dyson have failed? 3.1 The factors of production The fundamental economic problem of scarcity was explained in Section 1.1: resources are scarce in relation to wants, which are unlimited. Scarce resources and unlimited wants result in the need to make choices. Economists refer to the resources available in an economy as the factors of production. Factors of production are the means by which an economy produces a whole range of goods and services to meet the needs of its population. The owners of factors of production receive payments when the factors are used by others. There are four main types of factors of production, as shown in Figure 3.2. Figure 3.2: The factors of production Land Land is a natural resource. This factor of production includes a wide range of things such as mineral deposits like oil and coal, the earth’s rivers and lakes, climate and the land itself, in terms of the soil for agriculture and trees and vegetation. This factor of production can be used to describe the natural resources such as sea, sand and sun that are important for the development of tourism and leisure activities. The quality as well as the quantity of land as a factor of production is important. Too much sun, too little rain or poor soil can mean that this factor of production has little or no productive use. The quality of land as a factor of production is increasingly relevant in view of climate change. The reward for owning land is the rent or income that its owners receive. In the case of minerals, such as coal or precious metals, this can be a payment that is made for the minerals after they have been extracted. TIP Some learners struggle to understand the scope of the ‘land’ factor of production. It is much broader than the physical space on which an office or factory is built. Remember that it includes oil reserves, climate, rain forests and other natural resources. Labour Labour is the human resources available in any economy. The quantity and quality of labour is of major importance: Some economies, particularly low-income countries, often have large populations but suffer from a lack of a well-trained and well- educated labour force. Not all of the population is available for work. Some people are above or below the normal working age while others choose not to work for family or social reasons. In some economies there are cultural limitations on women working or the type of work that women are permitted to do. Some countries, for example China, Russia and Italy, have declining populations and rely on immigrant workers (workers from abroad) to do both skilled and unskilled jobs. The quality of labour is essential for economic progress. In India, emphasis has been given to increasing the IT skills of workers and has in part resulted in the growing importance of India in the global economy. The reward for labour is the wage or earnings paid for labour’s services. The payment received depends on the value of labour to whoever is hiring the labour. Capital Capital is a type of physical resource including anything that can be regarded as made by humans to aid production. Capital covers a wide range of items such as factories, office blocks, machinery, information technology, transport vehicles and infrastructure in the form of roads, railways, pipelines, electricity supplies, water supplies and so on. Capital is combined with land and labour to produce goods and services that are required. The quality as well as the quantity of capital is important, particularly in low-income economies where essential services may be unreliable. The reward for using capital is the financial return that is earned or income if the capital resource is rented. Enterprise Enterprise is a form of human capital. As a factor of production, enterprise has two main functions: It organises the other factors of production so as to produce goods and services. It refers to the ability and inventiveness of the entrepreneurs who are prepared to take risks. Well-known entrepreneurs include: Richard Branson (Virgin Group), Jeff Bezos (Amazon), Cher Wang (HTC Corporation), Jack Ma (Alibaba), Folorunsho Alakija (Rose of Sharon Group), Mukesh Ambani (Reliance Industries), Indra Nooyi (PepsiCo) and Bill Gates (joint founder, Microsoft). More typical though are the millions of people who own small businesses and organise the factors of production in order to make a profit. This is the reward for enterprise. ACTIVITY 3.1 Think about where you live. Make a list of examples of each of the factors of production in your area. Once you have completed the activity, share your list with another learner. Have you got the same examples? In a group, discuss how relevant the factors are to the local economy. TIP It is often overlooked that the quality of a factor of production is often more important than the quantity. Remember this point when writing about labour and capital as factors of production. 3.2 The difference between human capital and physical capital As a factor of production, ‘capital’ can be more correctly described as physical capital. It is the result of more resources being made by businesses and government in the wide range of items such as factories, machinery and infrastructure referred to earlier. The quality as well as the quantity of physical capital is often considered to be the most important source of economic growth in low-income and lower middle-income countries. The importance of the quality of labour as a factor of production has been referred to earlier. Building on this idea, economists often refer to human capital. This is the value of labour in contributing to the productive potential or future growth in an economy. Human capital can apply to individuals as well as to the population as a whole. It covers the skills, knowledge and experience of labour that is being used to produce goods and services. These skills may affect the future earnings of individuals and of the economy. Therefore, human capital can be seen as an investment by individuals, employers and the government to increase the future rate of economic growth. 3.3 Specialisation and the division of labour One of the ways in which more goods and services can be produced in the economy is through the process of specialisation. Specialisation refers to a situation where individuals and firms, regions and entire economies concentrate on producing some goods and services rather than others. For example, at the individual level, within the household there may be some specialisation in the performance of household tasks, with one person doing the ironing and gardening while another does the shopping and cooking. In the workplace, of course, the fact that some people are labourers or lorry drivers while others have office jobs or are economics teachers is a reflection of specialisation. At this level, specialisation allows individuals to concentrate upon what they are best at doing, meaning more goods and services will be produced. However, with specialisation, although more is produced, no one is self- sufficient (able to produce everything they need). It becomes necessary to exchange or trade goods and services. As an individual specialises, they will produce a surplus (more than their needs), which they can exchange for the surpluses of others. ACTIVITY 3.2 Figure 3.3: Sugar cane harvest Cane sugar is a valuable export crop for some of the world’s lower middle-income countries in Africa and in the Caribbean. Sugar, refined from sugar beet, is produced in the UK. 1 Explain why it is possible for producers in lower middle- income countries and in the UK to each specialise in producing sugar. 2 Think about the likely benefits and the risks to sugar producers in lower middle-income countries and in the UK. Where are the benefits likely to be greatest? Where are the risks likely to be greatest? Specialisation has resulted in a major expansion in global living standards, but there are dangers too. The pace of technological change means there is always the possibility that the specialist skills and experience that any individual has acquired may become redundant as the economy develops. Individuals need to be flexible and multi-skilled and to be able to move between occupations. At regional and national levels, changes in consumers’ wants can sometimes mean that the goods and services produced in a region or country are no longer required in the same quantity, so unemployment can result. Policies then have to be adopted to deal with the economic and social problems that arise. ACTIVITY 3.3 The aim of this activity is for you to consider the specialisms in your own economy or an economy that is known to you. When you have completed this, list the factors of production that are responsible for why such specialisation has come about. Try to rank the factors of production in terms of their importance. In a pair, compare your list and your rankings. REFLECTION Activities 3.1 and 3.3 suggest that you compare your answers with those of others in your class. How did your factors of production and specialisms compare? How far were you able to agree any differences? Did you find this a helpful way of learning about factors of production? The division of labour With the technical advances of the last few hundred years, production of goods and services has taken place on a much bigger scale. Large numbers of workers within very large production units has allowed the process of production to be broken down into a series of tasks. This is called the division of labour. For example, the economist Adam Smith, writing at the end of the eighteenth century, showed how the production of pins would benefit from the application of the division of labour in a factory. He suggested that pin making could be divided into 18 distinct operations and that, if each employee carried out only one of the operations, production would rise to 5000 pins per employee per day. He had estimated that each employee would be able to produce only a few dozen (about 50) pins each day if they produced pins individually. Modern manufacturing processes are usually split up into a number of tasks. A typical example is in a garment factory where each worker produces one part of an item of clothing such as a shirt sleeve, the front part or button holes. This division of labour is usually quicker and cheaper than having one person complete each garment on their own. It allows workers to become more specialised and can lead to an increase in output per worker and an improvement in the quality of the finished product. In the United States, the division of labour was taken a stage further in the 1920s when Henry Ford introduced conveyor belt production into the automobile industry. Ford’s method of automobile production provided the model for much of manufacturing production in the twentieth century. Figure 3.4: Conveyor belt production line at Ford’s automobile factory, 1934 Although the division of labour raises output, it often creates dissatisfaction among the workforce as they become de-skilled and bored with the repetitive nature of their work. In high-income countries, the dehumanising impact of production techniques, such as using a conveyor belt and robots, has been acknowledged and procedures introduced to counteract boredom such as moving workers around the production plant. KEY CONCEPT LINKS Scarcity and choice: Through specialisation and the division of labour, resources that are available can be used to increase what is being produced, so meeting more wants. 3.4 The role of the entrepreneur Entrepreneurs are individuals who: organise production by putting together the various factors of production to form a business opportunity are prepared to take risks by using their own money or by borrowing from banks or other people to try to achieve their ambitions. The risks are considerable and if their plans fail, they will lose their own money and that of others. Successful entrepreneurs are creative and innovate to produce something that has recognised value in the market. They require the skills and passion to anticipate current and future needs. Figure 3.5 shows the qualities and skills needed to be a successful entrepreneur. Figure 3.5: Entrepreneurs require a range of qualities and skills. THINK LIKE AN ECONOMIST India’s top ten richest people in 2019 Ranking Name Net worth Source of wealth in $ billion 1 Mukesh 51.4 Petrochemicals, oil, gas Ambani 2 Gautam 15.7 Commodities, Adani infrastructure 3 Hinduja 15.6 Various brothers 4 Pallonji 15.0 Construction Mistry 5 Uday Kotak 14.8 Banking 6 Shiv Nadar 14.4 Software services 7 Radhakishan 14.3 Investments, retail Damani 8 Godrej 12.0 Godrej Group family 9 Lakshmi 10.5 Steel Mittal 10 Kumar Birla 9.6 Commodities Table 3.1: India’s richest people in 2019 Look at Table 3.1. Then discuss the following statement in a group: India has many rich people, yet many people are living in extreme poverty (defined as household income of less than $1.90 per day). In researching this topic, you may find it useful to look at the profiles of a selection of India’s richest people and to see how they match the qualities and skills of entrepreneurs, as shown in Figure 3.3. EXAM-STYLE QUESTIONS: MULTIPLE CHOICE 1 What are the factors of production? A natural resources that are available for production B another term for resources in an economy C what are required in the future to produce goods and services D the human resources used in the production of goods and services 2 The factor of production capital means: A what is combined with land and labour to produce goods and services. B the value of assets owned by a firm. C money needed to set up a firm. D money provided by shareholders to expand production in a firm. 3 Which of these is the best explanation of how an economist describes an entrepreneur? A someone who is lucky and makes a lot of money B someone who succeeds in some but not all business activities C someone who is in charge of a firm D someone who seeks out business opportunities and is willing to take risks 4 Which of these is an example of land as a factor of production? A an airline pilot B an airfield C an aeroplane D aircraft fuel 5 Specialisation can only occur when: A a price has been agreed to buy and sell a product. B a firm has modern methods of production. C a firm is more efficient than all others in making a product. D an entrepreneur sees a business opportunity. 6 Three workers (A, B and C) are employed in a shoe factory. The table below shows the output of each worker if they divide their time equally between the three stages in the production process. Soles Uppers Finishing and polishing Worker A 100 40 40 Worker B 40 100 40 Worker C 40 40 100 Each worker is now asked to work on the part of the production process where they are a specialist. What would be the increase in the total production of shoes? A 140 shoes B 180 shoes C 360 shoes D 540 shoes 7 Which reason is most likely to explain why an entrepreneur is prepared to take risks? A to secure a large bank loan B to realise a business ambition C to justify giving up a safe job D to increase their self-esteem SELF-EVALUATION CHECKLIST After studying this chapter, complete a table like this: You should be able to: Needs Almost Ready more there to move work on Understand the nature of the four factors of production: land, labour, capital, enterprise Describe the rewards for each of the factors of production Explain the difference between human capital and physical capital Explain why more goods and services can be produced in an economy through the process of specialisation Explain that the division of labour enables the more efficient use of factors of production Explain the role of the entrepreneur as an organiser of factors of production and a risk taker Chapter 4 Resource allocation in different economic systems LEARNING INTENTIONS In this chapter you will learn how to: explain decision-making in market, planned and mixed economic systems analyse the advantages and disadvantages of resource allocation in market, planned and mixed economic systems. ECONOMICS IN CONTEXT Vietnam: Asia’s rising star Over the past 30 years, Vietnam has changed from one of the world’s poorest economies to a lower middle-income country. This remarkable achievement originates from the development of its economic system. Since 1986, under the Doi Moi reforms, Vietnam has changed from a centrally planned economy to an economy that has the characteristics of both a state planned and a market economy. Figure 4.1: The business district of Ho Chi Minh City, Vietnam Vietnam’s recent economic growth has been spectacular. In 2019, growth was expected to reach 6.6%, slightly below the 7.1% which it achieved in 2018. This growth is largely attributed to the manufacturing of electronic goods, industrial parts and footwear for export as well as strong domestic demand. Vietnam has embraced the global economy. The country has negotiated free trade deals including the Comprehensive and Progressive Agreement for a Trans-Pacific Partnership. Also, it has benefited, controversially, from the on-going trade dispute between China and the USA. Vietnam’s businesses remain state-owned. Some economists believe state ownership is a weakness. Private ownership and foreign investment are not allowed, in line with the government’s socialist planning objectives. Discuss in a pair or a group: What are the advantages and disadvantages of Vietnam’s economic system? How might Vietnam’s economic growth increase even further? 4.1 What are economic systems? The fundamental problem of scarcity requires choices to be made. The problem is common to all economies: low-income, middle-income and high-income. The choices that are made and how they are made is determined by the economic system of a particular country. A country’s economic system identifies the means by which households, firms and the government make decisions relating to the three resource allocation questions: What goods and services are to be produced? How are the goods and services to be produced? Who should receive the goods and services? TIP Re-read Sections 1.1 and 1.4 to remind yourself of the fundamental economic problem and the three questions related to the allocation of resources. Traditionally, economists have recognised three main types of economic system: the market economy, the planned economy and the mixed economy. In market economies, resource allocation decisions are largely driven by the market mechanism, whereby individuals and firms take these decisions without government intervention. Over the past 30 years or so, the planned economy has been replaced by the mixed economy in many countries in Central and Eastern Europe, the former Soviet Union and southern Asia. The market has an increasing role to play in mixed economies as the countries face a range of problems and prospects. KEY CONCEPT LINK Scarcity and choice: Scarcity and choice apply in all economic systems. How choices are made in an economic system depends on the relative importance of government and the market mechanism. 4.2 The market economy In the market economy, resources are allocated by the forces of demand and supply through the price mechanism (see Figure 4.2 below). Decisions on how resources are to be allocated are regularly taken by millions of individuals and thousands of firms. The government has little or no direct involvement in the process of resource allocation. Households and firms interact as buyers and sellers. Price and the unrestricted operation of the price mechanism are central to the way in which resources are allocated. How the price mechanism works Figure 4.2: The price mechanism at work Figure 4.2 shows how the market may operate with no government interference. The starting point is that there is excess supply in the market – too much is being produced compared to demand. Excess supply results in goods being stockpiled in shops and warehouses. To encourage individuals to buy and so clear the excess stocks, firms reduce the price. This may clear the excess supply, but it is likely to mean that some firms which previously produced the good will now no longer be willing to do so. With less supply in the market, the price rises. In time, assuming no change in demand, firms may choose to re- enter the market. The increase in supply will lead to a fall in price and the whole process will continue. Therefore, prices and the self-interest of individuals and businesses act as a guide to the decisions that have to be made. ACTIVITY 4.1 Using Figure 4.2, draw a similar diagram to show how the market responds to a situation where a firm is faced with a sudden, big increase in demand for one of its products. Role of the government in a market economy In principle, the government should have no direct role in the workings of the market economy and should not interfere in the operation of the price mechanism. As long as the price mechanism is working efficiently, the government’s role is to watch what is happening and only intervene when the price mechanism does not provide the best allocation of resources. Figure 4.3 shows how the market economy works. Figure 4.3: The market economy When the price mechanism does not work efficiently, the market ‘fails’. Examples of market failure are where the government provides goods such as healthcare which would be underprovided, fire services which would not be provided at all, and where it seeks to regulate situations to prevent firms using their power to control the market for excessive gain. The true market economy is in certain respects an ideal. No actual economy operates as a pure market economy. In the US, federal and state governments have important roles to play in providing some limited public services. Hong Kong SAR provides an interesting case of a near-perfect example of a market economy. All businesses are privately owned and Hong Kong’s bus, rapid transit rail service (MTR) and road tunnels are operated by private companies. The economy is dominated by local, US- and European-owned multinational companies. Since 1997, a ‘two systems, one country’ structure has been in place, retaining many of the benefits of a market economy. 4.3 The planned economy Like the market economy, the planned economy in its true form only exists in theory. (The planned economy may be referred to as the command economy or the centrally planned economy.) In a planned economic system, the government has a central role in all decisions that are made. The choices in terms of what to produce, how to produce and for whom to produce are all centralised. Decision- making is taken by planning boards and organisations and, in principle, production is controlled by the state. Unlike the market economy, the preferences of consumers and manufacturing organisations in a planned economy are controlled centrally. The key features of a planned economy are that central government and its organisations are responsible for the allocation of resources. Production targets are set for the main sectors of the economy, such as agriculture and manufacturing. Invariably, these are linked to planning for long-term growth through an increase in productive potential. Price control of most essential items and the determination of wages are also controlled. Finally, the ownership of most of the productive resources and property is in the hands of the state. In short, the market does not have a real role in the allocation of resources. In a planned economy, government organisations find it necessary, for political as well as economic reasons, to control the workings of the market mechanism. A typical example is where basic foods such as bread and meat are hugely subsidised by the government to keep prices at a low, fixed level. The rise and fall of prices, so important in the market economy, does not take place. A consequence of artificially low prices is often excess demand relative to supply. There are not enough basic foods for everyone, and queuing becomes a way of life. Private ownership of productive resources is restricted to small shops, restaurants and personal services, such as hairdressing. Figure 4.4: Empty supermarket shelves in Poland in the early 1980s Governments of planned economies tend to set goals which are different from those of governments in market economies. The objective is to achieve a high rate of growth in order to catch up on the progress made by the advanced market economies. Nowadays, there are very few planned economies; examples include Cuba and North Korea. TIP When writing an answer about a planned economy, try to include a present-day example. Cuba and North Korea are as close to planned economies as the theory suggests. Albania and Vietnam could be mentioned as socialist economies rather than full planned economies. 4.4 The mixed economy The mixed economy is the typical economic system. In a mixed economy, both the private sector and public sector have a part to play in the allocation of resources. Decisions involve an interaction between firms, labour and the government mainly through the market mechanism. There is private ownership of most productive resources although there is some public ownership. Over the past 30 years or so, privatisation has been the trend. Privatisation involves the transfer of resources from public ownership to the private sector. This has been the case in many economies including the emerging economies of Central and Eastern Europe and Pakistan. The previously planned economies in Europe have had to move along this path towards a mixed economic system prior to becoming full members of the European Union (EU). The increased emphasis on market forces has resulted in some problems. The UK, for example, has lost many jobs in manufacturing as factories have closed and production has moved to lower-cost locations mainly in China, the rest of Southeast Asia and in Central and Eastern Europe. Elsewhere, there have been similar trends. One of the most dramatic has been in the former Soviet Union where the economy has been restructured (perestroika). This has been the case in its former satellites such as Poland, the Czech Republic, Slovakia, Hungary, Lithuania and Estonia. Opening up the economy in this way has resulted in huge inward flows of foreign investment, particularly in the manufacturing and retail sectors. There have been opportunities for private sector businesses to be developed – cafés, small shops and garages as well as the local ownership of productive resources are now the norm. In some cases, such as where former state-owned companies have been sold to the private sector, the new owners have made vast sums of money in a very short period of time through adapting the businesses to make the most of the opportunities of the market mechanism. Even in Albania, once seen as one of the few remaining planned economies, the government has recently decided to allow limited privatisation and a greater emphasis on the market mechanism. The experience of the Asian Tiger economies varies. Singapore and Hong Kong, for example, have always focused strongly on the market to allocate resources. Their governments have created an economic situation where free enterprise is encouraged. The rewards can be high. Other economies have placed more emphasis on central planning, such as Malaysia, the Philippines and Indonesia. The extraordinary continual growth of China over the past 15 years or so is linked to the controlled management of the economy but with very clear opportunities for foreign investors as well as domestic companies to influence the allocation of resources. Figure 4.5 provides a broad explanation of where selected economies fall in terms of the relative strengths of the market and planned systems of resource allocation. To clearly varying degrees, all countries would seem to fit within the definition of a mixed economy. Figure 4.5: Mixed economic systems ACTIVITY 4.2 In a pair or a group, select one of the former planned economies that joined the European Union (EU) in 2004: Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia. Each pair or group should focus on a different country so that you cover as many countries as possible between you. For each country: 1 Try to find out what percentage of the economy is in the control of the government and what percentage of resource allocation is by the private sector. 2 Obtain information on the importance of the country’s manufacturing sector such as types of good, firms and what is exported to the rest of the EU. 3 Obtain data on the country’s annual economic growth rate since 2004. Display your findings on a poster for the classroom wall. If there is time, each pair or group could present its findings to the class. TIP A common misconception is that the classification of economies is exact. Most economies are some form of mixed system which depends on the relative importance of the roles of the market mechanism and government. KEY CONCEPT LINK Scarcity and choice: The fundamental economic problem exists in all three types of economy. REFLECTION Activity 4.2 required you to collect some data on a former planned economy that is now a member of the EU. How did you decide on which country to select? How did you set about collecting the data? What were some of the data interpretation problems you experienced? THINK LIKE AN ECONOMIST New Zealand’s near market economy Figure 4.6: New Zealand is a leading exporter of kiwifruit New Zealand is one of the top-ranked market economies in the world. In 2019, it was placed third in the Heritage Foundation’s Index of Economic Freedom. Only Hong Kong and Singapore have a higher score. New Zealand has followed a market-orientated economy for many years. It has fully accepted the principle that prices must be determined by supply and demand and that economic activity, including trade, should be as free from regulation as possible. Since 1980, New Zealand’s governments have pursued policies of deregulation and privatisation to liberalise the economy. The country has a range of free trade agreements, particularly with Australia and other Southeast Asian countries. It is a member of the Comprehensive and Progressive Agreement for a Trans-Pacific Partnership. New Zealand is the sixth richest country in the world in terms of gross domestic product (GDP) per head (a measure of national income) and has experienced steady economic growth since 2000, except for 2010–2012 when its economy was slightly affected by the global downturn. 1 Explore the Index of Economic Freedom to see how New Zealand compares with your country or one that you are familiar with. 2 How relevant are the comparisons you might make? EXAM-STYLE QUESTIONS: MULTIPLE CHOICE 1 Which of these terms describes a country where government planning, regulations and directives are responsible for the allocation of resources? A capitalist economy B mixed economy C market economy D planned economy 2 A criticism of a planned economy is that it puts more emphasis on producing capital goods than producing consumer goods. This is because: A the system of decision-making is too centralised. B there are shortages of many consumer goods. C the government’s focus is on growth and not current consumption. D consumers cannot afford to buy any more consumer goods. 3 A planned economy has recently become a mixed economy. This process has involved a change in the composition of what it produces. What is the most likely consequence of this change? A an increase in food prices B an increase in imports C an increase in structural unemployment D an increase in the growth rate of the economy 4 A mixed economy can best be described as one in which: A production is determined by the central government and the market mechanism. B agricultural and manufactured goods are produced. C production is determined by entrepreneurs. D consumer goods and capital goods are produced. 5 Which of these is the most likely outcome when a mixed economy privatises its rail services? A Peak train fares will increase. B Off-peak train fares will decrease. C Fewer rail services will be provided. D Train fares will now be determined by supply and demand. 6 After a planned economy changed to a more market economy, there was a reduction in the proportion of household income that was being saved. How might this be explained? A Households were more concerned about the economy’s future economic prospects. B More ‘big ticket’ goods had become available. C New charges were introduced for secondary education. D Household incomes fell. SELF-EVALUATION CHECKLIST After studying this chapter, complete a table like this: You should be able to: Needs Almost Ready more there to move work on Understand the roles of government and the market in the three types of economic system: market, planned, mixed Analyse the advantages and disadvantages of resource allocation in each of the economic systems Chapter 5 Production possibility curves LEARNING INTENTIONS In this chapter you will learn how to: explain the meaning and purpose of a production possibility curve explain the shape of the production possibility curve, including the difference between constant opportunity costs and increasing opportunity costs analyse the causes and consequences of shifts in a production possibility curve discuss the significance of a position within a production possibility curve. ECONOMICS IN CONTEXT Restructuring the Nigerian economy Figure 5.1: Nigeria started manufacturing smartphones in 2017 Nigeria is the largest country in Africa, with a population of around 160 million in 2018. The financial crisis of 2012 showed how vulnerable Nigeria’s oil industry was to external shocks in the global economy. Since then, government policy has been to restructure the economy to reduce its dependence on the oil industry. In particular, Nigeria’s service industries have grown while its oil industry, once the mainstay of the economy, has declined. Even so, oil still contributes two-thirds of government revenue. Manufacturing continues to grow and is the largest of any in Africa. Agriculture remains an important sector but has seen rapid decline since 2012. The changing structure of Nigeria’s economy is shown in Table 5.1. Estimated percentage contribution to GDP Economic sector 2012 2018 Agriculture 40 21 Manufacturing 15 19 Services 30 52 Oil 14 8 Table 5.1: The changing structure of Nigeria’s economy, 2012 and 2018 Discuss in a pair or a group: The data in Table 5.1 shows a major restructuring of the Nigerian economy over a short period of time. How might this restructuring have come about? Is there any cause to doubt the accuracy of the data? 5.1 The production possibility curve In any economy, what is produced is determined by the quantity and quality of resources that are available. In high-income economies, for example, many thousands of goods and services are produced as a result of the wide availability of factors of production. Low-income economies have fewer resources and the quality of resources is poorer. As a result, in low-income economies fewer goods and services are produced and there is less variety of production. Therefore, the quality and quantity of factors of production determines an economy’s production possibilities – the goods and services it can produce with the resources it has available. A simple economic model, known as a production possibility curve (PPC), can be used to show the choices available and how resources are allocated. How the production possibility curve works To understand how the production possibility curve works, imagine that the economy produces just two goods, say cars and televisions. These two industries use all of the economy’s current resources between them in their production of cars and televisions. The production technology available is being fully utilised. The PPC shows the maximum level of output of each of the two goods that can be produced. The PPC is sometimes called the production possibility frontier since it draws a type of boundary between what can be produced and what cannot be produced. Figures 5.2 and Figure 5.3 show two production possibility curves. Any point exactly on the line or curve represents a production situation where output is maximised. Figure 5.2: A straight line production possibility curve showing constant opportunity cost Figure 5.3: A curved production possibility curve showing increasing opportunity cost TIP Production possibility curves can be represented by a straight line as well as by a curve that is convex to the origin. When drawing a production possibility curve, remember to label both axes correctly. The axes are always labelled in terms of two goods. Table 5.2 shows the v

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