Econ Summary Book PDF

Contents Unit/Heading Page Number UNIT 1 4 - 29 UNIT 2 29 - 54 UNIT 3 54 – 70 UNIT 4 70 - 84 3 UNIT 1: Market System Chapter 1: Economic problems Basic Definitions 1) Needs: the basic n...

Contents Unit/Heading Page Number UNIT 1 4 - 29 UNIT 2 29 - 54 UNIT 3 54 – 70 UNIT 4 70 - 84 3 UNIT 1: Market System Chapter 1: Economic problems Basic Definitions 1) Needs: the basic necessities to live a life. Eg: Food and shelter 2) Wants: the desires of people. Eg: Luxurious vehicles 3) Scarce resources: insufficient resources 4) Capital intensive production: use of machineries to produce goods and services 5) Labor intensive production: use of labors to produce goods and services 6) Opportunity costs: the value of the next best alternative foregone 7) Capital goods: goods consumed by firms to produce other products Eg: machineries or raw materials 8) Consumer goods: goods consumed by consumers 9) Production Possibility curve: it’s a diagram that illustrates the combination of 2 products an economy can produce over a period of time by using its resources effectively and efficiently 10) Economic growth: an increase in the productive potential of a country over a period of time 11) Recession/negative economic growth: Fall in the productive potential of a country over a period of time The economic Problem The basic economic problem is the difficult in meeting the unlimited needs and wants of people around the globe with insufficient (scarce) resources. This problem arises 3 main question for all countries: What to produce? : Countries may have to pick up some of the most important products that are needed by the people to satisfy their basic necessities. This is because all products cannot be made due to the lack of resources. How to produce? : Governments should decide on how to produce the goods and services either by capital or labor intensive production techniques. 4 Opportunity costs This is the value of the next best alternative foregone. In simple words, when you have 2 choices with similar benefits and then you chose one of them, the benefit that may be gained by the unselected (or left out) option becomes the opportunity cost. Example: Adam has 3 choices to spend his money on. He has ranked them in an order depending on its benefits: 1) Spending on going to a club 2) Spending on travelling the world 3) Spending on purchasing a ball He chooses the first option. And the opportunity cost would be the benefit that he would have enjoyed by travelling the world as that option is the next best option Adam would have chosen in case the option 1 wasn’t there.  Governments may experience opportunity costs when spending. For instance, should they spend on infrastructure or education?  Consumers. (As given above)  Firms may have decide between spending on promotion or increasing pay for staff? Production possibility curve (PPC) Production possibility curve (definition in the basic definitions) has 3 main points. The concept of opportunity costs can be experienced in this diagram as well. P.T.O FOR GRAPH 5 A = Maximum productive potential of an economy/Fully employed resources X = Unemployed resources (resources are not utilized effectively) Y = Unobtainable. (Economy doesn’t have enough resources to reach that point Economic growth and decline using a PPC ECONOMIC GROWTH DECLINE/RECESSION Causes of Economic Growth  Introduction of new technology which helps to increase the production of goods and services  More efficient methods of producing products 6   Increase in spending on education and training helping to increase the knowledge and productivity of workers  Introduction of new resources helping to improve the competitiveness of a country Causes of Decline/Recession will be the exact opposite of the causes of economic growth PPC and the Opportunity cost For instance, an economy is currently producing 160 Kg of wheat and 400 Kg of cotton. But if it wants to increase its production of cotton to 480 Kg it may have to forego 80 Kg of wheat. (This is the opportunity cost) Chapter 2: Economics assumption Basic Definitions 1) Costs/Benefit analysis: Finding out the benefits and costs of each choice given and then selecting the choice with the highest benefit and lowest costs. 2) Rational decision: This is a decisions that is taken by consumers or firms after doing a proper cost/benefit analysis. Consumers and firms make decisions that maximizes their utility. 3) Irrational decision: is when consumers or firms make decisions that doesn’t maximize their welfare or utility. 4) Utility: Satisfaction. 7 Consumers and firms always try to maximize their utility. Consumers may want products that are of better quality and for reasonable prices. Whereas, producers may want to produce the products at lowest possible cost and charge higher price to maximize their profits. However, consumers and firms may not maximize their utility at all times. Below are some reasons for this strange behavior: Why do consumers not maximize their utility? There are 5 main reasons for this:  Poor at computation: Consumers may find it difficult to calculate the cost/benefit analysis. Therefore, they are unable to make proper judgments on which products would bring them the greatest satisfaction.  Consumer inertia: This is when consumers are reluctant to shift from one producer to another although the other producer offers cheaper products due to the fear of risks that may be associated. (Eg; lower quality products)  Habitual behavior: This is when consumers are addicted to a certain product that they could not stop consuming them regardless of the negative consequences it possesses. (Eg: Cigarettes)  Herding: this is when consumers are influenced by their friends and family and so do not want shift producers although, costs may be lower.  Feeling valued: consumers do not want to shift producers as they are emotionally attached to a particular brand. (Eg: Nike) Why do firms not maximize their profits?  As firms are run by managers and directors rather than owners, they may have different objectives in comparison to the owners and therefore, make decisions to achieve their objectives instead of profit which is the main objective of an owner.  Some businesses operate as Charity organization where there main objective is not profit  Some businesses operate as social businesses where there objectives is to maximize the welfare of the people rather than earning a higher profit.  Businesses may have to sacrifice profits to achieve other objectives such as being ethical. Chapter 3 and 4: Demand curve and Factors affecting the demand curve Basic Definitions 1. Consumer trends: These are the consumer behaviors or demand patterns. 2. Substitutes: They are products that could replace one another. They are alternatives to each product. (For example, Tea and Coffee) 3. Complements: These are products that are consumed together. (For instance, Tea and sugar) 8 Demand is the amount of goods consumers are willing to purchase at a given price over a period of time. It changes as the price increases or falls and also depends on certain conditions which would increase or reduce the demand for a particular product.  As the price for a product increases, the demand for the product reduces.  As the price for a product reduces, the demand for the product increases.  This is called an inverse relationship. Movement and shift along a demand curve Movements along the demand curve Shift in the demand curve When the price of the product falls from $499 to $449, the quantity demanded increases from 320 units to 460 units. This increase in quantity due to the fall in price is called a movement along the demand curve. 9 The demand curve shifts to the right when there is an increase in the quantity demanded due to changes in various factors (as discussed below) OR the demand curve would shift to the left if the quantity demanded falls due to changes in various factors. This is called the shift in the demand curve. The Factors affecting the demand curve  There are various factors that may increase or decrease the demand for a product:  Advertising: When business spend more on advertising their products, this will help them to increase the awareness of the products. As a result, demand for the product would rise significantly.  Income: When the income level of people increase due to better economic climate, this may increase the demand for products.  Changes in fashions, tastes or preferences: Consumer tastes, fashions or preferences may change from time to time due to changes in consumer trends. This can be from cultural or traditional or modern changes. For instance, a modern change to use social media has increased the demand for electronic devices.  Prices of substitutes: When the prices of substitute decreases, then the demand for products produced may fall. This is because consumers may shift to the consumption of substitutes.  Prices of complementary products: When prices of complements are higher then the demand for the product may fall.  Demographic changes: these are the changes that occur in the population of the country. For instance:  Changes in Age distribution (There may be old aged people living in a country)  Changes in ethnicity (More Muslims living in a country)  Changes in gender distribution (more female in a particular region)  Changes in geographical distribution (more people living in urban areas) Due to these changes consumer demand may increase for various products, especially products that meet this group’s needs. Chapter 5 and 6: Supply and the Factors affecting the supply Basic Definitions 1. Costs of production: This is the total costs incurred by a business to manufacture a product by using resources and put them into the market for sale 2. Indirect taxes: This is the tax that is imposed on production of goods and services and the consumption expenditures 3. Subsidies: They are the grants given by the government to business to lower their costs and increase their production 4. Economies of Scale: the average costs of producing a single unit falls as the production of goods increases Supply is the amount of goods or services that suppliers are willing to supply at a given price over a period of time. 10  P.T.O FOR GRAPH  When the prices for the products are high then the suppliers are often willing to increase their production as they may earn higher profits by selling more at higher prices.  When the prices are lower suppliers may restrict their production as they may earn lower profits by selling their products at lower prices. Movements and Shifts along the supply curve Shift in Supply curve Movement along the Supply curve When the price of the product increases from $6 to $12, the quantity supplied increases from 6 to 12 units. The increase quantity supplied is called the movement along the supply curve. The supply curve shifts to the right when there is an increase in the quantity supply due to changes in various factors (as discussed below) OR the supply curve would shift to the left if the quantity supplied falls due to changes in various factors. This is called the shift in the supply curve. 11 Factors affecting the Supply curve  Costs of production: When the costs of production for a firm is high, this can reduce the supply as the firm will not have enough money to fund the day to day operations of the business.  Indirect taxes: These taxes may discourage the firms from producing goods and services due to an increase in the costs. As a result, supply may fall. These taxes are used by the government to raise tax revenues and to discourage the production or consumption of harmful products. Eg: tobacco  Subsidies: When there is an increase in the subsidies provided by the government, this may increase the supply of goods. This is because as the costs to the firms will lower. Subsidies can be given in different forms such as cash, subsidized premise (no rent) or tax incentives (Less or no taxes) etc.  Natural Factors: Some products demand are influenced by natural factors such as season. For example, a Farmer may have a high yield in the crops at the rainy season and lower yield in a summer season.  Changes in technology: When better technology is used, the productivity of the firm would rise helping them to produce more goods and exploit the economies of scale. As a result, supply would rise. Chapter 7: Market Equilibrium Basic Definitions 1. Equilibrium Price: This is the price where both, supply and demand of the product is same 2. Total revenues: This is the amount of money generated by the sales of goods and services The equilibrium price is determined by the market forces. (The supply and demand) When the amount of goods supplied in the market by the producers is exactly equal to the amount of goods purchased by the customers at given price, this is known as the equilibrium or market clearing price. Supply Demand Price 100 200 Caps $20 150 150 Caps $30 200 100 Caps $45 250 50 Caps $50 Example: As per the table above the equilibrium price for the Cap is $30. This is because the quantity demanded is equal to the quantity supplied. At an equilibrium price there is no buyers left without products or there are no sellers left with unsold stocks. 12 In a graph, the equilibrium price can be presented in this way, Equilibrium price and the shift in demand and supply curves As the demand curve shifts to the right and the supply curve shifts to the right, the equilibrium point moves from the red point to the yellow point. Therefore, the equilibrium price falls from P1 to P2. Excess Demand and Supply Excess demand is when the demand is greater than the supply of a product. Therefore, consumers are left without goods. Whereas, Excess supply is when the supply of a product is greater than the demand and therefore, the suppliers are left with a lot of unsold stocks. The graph below shows this: 13 Let us take the same example of Caps to calculate the excess demand or supply for a product: Supply Demand Price 100 200 Caps $20 150 150 Caps $30 200 100 Caps $45 250 50 Caps $50  At the price of $20, the supply was 100 caps and the demand was 200 caps. Therefore, there was an excess demand of 100 caps (Shortage in supply).  At the price of $45, the supply was 200 caps and the demand was only 100 caps. Hence, there was an excess supply of 100 caps. (Shortage in demand) How to remove the excess demand and supply? To remove excess demand;  Increase the prices  Increase the production capacity to produce more goods To remove excess supply;  Reduce the prices  Increase spending on Advertising which will help to increase demand Chapter 8: Price elasticity of Demand Basic definitions 1. Perfectly elastic demand: Increase in prices will result in 0 demand 14  2. Perfectly inelastic demand: Change in price will result in no change in demand 3. Unitary elastic demand: The responsiveness of demand is proportionately equal to the change in prices Price elasticity of demand (PED) in the responsiveness of demand to a change in price of a product. They are of 2 types:  Inelastic demand: This is when the change in price results in smaller change in quantity demanded. The value of PED would be less than 1 for inelastic products.  Elastic demand: This is when the change in price results in a greater change in quantity demanded. The value of PED would be more than 1 for inelastic products. Note: PED value is always negative. But the negative sign should not be taken into account while deciding on whether the product inelastic or elastic. Formula of PED PED = Percentage (%) Change in quantity demanded / Percentage (%) Change in price Example: The price of a ball increased from $400 to $450. However, the demand for the ball dropped from 20 balls to 15 balls. Find out the PED for the ball. Answer: Step 1 = Percentage change in Price = ((450 – 400) / 400) x 100 = (+) 12.5% Step 2 = Percentage change in Demand = ((20 – 15) / 20) x 100 = (-) 25% Step 3 – PED = (+) 12.5 / (-) 25 (No need to write the percentage sign while calculating PED) = (-) 0.5 (PED do not have any units) Diagrams to show the Price elastic and Price inelastic demand Each value in the PED will have a certain term  Inelastic demand: Less than 1  Elastic demand: More than 1  Unitary elasticity: Equal to 1  Perfectly price inelastic: 0 15   Perfectly price elastic: Infinity Perfectly inelastic demand Perfectly elastic demand All numerical values can be presented in one graph RED = Infinity BLUE = More than 1 YELLOW = (-) 1 PURPLE = Less than 1 BLACK = Zero (0) Factors influencing the PED for a Product  Substitutes: When a product has lot of substitutes then the PED is elastic. This is because consumers can easily shift from one to another product. Therefore, an increase in price can lead to lower demand.  Degree of Necessity: As the necessity of the product is high, the PED value tends to be inelastic. This is because an increase in price will result in smaller changes in quantity demanded as consumers may have to purchase the product regardless of the higher prices.  Percentage of income spend on goods or services: When people spend high amount of money on products, the PED would be elastic. This means an increase in price of the product will have a greater reduction in the quantity demanded. This is because consumers are already spending a huge amount on the product so they are reluctant to spend more. This is mostly the case for luxurious products. 16   Time: In the short –run the demand for a product is inelastic. This is because in the short-run consumers have no choice but to purchase the product regardless of the price. However, in the long-run they can find alternatives and also and easily switch. Total revenues and PED Calculations Example 1: A ball has a decrease in the price from $8 to $5. The quantity demanded has increased from 100 balls to 200 balls. (This is an elastic product) Answer: When Price was $8 = 8 x 100 = $800 Therefore, a fall in price for an elastic product will increase the total revenues generated (VICE VERSA FOR INCREASE IN PRICE) Example 2: A water bottle has a decrease in the price from $7 to $5. The quantity demanded has increased from 200 bottles to 210 bottles. (This is a inelastic product) Answer: When price was $7 = 7 x 200 = $1400 When price was $5 = 5 x 200 = $ 1000 Therefore, fall in price for elastic products would reduce the total revenues generated (VICE VERSA FOR INCREASE IN PRICE) Price elasticity Value Price change Effect of TR Inelastic Less than 1 Price increase Increase Inelastic Less than 1 Price decrease Decrease Elastic More than 1 Price increase Decrease Elastic More than 1 Price decrease Increase Chapter 9: Price elasticity of Supply Basic definition 1. Perfectly elastic supply: This is where Producers will supply an infinite amount of products at a given price. PES = infinity 2. Perfectly inelastic supply: This is where the Supply is fixed at cannot be adjusted whatever the price is. PES = 0 3. Unitary elastic supply: This is when the quantity supplied and the price change will be equal. 17  PES = 1 Price elasticity of supply (PES) is the responsiveness of supply to a change in the price. They are of 2 main types:  Inelastic supply: This is when the responsiveness of supply to a change in price is smaller.  Elastic supply: This is when the responsiveness of supply to a change in price is greater. Formula of PES PES = Percentage (%) change in the quantity supplied / Percentage (%) change in the price Example: The price of a Vanilla pods (Agricultural product) increased from $2 to $3. In the meantime, the supply of Vanilla pods increased from 250 pods to 275 pods. Calculate the PES for the Vanilla pods. Answer: Step 1: Percentage change in quantity supplied = ((275 – 250) / 250) x 100 = 10% Step 2: Percentage change in Price = ((3 – 2) / 2) x 100 = 50% Step 3: PES = 10 / 50 (No need to write the percentage sign while calculating PES) = 0.2 (PES do not have any units) Price elastic and Price inelastic supply Graphical representation Interpretation of the numerical values of PES  Perfectly inelastic supply: Exactly 0  Perfectly elastic supply: Infinity 18   Unitary elastic supply: Equal to 1  Inelastic supply: Less than 1  Elastic supply: More than 1 P.T.O FOR GRAPH Diagram to show perfectly inelastic, elastic and unitary elastic curves Factors influencing the PES  Factors of production: If the factors of production such as raw materials and other materials are easily available for lower costs, this will make it easier for the producers to easily increase or decrease their production depending on the price. Therefore, PES is elastic  Availability of stocks: If the producers are supplying perishable products then stock holding for a long period would be impossible as the products may perish and if not the costs of maintaining the quality will be extremely high. Therefore, in this case PES is inelastic.  Spare capacity: when producers have enough of capacity to produce extra output then supply tends to be elastic. This is because in case there is a surge in the price due to various factors, this would help producers to increase their production. As a result, profits can be maximized at this period.  Time: the longer to produce gods, the lower the PES. (Inelastic) for instance, Agricultural products can only be harvested on a particular season of the year. Although, there is a price increase in other seasons, farmers are unable to increase the production of their goods. So, agricultural products are price inelastic. PES for manufactured and primary products As stated above, producers of agricultural products are unable to increase the production of their products whatsoever the price increase is.(Inelastic) Whereas, producers of FMCG (fast moving consumer goods) can easily increase their production, perhaps by asking workers to work overtime and increasing the output in the factory. (Elastic) 19 Chapter 10: Income elasticity of Demand (YED) Basic definitions 1. Indirect taxes: This is tax that is levied on the production of goods and service and consumption expenditures. 2. Inferior products: these are products for which demand increases when income falls 3. Normal goods: : these are products for which demand increases when income increases 4. Luxurious products: these are products for which demand is optional. High income earners may purchase these products. Example: Cars, gold etc. 5. Subsides: they are the grants provided by the government to businesses to encourage consumption and production of beneficial products. (Example: Food) Income elasticity of demand (YED) is the responsiveness of demand to a change in the income level. They are of 2 types:  Inelastic: When the responsiveness of demand to a change in income is less.  Elastic: When the responsiveness of demand to a change in income is high. Formula of YED YED = Percentage (%) change in quantity demanded / Percentage (%) change in the income Example: The average income per person in USA increased from $5000 to $7500. The quantity of milk demanded has increased from 4 bottles to 5 bottles. Find out the YED. Answers: Step 1: Percentage change in Quantity demanded = (5 - 4/4) x 100 = 25% Step 2: Percentage change in Income = (7500 – 5000 / 5000) x 100 = 50% Step 3: YED = 25/50 (No need to write the percentage sign while calculating YED) = 0.5 (YED has no any units) Interpretation of the YED numerical values  Luxurious goods: All positive values above 1 (Example: Travel tickets)  Normal goods: Positive value up to 1 (Example: Balls) 20   Inferior goods: below zero (All values with (-) Negative sign) (Example: Supermarket labelled products) Significance of PED and YED For Businesses PED could be used by businesses to predict changes in Total revenues in case the prices are to be changed. This will help businesses be well-prepared for the future events and effective forecasts can be prepared. Furthermore, YED could be a useful tool for businesses to predict the changes in demand for their products as income influences the consumption habits. So, manufacturers may be able to switch production from one product to another which may be profitable in the future due to changes in income. As a result, products can be maximized. For government Government may use the PED for a product when charging taxes because inelastic products may be consumed regardless of the price increase. So, by charging more tax on inelastic products they are able to main creases tax revenues generated. On the other hand, government may grant subsides to inelastic product manufacturers as if their costs are lower they may charge lower prices. As a result, poor people can also afford the inelastic products such as the basic necessities. Hence, social welfare is improved. Chapter 11: The Mixed Economy Basic definitions 1. Economy: a system that attempts to solve all the economic problems 2. Dividends: Payments in return to the shareholders for their investments in the business. (they are not a must but if the business makes higher profits they should be paid) 3. Nationalize: Process of converting private firms to government owned firms 4. Market failure: this is when private sector firms fails to achieve the objectives of the society 5. External costs: negative consequences caused by production or consumption of a product which may affect the third party 6. Monopolies: A single firm that produce goods and dominates the entire market and restricts all sort s of competition Private and Public sector businesses Private sector businesses are owned and run by individuals or group of individuals. Whereas, public sector businesses are owned and funded by the Central or state government. 21 Private sector Businesses (Ownership, Control and Aims) Ownership and Control  Sole traders: Owned and run by one person  Partnerships: Owned and run by 2 to 20 members  Companies: Owned by shareholders who have a share in the business due to the contribution that they made. They are run by directors appointed by shareholders in Annual General Meeting. Aims of Private sector businesses Private sector firms are generally set-up to earn profits. Some of the main aims of a Private sector firm would be: Survival: One of the main objective of many small businesses is survival in the first few years of their trading. This is because they may be operating in a competitive environment in which they may threatened by trading conditions such as, competition. Profit Maximization and Satisficing: Profit maximization is where firms try to get as much as profit that they possible could to pay their shareholder higher dividends so that they continue to inject capital. While, Profit satisficing is when the business makes just enough profit to satisfy the owners and meet their daily needs. Growth: Most business aim to grow. They may do this by expanding their operations and increasing their revenues further by spending more on advertising. Costs may be lowered to increase the profits and fund growth. Social responsibility: Social objectives are designed to improve the well-being of humans. Most public service business such as government owned businesses aim to provide public services. However, these services may not be of high quality as they may be produced at lower costs. This is because the products are not charged for or may be charged a very low price. Examples: Government schools. Some businesses operate as charity organizations and other non-profit making organization as they may aim to bring positive impacts to the society such as to eradicate poverty. Public sector businesses (Ownership, Control and Aims) Ownership and Control  Central government: Departments such as Health and transport are managed and controlled usually by teams and boards led by a minister.  Public corporations: These are public sector organization which are usually funded by the tax revenues. Government appoints a team of Board of directors to run the organization.  Local authority services: Services such as fire and police services are usually run by councilors who are elected by the residents living in a city. (Local community)  Other public sector organizations: Central banks and other government bodies are usually run by a board that is selected by the government of the country. 22 Aims Public sector organizations are generally set-up to maximize the social welfare and well-being. Some of the main aims of a Public sector organization would be:  Improving the quality of services: Governments may want to improve the quality, quantity and professionalism of the service that they provide in order to maximize the welfare for the citizens.  Minimize costs: This is when public sector businesses wish to become cost-efficient and reduce wastages.  Allow for social costs and benefits: Public sector businesses can take into account the pollution caused by their production and other negative effects on the environment. This can be one of the important aim as they don’t aim to increase their profits.  Sometimes the government nationalize some large businesses that make huge profits. Therefore, in this case they may aim to make higher profits. Types of Economy There are 3 main types of economy. An economy will have to carry out functions such as deciding what to produce, for whom to produce and how to produce. These questions will be addressed by the public or the private sector depending on the economy. They are:  Market/Free enterprise economy: This economy depends almost completely on the private sector businesses. Allocation of resources are dependent on the supply and demand. Government may play a role in provide some public services such as Fire services.  Command economy: This economy is completely relies on the public sector. Everything is state-owned from the shops to the products sold. Therefore, taxes may be high as revenues have to be generated to fund all these operations.  Mixed economy: this economy relies on both, the private and the public sector. Examples: Saudi Arabia Mixed Economy In this economy the question of what to produce? Will be determined by both the sectors, private and public. For instance, goods and services such as travel and Fast moving consumer goods are provided by the public sector. However, services such education and police services are provided by the public. This ensures that a market failure is avoided. This is because all goods are provided in the economy, as the services that private sector firms fails to provide are provided by the public sector firms. The question of How to produce? May be addressed by the private sector firms. This is because they will be keen in maintaining the quality and maximizing the profits. While, Public sector will be in charge of making decisions related to the services such as education, police and fire services. For whom to produce? Will be addressed by both the sectors. People who have money can afford private services and who don’t have money can use the public services as they are usually free. However, taxation may be high as the main source of income to provide these service would the tax receipts. Different countries may decide on the proportion of mixing the both sectors depending on their requirements. 23 Market failure This is when the private sector firms fails to achieve the objectives of the society. There are various forms in which this can take place: External costs: This is where production of goods and services may bring negative consequences to the environment and the people around. Example: All kinds of pollution, soil erosion, unemployment etc. Lack of competition: when there is no or less competition consumers may be at a disadvantage due to high prices, less choices and sometimes lower quality products. Missing market: this is when some important goods such as education, fire and police services (which are known as public goods) are not provided by the private sector firms as they are unable to charge a proper price for their services or they may be expensive to provide. Information Failure/ Asymmetric information: this is when there is an imbalance of information between the consumers and the businesses. A lack of information about the quality of the goods and the pricing strategies may cause wrong goods being bought and higher prices being charged. Factor immobility: in order to be successful, the mobility of factors of production (land, labor, capital and enterprise) is important. However, some machineries or other factors cannot be used for more than one purpose. As a result, there is a lot of wastage. All the causes that are mentioned above may eventually lead to market failure. How can the government intervene to reduce or stop the market failure?  Charge taxes to on business to lower the external costs created.  Introduce competition regulations such as the (regulating the formation of monopolies) to stimulate competition in the market  Government can directly intervene and provide these goods and services that private sector firms fail to provide 24   Government can produce campaigns to inform and educate the customers and business about all related information such as prices, quality etc.  Government invest on training to help employees become more flexible Provision of goods and services by the Private and public sector Private sector is responsible for producing goods such as clothes, food materials and toys. On the other hand, the public sector may have to provide the public goods which are known as the merit goods as they do bring benefits to the economy. Example: education and health care. Public goods are not provided y the private sector due to some reasons (mentioned below) Public goods have 2 main characteristics:  Non – excludability: No one can be excluded from its consumption. This is because they are usually free of charge.  Non – rivalry: this means the consumption for the product by one person may not reduce the availability of products for others. From instance, when one person consumes education, this will not reduce the availability of education for the consumption of the other citizens. Why are private sector firms reluctant to supply public goods?  Free rider problem: everyone can access it and by the consumption of one. So, this may lower their profits.  Expensive: these goods and service as are very expensive to produce  Proper pricing strategies cannot be used as the consumption cannot be measured Conclusively, it depends on the countries about the role the public sector r has to play. For example, in countries such as the UAE the public sector play a major role? In contrast, in countries such as USA private sector play the dominant role? As a result, we cannot accurately say the importance of each sector as they may vary. Chapter 12: Privatization Basic definitions 1. Monopolies: It’s a situation where the business activity is controlled by one company or the government by not allowing other firms to compete. 2. Nationalize: Process of converting private firms to government owned firms 3. Redundant: laying off workers due to lack of work or finance and it’s not same as dismissal 4. Takeovers: it is an act of taking control of a company by purchasing 50% of its shares 5. Mergers: this is when 2 companies join together and share all the responsibilities and profits/losses Privatization is an act of selling a state-owned business to the private sector. This can take place in 3 forms: 25   Sale of Nationalized industries: This is where businesses that nationalized previously due to various reasons such as inefficient supply of services is now being sold back to the private sector.  Contracting out: services that were previously supplied by the public sector such as health and education are now sold to the private sector. Here, businesses or individuals are allowed to bid for the services and thereby, the highest bidder will be given the opportunity to provide the service to the citizens.  Sale of land and property: this s where government sells some of the state-owned properties to the general public. (Citizens) Reasons for Privatization  To generate income: government may need income to fund other public services that they provide. So, to raise finance they may privatize these industries.  To make services more efficient: when the public services are privatized, this will make private sector firms be more efficient due to the competition that they may face. However, when these services were provided by the government, the quality of the services were low and they had made huge losses.  To reduce the political interference: the services provided by the government may be subjected to political interference. Therefore, if these services are privatized, all decisions will be free to be made by the private sector. As a result, time lags would be prevented and the quality of the services may also improve. Effects of Privatization on various groups Consumers  Quality services would be provided  Reasonable prices may be charged  Efficiency will be improved  However, tax payers may have to face increased burden due to huge subsidies provided by the government and sometimes prices may be higher. Workers  Redundancy level increases  Workers are forced to adopt flexible working practices Business  Objectives are changed to profit maximizing, so costs may have to be reduced which may mean the quality may be compromised  Increasing investments on providing these services  More takeovers and mergers are taking place  Firms have diversified themselves to different areas and striving for growth 26 Government  It’s an expensive process due to the money spent on advertising  Privatized businesses are subject to takeovers that they don’t agree for (hostile takeovers)  However, revenues will be generated and government can focus more on the government businesses, as a result, efficiency could be improved. Chapter 13: Externalities Externalities are the spillover effects on third parties caused by production and consumption of private individuals. They are of 2 types:  Negative externality  Positive externality Negative externalities There are 3 main costs associated with negative externalities: 1) Private cost: costs incurred by producers and consumers for their production and consumption. Example for producers: Costs of materials Example for consumers: price of the product 2) External costs: this is the negative spillover effect on third parties caused by production and consumption of private individuals. Examples: Pollution, congestion etc. 3) Social costs: External costs + Private costs Positive externality There are 3 main benefits associated with positive externalities: 1) Private benefits: Benefits enjoyed by producers and consumers from production and consumption. Example for producer: Profits Example for consumer: Consumers satisfaction 2) External benefits: they are the positive spillover effect on third parties caused by production and consumption of private individuals. Example: Unemployment, Economic Growth etc. 3) Social benefits: Private benefits + External benefits Impact of externalities on various contexts (External costs and External benefits) Transport sector Lot of external costs are created in the transport sector. This is because it involves air travel and land travel. Both of these emit greenhouse gases such as CO2 which increases the air pollution and thereby, causes various health issues such as asthma. As a result, this can lead to higher government expenditures on health care sector. 27 Health sector In this sector external benefits are being experienced. This is because, when government spends more on health care, this can result in people getting better treatment. Therefore, they may be healthy and fit to work. As a consequence, absenteeism rates for businesses may fall drastically which may increase the labor productivity due to less disruption in the production process. Education sector External benefits are experienced in this sector. This is because in an educated society, citizens may easily get employed in different organizations and this can result in innovative ideas and strategies being used by these educated citizens. As a result, productivity may be improved. Also as the income of citizen’s increases due to employment, the tax income for government may rise which could be used to spend on other development based projects which eventually could result in higher economic growth rates. (Other benefits: Higher property prices, fall in social unrest and increase in social harmony) Environment External benefits and cost may be experienced her. The external costs that may be experienced is the pollution of production of various activities which may deplete natural resources and reduce the sustainable growth by compromising on the availability of resources for the future generations. External benefits enjoyed will be that educated people will bring in innovative ideas to reduce the impact on the society such as use of renewable resources or eco-friendly machineries. Vaccinations This is when a vaccination is consumed by a person for an infectious viral diseases (such as the COVID-19) then the chances of it spreading would be lower. Hence, there is a benefit to the third part of not contracting the disease. As a result, an external benefit is created. Government polices to deal with externalities Taxation Government can charge higher taxes on firms that pollute the environment. This will increase their costs and thereby, increasing their costs of production. As a result, their profit margins may fall. Hence, immediate actions will be taken to reduce the external costs caused by their production (such as using environmental friendly products) As a result, the external costs can be controlled. Also, the tax revenues generated by the government could be used to fund the cleaning of the pollution caused Subsidies If the governments provides subsides to firms that produce goods that are beneficial to the environment, (education, health products) this can lower their costs of production. Hence, prices charged may be low as possible. As a consequence, more people will be able to afford these products. Therefore, the external benefits could be enjoyed by a larger number of people. Fines If fines are implemented on the consumption and production of products that may cause health damages (such as tobacco) then the consumption and production would be comparatively lower. As a result, the external 28 costs (such as health issues) created by these products would be controlled. This is because people are fearful for the fines due to the increased financial burden. Government regulations The government may impose legislations to ensure that the concerned parties are aware of the punishments and fines and therefore, reduce or eliminate the activities that may create external costs. Therefore, government health care expenses would reduce significantly. Pollution permits These are permissions that are granted by the government to discharge a fixed amount of pollution. If more is required permits are to be purchased for extremely higher prices which may discourage firms from purchasing permits and thereby, reducing the pollution. External costs Analysis (Advantages)  Write the type of external costs from the case  Reasons for the creation of the external costs  Consequences of the external costs on the third parties (consumers, government and suppliers) Evaluation (Disadvantages)  External costs cannot be measured  Depends on the magnitude  External benefits are created  Suggestions/Solutions to overcome external costs Unit 2: Business Economics Chapter 14: Factors of Production and Sectors of an economy Basic definitions 1. Human capital: the value of an individual worker or a workforce 2. Labor productivity: it is the amount of goods that can be produced with a given set of input over a period of time Production It is a process that involves converting resources (raw materials) into goods and services. Factors of productions are the factors that businesses may use to produce a good or service. They are of 4 types: 1) Land 29 A plot of land is required by a business to locate its premises or operations. Furthermore, land also provides natural resources such as coal, iron and oil which could be used for production purposes. The resources that are provided by the land could be divided into 2 types:  Non – renewable resources: these resources can only be used once. Once used up, they cannot be used again.  Renewable resources: These resources could be used over and over again. Once used up, they can be used again. 2) Labor Labor is the workforce in the economy. They are of different types from skilled, manual and unskilled workers. They have skills, education, experiences and emotions. The value of the workers are known as human capital and can be increased by providing more training and education which will help to improve the labor productivity. 3) Capital Capital are of 2 types:  Working capital: this is the stock of raw materials and other components that are used in the production to be converted into final products.  Fixed Capital: These are the furniture and machineries that are used in the production process s but are not converted into the final product, For instance: Machineries etc. 4) Enterprise/Entrepreneur In general, enterprise is a business operation. They are run by owners who are known to be as entrepreneurs. They have crucial role:  They come up with business ideas: they come up with great ideas to start their business. The ideas may come from different ways, for instance copying a rival’s product, own experience or from analyzing the market and the needs of consumers. These ideas are then put into a business model.  They are the owners: they provide the required fund to start up the business and to run its operations. They are responsible for its direction and are the main decision makers.  They are risk taker: They risk their own money in the venture having no any certainty for the returns. Therefore, if the business fails they would completely lose all the money that they invested.  They are responsible for the organization of the other 3 factors of production: they have to bring all the 3 factor of production to make the product. 30 Labor intensive and Capital intensive production Labor intensive production is when a business uses more labor in its production process than capital. (Machineries) This is widely used in countries such as China, India and Brazil. As these countries have lower wages for labors, this makes it more affordable than machineries. Capital intensive production is when a business uses more machineries that labor. This is widely used in developed countries such as Saudi Arabia and USA. Labor intensive production Advantages Disadvantages Cheaper for small scale production People are difficult to manage More flexible than machineries as they can be People needs breaks and holidays retrained People are more creative than machineries People can be unreliable as they may take sudden holidays from work Capital intensive production Advantages Disadvantages Machineries can operate 24/7 Huge set-up costs Machineries are easier to manage than labor May be inflexible Machineries are more precise and accurate May leave the workforce facing the redundancy and effect their morale Sectors in an economy The economy is divided into 3 main sectors: 1) Primary sector This sector is mostly involved with the extraction of natural resources from the earth. Some examples would be farming, forestry and fishing. 2) Secondary Sector This secondary is mostly involved in turning the resources or raw materials into finished or semi-finished goods. They are involved in the manufacturing of the products. Some examples are: textile, chemical and engineering industries. 3) Tertiary sector This sector is mostly involved in the provision of services to the economy. For instance, leisure, accountancy and banking services. De-industrialization This is the decline in manufacturing or secondary sector in developed countries due to the emergence and flourishing of the tertiary sector. Some of the main reasons for this are: 31   People prefer to spend more of their income on services such as leisure than on manufactured product. Hence, the demand for the manufactured products are falling.  There are huge competitions for the manufacturing sector from countries such as Brazil, India and China  As public sector grows, they spend more on public sector businesses which are usually services based  Advancement in technology has replaced labor in the manufacturing sector, hence, this sector is declining. It’s very important to know the proportion of growth in each sector in developed and developing countries: Developing countries have most of their labor and growth from the primary sector and the least from the tertiary sector as they mostly import these services The manufacturing sector is not as prosperous as the primary sector neither are they worse as the tertiary sector. Developed countries have most of their labor and growth from the tertiary sector and the least from the primary sector as they import primary products. The manufacturing sector is not as prosperous as the tertiary sector neither are they worse as the primary sector. USA = Developed economy Brazil = Developing economy Nepal = Underdeveloped economy Chapter: 15 Productivity and Division of Labor Basic definitions 1) Bonus: it is a financial method of motivation often given to sales staff for reaching set targets within a period. They are in addition to the basic salary. 2) Flexible working practices: they are working practices that help employees to cater surges in demand in a short time period. Eg: Part time working What is productivity and the factors that affect the productivity? Productivity is the rate at which goods are being produced and the amount at which they are produced in relation to the time, money and work that is required to produce them. To increase the productivity the business can modify the 3 factors of production: Land, Labor and Capital. 1) Land (Only some are mentioned as others are less important as these are examples)  Fertilizers and Pesticides: fertilizers can be used to increase the amount of crops harvested (yield) and improve their health. Pesticides could be used to kill insects that damage the crops. However, they may also kill some other animals that are harmless. 32   Drainage: they could be used to improve the productivity of land as they eliminate the flood of water in the productive parts of the land.  Irrigation: this system can be used by farmers to increase the productivity in seasons where there is a shortage of rain. Hence, the yield will continue to improve regardless of the rain. 2) Labor  Training: this is the process of increasing the knowledge and the skills of the workers so that they get familiarized with their jobs and thereby, do the work more effectively. As a result, they are well- motivated leading to higher productivity.  Increasing the motivation: businesses can provide various motivational schemes to encourage employees to be more efficient and productive. For instance, they can use bonuses as a motivation to achieve targets. Hence, employees will have a reward to work towards leading to higher labor productivity.  Improved working practices: businesses can adopt new working practices such as flexible working practices. This will help them to be more innovative and efficient helping them to work in an organized manner. As a result, the productivity would rise significantly.  Migration: when a government of a country promotes migration, this would help them to attract foreign highly skilled workers who may positively contribute to the productivity of an economy by bringing in innovative ideas that would help to reduce the time consumed and the wastages. As a consequence, the productivity and the profits for businesses may rise drastically. 3) Capital Use of technology has helped to improve the productivity in all 3 sectors of an economy:  Primary sector: in this sector drones, tractors, lifting equipment and irrigation systems have been introduced to reduce the waste and improve the working conditions which has helped to improve the productivity.  Secondary sector: this sector has been the mostly influenced by the advancement of technology. This is because of the newly introduced complex machineries such as robotic arms and Computer aided designing systems which has helped to save more time and labor costs for business. Therefore, the productivity has also rose.  Tertiary sector: although this sector is not affected by much, there are still slight improvements due to the advanced technology used in the health care sector. For instance, newly introduced operating machines has made the job of the doctor easier. Also, the use of internet shopping has grown in emergence due to various factors, currently the COVID-19. Division of labor and specialization Division of labor is the division of workers to do separate tasks of a complete work, so that together the product could be made faster. It also means to break down the production process into smaller parts, so that each worker can specialize in their area of expertise. On the other hand, Specialization is production of limited range of good by a firm, region or a country. 33 Division of labor – Workers Advantages Disadvantages They can become expertise on a particular task Boredom/Monotonous Workers pay will be higher if they are highly Less chances to get employed in other jobs due to expertise lack of diversification of jobs They can concentrate on a narrow range of task – less stress Division of labor – Businesses Advantages Disadvantages Efficiency is improved as worker waste less time as Due to boredom, motivation suffers causing a fall in they are familiar with the job productivity Tools could be given to a group of workers rather If production fails to deliver the product on time, than an individual worker, hence, les tools are then the rest of the production would be delayed required No time wasted moving from one job to another Loss of flexibility in the workplace. They are confined to one job only Production organizing becomes more easier CHAPTER 16: COSTS Basic definitions 1) Costs: expenses that must while running the business 2) Fixed cost: the costs that remain constant 3) Variable costs: the costs that vary with the level of output 4) Total costs: the total of the fixed cost with the variable costs 5) Total revenue: money generated from the sale of outputs Fixed costs Fixed costs do not vary with the level of output. They don’t increase when output increases neither do they decrease when the output decreases. However, they are to be met even if no output is produced. They form a straight horizontal line in a graph. Examples: rent, development costs etc. Variable costs Variable costs are the costs that vary with the level of output. When output increases they increase and the vice versa. Examples: raw materials, packaging. To find total variable costs = Variable cost per unit x number of units Total costs This is the addition of the Variable and fixed costs. 34 Total cost = Fixed cost + Total Variable costs Average costs This is the average cost of producing one single unit: Average costs = Total cost / total quantity produced The below labelled terms will be explained in the following chapter Diseconomies Economies of scale of scale Minimum Efficient Scale (MES) Total revenues The amount of money the firm receives after selling its outputs. Total revenues = Price x Quantity Profit The amount of money that is given to the owner or distributed among the owners or shareholders after the deduction of all costs is called profit. Profit = Total revenues – Total costs Chapter 17: Economies and Diseconomies of scale Basic definitions 35  1) Bulk purchases: buying in large quantities 2) Product portfolio: this is the range of products that a business is currently marketing (selling) 3) Vocational training: this is a form of training that emphasizes the skills and knowledge of a particular industry or job. 4) Staff turnover rates: amount of workers leaving the organization Economies of scale is the fall in the average costs due to expansion of the business. This is because as more output is produced the costs can be shared among more outputs. Diseconomies of scale is the rise in the average costs when a firm becomes too large and everything goes out of control. Economies of scale can be divided into 2 categories: 1) Internal Economies of scale is the costs benefits that an individual can enjoy as they expand. They are have of 6 types:  Purchasing economies of scale: This is when firms are given discounts when they buy raw materials in Bulk. As a result, their average costs falls significantly helping them to maximize their profits.  Marketing economies of scale: This can be experienced as the firm increases in size. For instance, large firms can find it cheaper to purchase their own delivery vehicles instead of paying a distributor to carry their orders. As a result, the average costs may reduce.  Technical economies of scale: Large firms may have the opportunity to invest heavily on machineries that may be more productive and efficient while smaller firms may find difficulties in affording this. As a result, the sales can be maximized.  Financial economies of scale: financial institutions may find large firms to be less risky and may easily provide finances for lower interest costs. Therefore, they will find it easier to raise finance to fund further expansion.  Managerial economies of scale: larger firms may be able to attract highly skilled employees from all over the world as they are able to provide higher salaries and other benefits while, smaller firms may find it difficult. So, better decisions may be made by these highly qualified managers helping to improve the business performance.  Risk-bearing economies of scale: this is when larger firms are able to be spread their risk among more products due to their diversification. (more product in the product portfolio) So, in case a loss is incurred in one of their products, then they are able to compensate with other products but small firms are more vulnerable to changes in the market conditions. (They can easily fail) 2) External economies of scale: costs benefits that all firms can enjoy once the industry they are in expands. They are of 4 types:  Skilled labor: if an industry is focused on one particular region or area of a country, then the highly qualified workers who are working in fields that are related to this industry may be attracted, hence, the costs of training will be much lower for the firms. Also, local schools may provide vocational training to mold children to the expectation of the industry.  Infrastructure: governments of the country may be keen to invest on roads, railways or ports if a particular industry dominates the country. As a result, the productivity rates increases as time is saved due to fast delivery of raw materials caused by the better roads etc.  Access to suppliers: as a particular area is dominated by an industry, this will encourage suppliers to set up close to those areas to easily attract more business. Therefore, the business in the industry may find it easier to purchase the components that is required.  Similar business in the area: when the firms in the same industry are located in the same area, they are likely to corporate well to gain the benefits of external economies of scale. 36 Diseconomies of scale There are 4 main types of diseconomies of scale that may be encountered as the business increases in its size:  Bureaucracy: This is experienced by businesses as they spend more time on administration and get signs for authorities before a decision is being made. Hence, this red tape (increase in paper work) can cause a business to spend more time and eventually, lose important opportunities.  Communication and Coordination problems (2 points related to each other): as the business increases in size, the number of employees and number of machineries may increase. Hence, coordination problems may arise as managers may not have tighter control with their employees as it may be impossible to control all of them. Hence, message may be misunderstood causing huge mistakes to happen which may incur costs to the business.  Distance between top management and shop floor workers: the distance between the top management and the ground workers such as clerks will worsen. Hence, the needs of these workers will not be met causing a demotivation at the work place. Hence, staff turnover rates may increase significantly. P.T.O FOR GRAPH  Economies of scale: Falling average costs  Diseconomies of scale: Rising average costs  Minimum efficient scale: This is where all business must try to be. They should expand so that they can enjoy economies of scale but should not overgrow so that they don’t experience diseconomies of scale. Chapter 18: Competitive Markets Basic definitions 1. Rivals: competitors 37  2. Product differentiation: this is when firms have to exploit a unique feature of their product that would distinguish their products from that of the rivals. 3. Market share; this is the proportion of the market a business or a product holds 4. Competitive edge: this is when a firm has unique feature that completely differentiates its products from the rivals. 5. Barriers to entry: Obstacles that may discourage firms from entering the market Competition is the rivalry that exists between 2 or more firms when trying to sell their products to the same group of customers. The products sold in a competitive market will be similar or identical. Some of the prominent features of a competitive market are:  Large number of consumers and sellers  Lower barriers to entry  Similar products sold  No firm have control over the prices that they charge  Free flow of information: Nature of the product, availability and the location of outlets etc. Effects of competition on firms  There is a need to innovate new products as to attract customers from the rivals  Product differentiation is encouraged as to attract more consumers and increase market share  Businesses should operate efficiently and keep costs low as possible  Charge prices that are acceptable to customers  Provide better quality products Advantages of competition to consumers  Lower prices: in competitive markets firms try to charge as low as possible as to attract consumers and to maximize their revenues  More choices: as the barriers to entry are low, more firms enter the market and consumers have more products to choose from. They can chose the product with the best quality for reasonable prices.  Better quality: as firms want to increase their profits, they put more effort to improve the quality of their product hence, consumers get better quality products.  More innovation (Can also be used as a disadvantage): as firms may want to earn a competitive edge in the market, they may innovate new products and thereby, consumers get the best products. Disadvantages of competition to consumers  Market uncertainty: due to high competitions, firms may eventually leave the market, thus, reducing the choices for consumers.  Lack of innovation: as firms have less profit margins, they have less finance to fund the innovation of new products. Therefore, consumers may not be able to get new products. 38 Advantages of competition to the economy  Resources will be allocated more effectively as firms’ competition may try to reduce the wastages to lower their costs.  More innovative products may be introduced which may help to increase the standard of living for the people in the economy. Disadvantage of competition to the economy  Resources may be wasted in a competitive market as when a business fails due to high competition. Chapter 19: Small and Large firms Basic definitions 1. Turnover: Revenues of the business 2. Balance sheet: is a financial document that lists out all the assets and liabilities of the business at the end of each financial year The size of the firms can be measured in 3 main ways:  The turnover of the business  The number of employees employed  The total of the balance sheet Small firms These firms have limited growth potential and fill up a vast majority of the firms in a country. They can be either sole traders (single owner businesses) or partnerships. (2-20 owner businesses) Advantages  They are flexible as there is only one decision maker who would adopt to changes quickly. Hence, they can easily cope up with surge or a fall in demand or to the market conditions. There is no delay in time.  They are able to offer personal services as most consumers would be prepared to pay higher prices if they deal directly with the owner.  Lower wage costs as there are trade unions and the employees are unlikely to demand for higher wages.  Better communication as there are less employees. Therefore, messages would be clear and not misunderstood. Hence, avoiding high costs of mistakes.  Innovative as they face huge pressure to innovate as they compete with larger firms. So, to remain competitive, they have to continuously bring in new products. Disadvantages  Higher costs: as they cannot exploit the economies of scale due to less output produced. 39   Difficulties in raising finance: financial institutions may find it ‘risky’ to provide finance to small firms as they may be unable to repay them along with interest payments.  Difficulty in attracting quality staff: this is because highly qualified staff may expect higher wages and more additional benefits (perks) which small firms are incapable of doing.  Vulnerability: small firms are vulnerable to changes in market conditions. For example, in the case of COVID-19, many small firms have already close down their operations as they have become unprofitable.  Monopolies: this is when there is one business dominating the whole market. Large firms Large firms are global giants known to be as Multinational companies. Some examples are: Nestle, Unileiver etc. Advantages  They can easily access the economies of scale as they produce in large quantities  They are also able to dominate the market due to their huge size. They can charge lower prices to drive out smaller rivals from the market and later on increase the prices to a higher level.  They can easily attract large scale contracts as they may be more efficient in completing projects on time and are more recognizable to the public due to their giant size. Disadvantages  Too bureaucratic: large firms always have more paper work to complete. Decisions cannot be taken immediately due to the red tape involved in decision making. So, they tend to lose more opportunities than small firms do.  Communication and Coordination problems: as the business increases in size, the number of employees and number of machineries may increase. Hence, coordination problems may arise as managers may not have tighter control with their employees as it may be impossible to control all of them. Hence, message may be misunderstood causing huge mistakes to happen which may incur costs to the business.  Poor motivation: in large firms employees at the bottom will not be given more importance. Hence, motivation suffers causing an increase in the staff turnover rates. As a result, business costs may rise drastically. Factors influencing the growth of the business  Government regulations: as governments are highly involved in releasing new regulations to protect the consumers and the economy from being exploited, this may have a great impact on the firms. For instance, governments may investigate mergers and takeovers to ensure that together the businesses may not become monopolies and exploit the consumers by charging higher prices. Therefore, this may prevent the growth of businesses.  Access to finance: Some firms may have the desire to grow but are unable to raise the necessary finance that is required. This is because financial institutions may be reluctant to provide small firms with loans as they fear that these firms will not repay the loans alongside the interest payments. Therefore, this may restrict the growth of certain businesses. 40   Economies of scale: although some businesses find it easy to exploit the economies of scale due to higher production, there are some small firms who may find difficulties in exploiting the economies of scale. Hence, due to higher average costs they tend grow slowly or even not grow.  Desire to spread risks: firms may want to diversify their product portfolio to spread their risk within all their products. So, this reduce the amount that they may lose in case a single product fails as they can rely on other products. Therefore, they may want to grow.  Desire to take over competitors: businesses may want to grow so that they can take over their rivals and increase their market share. Also, by driving off rivals or by taking over them they would be able to dominate the market and charge higher prices. So, this can be a desire for firms to maximize their profits. Reasons for small businesses to stay small  Size of the market: some businesses operate in a market where large businesses are unlikely to exist. For example, luxurious product market. This is because the demand for these products are limited to the rich people.  Nature of the market: some businesses are existing in markets where barriers to entry are very low. So, many firms can enter the market easily and therefore, competition is high. This may prevent small firms from growing.  Lack of finance: some firms have the desire to grow but unfortunately do not have the required as they cannot even borrow due to their size and nature. So, this is another barrier for the growth of small business.  Aim of the entrepreneur: this is usually another reason to restrict the business growth. Some business owners want to run a business that would make them enough money to fund their lifestyle. They may not want to shoulder the extra responsibility associated with increasing the size of the business.  Diseconomies of scale: some firms may not like to grow much as they fear that due to diseconomies of scale their average costs would rise significantly. Hence, this may also reduce the potential for growth. Chapter 20: Monopoly Basic definitions 1. Patents: this is a license that prevents other firms from copying the design of the product made by the firm. It can exist up to 20 years. 2. Natural monopolies: this is where one its more practical for a single firm to supply the entire market at a low cost than more may small firms to supply the whole market. 3. National income: income of a country (total) 4. International market: where all country markets compete Monopoly is a situation where there is one dominant seller in the market. They have almost 25% of the market share. Features of Monopoly  One business dominates the market: this is when a product is supplied by only one supplier in the market. However, there can be a monopoly even when there are other suppliers. For instance, if there was a single supplier who dominates the market with more than 25%. 41   Unique product: the product that is supplied by the monopolistic business is unique as they may be highly differentiated from any other alternatives. So, consumers who may want to purchase the product may have no any other choices.  Price makers: monopolists can adjust the prices accordingly. For instance, they can increase the prices by restricting the quantity of outputs. Or they can fix a lower price to sell more quantities.  Barriers to entry: as the barriers to entry are very high and strict, this discourages firms from entering the market. Hence, monopolies usually dominate the market and at times exploit the consumers. Some of the common barriers to entry into the monopolistic market:  Legal barriers: this is when the government wants to contract out a particular service to one firm. For example, the water services. So, once the firms has the government contract, competition is legally forbidden.  Patents: as some firms have patents for their products, competition can be eliminated. Hence, higher prices can be charged for the products.  Marketing budgets: Monopolies are highly branded businesses who have already built trust and loyalty for their brand. New firms may find it difficult to compete with these businesses as consumers may not be willing to purchase their product as they are loyal to the monopolies and have more trust on them. They also spend huge amount on advertisements.  Technology: as monopolies are already established in the market and are highly profit making, they may invest more on complicated machineries which may help to improve the efficiency of their products. Therefore, small firma are unlikely to be competing with these businesses as they do not have the required finance to fund the purchase these machineries.  High start-up costs: setting up a business to compete giant businesses which are the sole producer of a product can be an expensive process. Therefore, businesses are reluctant to come forward and compete with these giant leaders. Advantages of a monopoly  Efficiency: When natural monopolies exist, the efficiency of the production would be improved due to one supplier supplying the whole market. As there is no duplication of resources, there is no wastage of resources.  Innovation: as monopolies make huge profits, they spend more on research and development of new efficient, innovative and low cost products. This would help an economy to improve their living standards making life much easier with new products.  Economies of scale: as monopolists are huge firms with high products, they are able to exploit the economies of scale. Therefore, their average costs are lower which means prices may be lower. This will also help them to be competitive in the international market which will help them to dominate the international market and thus, increase the national income and employment opportunities. Disadvantages of monopoly  Higher prices: as there is no competition in the monopolistic market, the prices charged may be extremely high. This is because consumers may have to purchase the product regardless of the price charged as there is no any suitable alternative to the product. Therefore, consumers are exploited. 42   Restricted choices: as there is less or no firms in this market, the choices for consumers are limited. They have to choose from a restricted amount of choice.  Innovation: as there is no competition in the market, monopolies do not find any incentive to innovate products. This is because they are already dominating the market and therefore, there is no need for them to be innovative.  Inefficiency: They may also be inefficient as they may not have the incentive to be cost-efficient. Therefore, due to their huge size, they may experience, diseconomies of scale and thus, average costs start to rise. Hence, the services that they may offer will be of lower quality as to reduce the costs. Chapter 21: Oligopoly Basic definitions 1. Cartel: is when a group of firms agree to ho together and agree on pricing and output levels 2. Oligopoly is a market that is dominated by a few large firms. Features of Oligopoly  Few firms: in an oligopolistic market there are few firms that would dominate the market and have the most market share.  Large firms dominate: the firms with the highest production capacity and the lowest costs would dominate the entire market as they have higher market shares. Smaller firms would just copy the prices charged by the large dominating firms.  Different products: products sold in an oligopolistic market are similar but have differences. Firms put more effort to differentiate their products from their rivals so that they can get higher revenues.  Barriers to entry: they may also be high as the costs of starting up a business in an oligopolistic environment would definitely be high. Hence, less firms enter the market.  Collusion: this is when dominant firms in an industry decide to charge a fixed price, or supply in a particular region or restrict the supply to force the prices up. This is illegal in many countries.  Non-price competition: This is where firms use loyalty cards, free gifts etc. to compete instead of reducing prices and causing disruption in the market where all firms may lose due to one firm’s decision.  Price competition: This is when firms compete by reducing their prices and offering more generous discounts. This will force other firms to lower their prices and to maintain the market share and eventually cause a price war. But this may exist only for a short period of time. Advantages of Oligopoly  Choice: These businesses compete by launching new brands with different features although they may be the same product. Therefore, consumers have more choices. Small producers also provide choice by supplying into a niche market. 43   Quality: Businesses in this market will spend more money to differentiate their products in terms of quality. Therefore, consumers get better products due to the non-price competition that puts pressure on the business to improve the quality.  Economies of scale: as the dominant firms in the m market produce high quantity of products, they are able to exploit the economies of scale. Hence, due to lower average costs incurred the prices of the products may be lower.  Innovation: there is a contradiction over here. This is because as oligapolists make higher profits they are able spend more on research and development of new products. However, due to the high amount of spending on advertisements, the chance of innovation would fall.  Price wars: consumers may benefit from price wars. This is when the market leader (usually the business with the highest market share) reduces the price. Hence, the rest of the firms may follow the leader and reduce their prices. This will provide consumers an opportunity to save money and so on. However, this may only be for a short-term period. Disadvantages of Oligopoly  If a collusion takes place between firms, this can exploit consumers as the prices charged would be high.  In some oligopolistic markets a cartel may exist. Therefore, if output is restricted then the consumers may have to pay higher prices for the output available.  Lack of innovation as explained above Chapter 22: The labor market Basic definition 1. Wage rate: This is the amount of money paid to workers for their services over a period of time. 2. Dependency ratio: proportion of the population that are unable to work and are dependent on the youth workers and the middle aged works. Dependency ratio = Extremely young + Extremely Old (only for reference) Demand for labor: Worker’s rewards are the payments that they get for their services. The demand curve for labor for labor is similar to the normal demand curve learnt in the first few chapters. The demand for labor increases as the wages per hour falls. 44 Factors that affect the demand for labor Demand for labor means the business’s need for labor. There are several factors that affect the demand for labor in a country:  Derived demand: This is when the demand for all products increases due to changes in income, businesses will hire more workers as to cope up with the increased demand.  Availability of substitutes: businesses may also take into consideration the costs and availability of substitutes for labor such as machineries. If machineries were cheaper than labor then they may prefer to hire machineries instead.  Productivity of labor: if labor is more productive the business may hire more workers as they become more profitable.  Other employment costs: if the costs that are related to employment such as insurance and car costs are increased then the demand for labor may fall. Increase or decrease in each factor will shift the demand curve to the right or left (same like the normal demand curve) 45 Supply of labor: The supply of labor increases as the wages increases. This the number of people willing to work. Factors affecting the supply of labor  Population size: As the population grows yearly there will be more people available for work.  Migration: when people migrate to countries they increase the supply of labor in that country as they are willing to work as to earn a living.  Age distribution of the population: as the population age increases (65+) the dependency ratio increases which forces the middle and the young aged population to work longer hours.  Retirement age: as the retirement age is increased in some countries the number of people who are willing to work may also rise. Hence, the supply of labor increases.  School leaving age: this is the minimum age that children have to study until. If this age changes then the supply for labor would also change accordingly.  Female participation: due to favorable changes in the society and emerging of the equality acts, females now prefer to work and thus, increase the supply labor in many countries.  Skills and qualifications: this is where employees get more qualifications and they are more employable. Also, as the number graduates entering the work force increase the supply of labor tends to increase sharply.  Labor mobility: this is the ease with which labor can move geographically and occupationally between jobs. Geographically means that they can move from one place to another and occupationally means they can move from one job to another. Increase or decrease in each factor will shift the supply curve to the right or left (same like the normal supply curve) Wage determination The wage of labors are determined by the supply and the demand for labor. Where the supply and demand are equal, the equilibrium wage rate will be set. Minimum wage laws can also determine the wage rate. These 46 are laws which are set by the government above the equilibrium rate to protect the disadvantages working groups. (Women, black people and minority ethnic groups) What business have to look for when choosing the premise location?  The quality, skills or qualifications that employees must have to maintain the standards of the business.  The costs of labor  The costs of training – this depends on the level of skills that employees possess.  They should also ensure that there are enough workers in the site.  They should also be convinced that there are enough workers if the business expands in the future. Impact of education and training on the quality of human capital Employers may want to employ workers who are professional, well-educated, qualified and responsible for the job. They may invest on training for the following reasons:  Increase the skills and the knowledge that is needed to do the jobs more effectively  Increase the flexibility of workers  Ensure that are workers are familiar with the company’s polices and health and safety procedures  Make employees familiar to the job so that they don’t feel anxious while doing the job  Improve the motivation Chapter 23: Impact of changes in supply and demand of labor and trade union activities in labor markets Basic definitions 1. Secondary picketing: when workers in one company strikes in a group at a particular location to support the striking workers in a different company. 2. Closed shops: where all workers should belong to a particular trade union P.T.O 47 Graphs for increase in demand for labor The demand for a caps increased due to an increase in income in the country. Therefore, the demand for production workers to produce more caps increased. As a result, the wage rate per hour has also rose. Graphs for increase in supply for labor The supply of labor in Saudi Arabia has increased due to the increase I the educational qualifications in the country as more graduates are emerging from top universities. Trade unions They are organizations or group of people who exist in a business or separately out of a business to protect the rights of the workers. They fight for better pay, better working conditions and working time. Some of the aims of Trade unions are:  Negotiate pay and working conditions with employer  Provide legal protection of members. For instance, represent in a court  Put pressure on governments to on legislations in favor of labors  Provide financial benefits when there is a strike (work is stopped due to a fight) The trade union laws for limiting power is not required. If you want you can refer to the book.. 48 Effects of trade unions on employment and wages Trade unions usually negotiate for higher pay for their members. This can put pressure on the business and make them to redundant (dismiss) some of their employees to lower the costs. However, this could be avoided if:  Labor productivity rises at the same time  Employers are able to pass the increase in wage costs to customers in terms of higher prices  If profit margins are reduced The diagram above shows the interference if the trade union has increased the wage rate from W1 to W2. The supply of labor has become perfectly elastic. Chapter 24: Government intervention Basic definitions 1. Government intervention: this is where government get involved in a situation to help the problems to be solved Government intervention to deal with externalities Taxation Taxes are the government charges on certain activities that may create external costs. Taxes would increase the costs of production for firms and therefore, encourage them to take immediate decisions. The tax revenues generated by the government can be used to clean up pollution. Analysis (Advantages)  Generate more revenues which could be used clean up pollution.  Tax system can be adjusted according to the gravity (size) of the problem.  Directly influences on costs of production and therefore, immediate actions may be taken. 49   Tax revenues could be used to develop economy.  Can easily control external costs Evaluation (disadvantages)  Appropriate taxation cannot be charged as external costs cannot be measured.  Impact of taxes depends on the magnitude of tax charged.  Profits may lower, leading to lower investments and therefore, lower economic growth rates.  Depends on elasticity of the product.  It can be regressive – Impact may be more on poor.  It may restrict external benefits Subsidies Subsidies are grants provided by government to businesses in order to encourage them to do something. Subsides will lower the costs of production and would encourage firms to adopt new working practices and purchase green technologies that would help to reduce the emissions and impact on the environment. Analysis (Advantages)  Subsidies will encourage producers to produce more merit goods  Lowers the costs of production  Greater efficiency  Can easily control external costs Evaluation (Disadvantages)  Costs to the government  Opportunity cost  Depends on the magnitude  Only effective in the short-term  Firms become inefficient  No monitoring systems by government 50 Government rules and regulations The government may impose legislations to ensure that the concerned parties are aware of the punishments and fines and therefore, reduce or eliminate the activities that may create external costs. Analysis (Advantages)  Simple and easy to understand  Quick response as people and firms may fear the punishments or fines  Cheaper to enforce  Can easily control external costs Evaluation (Disadvantages)  Time lag  Monitoring problems  Negligence by firms  Appropriate laws cannot be implemented based on the gravity of problems  It may restrict external benefits Pollution permits These are permissions that are granted by the government to discharge a fixed amount of pollution. If more is required permits are to be purchased for extremely higher prices which may discourage firms from purchasing permits and thereby, reducing the pollution. Analysis (Advantages)  High prices can discourage firms from purchasing extra permits to discharge extra emissions  Marketable or tradable  More revenues  Can easily control external costs Evaluation  Depends on the elasticity of the product. If inelastic costs can be passed to consumers  It may restrict external benefits  It would be difficult to set appropriate levels of permits for each industry  Lack of monitoring and negligence. 51 Fines If fines are implemented on the consumption and production of products that may cause health damages (such as tobacco) then the consumption and production would be comparatively lower. As a result, the external costs (such as health issues) created by these products would be controlled. This is because people are fearful for the fines due to the increased financial burden. Analysis (Advantages)  They can be adjusted according to the gravity of the problem  Producers may fear the fines and may reduce the external costs created  Help government to control the external costs effectively Evaluation (Disadvantages)  Depends on the magnitude  In the long-term it may not be effective Government regulations aiming to increase the competition in the market  Promoting competition: the governments all over the world may take measures to promote and to prevent anti-competitive practices which may eliminate competition. Some examples would be:  To encourage the growth of small firms in the market, this will increase the completion and thus, reduce the prices.  Lowering the barriers to entry which will help firms to easily enter the market. They can do this easing the legal procedures  Introduce anti-competitive legislations su