New O Level Economics Notes by SAA

COMPREHENSIVE O’LEVEL ECONOMICS
NOTES
2020 onwards CURRICULUM
BY
SOHAIB ALAVI
MSc Economics (Distinction), University of Warwick
Faculty Member At
LACAS
LGS Gulberg
City School DHA
Roots International
Lahore School of Economics
1
Preface
In the name of Allah, the Most Gracious, the Most Merciful. All Praise is Allah’s.
By the Almighty’s Grace, these notes that I have compiled and prepared for the O level
Economics students are the first of their kind. Firstly, these are the first notes that
incorporate the changes made in the 2020 curriculum by the Cambridge International
Examination board. So, these notes are updated with all the changes made by the board for
the 2020 and beyond curriculum. Secondly, these notes include a formula template which
cover all important and basic formulas expected in the final exams. Thirdly, and most
importantly, these notes contain a unique set of exam pointers that advise students on all
the different questions and sections that appear in both papers (P1 and P2). This is a first for
any set of notes. And finally, these notes contain a comprehensive and, simultaneously, to-
the-point explanation of all the important topics and sub-topics which will give students the
ideal platform to perfect their theoretical foundations of the O level Economics curriculum,
without needing any further book for assistance, Insha’Allah.
2
Table of Contents
Chapter 1 ................................................................................................................................................ 5
Scarcity ............................................................................................................................................ 5
Types of goods ................................................................................................................................. 5
Factors of Production:...................................................................................................................... 6
Opportunity cost .............................................................................................................................. 8
Production Possibility Curve (PPC).................................................................................................... 9
Past paper practice questions (M2016-N2018 topical questions) ................................................... 11
Chapter 2 .............................................................................................................................................. 12
Unit 2.1: Microeconomics vs Macroeconomics ............................................................................... 12
Unit 2.2: Resource allocation and markets role .............................................................................. 12
Unit 2.3: Demand ........................................................................................................................... 14
Unit 2.4: Supply.............................................................................................................................. 15
Unit 2.5: Market equilibrium .......................................................................................................... 16
Unit 2.6: Changes in market equilibrium ........................................................................................ 18
Unit 2.7: Price Elasticity of Demand (PED) ...................................................................................... 20
Unit 2.8: Price Elasticity of Supply (PES).......................................................................................... 23
Unit 2.9: Market economic system ................................................................................................. 25
Unit 2.10: Market Failure ............................................................................................................... 26
Unit 2.11: Mixed economic system................................................................................................. 28
Past paper practice questions (M2016-N2018) ............................................................................... 30
Chapter 3 .............................................................................................................................................. 31
Unit 3.1: Money and banking ......................................................................................................... 31
Unit 3.2: Households ...................................................................................................................... 34
Unit 3.3: Labor markets .................................................................................................................. 36
Unit 3.4: Trade unions .................................................................................................................... 42
Unit 3.5: Firms ............................................................................................................................... 45
Unit 3.6: Production, costs and revenue ......................................................................................... 52
Unit 3.7: Market structure and monopoly ...................................................................................... 56
Chapter 4 .............................................................................................................................................. 62
3
Unit 4.1: The role of the government ............................................................................................. 62
Unit 4.2: Macroeconomic aims of the government ......................................................................... 62
Unit 4.3: Fiscal Policy & Taxes ........................................................................................................ 65
Unit 4.4: Monetary Policy ............................................................................................................... 70
Unit 4.5: Supply-side policy ............................................................................................................ 71
Unit 4.6: Economic growth ............................................................................................................. 73
Unit 4.7: Employment and unemployment ..................................................................................... 77
Unit 4.8: Inflation and deflation ..................................................................................................... 80
Past paper practice (M2016-N2018) ............................................................................................... 87
Chapter 5 .............................................................................................................................................. 88
Unit 5.1: Development ................................................................................................................... 88
Unit 5.2: Population ....................................................................................................................... 93
Chapter 6 .............................................................................................................................................. 99
Unit 6.1: International specialization .............................................................................................. 99
Unit 6.2: Free trade and protectionism......................................................................................... 100
Unit 6.3: Exchange rates............................................................................................................... 103
Unit 6.4: Structure of the Current Account of the Balance of Payments ........................................ 108
Past paper practice questions (M2016-N2018) ............................................................................. 110
Exam pointers ..................................................................................................................................... 111
Paper 1 ........................................................................................................................................ 111
Paper 2 ........................................................................................................................................ 111
Section A ................................................................................................................................. 111
Section B ................................................................................................................................. 112
Formula Index ..................................................................................................................................... 114
Bibliography/References .................................................................................................................... 116
4
Chapter 1
Economics: it is a social study that deals with organization of productive resources for the
satisfaction of human needs and wants. It can be defined as a social science that studies how
to allocate scarce resources in a way that satisfies as many wants as possible.
Scarcity
Limited /Finite Wants are

Resources unlimited
FOPs are scarce
Key point 1: Needs are limited. Needs are the basic essentials of life, without which one
cannot survive. These are few, e.g. water, food, clothing etc. Wants are non-essentials, which
keep on increasing as previous wants are satisfied.
Resource Allocation: to use the resource in the best possible way to fulfill as many wants as
possible
Types of goods
Free goods: these are goods which we may need or want that are without limit. Hence, as
they are unlimited, their opportunity cost is zero.
Economic goods are goods that are scarce in supply and hence these goods have some
opportunity costs.
1. Consumer good: goods that satisfy consumer wants.

Durable consumer goods: can be used multiple times, e.g. chair, cars.
Nondurable: goods that diminish after one use, e.g. food, drinks
2. Capital goods: goods that are used to produce other goods and services: e.g. tools,
tractor
3. Public goods: these are goods that are only provided by the govt and no one is willing to
pay for them and hence they are not profitable for the private sector, e.g. streetlights,
roads etc.
Public goods are not profitable due to the characteristics of non-excludability (no one can
be stopped from consuming them) and non-rivalry (no one’s benefit falls when other
people start consuming them, as well), which leads to the free rider problem
5
4. Merit good: these are goods that are highly beneficial for the general public but people
do not know their actual benefits and hence they undervalue these goods (known as
information failure). Hence the private sector only produces these goods for those who
can afford them, while the govt provides for those who are poor, e.g. education and
health care.
5. De-merit good: these are goods that are highly harmful for the society but people do not
know their actual dangers and hence they overvalue these goods (also known as
information failure). Hence the private sector overproduces these goods as they are
profitable, which is why the govt intervenes by imposing bans or taxes, eg cigarettes and
drugs
Factors of Production
1. Land: Natural resources to produce goods & services e.g. oil, land, gas. Reward: RENT
2. Labor: Physical effort and mental efforts to produce goods & services. Reward: WAGES
3. Capital: Manmade resources used to produce goods & services e.g. money, tools,
machine. Reward: INTEREST
4. Enterprise: risk-taking and decision-making ability. Reward: PROFIT
REWARD means the payments different FoPs are required to be given in order for them to
participate in productive activity.
Factor Mobility: How easily a resource can be moved from one productive activity to
another
Geographic Mobility: refers to the ease with which a resource can be moved from one place
to another.
Occupational Mobility: refers to the ease with which a resource can be used for alternative
jobs or purposes.
Why are some FoPs more mobile than others?
Many workers and capital are occupationally immobile due to certain characteristics, e.g.
specialization in certain skills/jobs. However, capital is geographically mobile as it can be
moved from one place to another. Workers are occupationally immobile as well, as family
ties and residence in a city discourage workers to move to other places. Land is also
geographically immobile, though it is occupationally mobile.
6
FoP How can FoP’s quantity How can FoP’s quality
increase? increase?
Land -increase in rents leads to - fertilizers and better land
increased willingness to management to improve soil
supply land - using organic farming
-new discoveries of natural methods to improve quality
resources of corps, dairy goods etc.
- afforestation
Labour - increase in wage will - training and education
increase supply of labor - healthcare
- increase in population
- improved healthcare
Capital - increased production of -advances in technology
capital goods - modern equipment
- increase in interest
payments which increases
willingness to supply
Enterprise - increase in price so that - better training courses for
profits increase would-be entrepreneurs
- fall in cost of production - more and better business
advice and support for
entrepreneurs
7
Opportunity cost
Opportunity cost: next best alternative forgone
It is the cost of a decision in terms of next best alternatives forgone to achieve it.
Link between scarcity, choice and OC
Scarcity (limited resources and unlimited wants) means that people cannot produce or
purchase all goods and services in the world, which causes people to choose from which
goods and services to produce/consume, and that means they have to forgo other
goods/services, which causes opportunity cost.
Opportunity cost can be for consumers, producers or govt. In case of a consumer, if the
consumer is planning on watching a movie, he forgoes the chance of watching a cricket
match, which is opportunity cost of the movie.
Conservation or Exploitation
Conservation refers to saving of resources of an economy for future use.

Exploitation (commercialization) refers to the using up of resources to produce goods and
services.
There needs to be a balance between these two. If we conserve too much, the present
generation will be worse off as they won’t have enough output which lowers consumer
choice and, of course, income. But if there is too much commercialization, then all the
resources will be exploited today, which will make future generations worse off, while also
leading to environment degradation. A balanced approach is known as sustainable growth.
8
Production Possibility Curve (PPC)
Economy is an area in which economic activities of production, exchange and consumption

take place.
PPC is a curve that shows the maximum output of 2 types of products and combination of
those products that can be produced in an economy with the existing resources .
Use of PPC to depict resource allocation and Opportunity Cost
Manufactured
goods
A Economy reallocates resources away
100 from manufactured goods to
agricultural goods (from A to B), and
B hence the opportunity cost of producing
70 100 extra agricultural goods is 30
manufactured goods forgone
300 400
Agriculture goods
Use of PPC to depict efficiency/full employment and unemployment
Manufactured
goods Point A: unemployment in the economy +
B inefficiency in resource allocation
Point B: full employment
Movement from A to B shows an economy’s

A
unemployment is falling, and there is an
increase in actual output or real GDP in the
economy (actual growth)
Agriculture goods
9
Outward shift in PPC due to increase in quantity or
Shifts in PPC (types and reasons)
quality of factors of production which increases
Manufactured the economy’s productive capacity, eg discovery
goods of natural resources, increase in no. of graduates,
increase in technology, tertiary sector
advancements etc
Inward shift in PPC due to decrease in quantity or

quality of resources, eg natural disasters, wars,
increase in death rates, fall in tertiary sector etc
Agriculture goods
Reallocation from consumer to capital goods or primary to tertiary sector
1: When an economy decides to reallocate

Capital goods resources away from consumer goods to capital
B 2 goods, there is a movement on PPC from A to B
immediately
2: However, in the long run, as more capital goods
1
A are being produced, which means that more FoPs
are available, the economy’s productive capacity
increases, and PPC shifts outwards
Consumer goods The same is the case when resources are

reallocated away from primary towards tertiary
sector
Exam pointer 1: Make sure you label both the axes with any types of goods of your choice.
Failure to do so will result in a loss of 2 marks out of a possible 6. The other four marks will be
divided into correct explanation (2 marks) and correct PPC diagram required for the question
(2 marks)
10
Past paper practice questions (M2016-N2018 topical questions)
1. Explain using a PPC, what happens to the economy when the number of graduates
increase. (6)
2. Explain using a PPC, what happens to the economy when an economy recovers from
recession. (6)
3. Explain using a PPC, the concept of opportunity cost. (6)
4. Discuss whether or not a government should subsidise bus transport. (8)
5. Analyse, using a production possibility curve (PPC) diagram, the effects of high
unemployment in a country. (6)
6. Explain two economic concepts shown by a production possibility curve diagram. (4)
7. Explain the connection between opportunity cost and the purchase of shares. (4)
8. Discuss whether an increase in spending on capital goods will help to achieve the aims of
government policies. (8)
9. Explain two factors that would increase the supply of entrepreneurs in an economy. (4)
10. Analyse, using a production possibility curve diagram, how an increase in labour
productivity will affect an economy. (6)
11. Discuss whether spending on health care is the best use of scarce resources by a govt. (8)
Answers will be discussed in my classes
11
Chapter 2
Unit 2.1: Microeconomics vs Macroeconomics
Microeconomics: it is a study of economic decisions and actions of individual consumers,

producers and households and how these economic decision makers interact.
Microeconomics includes: (ch 1-3 deal with micro)
• How firms organize production

• How wages are determined
• How prices of goods and services are determined
• Decision making processes of consumers, firms and workers
• Government actions that affect consumers, producers and workers
Macroeconomics: it is a study of the entire economy as a whole. It considers economic
issues and actions that affect the whole economy. Macroeconomics includes (ch 4-6 deal
with macro)
• What determines the total output of an economy

• What is the total national income of the economy and what changes it
• What determines unemployment and total employment in an economy
• What determines price level of an economy and inflation
• Different actions that the govt takes to achieve its aims
• Reasons for changes in living standards
• International trade
Unit 2.2: Resource allocation and markets role
As there is scarcity, all wants cannot be fulfilled. This involves resource allocation, which
involves deciding how to best allocate limited resources to different productive uses.
Basic economic problem creates three basic questions for resource allocation
Resource allocation
What How for Whom
To produce
12
Economic systems: how an economy answers the questions of what, how and for whom to
produce. There are three types of economic systems (methods of solving these three
questions)
Market eco Mixed eco Planned eco
• Everything produced • Combination of pvt. firms • Everything owned and

and owned by private and govt produced by govt
firms • Profitable goods • Basic necessities
• Consumer demand produced by pvt. while provided by govt
decides what to govt produces/ provides • Low quality goods
produce (consumer necessities and service • Profit motive not
sovereignty) like public and merit important, welfare
• Everything produced good motive is important
to maximum profit • Taxes and regulation by • Rationing mechanism
• Price mechanism govt on pvt. consumer allocates resources
allocates resources and producer • Consumer demand not
• Market prices • Not everything that has a important in resource
decided through demand is allowed to be allocation
forces of demand and produced e.g. drugs
supply, called market • Price mechanism used by
equilibrium private sector and
rationing mechanism
used by the govt
Price mechanism: it is a way used by the private sector to allocate resources.

How does it work? We assume that potatoes are being produced in a market.
Step 1: for some reason demand for potatoes increase

Step 2: this leads to a shortage of potatoes in the market
Step 3: shortage of potatoes leads to an increase in market price of potatoes
Step 4: this creates a signal for potato producers that profits in potato production is
increasing
Step 5: this price signal leads to greater incentive for producers to allocate more resources to
potato production, which increases the supply of potatoes in the market
13
Unit 2.3: Demand
Demand: is the willingness and ability to buy goods and services. (Effective demand)
It is negatively related to price. Thus as price falls, quantity demand rises, and vice versa
Downward sloping demand curve: Due to the negative relationship, demand curve is
downward sloping. Remember that y-axis always has price while x-axis has quantity
Price
This upward
movement is
P1 Key point 1: this diagram
contraction in
demand (Qd ) shows a movement along
P2 the demand curve.
This downward
Movement along the curve
movement is
extension in (MAC) only occurs only
demand (Qd ) when price changes
D
Q1 Q2 Quantity
Ceteris Paribus: a Latin term which means holding all other factors constant. So, in the
above diagram, except for price, all other factors that may affect demand, are held constant.
Individual demand is the demand for one consumer of a product whereas market demand is
for the entire market for one good for all consumers in the market.
Shift in Demand
Factors shifting demand (rightwards/increase in demand to D2)
• change in taste / fashion Price
• increase in people’s income (normal good)
• decrease in income tax
• rise in the price of substitutes (goods with alternative demand) D2
eg tea, coffee
• fall in price of complimentary good or compliments (goods
with joint demand) e.g. car, petrol
• increase in population
• increase in advertisement D1
D3
Quantity
14
Note: factors shifting demand leftwards are the same, but in the opposite direction, e.g.
decrease in people’s income etc. leftwards shift means demand falls
Note: there is a type of good whose demand falls when people’s incomes increase. Such
good is known as an inferior good, eg public transport
Key point 2: factors that shift demand are non-price factors. They only cause a shift, while
price causes a MAC
Unit 2.4: Supply

Supply: it is the willingness and ability to sell to good/service.
It is positively related to price. Thus as price rises, quantity supplied rises, and vice versa.
Upward sloping supply curve: Due to the positive relationship, supply curve is always upward
sloping. Remember y-axis always has price and x-axis always has quantity.
Price S
This upward Key point 3: this diagram
movement is shows a movement along
P2 extension in
supply (Qs )
the supply curve.
Movement along the curve
P1 This downward (MAC) only occurs only
movement is when price changes
contraction in
supply (Qs )
Q1 Q2 Quantity
Individual supply is the supply of one firm for a product whereas market supply is for the
entire market for one good which includes all firms in the market.
15
Shift in Supply Curve
S3
Factors shifting supply curve rightwards (increase in supply to S2)

S1
Price
• Fall in the cost of production S2
• Fall in the price of other goods i.e. potato and cabbage
• Technological advancement
• Increase in raw materials availability and productivity
• Improvement in business/economic optimism
• Subsidies to producers
• Decrease in indirect taxes
Note: direct/income taxes shift demand while indirect taxes shift supply Quantity
Note: factors shifting demand leftwards are the same, but in the opposite direction, e.g.
decrease in people’s income etc. leftward shift means demand falls
Key point 4: factors that shift supply are non-price factors. They only cause a shift, while price
causes a MAC
Unit 2.5: Market equilibrium

Market Equilibrium: this is a condition where there is no tendency for market to change the
level of price and output. This is where demand equals supply.
S
Price This diagram shows
market equilibrium, where
demand and supply
intersect at point e, where
P1 e P1 is equilibrium price and
Q1 is equilibrium quantity
Q1 Quantity
16
Disequilibrium: This is where demand and supply are not equal. This happens when the
price charged is either above equilibrium (P2) or below equilibrium (P3). Such prices cannot
last forever and ultimately, they have to come back to equilibrium due to the working of the
price mechanism explained in unit 2.2, as shown below.
Price Excess supply S

At P2 D<S Surplus P till it
P2 comes to P1 where D = S (MAC)
Price falls
P1
Price rises
P3 At P3 D>S Shortage P till it
comes to P1 where D = S (MAC)
Excess demand D
Quantity
Tabular example of equilibrium
Price Demand Supply

300 100 500 Equilibrium price is
where demand and
250 200 400
supply are equal at
200 300 300 P = 200, Q = 300
150 400 200
100 500 100
Exam pointer 2: demand and supply question normally is a 6 mark question. 4 marks are
allocated for the diagram and 2 for explanation. The diagram mark division is as follows:
1 mark: correctly labelled axes
1 mark: correctly labelled demand and supply curves
1 mark: correct shift which is asked in the question (eg increase in income will shift demand
right)
1 mark: show old and new equilibrium price and quantity, as shown on the next page
Explanation is basic, explain why the curve is shifting (1 mark) and what is happening to
market price and quantity as a result
17
Unit 2.6: Changes in market equilibrium
Equilibrium changes due to shift in demand or supply.
Changes in Demand
S
Price An increase in demand
causes an increase in the
P2 price and quantity of the
good, while a fall in
P1
demand causes a decrease
in price and quantity of the
P3
D2 good in the market
D1
D3
Q3 Q1 Q2 Quantity
Changes in Supply
S3
S1
Price An increase in supply
S2 causes price to decrease
P3
while quantity increases,
P1
whereas a fall in supply
causes price to increase
P2 while quantity decreases
Q3 Q1 Q2 Quantity
Shift in both curves at the same time

Key point 5: Remember, when demand and supply both change in the same direction,
quantity changes but change in price remains uncertain (increase in D & S increases quantity,
and vice versa for fall in D & S). Whereas, when demand supply both change in opposite
directions, price changes but change in quantity remains uncertain (increase in D and fall in S
causes price to rise, and vice versa).
18
Demand rises & supply rises Demand rises & supply falls
S1 S2 S2 S1
Price
Price
P2
P1
P1
D2 D2
D1 D1
Quantity Q1 Quantity
Q1 Q2
Quantity rises, Price uncertain Price rises, Quantity uncertain
Price controls (govt intervention in market)

There are two types of price controls.
Maximum price (price ceiling): It is the price set by govt below equilibrium and it results in
shortage or excess demand. It is essentially done for the benefit/ease of consumers.
Minimum price (price floor): It is the price set by the govt above the equilibrium and it results
in excess supply or surplus. It is essentially set to provide relief/support for the producers.
Price Excess supply S
PMIN
P1
PMAX
Excess demand D
Quantity
19
Unit 2.7: Price Elasticity of Demand (PED)
Price elasticity of demand: it is the responsiveness of quantity demanded to changes in
price. It shows how much demand changes when price changes by 1%.
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅
Formula: PED = 1
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆
Which can be simplified into:

𝑄2−𝑄1
% change in quantity demanded = 𝑋 100 2
𝑄1
𝑃2−𝑃1
% change in price = 𝑋 100
𝑃1
This can be further simplified into an easier formula

𝑸𝟐−𝑸𝟏 𝑷𝟏
PED = 𝑿 3
𝑷𝟐−𝑷𝟏 𝑸𝟏
Key point 6: remember the answer of PED is always negative due to the negative relationship
between price and quantity demanded, as established in unit 2.3, and so it is advisable to
ignore the negative sign unless stated in the question. Also you should remember all these
three formulas.
Year Price Quantity

1 5 100
2 4 110
Calculate PED? 0.5. Attempt it.
20
Types of PEDs
Characteristics Price elastic Unitary elastic Price inelastic
1 Definition Small change in price Same change in price Large change in price
causes a large causes equal causes a small
change in quantity proportionate change change in quantity
demanded in quantity demanded demanded
2 Value PED > 1, eg 2.5, 5 ect PED = 1 PED < 1, eg 0.5, 0.75
etc
3 Type of goods Luxuries eg car, ACs - Necessities, addictive

eg wheat, cigarettes
4 Shape of demand Flatter, as ∆P < ∆Q Hyperbola, as ∆P = ∆Q Steeper, as ∆P > ∆Q

curve
P P P
D D
D
5 Relationship between In price in As ∆P = ∆QD, TR/TE In price in

price and TR/TE as QD by a remains unchanged TR/TE as QD by a
revenue/expenditure lot, hence the whether price or little, hence
producer should Thus price should producer should
increase price to remain constant increase price to
increase revenue increase revenue
Extreme types of elasticities

Perfectly elastic demand: when a negligible change in price causes an infinite change in
quantity demanded. PED = ∞. Demand curve is horizontal, as shown below (left)
Perfectly inelastic demand: when an infinite change in price causes no change in quantity
demanded. PED = 0. Demand curve is vertical, as shown below (right)
21
P
PED = ∞ PED = 0
P
Q Q
Determinants of PED
1) No. of substitutes: the larger the no. of substitute the more elastic the demand is, as
the more the consumer has in terms of alternatives, the more sensitive to price he is.
2) The period of time: demand will be more elastic in the long run, as consumers are likely
to find alternatives over a longer period of time
3) The proportion of income spent on a product: if a good is very cheap e.g. a newspaper
even if price increases substantially the demand for that product won’t fall by a large
amount, while goods like cars are highly elastic as they take a large portion of income, and
hence consumers are highly sensitive to small price changes
4) Nature of the product: if the product is a luxury item, its demand will always be more
elastic, while an essential item’s demand will always be less elastic, as people can’t live
without such goods
Uses of PED for firms and governments

1) Firms know when to lower or increase the price of their goods. As discussed in the table
above, if the product the firm produces has an elastic demand, it should reduce its price,
while if the product has an inelastic demand, it should increase its price to increase revenue
2) Govts know which products to tax (indirect/sales tax) to increase revenue. To raise
higher tax revenue, the govt should tax goods with inelastic demand e.g. cigarettes
3) Firms can use PED to lower the burden of indirect tax on themselves. If PED is inelastic,
the burden of indirect tax will be more on the consumer, while if PED is elastic, the burden
will be more on producer
22
Unit 2.8: Price Elasticity of Supply (PES)
Price elasticity of demand: it is the responsiveness of quantity supplied to changes in price.
It shows how much supply changes when price changes by 1%.
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒔𝒖𝒑𝒑𝒍𝒊𝒆𝒅

Formula: PES = 1
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆
These can be broken further into (2) and (3) as in the PED formula breakdown.
Key point 7: remember the answer of PES is always positive due to the positive relationship
between price and quantity supplied, as established in unit 2.4, and so it is advisable to
ignore the positive sign unless stated in the question. Also, you should remember all these
three formulas.
Types of PES
Characteristics Price elastic Unitary elastic Price inelastic
1 Definition Small change in price Same change in price Large change in price
causes a large causes equal causes a small
change in quantity proportionate change change in quantity
supplied in quantity supplied supplied
2 Value PES > 1, eg 2.5, 5 ect PES = 1 PES < 1, eg 0.5, 0.75
etc
3 Shape of supply curve Flatter, as ∆P < ∆Q Starting from origin Steeper, as ∆P > ∆Q
P P P
S S
Q Q
Q
23
Determinants of PES
1) Time period: In the short run, supply is inelastic, as even if the price rises, producers
cannot increase their output by a lot since in the short run they can only hire more workers,
not any other FoP. In long run, it is elastic.
2) Nature of product: Primary products like agricultural goods have an inelastic supply due
to their lack of storability, while durable products have elastic supply as they can be stored
for a longer time period.
3) Excess capacity in plants/factories: If a firm has greater resources/FoPs/space in its
factory at its disposal, its supply is elastic as an increase in price can induce it to increase
production easily.
4) Ability to import inputs: If a country can easily import raw materials from abroad in
quick time, supply of its goods will be mostly elastic as FoPs can be changed easily
Uses of PES
1) Firm can use PES to analyze how much it can change its sales when there is a change in
demand. E.g., if demand rises, firm will only be able to change supply significantly if its
supply is elastic
2) Firms can use PES to lower the burden of indirect tax on themselves. If PES is inelastic,
the burden of indirect tax will be more on the producer, while if PES is elastic, the burden
will be more on consumer
Key point 8: Remember that the burden of indirect tax will fall more on the person whose
curve is inelastic. Therefore, the firm would want to make the demand for its goods more
inelastic so that the greater burden of the tax is on the consumer and not the firm.
Burden of indirect tax and its revenue in graphical terms

S2
S1
Price An indirect tax shifts supply
leftwards. The price consumer pays
Pc
after the tax is Pc and the price
A
P1
producer receives is Ps, as the
P1 difference between the two prices
B
Ps
goes to the govt. Moreover:
Consumer’s burden of tax = area A
Producer’s burden of tax = area B
D Govt’s tax revenue = area A + B
Q2 Q1 Quantity
24
Unit 2.9: Market economic system
Free market economy: it is an economic system in which resources are owned and
controlled by the private sector, with no government intervention, and resources are
allocated through the price mechanism.
Advantages of free markets Disadvantages of free markets

1. Respond quickly to consumer wants & allocate 1. High unemployment in sectors whose
resources accordingly demand is low
2. More variety of goods 2. Do not provide public goods as they are
3. Use of better production methods to increase unprofitable
efficiency 3. Produce harmful/demerit goods for profit
4. No govt intervention 4. Merit goods underproduced and only for
5. Profits are high and hence investment in R&D those who can afford
will be high, leading to high wages, improving 5. Social cost totally ignored of harmful goods
living standards. e.g. pollution
6. Prices are usually low due to efficiency, while 6. Income inequality as the rich are well off
quality is high and poor worse off
Government’s role in market economy
Govt intervenes in markets as a (i) regulator, (ii) consumer and (iii) producer. That makes the
market a mixed economy, to be discussed in 2.11.
25
Unit 2.10: Market Failure
Market failure: inefficiency resulting from over or under allocation (misallocation) of

resources in a free market economy results in market failure. The disadvantages of free
market economy, listed above, result from market failure. Market failure results in a
reduction of social and economic welfare due to inefficiency.
Reasons for Market Failures
There are essentially 6 reasons why markets fail. Here we look at each one of them and how
they cause market failures, and how the govt can intervene to prevent these.
1. Externalities: Before looking at the two types of externalities, let’s look at the social
costs and benefits of a business activity/production/consumption of a good:
Social benefits are the benefits of the production or consumption of a good to the entire
society:
Social Benefits = Private benefits + External benefits
where Private benefits are the benefits to the producer or consumer of some product
Social costs are the costs of the production or consumption of a good to the entire society:
Social costs = Private costs + External costs
where private costs are the costs to the producer or consumer of a good to that person/firm
26
Externalities
Positive Externalities Negative externalities
What Positive externalities create external Negative externalities create external
are they? benefits, which are benefits to the 3rd costs, which are the costs to the 3rd
party, which is not directly involved in party which is not directly involved in
the business activity, e.g. university the business activity, e.g. chemical
education/degrees leading to increased pollution affecting nearby residents
profits of firms hiring graduates
Why do Positive externalities cause market Negative externalities cause market
they failures as those who are directly failure as those directly involved in the
cause involved in the business activity do not business activity do not have to pay the
market get the full benefit of such goods, full cost of such goods, which results in
failure? which results in their their overproduction/allocation
underproduction/allocation
How Govt can give firms incentive for firms, Govt can give firms incentive to firms,
does the exactly equal to the external benefits exactly equal to the external costs, eg.
govt e.g. subsidies, which increase their tax, which reduce their production and
correct production and eliminates mkt failures. eliminate market failure. So, to
market So, to eliminate market failure, govt eliminate market failure, govt charges
failure gives subsidy = external benefit indirect tax = external cost
Key point 9: Firms are only interested in private cost and benefit as they pay private cost and
gain private benefits. It is also worth noting that the Optimum level of output is when social
costs equal social benefits. If social costs are NOT equal to social benefits, markets fail, and
that happens when external costs and benefits are not equal to zero.
2. Merit goods: definition already covered in unit 1

How do they cause market failure? As merit goods are undervalued because people do not
know their true benefits (information failure), they are under-consumed by people which is
why they under-produced/allocated, which causes market failure.
What can the govt do? Either provide subsidies to private sector, or pass laws/regulations
making consumption of merit goods compulsory
27
3. Public goods: definition already covered in unit 1
How do they cause market failure? As these goods are not profitable since no one pays for
them, private sector has no motive to produce them. Hence, they are not
produced/allocated.
What can the govt do? Govt can provide public goods themselves to the public through self-
provision, or can subsidize them by hiring private firms on contracts.
4. De-merit goods: definition already covered in unit 1

How do they cause market failure? As these goods are overvalued since people do not know
their true costs (information failure), these goods are overconsumed and hence
overproduced/allocated, causing market failure.
What can the govt do? Govt can either ban these goods, or impose indirect taxes on them to
reduce consumption, or they can also impose minimum price laws to reduce demand.
5. Monopoly power: Monopoly is a market in which one firm controls the supply of the
entire market (detail in unit 3.5).
How do they cause market failure? As they are the only powerful firm and control the
market, they purposefully restrict the supply of their product to increase their prices to
increase profits, resulting in underproduction/allocation, causing market failure.
What can the govt do? Govt can make anti-trust laws that lower market power of firms and
increase competition in the power, through taxes on large firms, or subsidies to small firms,
or govt can also impose maximum price laws to reduce monopoly’s ability to exploit
consumers.
Unit 2.11: Mixed economic system
Mixed economy: it is an economic system where private and public sectors co-exit, and the
private entrepreneurs as well as govts allocate resources to produce goods and services. It
can also be said that when the government intervenes in a free market economy to
eliminate market failure, that economic system becomes mixed.
28
Advantages Disadvantages
1. Govt takes the responsibility to provide 1. Govt intervention involves taxes which
employment for those who have been distort market prices and lower work
unemployed by the private sector incentives
2. Govt provides public and merit goods which 2. Since govt enterprises don’t have profit
the citizens need but aren’t willing to pay for, motives, they are often inefficient
e.g. roads, streetlights, education (incurring high costs), while also producing
3. Govt makes laws to either discourage or ban poor quality goods/services
the use/production of harmful (de-merit) 3. Corruption is often high, leading to wastage
goods, e.g. drugs, cigarettes 4. Price controls can lead to black markets
4. Social costs of harmful goods catered for by the and smuggling
govt and are either taxed or outlawed, e.g. 5. Govt intervention can cause conflicts of
pollutants interest, as there are always winners and
5. Govt provides income and various essentials losers from govt policy measures
for the poor and needy and tries to improve
income inequality
6. Market failure is either minimized or alleviated
Why should the private sector’s role be high in a mixed economy? (pros of privatization)
1) Running public organization is expensive for the govt which may lead to high deficits and
hence high taxes. Greater role of private sector can reduce this
2) Private sector will produce better quality goods, with lesser wastage and inefficiency
than public sector enterprises
3) Greater competition among the private sector leads to more investment opportunities in
the economy which improves GDP and employment opportunities
Why should there be nationalization?
1) It is carried out to control large and powerful monopolies, especially those providing
essential goods/services e.g. electricity, water, gas, etc., to lower prices and increase
supply
2) To increase employment in economy
3) Some industries require large capital outlay which can only be financed/afforded by the
govt through taxes
29
Past paper practice questions (M2016-N2018)
1. Analyse, using a demand and supply diagram, the effect of an increase in income on the
market for ice cream. (6)
2. Analyse the external costs that can be caused by the building and expansion of an airport.
[6]
3. Analyse how price elasticity of demand for a product influences the revenue a firm
receives. [6]
4. Explain why the price of housing may increase. [4]
5. Explain two ways a government could reduce external costs. [4]
6. Analyse how an increase in the price elasticity of demand (PED) and the price elasticity of
supply (PES) of its products could benefit a firm. [6]
7. Analyse why demand for a product may become more elastic over time. [6]
8. Analyse how advances in technology can affect demand and supply. [6]
9. Analyse why price elasticity of supply can differ between products. [6]
10. Analyse how the market for a product would be affected by a reduction of the tax on
the product combined with a fall in the price of a complement. [6]
11. Discuss whether demand for cars is likely to increase in the future. [8]
12. Discuss whether the price of chocolate is likely to increase in the future. [6]
13. Explain the difference between private costs and social costs. [4]
14. Using a demand and supply diagram, analyse the effect of imposing a tax on fizzy drinks.
[6]
15. Explain the importance of price elasticity of demand for a government. [4]
16. Using a demand and supply diagram, analyse the effect of a rise in the price of Firm X’s
jeans on the market for Firm Y’s jeans. [6]
17. Analyse the social costs created by car production and car use. [6]
18. Discuss whether or not a market system benefits consumers. [6]
19. Explain how pollution is a market failure. (4)
20. Discuss whether a mixed economic system is considered the best. (8)
Answers to be discussed in my classes
30
Chapter 3
Unit 3.1: Money and banking

Money: it is a generally accepted medium of exchange.
Why do we need money?
1. To support specialization and exchange: Specialization is when we produce a certain
type of product in which we are good at and buy other products. When people specialize
in certain goods, they sell them for money, and from that money income, they buy those
goods and services in which they haven’t specialized. This leads to trade. Thus,
specialization and trade are facilitated by money
2. To overcome the problems of barter: barter is the trade of goods with other goods.
There are three main problems of barter; (1) in barter the value of each good must be
expressed in terms of every other good, which makes it tough to fix rate of exchange.
Money is used to fix prices of goods (2) it needs double co-incidence of wants, i.e. Ahmed
wants 5 tables from Sheraz in exchange for 10 chairs, but Sheraz will only give his tables in
return for a TV. (3) if someone wants to save his goods, it is very difficult to save for long
periods of time as they might perish/depreciate. Money can be saved for long time
periods.
Functions of money: Money overcomes problems of barter by performing the following

functions:
1. Medium of exchange: money can be used to buy goods and services as it is acceptable as
a tool for exchange
2. Unit of account: money can be used to determine the exchange rate, known as the price,
of all goods and services
3. Store of value: money can be saved as it retains its value for long time periods, unless
there is high inflation. Money can be used to accumulate wealth
4. Means of deferred payments: money can be used to make credit purchases, i.e. buy now
and pay later
31
What makes money good (characteristics of money)
1. Acceptability: issued by central bank, acceptable everywhere in the country by everyone
2. Portability: easy to carry
3. Durability: long lasting
4. Divisibility: can be divided into smaller units
5. Scarcity: limited in supply. Money cannot remain valuable if it is unlimited
Money supply: consists of three things: notes, coins and bank deposits
Financial assets: two types; near money/liquid assets which can be easily converted into
cash e.g. bank deposits, and illiquid assets which take time to be converted into cash and do
not perform most functions of money, e.g. physical assets like cars
Banks: these are financial intermediaries because they bring together customers who want
to save money and customers who want to borrow it.
Types of banks:
➢ Commercial banks: It is a bank which provides banking services to the private individuals
and businesses through a network of branches. It has many functions:
1. Keep money safely for customers in accounts, and give interest on saving accounts
2. Help customers make and receive payments through cheques
3. Lend money to its customers and charge interest for profit
4. Provides services like ATM, credit cards, lockers and can even provide services of
brokerage
5. Manages exchange rate of a country’s currency
6. Buy and sell shares for customers
7. Operate pension funds
8. Give financial advice to customers
32
Types of account Types of loans
A deposit account is a current account, savings An overdraft allows bank customers to

account or another type of bank account which overdraw their account by an agreed amount.
allows money to be deposited and withdrawn by It provides a convenient short-term loan, for
example, to pay unexpected bills.
the account holder.
A personal loan is repaid with interest over a

A current account or checking account is used by fixed period, usually for more than 6 months
the account holder for everyday transactions. and up to 10 years.
Most people will have their weekly or monthly
wages or salaries paid directly into their current A commercial loan is a loan to a business to
pay for operating costs and the purchase of
account.
materials and machinery. The loan is repayable
with interest over a fixed period of time.
A savings account is a safe place to store your
savings. Interest will usually be added to your A mortgage is a long-term loan, often up to 25
savings by a bank depending on how much you years, used by people or firms to buy property.
have saved and how often you can make
withdrawals
➢ Central bank: it is a bank that governs the banking system of an economy, and is in charge
of setting the monetary policy of an economy. It has the following functions:
1. It is the only organization that can issue notes and coins
2. It is the govt’s banker, as it makes and receives payments on its behalf
3. Manages the national debt of an economy
4. Supervises the banking system with banking regulations
5. It is known as the lender of the last resort, i.e. it lends to commercial banks when they are
facing a risk of default
6. It manages the gold & foreign currency reserves
7. It operates the govt monetary policy, i.e. sets interest rates and exchange rates to change
aggregate demand in an economy (will be discussed in detail in unit 4.2)
33
Unit 3.2: Households
Consumption:
Factor that effect consumption/ spending
1) Real disposable income: disposable income is that income that a person has left over
after income related taxes and charges have been deducted. Real disposable income
measures how much a person can spend from his income on goods and services, taking
into account inflation. Thus, real disposable income measures a person’s purchasing
power of his/her after tax income. Higher the real disposable income, greater will be
spending in the economy
2) Wealth: higher the wealth greater will be the spending in an economy.
3) Consumer confidence: higher the confidence of people about their jobs and future
incomes the more likely are they spend on goods and services
4) Interest rate: IR↑→ spend↓ → saving↑.
Interest rates are the return on saving and the cost of borrowing.
Savings:
Factors that affect saving
1) Income (disposable income): Rise in income has caused, over the years, a higher saving,
but at the same time a fall in saving ratio because people spend more of their income
rather than saving it.
2) Interest rate:↑IR → ↑saving as return on saving ↑
3) Consumer confidence: CF → saving↓ → spend ↑
4) Availability of saving schemes: the more opportunities there are to save, the greater the
savings in an economy will be.
Borrowing:
Why do people borrow?

1) To increase their expenditure on goods & services
2) People borrow to pay for their everyday expense e.g. bills
3) People borrow money to make big purchase e.g. mortgage for houses
4) People borrow money to set up business
5) People borrow money to expand the business
6) People borrow money to pay for higher education through student loans
34
What affects borrowing?
1) Interest rate: which is the cost of borrowing. Inverse relationship. So ↓IR → borrowing↑
2) Consumer confidence: if people think they will be unemployed in the near future, they
will decide against borrowing money because they won’t be able to repay that loan
3) Availability and ways of credit: if loans are readily available, borrowing will rise
Problems with borrowing
1) Bankruptcy and insolvency for firms/countries who cannot repay loans

2) Greater debt burden for the economy and firms
3) Greater opportunity cost, as the money used for high interest payments could have been
used for other purposes
Differences in spending, saving and borrowing patterns among people
1) Difference between Rich and Poor people
Rich Poor
1 They spend a higher amount of income They spend lesser amount of income as
as they have more income to spend they earn less
2 They spend greater proportion of income They spend greater proportion of income
on luxuries due to high incomes on necessities due to low affordability
3 They save a higher proportion of their They spend a greater proportion of their
incomes due to high incomes income due to low saving potential
4 They tend to borrow more for large They tend to borrow less due to low
purchases incomes and less wants
35
2) Difference between Older and Young workers
Older workers Young workers
1 They save a higher proportion of their They spend a higher proportion of their
incomes due to family commitments incomes due to lesser commitments
2 They tend to borrow more , They tend to borrow less due to lesser
incomes, while they less too
3 They tend to spend more on household They tend to spend more on
goods and children’s education entertainment/leisure
Note this does not include retired people,
who tend to indulge in dissaving
(withdrawals from past savings)
Unit 3.3: Labor markets
Factors affecting choice of occupation
There are two main factors that influence a person’s choice of occupation, i.e. which jobs
would a person prefer to do:
Wage factors Non-wage factors
➢ Wage/salary which can be in the form ➢ Working conditions (safety & ease)
of time rate (normally based on hourly ➢ Holiday entitlements annually
wage), piece rate (based on output ➢ Fringe benefits eg medical insurance,
produced per worker), and fixed salary staff car, etc
(based on a fixed monthly income ➢ Pension entitlements (post retirement)
stream) ➢ Promotion prospects
➢ Overtime pay: based on extra hours of ➢ Job security
work beyond the contractual time
➢ Bonuses: performance related
payments
Wage + Non-wage factors = Net Advantages of an occupation
36
In most jobs, there is a trade-off between wage and non-wage factors. E.g., if a job has
greater holiday entitlements, there are greater chances that wages offered in that job will be
low, while if a job is dangerous, it will offer a higher wage as compensation.
Wage determination in labor markets
Demand for Labor

Demand for labor is a derived demand. This means that it is derived/taken from the demand
of the goods and services produced by that labor. E.g. If the demand for chairs increases,
demand for carpenters increases as well.
Demand for labor → downward sloping curve

As the wages rise the demand for labor decreases as all firms are profit maximizing. If the
wages rise, cost rises and profit decreases. So, the demand for labor decreases.
Factors that shift demand for labor

1) Changes in consumer demand for goods & services: higher demand for the good
produced by a worker will lead to rightward shift in demand for the worker
2) Changes in productivity of labor: higher productivity leads to rightward shift in demand
for that worker
3) Changes in non-wage employment cost e.g. Compulsory health insurance for workers by
the govt leads to increase in cost of hiring workers which shifts demand for labor
leftwards
4) Change in price and productivity of capital: if capital becomes less productive or more
expensive, demand for labor shifts rightwards
Supply of Labor
Supply of labor is upward sloping curve as, if the wage rises, the supply of labor increases. As
willingness and ability of workers rises and vice versa.
Shift in supply curve

1) changes in the net advantages of an occupation e.g. fringe benefits, working condition.
Greater non-wage factors in an occupation will shift supply of labor rightwards
2) changes in the training & education: more provision of training and education will
increase supply of skilled workers (rightwards). Normally, supply of skilled workers is less
than supply of unskilled workers as time and cost of acquiring skills are high
37
Equilibrium Wage
SL
Wage Key point 5: this diagram
shows equilibrium in a
labor markets, where
W1 demand (DL) and supply
e
(SL) intersect at point e,
where W1 is equilibrium
wage and N1 is equilibrium
number of workers hired in
DL
a market/industry
N1 Labor
Change in equilibrium wage
Changes in Demand
S Key point 6: An
Wage
increase in demand
W2 causes an increase in
the wage, while a fall
W1 in demand causes a
decrease in wage
W3
D2
D1
D3
N3 N1 N2 Labor
38
Changes in Supply
S3
S1
Wage Key point 7: An
S2 increase in supply
W3
causes wage to
W1
decrease, whereas a
fall in supply causes
W2 wage to increase
N3 N1 N2 Labor
Reasons for differences in earnings (wage differentials)

The reasons for different people in different occupations earning different wages, like
teachers and doctors, are:
1. Different abilities and qualifications

Workers that have greater skills and educational qualifications are paid more than workers
with lower skills and qualifications. This is because such workers are high in demand as their
productivity is high. Moreover, such workers are low in supply as they require years of
training and education to acquire skills. This is shown in the following diagram
SS
SUS
Wskilled
Wunskilled
DS
DUS
Q1 Labor
39
2. Dirty jobs and unsociable hours: jobs that either are dangerous, e.g. working in oil fields,
or that require unsociable hours of work, e.g. night duty, have low supply of workers
which means that they offer higher wages than other normal jobs.
3. Job satisfaction and fringe benefits: high job satisfaction and fringe benefits are non-
wage factors, which increase supply of labor in such occupations as people want to work
more in such occupations, which is why lower wages are offered in such jobs
4. Labor immobility: Labor mobility is of two types: (i) occupational mobility, which refers
to the ease with which workers can change occupations/jobs, and (ii) geographic
mobility, which refers to the ease with which workers can move from one place to
another. Workers may earn differently based on their mobility/immobility.
Key point 1: Skilled workers are occupationally immobile as they are specialists in one
particular field
Workers may also earn different wages in same occupation due to differences in experience
among workers (experienced workers have low supply hence high wage), regional
differences in pay agreements between unions and employers, discrimination related to
gender, religion etc.
Unemployment S
Government intervention in labor markets WMIN

1. Minimum wage laws: this is a limit the
govt sets so that no employer gives wages to W
their unskilled employees below a certain
level. This is effective when it is above the D
equilibrium wage rate, but it causes
unemployment Labor
2. Making wage discrimination based on gender,
race, religion etc. is unlawful
3. Introducing training and educational
programs to improve workers skills and hence
their prospects in the labor market
40
Which is better: Private sector job or Public sector job?
Why private sector? Why public sector?

1. Private firms pay higher wage 1. Greater ease of jobs
2. They offer greater promotion 2. Higher fringe benefits like pensions
prospects 3. Greater job security
3. Greater chance of bonus payments 4. More rights given to workers
4. Greater prospects of training and
learning, thus greater job satisfaction
Wage differentials among different demographic groups

Younger and older workers
Younger workers have fewer skills, less experience, and hence are less productive, and so
they earn less as their demand is low and supply is high. However, they are more energetic,
they are open to working at flexible timings, and are open to acquiring latest training for
technological changes. Older workers have more skills and knowledge, greater experience,
and hence are more productive and efficient, and so earn more due to high demand and low
supply. They are however not very flexible, both in terms of timing and acquiring latest
training
Skilled and unskilled workers

Already discussed above through diagram
Public and private sector

Already discussed above
Male and female workers

Male workers on average earn more than female workers for the same jobs. This is due to
the following reasons:
• Discrimination
• Females tend to take career breaks/leaves to raise children
• Differences in choice of occupation, e.g. females tend to work in occupations offering
lesser wages
• More females tend to work part-time than males
However, this wage gap is declining recently as more females enter labor force as highly
skilled and educated workers, while there is also a fall in birth rates and anti-discriminatory
laws.
41
Industrial wage gap
Primary sector workers earn the lowest wages, as they are lowly skilled, there has been a
movement towards machinery which has lowered labor demand, while as their supply is
high, there is high level of unemployment in this sector in rural areas. Skilled manufacturing
workers are normally skilled engineers, and hence they have higher pays. However, unskilled
manufacturing workers earn low wages due to mechanization leading to low demand for
their labor. Services sector workers earn the highest wages, as they are highly skilled and
qualified, while the tertiary sector industries are continuously expanding around the world
which is increasing their demand.
Worker Specialization
This is when workers specialize in one type of task, also called division of labor.
➢ Allows workers to make best use of ➢ Reliance on others to produce goods

their skills that they want but which they can’t
➢ Can improve skills and productivity by produce themselves
doing same task repeatedly ➢ Boredom while doing same job which
➢ Skilled workers often earn more than can cause a fall in productivity
unskilled workers ➢ Some skills might become unwanted
and their demand may diminish which
may lead to high unemployment
Unit 3.4: Trade unions

Trade union: an organization which promotes and protects the interests of their member
(workers) with the purpose of improving their wages and working conditions. In return
members usually pay a membership fee.
Function of TRs
1) Improve wages and salaries
2) Improve working condition like better working hours
3) Improve other benefits such as holiday entitlement, pension
4) Encouraging firms to increase workers participation in business decision making
5) Supporting members who have been fired, who are taking industrial action
42
6) Developing skills of the members through training.
Types of trade union

1) General union: they represent workers from many different occupation and industries
and generally a country only has one
2) Industrial union: these represents workers in the same industry in a country e.g. doctors
union
3) Craft union: they usually represent workers with the same skills across several industries
e.g. engineers’ union and carpenters’ union
4) Professional association: these represent white collar workers in non – industrial and
professional occupation like generalist associations or bankers’ unions
Note: Union membership in the developing country is rising and falling in developed
countries due to a decline in the manufacturing industries and a growth in service sector and
due to an increase in the private sector of an economy which discourages union activity
Collective bargaining: it is the process of negotiating over pay and working condition
between trade union and employers
Union representation in the workplace
Closed shop: it is an agreement between the trade union and a firm to ensure that the firm
will not hire any worker who is not a member of the trade union.
Open shop: it is when a firm can hire both unionized as well as non-unionized workers.
Single union agreement: it is when an employer agrees to a single union representing all its
employees.
Factors determining bargaining power of trade union
1) a union is powerful when most or all workers in a firm or industry are its members
2) a union is powerful when its members are involved in providing goods that are essential
and which have no close substitutes (inelastic goods) e.g. electricity, education
3) a union is powerful if it can ably support its members financially during strike action
4) firm’s profits are high and workers’ wages are a small proportion of the firm’s total costs
5) Govt’s support to the union
43
Industrial action
is when negotiating between employers and union failed to end in agreement workers may
take disruptive industrial action to put pressure on their employer to address their demands
and grievances.
Types of industrial action

1) overtime ban: refusal to work beyond the work timings
2) work to rule: workers deliberately slow down production by complying rigidly with every
rule and regulation
3) go slow: when workers deliberately become inefficient
4) strike: worker refuse to work and may protest or may picket outside of their factories
Problems caused by Trade Unions

The main problem of the trade union is the fact that they can become very strong and can
cause industrial actions on the smallest of matters. These actions can have dire
consequences:
• Firms suffer higher costs and lose output, revenues and profits during such actions
• Union members do not get paid by the firm during strikers, lowering living standards and
causing high unemployment
• Consumers lose out on variety hence lower choice
• Economy suffers from bad reputation for business thus lower growth and investment
Arbitration: it involves employers and unions agreeing to let an independent referee, often
government officials or lawyers, to help them reach an agreement and break the deadlock.
Benefits of Trade unions:

• Workers get better wages and working conditions and are exploited less by employers
• Improved wages and conditions will increase job satisfaction and hence will motivate
them to produce better quality goods, making consumers better-off
• They provide training to workers to improve skills and productivity which, improves firm
profits
• They can improve a govt’s tax revenue if incomes and labor productivity increase
simultaneously, while also increasing a country’s GDP and export revenue
44
Unit 3.5: Firms
Firm: it is an organization where goods and services are produced
Classification of firms
Firms are classified based on three characteristics
1. According to different industrial sectors
There are three types of industrial sectors:
Primary sector is a sector that includes all the production or extraction of natural resources,
and which normally is the first stage of production. Agriculture, mining, oil, fishing industries
come under this.
Secondary sector is a sector in which unprocessed natural resources and other unfinished
goods are used to produce and manufacture other goods and services. It involves
manufacturing and construction firms
Tertiary sector is a sector that involves distribution and sale of goods and services to the
consumer. It includes all firms in the services industry, e.g. banking, retailing, education etc.
2. According to private or public sector ownership

Private sector firms are owned and controlled by the private individuals/organizations that
are not under government control. Private firms are of the following types:
Legal form Ownership Control Main source of Distribution of Liability

finance profits
Sole trader Owned by one The owner is the The owner’s The owner Unlimited
person decision maker personal savings receives all liability:
profits but is owner’s
also responsible personal
for all of firm’s assets are
debts at risk of
default
Partnership Owned by Partners Partners put in Partners receive Unlimited
multiple people collectively the capital all profits but liability:
(normally decide how to collectively from are also partners’
between 2-20) run the business their personal responsible for personal
savings all of firm’s assets are
debts at risk of
default
Joint stock It is owned by It will be It is financed by Any profit made Limited
companies one or more managed by one the sale of shares by a company liability:
shareholders or more directors to shareholders belongs to the share-
appointed by There are two shareholders in holders’
shareholders types of the form of personal
companies: dividends assets are
safe from
45
Private limited default,
company can only Shareholders only
sell shares to are not company’s
private individuals personally liable assets are
who are relatives to repay any at risk
or friends of company debts
existing
shareholders
Public limited
company can sell
shares publicly
through stock
exchange
Cooperative It is owned by its It is managed by From membership Members Limited
members a board of fee and drawings receive any liability
directors on reserves surplus revenue
appointed by its that is not
members added to
reserves of the
cooperative,
which are used
to run/finance it
Charity It is set up and It is run by a Gifts and Its aim isn’t
registered by a board of trustees donations from profit. Any
private individual people and surplus money
or another organizations will be
organization to reinvested in
provide beneficial the charity to
services for public fund the
benefit but it services it
cannot be owned provides
Key point 1: a shareholder is a part owner of a joint-stock company. There are two types of
shares: common stock (which has voting rights but get dividends at the end if there are any
left) and preferred stock (which does not have voting rights but get preference in receiving
dividends)
State-owned enterprises (public sector firms) are organizations that are owned and
controlled by the government primarily to carry out commercial activities in order to earn
revenue and to even earn profits. However, their main motive is not profit maximization,
and when they earn losses, those losses are financed from taxes. These organizations are
also known as public corporations.
Key point 2: public corporation are govt owned, while public limited companies are owned by
shareholders through stock exchanges.
46
Advantages and disadvantages of sole trader
1. Easy to start as little capital needed 1. Unlimited liability, i.e. owner can lose
with few procedures all his possessions to pay off any
2. Easy to manage as business not very business debt in case of bankruptcy
large and flexible timings 2. Complete responsibility lies on the
3. Personal contact/relationship with owner’s shoulders and in tough times
customers and staff he has to work for longer hours and
4. Full control of the business, hence he is bear all losses
his own boss 3. Lack of capital limits expansion and
growth
Advantages and disadvantages of joint-stock companies
1. Limited Liability 1. Required to disclose financial

2. Shareholders don’t have management information which is expensive and
responsibilities as directors are might disclose some company secrets
hired/elected 2. Can be expensive to form a public
3. Has a separate legal identity, i.e. it can limited company as advertising and
enter into agreements in its own name developing prospectus can be expensive
and not in the owners’ names 3. Double taxation, 1st on company profits
4. Partnerships normally convert into these and 2nd on shareholders’ dividends
for additional capital
3. According to relative size of the firm

Size of a firm depends on that firm’s total output and productive capacity. Moreover, the
size of a firm is measure and compared using following factors:
➢ No of worker (labor intensive firms)
➢ The amount of capital employed (capital intensive firms)
➢ Organization structure: larger firms are divided into different departments which have
different management buyers
Total sales of one firm in the market for the product
➢ Market share: x 100
Total sales of the product of all firms in the market
Greater the market share, greater the size of a firm
47
Small firms
These are firms whose market share and output is small.
Why do small firms exist? (advantages of small firms)

1. Small firm easy to control and manage, especially for sole traders
2. Personal contact/relationship with customers/staff which means better relations with
customers and staff, creating loyalty and worker motivation
3. Size of the market is often small, e.g. local food joints for specific places. In such small
markets, small firms create customer loyalty and their demand remains high
4. Nature of the product requires customized services e.g. hairdressing, tailors etc. Such
customized products/services are only created by small firms, and as the demand for such
goods always remains, small firms can flourish
5. Access to capital limited, which is why they cannot grow in size
Disadvantages of small firms

1. The owner of the small business is completely responsible for the day-to-day running of
the business as well as sharing the entire burden of any debts/losses
2. Small firms are usually vulnerable to takeovers from large firms and can struggle to
survive
3. Small firms face high average costs due to inefficiencies
Types and methods of growth for a firm

Before looking at types of growth, we should know the difference between short run and
long run time periods that firms face.
Short run time is when all factors of production (FoPs), except labor, is fixed and cannot be
changed. Only labor can be changed by a firm, and thus, growth is limited.
Long run time is when all factors of production are variable and can be changed. Thus,
growth can be easily achieved over a longer time as FoPs are variable.
Types of growth
• Internal growth: it involves expanding a firm’s own scale of production by investing
money in the firm to increase its FoPs. This can be done through investing a firm’s profits
(retained earnings) or through borrowing.
• External growth: it involves combining two or more firms’ production processes to form a
larger enterprise. This process is known as integration.
48
Integration
Mergers Takeovers
These occur when owners of These occur when a larger firm
multiple firms, usually of acquires smaller firms and takeover
similar size, agree to combine their business operations by buying
their operations to form a the smaller firms’ shares with or
larger enterprise. without any agreement.
Ownership structure changes Ownership structure changes
Types of integration/mergers
• Horizontal integration/mergers: firms in same industry and in same stage of production
merge with each other, e.g. cheese factory merges with another cheese factory.
Its benefits are (1) greater market share for a firm and greater profits, (2) economies of
scale as average costs fall.
Its drawbacks are (1) consumers may be exploited as competition falls which increases
prices and lower product quality, (2) diseconomies of scale as average costs may rise.
• Vertical integration/mergers
Backward integration: when a firm merges with another firm in the previous stage of
production, but the same industry, e.g. a cheese factory takes over a dairy farm.
Its benefits are (1) a firm can now control its own supplies, making supplies cheaper and
better quality and lesser disputes, (2) this can lead to economies of scale like purchasing
and marketing economies.
Forward integration: when a firm merges with another firm in the next stage of
production, but the industry remains the same, e.g. a cheese factory merges with its
retailer.
Its benefits are (1) it will be able to control its sales and hence charge prices according to
their will while also promoting their product the way they want to
Drawbacks of vertical integration (both combined) are (1) when a firm merges with other
firms in different stages of production in which that firm doesn’t have relevant expertise,
this creates efficiency problems causing diseconomies of scale, (2) the takeover of firms in
other stages of production requires a lot of capital which could have been invested in
other areas e.g. R&D, creating opportunity cost.
49
• Conglomerate integration: it is when firms in completely different industries merge with
each other, e.g. a cheese factory merges with a furniture factory.
Its benefits include (1) diversification which reduces risk, (2) increases customer base of a
firm thereby increasing sales and profits, (3) economies of scale.
Its drawbacks are (1) firm becomes too large and complex with many different
departments and management layers leading to slow and inefficient decision making, (2)
diseconomies of scale.
Economies of scale (EoS)

A fall in average costs as output rises
There are two types of EoS: Internal and External economies of scale
Internal Economies of Scale: As the firm expands, the average costs fall. Their types are:
1. Financial Economies: banks provide large firms with large loans at low interest rates and
easy conditions which lower costs
2. Marketing economies: large firms buy raw materials in bulk at discounted rates, while
they can advertise their products at large scale, spreading their advertising costs over
larger product range
3. Technical economies: large firms can employ specialist technical staff and machinery
which makes production more efficient
4. Risk-bearing economies: large firms can diversify products which makes it easier for them
to be protected against risk
External Economies of Scale: As the entire industry grows, average costs of firms fall. Also
known as economies of concentration. Their types are:
1. Skilled workforce: When the whole industry expands, it will result in availability of skilled
workforce which will lower training costs
2. Ancillary firms: similar firms situated nearby. E.g., small car part producer sets up in an
area where a large car manufacturer company operates
3. Shared infrastructure: with govt buildings roads, dams, airports, dock facilities etc. for
economic activity, firm’s share these infrastructures which lower costs
50
Average Cost AC
EoS DEoS
Q0 Output
Diseconomies of scale (DEoS)

This is when a firm grows too much, that is as the firm expands, average costs rise. Their
types are:
1. Management diseconomies: large firms are divided into numerous departments and
every department needs a separate manager, which may result in high costs, with
disagreements regularly associated with such scenarios, leading to inefficiency
2. Labor diseconomies: large firms need highly skilled workers and such workers have high
costs
3. Agglomeration diseconomies: when a company takes over or merges with too many
other firms producing different products at different stages of production
Returns to scale
Increasing returns to scale: as the firm doubles its inputs, output more than doubles
Constant returns to scale: as the firm doubles its inputs, output doubles as well
Decreasing returns to scale: as the firm doubles its inputs, output less than doubles
51
Unit 3.6: Production, costs and revenue
Production: it is a process of converting inputs into output, OR, it is a process of converting
raw materials into finished or semi-finished goods.
Specialization by firms: when a firm concentrates its production on one type of products in
which it can make the best use of its resources and hence add more value to its goods. The
opposite to it is diversification, in which a firm produces a wide range of products in case
one product’s demand falls.
Value added in production is the difference between the market price paid for a product and
the cost of natural and man-made resources which are used to produce that product.
Productivity
It measures the amount of output that can be produced from a given amount of input.
𝑻𝒐𝒕𝒂𝒍 𝑶𝒖𝒕𝒑𝒖𝒕
It is measured by the formula:
𝒏𝒐 𝒐𝒇 𝒘𝒐𝒓𝒌𝒆𝒓𝒔 𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅
Methods to improve productivity (of labor)

1. Division of labor: workers specialize in the jobs they’re best at/most skilled at.
2. Training workers to improve their existing skills
3. Rewarding increases in productivity with performance-based pays/bonuses
4. Increasing job satisfaction
5. Replacing old machinery with new, better ones
6. Lean production: production processes which reduce waste, increase speed and quality
leading to higher output
Capital vs Labor intensive firm

Capital-intensive production is when a firm relies more on machinery for the production of
its goods and services, and the ratio of capital is higher than labor. Manufacturing industries
are primarily capital intensive.
Labor-intensive production is when a firm relies more on workers for the production of its
goods and services, and the ratio of labor is higher than capital. Services and agricultural
sectors are primarily labor intensive.
52
Advantages of capital-intensive production Disadvantages of capital-intensive production
• Goods can be mass produced, especially • Capital can be very expensive while
if market size is big, which will reduce maintenance cost is high as well
average costs
• There is a lesser chance of disruptions • Breakdowns and power-cuts will disrupt
due to worker absences or strikes production
• Programmed equipment will not lose • It may be difficult to change production

skills, concentration or motivation process once a machine has been installed,
especially when consumer demand or
technology changes
Advantages of labor-intensive production Disadvantages of labor-intensive production
• Consumers may pay a high price for • Workers may end up with disagreements
many handmade and personalized and disputes against employers causing low
goods of high value productivity
• Labor can be more flexible than • Labor intensive methods aren’t suited for
machines large-scale/mass production
• There is a lower risk of losses due to • Workers may need to be trained and re-
power cuts and outages, and fixed costs trained for new skills which is costly
are low
Factor substitution: it is when a firm substitutes one factor of production for another, or
when labor is replaced by capital and vice versa for the production of goods and services.
Reasons for factor substitution (what determines demand for a FoP?)

1. The amount of goods and services consumers demand, e.g., if capital-intensive goods are
high in demand, demand for capital will be high
2. The market prices of labor and capital: if labor is more expensive than capital, demand for
capital will increase, and vice versa
3. Productivity of labor and capital: if labor is more productive, demand for labor will
increase, and vice versa
53
Costs: diagrams and calculations Costs TC
Fixed cost: it is a cost that does not A VC
change with the level of output. As output rises,
FC stays constant, e.g. rent, insurance,
depreciation, interest payments, etc.
B
Variable cost: it is a cost that changes with the FC
C
level of output. As output increase VC increases,
e.g. raw materials, wage costs etc.
Total cost = Fixed cost + Variable cost D

Output
Properties of TC curve
• It starts from where the FC curve intersects A-D: Total cost

the y-axis, and not from the origin. This is B-D: Variable cost
C-D: Fixed cost
because when output is zero, TC = FC
A-B: Fixed cost as it is the difference
• It is always parallel to VC curve, as their
between TC and VC
difference is FC which is always constant, and
so is the gap between TC and VC curves
Average fixed cost (AFC): it is equal to

fixed cost divided by total output (FC/Q), Costs
ATC
AVC
and it keeps decreasing as output rises
Average variable cost (AVC): it is equal to
variable cost divided by total output (VC/Q), and
it falls initially and then rises
Average total cost (ATC): it is equal to total cost
divided by total output (TC/Q), and it falls initially
AFC
and then rises. It is also equal to AFC + AVC
Minimum Efficient scale: the output where Q0 Output
average cost (ATC) is minimized and efficiency
maximized. Where a firm maximized EoS (Q0)
Note: AVC and ATC are not parallel, as their
difference, AFC, is not fixed. In fact, their gap
keeps reducing, as AFC keeps falling
54
Total revenue: it is the return from sales that TR TC
Profit VC
a firm earns. R/C
TR = Price per unit x Quantity of output sold
Profit = Total revenue – Total cost (TR-TC) BEP
Break-even point (BEP): it is where total revenue
equals total cost, or where profit is zero. Break
FC
even quantity or output (BEQ) is the amount of
output needed to cover all production costs.
𝑻𝒐𝒕𝒂𝒍 𝒇𝒊𝒙𝒆𝒅 𝒄𝒐𝒔𝒕
Loss
BEQ =
𝑷𝒓𝒊𝒄𝒆 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕−𝒗𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕 BEQ Output
Objectives of a firm
1. Profit Maximization: this means maximizing the gap between total revenue and total
cost.
Maximizing TR Minimizing TC
• Charge prices based on demand for a • Economies of scale (AC as output )

good (if D P and vice versa)
• Lower price of elastic good, increase • Efficient allocation of resources
price of inelastic good (minimize waste)
• Promotional/ad campaigns D • Using cheaper and more productive
FoPs
• After sale services to increase customer
loyalty
• Increase quality
Why are profits important?

1. They are necessary for an entrepreneur’s risk taking, as without it there would be no
incentive to take risk
2. They are a source of finance for a firm to expand its output
3. They are a measure of any firm’s success
55
2. Growth/Expansion: Firms can grow internally and externally. Any firm will grow if it is
able to increase its scale of production and hence increase output.
Why is growth important?
1. To achieve economies of scale (lower AC)
2. Increase sales and market share
3. Increases the chance of diversification and lowers risk
3. Survival: New and struggling firms find it difficult to survive in a market as set up cost are
high, competition from larger and well-known firms is high and consumer demand can
change very quickly. Therefore, in its initial stages a firm’s major objective is to survive. This
can also be an objective of already established firms, when an economy is going through a
recession when demand is low and so are profits.
4. Social welfare and environment objectives: there are some firms which aim to achieve
welfare for the poor and needy, and which aim to protect the environment from higher
pollution levels, e.g. charitable organizations, NGOs, etc.
Unit 3.7: Market structure and monopoly

Why do firms compete?
1) To increase their customer base that is to increase the number of people who are buying
their products
2) To increase sales and revenue
3) To expand market share
4) To achieve product superiority by either making their product better or by dominating the
market by out selling their rivals
5) To enhance the firm’s brand image
6) To maximize profit
56
Types of competition
Price competition
Firms compete by offering low/best possible prices
Non – price competition

• Involves competition in factors like ads, after sale services, customer services, quality, etc
• It offers best value for money for customers
Pricing strategies
Three factors that influence pricing decision of a firm

A firm can charge the best and the lowest possible price depending on whether:
1) The demand for that product is elastic or inelastic. if the demand is elastic, then yes price
should be lower but if it is inelastic lowering the prices will not be a beneficial for a firm
2) Competition is high or not
3) Costs of production are high or low
Three types pricing strategies:

1) Demand base pricing strategies: it involves setting a price according to how much
consumers are willing to pay for a product, whether the demand is elastic or inelastic
Demand based
Price skimming Penetration pricing

➢ Higher prices are charged for *Lower prices are charged to
products which are new and which increase peoples demand
don’t have substitutes but as and sales of a product. Usually
competition rises price are lowered. done for goods with low and
These goods have high demand elastic demand
2) Competitive pricing strategies: these involve setting prices at the same level or below the
prices of rival producer. Firms adopt aggressive competitive pricing strategies in this
57
➢ Destructive predatory
Charging very low prices sometimes even below cost in order to destroy rival firm’s sales
➢ Price wars
In this, if one firm cuts its prices, it is followed by a cut in price of most of the rival firm’s
entire product. This discourages new firm entering the market.
➢ Price leadership
It may be used to avoid price wars, where most of the firms agree to charge same prices.
3) Cost base pricing: this involves charging a price a certain percentage above the cost of
producing a product. This difference is known as firm’s mark-up and it is used to earn
profit
Cost base price = Average cost + Mark up
Market structure
It refers to the characteristics of a market, which include how many firms compete for the
market, the degree of competition between them, intent of their product differentiation and
the ease with which new firms can enter the market to compete with them.
Perfect competition:
Characteristics:
1) Many buyers and sellers
2) Identical product: homogeneity
3) All firms are price takers: no one firm has the power to set its own market price and all
the firms have to charge the same price. Prices are very low
4) Normal profits: economic profit i.e. no firm makes any sort of profits.
5) Perfect information: when all the firms in the market have the same information about
the other firms
6) No barriers to entry
58
Characteristic of imperfect competition
1) Rigorous price and non-price competition: compete furiously with each other through
prices and other means
2) Differentiated products: firms try to make their product better than their rival’s
3) Price levels vary with level of competition. Higher the competition the lower the price.
4) Firms can earn high profits and can increase their market share
Monopoly
If one firm has sufficient market power to restrict competition and influence the price and
the quantity traded in the market to its own favor or advantage, that firm is known as the
monopoly.
Characteristics of monopoly:
1) A monopoly can lower the supply of the goods and services that it is producing in order to
increase market price. This leads to an increase in the profit
2) It earns abnormal profit
3) It is a price maker firm: it has the power to set its own price of the product it sells
4) Imperfect information
5) High barrier to entry for new firms
Disadvantages of monopoly:
1) Monopoly offers less consumer choice and variety to people
2) Lower output and higher prices
3) Lower product quality as there is no competition
4) Inefficiency: resources are not used in an efficient way and these are wasted due to
organization slack
5) The need for regulation: concept of opportunity cost as money is tied up in regulation
Advantages:
1) Monopolies benefit from economies of scale which result in lower per unit cost
2) Lower cost could lead to monopolies charging lower prices to its customers
3) Monopolies can carry out extensive R&D to develop new product
59
Barriers to entry
Natural barriers
➢ When large firms are automatically more efficient than smaller firms
Artificial barrier
➢ When monopolies restrict smaller firms’ supply purposely
Natural barriers
1) Economics of scale: through lower avg. cost,b a monopoly can produce higher and better
output than smaller firms and it can also charge lower prices
2) Capital size
3) Historical reasons: brand image, brand loyalty
4) Legal consideration: patents and copy rights employed by the monopoly
Artificial barriers
1) Restriction on supply: monopolies tell the supplier of raw materials that if they supply raw
materials to anyone else, that monopoly will stop buying raw material from them
2) Predatory pricing: charging prices below average cost to destroy competition
3) Exclusive dealing: monopolies prevent retailers from stocking the products of competing
firm and since retailers are overly dependent on sale of monopoly products, they have to
comply
60
1. Discuss whether people would prefer to buy a product from a small firm or a large firm.
[8]
2. Analyse the economies of scale from which a farm may benefit. [6]
3. Explain two advantages a firm may gain from being a monopoly. [4]
4. Analyse why more women may enter the labour force. [6]
5. Explain two non-wage factors that influence an individual’s choice of occupation. [4]
6. Analyse why economics graduates are well-paid. [6]
7. Explain two reasons why productivity may fall. [4]
8. Discuss whether or not small firms are likely to survive in the long run. [8]
9. Explain two reasons why a person may be willing to work at night. [4]
10. Analyse how perfect competition differs from monopoly. [6]
11. Discuss whether small firms can compete successfully against large firms. [8]
12. Explain two possible causes of a fall in a worker’s earnings. [4]
13. Explain how money helps specialisation and trade to occur. [4]
14. Discuss whether the rich in one country will save more than the rich in another country.
[8]
15. Explain two reasons why older workers tend to earn more than younger workers. [4]
16. Explain two disadvantages that workers may experience from specialising. [4]
17. Explain the difference between average fixed cost and average variable cost. [4]
18. Analyse how a central bank might reduce household borrowing. [6]
19. Discuss whether it is better to work in the public sector or the private sector. [8]
20. Explain why fixed costs are high in the aircraft-making industry. [4]
21. Discuss whether the quality of products is likely to be higher in a monopoly or in a
perfectly competitive market. [8]
22. Analyse what may cause an increase in a country’s labour force. [6]
23. Analyse two internal diseconomies of scale that a large firm may experience. [6]
24. Explain two ways in which a central bank differs from a commercial bank. [4]
25. Analyse how the spending, saving and borrowing patterns of young workers may differ
from older workers. [6]
26. Explain two reasons why workers specialising can reduce the average cost of
production. [4]
27. Explain two reasons why someone may be willing to do a low-paid job with little job
security. [4]
28. Discuss whether workers working in banks always earn more than workers working in
farms. [8]
29. Discuss whether a trade union will always be beneficial for its members. [8]
61
Chapter 4
Unit 4.1: The role of the government

Government as producer: In all major economies, govts own factors of production to
produce and supply certain goods and services. These goods include merit goods like public
schools and hospitals, public goods like roads, dams etc., while state owned enterprises are
also in charge of providing important services e.g. Public transport, airports, electricity and
power supplies, etc., while also providing necessary services like low cost housing, subsidized
health, pensions, etc. As it is a producer, it also acts as an employer of public sector
employees.
Government as a consumer: Govt is also a major consumer of goods and services in a
country, and this consumption is known as public expenditure. It is of the following types:
Current expenditure: any day-to-day expenses of the govt e.g. govt employ wages.
Capital expenditure: long term investments e.g. cars of the govt, roads.
Transfer payment: welfare payments provided by the govt e.g. unemployment benefits.
Government as a regulator and tax collector: Govts set and enforce laws and regulations
that govern the way people and firms behave. Govts regulate markets to ensure markets do
not fail, and so that socially desirable outcomes are achieved by markets. The govts also set
and collect taxes, which are a main source of govt finance and expenditure, while there are
other objectives of raising taxes which we’ll discuss in unit 4.3.
Unit 4.2: Macroeconomic aims of the government

Macroeconomics: is the study of the overall national economy
Indicator: GDP, inflation, employment, tax exchange rate
Aggregate Demand: it is the total spending/expenditure on all goods and services in the
economy. It includes spending done by all sectors of the economy, namely households
(consumption), firms (investment), government (govt spending), and international markets
(net exports). Therefore:
Aggregate Demand = Consumption + investment + Govt spending + Exports – imports
OR AD = C + I + G + X – M
62
Aggregate Supply: it is the total output supplied in the entire economy over a given time.
Macroeconomic Equilibrium: it is where AD and AS intersect (AD = AS)

AS
The macroeconomic equilibrium any
Price level
economy faces is where its AD = AS.
This is where economy’s price level
(CPI) and economy’s output (RGDP) is
CPI determined
AD
Y Output/RGDP
Macroeconomic aims of the government

There are 6 major aims of the govt:
1. Economic growth: an increase in the total output of the economy, measured by real gross
domestic product (RGDP). Sustained economic growth is important as it creates more
business opportunities, employment, and improves living standards. Negative growth in
RGDP or recession is when total output in an economy falls, which leads to fall in incomes,
profits, employment, enterprise, tax revenue and living standards.
2. Full employment: it is when a government achieves the lowest possible unemployment
rate in an economy (where cyclical unemployment is zero). Low unemployment is
important as it increases output, incomes, lowers poverty and govt spending on welfare,
and raises enterprise and living standards.
3. Low and stable inflation/price stability: sustained increase in price level is called
inflation. Price stability and low inflation is important as people’s purchasing power is
protected, firm’s costs are controlled, exports are demanded and living standards are
improved.
4. Balance of payments stability: BoP records all the international transactions that a
country undertakes with other countries. It basically records all inflows and outflows of
money to and from a country. In simple terms, it is the difference between a country’s
exports and imports. A stable and favorable BoP is when either exports are more than
imports, or the gap between inflows and outflows of money is low and sustainable. A
63
favorable BoP is important for a country because a country may run out of foreign
currency if there is an unfavorable BoP, or it may experience high imported inflation, or it
may undertake massive debt burdens, or it may potentially adversely affect local firms.
5. Redistribution of income: this refers to reducing the gap between the rich and the poor
in an economy. Lowering income inequality is important as it is equitable to reduce
income gaps in an economy, and because it is important to improve the living standards
of the poor as well. Progressive taxes are normally used coupled with transfer payments
6. Environment protection: this refers to reducing the overall pollution levels and improving
cleanliness and viability of the environment for current and future generations. This is
important to improve living standards of people through improving health, while also
creating income for the economy through tourism.
Policies used to achieve these aims are known as fiscal, monetary (both known as demand
side policies) and supply side policies, all of which we’ll study in detail later in the chapter.
Conflicts between macroeconomic aims

Conflict in aims refers to when there is a trade-off in the govt’s macro aims, that is, when
they pursue a policy to achieve one aim, that coincides with them forgoing another.
1. Low unemployment OR low inflation: Low unemployment and price stability can often
conflict with each other. If there are policies that lower unemployment (demand side
policies), this leads to higher incomes, which leads to an increase in aggregate demand,
and as aggregate demand rises, that leads to high inflation. Moreover, if the govt wants to
reduce inflation, they might implement policies that may increase taxes, which may lower
employment opportunities as firms might not want to hire workers. We will discuss this
conflict in particular with each policy.
2. High growth and employment OR Favorable BoP: High growth and employment means
higher incomes. As there are high incomes, people tend to demand higher imports, which
creates an unfavorable and unstable BoP for an economy.
3. High growth OR better environment: High growth means high output being produced,
and greater the production levels in an economy, the greater will be the pollution levels in
the economy, which negatively affect the environment
Do conflicts always exist?

Not necessarily. We will see that supply side policies eliminate the conflicts between
inflation, growth and employment, the three most important economic aims of the govt.
Low inflation will encourage people to buy more, which increases growth and creates more
employment, while low inflation also encourages locals to buy domestic goods and reduce
imports, thus maintaining stable BoPs.
64
Unit 4.3: Fiscal Policy & Taxes
Government’s Budget
It is a forecast of the govt’s expected spending and revenue the govt may earn over a 12-
month period (financial year).
• Balanced budget: Govt spending = Govt revenue.
• Budget surplus: Govt spending < Govt revenue.
Normally the govt plans for a surplus when its economy is growing fast and there is high
inflation.
• Budget deficit: Govt spending > Govt revenue.
Normally the govt plans for a deficit when the economy is either in a recession or the
growth rate is very low.
Government spending: Objectives

• To provide public and merit goods
• To invest in national infrastructure e.g. roads
• To support agriculture and other industries through subsides
• To manage the macroeconomy through fiscal policy e.g. inflation, GDP
• To lower income inequality through welfare payments for poor e.g. unemployment
benefits, poverty support payments
Sources of govt finance

• Borrowing from private sector e.g. commercial banks and general public or public sector
borrowing i.e. central banks. National debt is the amount of money borrowed by the
public sector
• Sale of nationalized assets and industries
• Revenue from govt owned firms
• Revenue from direct and indirect taxes
Taxation: Objectives
• Taxes are used to generate revenue for public expenditure
• Taxes are used to manage macroeconomy through fiscal policy
• These can reduce inequality by taxing the rich and spending on the poor (progressive tax)
• Discourage people/firms to use/produce harmful goods (excise duties)
• Discourage people from buying imported goods (tariffs)
65
What is a good tax? (cannons of taxation)
There are six characteristic which a tax system should have.
1) Equity: they should be fair i.e. higher on rich and lower in poor
2) Non-distortionary: should not affect workers’ willingness to work or producers’
willingness to produce
3) Certainty: workers and firms should know when and how much tax they have to pay.
4) Convenience: firms and workers should not find it difficult to give taxes to the govt and
the govt should provide ease of tax payments
5) Simplicity: tax should be easy to understand and tax rates should not be too complex to
calculate, moreover govt should be able to collect tax easily and efficiently
6) Economic: The tax revenue govt collect should always be greater than the expenditure to
collect tax
Tax Systems
1) Progressive tax: it is a tax system which charges a higher income tax rate on the rich.
Higher the income, greater the tax rate, e.g. people earning between 0-50k pay 0% tax,
from 50k-100k they pay 5%, from 100k-200k they pay 10% and above 200k pay 15%.
Higher marginal rate of tax (MRT) is applied to high income people
2) Proportional tax: it is a tax system which charges the same tax rate on all income groups.
So the tax rate remains the same, e.g. people earning below 100k and above 100k pay
10% income tax. MRT stays the same throughout.
3) Regressive tax: it is a tax system which charges a higher income tax rate on the poor. So
higher the income, lower the rate, e.g. people earning between 50k-100k pay 15%,
people earning 100k-200k pay 10% income tax etc. Lower MRT is applied to high income
people.
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡𝑎𝑥 𝑝𝑎𝑖𝑑

Note: MRT = x 100
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
Tax
Progressive
Rate MRT means extra tax taken from
one extra unit of income earned.
MRT keeps changing with changes
in income, as shown in the example
Proportional
below
Regressive
Income
66
How to calculate tax rates (ART)?
𝑇𝑜𝑡𝑎𝑙 𝑡𝑎𝑥 𝑝𝑎𝑖𝑑
Average rate of tax (tax rate) = 𝑥 100
𝑇𝑜𝑡𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 𝑒𝑎𝑟𝑛𝑒𝑑
An example: this individual has an income of $25k. The MRT is given below. MRT shows this
tax system is progressive. We calculate tax rate
Taxable income MRT Amount of income Amount of tax paid in

bracket MRT is applicable to dollars
0-10000 0 10000 0
10001-50000 20% 15000 3000
50001 and over 40% 0 0
Total tax 3000
3000
Thus, ART = 𝑥 100 = 12%
25000
Types of taxes
Direct tax: are charged directly on the incomes of consumers and profit of producers. It is
mostly progressive in nature, as seen in the example above. They shift the demand curve
left.
Types of direct taxes include:
• Capital gain tax: it is a tax levied on the gains made from the sale of some asset
• Wealth tax: it is a tax on the personal wealth/assets/savings of a person
• Income tax: it is a tax levied on an individual’s income over a year
• Cooperative tax: it is a tax levied on the profits of corporations
❖ High revenue is generated: in case of

❖ Reduce work incentive as people may
progressive tax system
not work for fear of paying high taxes
❖ Reduce income inequality: taken from
❖ Tax evasion: people can hide their actual
rich and given to the poor
income and hence pay lower taxes than
❖ Based on ability to pay: progressive tax
what they should
❖ Negatively affects aggregate demand
which may reduce employment
67
Indirect tax: these are taxes that are added to the price of goods and services and are therefore
collected from transactions made by or spending done by people. They are always regressive in
nature, as most of the burden of such taxes falls on the poor. They shift the supply curve left, as
they increase the producers’ cost of production.
There are two main types of indirect taxes
Specific tax Ad Volerum tax
➢ These are a fixed amount of tax per unit of ➢ These are a fixed percentage of tax on the
a good, e.g. Rs. 50 per pack of cigarettes. price of a good/service, e.g. 16% sales tax
Excise duties (tax imposed on harmful in Pakistan. VAT (tax imposed on value of
goods) are examples of specific tax transactions at multiple stages of
production), GST (tax imposed on sale of
finished goods) and import tariffs (taxes on
value of imported goods) are examples of
ad volerum tax
➢ They shift the supply curve parallel to the ➢ They shift the supply curve left, but not
left, as they are a fixed amount at all price parallelly. This is because as the price of a
levels. E.g. a Rs. 50 tax on a good with price good rises, the burden of a 16% ad volerum
of Rs. 100 will remain Rs. 50 if the price tax will rise, and so the gap between old
increases to Rs. 150, as it is a fixed amount and new supply curves will keep on
of tax increasing as we move up the curve, as
shown. E.g. a Rs. 100 good will have a tax of
Rs. 16 (16% of 100), but if its price increase
to Rs. 150, the tax will now increase to Rs.
P 24 (16% of 150)
68
❖ Cost effective: lower cost of collection for

❖ they are inflationary: they increase
govt
prices of goods and services
❖ Expand the tax base as it is paid by
❖ they are regressive: poor bear a
young, old, children etc. Tax base means
greater burden
the amount of people legible to pay tax
❖ less predictable: can change very
❖ Can target a specific product to reduce
quickly
consumer/production
❖ They are flexible: can be lowered or
raised at short time span
Fiscal policy
It is a policy through which the government tries to achieve its macro aims by influencing
aggregate demand through the tools of taxes and government spending.
Expansionary (↑AD) Contractionary (↓AD)

➢ ↑in G or ↓ in T ➢ ↓ in G or ↑ in T
➢ Rightward shift in AD ➢ Leftward shift in AD
CPI AS AS
CPI
AD2 AD1
AD1 AD2
Y
Y
➢ Which aims are achieved? ➢ Which aims are achieved?

↑ in employment, eco growth ↓ in inflation, environment improves, ↑ in
BoP as imports ↓
➢ Which aims are not achieved? ➢ Which aims are not achieved?
↑ in inflation, ↓ in BoP as imports ↑, ↓ in employment & eco growth
environment worsens
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➢ CONFLICT IN AIMS ➢ CONFLICT IN AIMS
High employment and eco growth is Low inflation and improved BoP conflicted
conflicted by high inflation and low BoP by low employment and eco growth
Problems with fiscal policy

1. Fiscal policy is difficult to use optimally e.g. it can result in over-heating if aggregate
demand > aggregate supply leading to inflation and shortage. Sometimes fiscal policy
cannot be correctly measured and approximated. This is why sometimes a Govt. can
increase its expenditure to come out of recession much more than what is required which
leads to over-heating. This leads to conflict in aims of growth and inflation.
2. Fiscal policy can lead crowding out effect.
To increase govt spending, govt needs to increase borrowing from private sector→ fall in
investment in private sector as funds to invest falls
As govt borrows more, this leads to increase in loan repayments and interest payment of
the govt.
3. Expansionary fiscal policy can develop inflationary expectations. As a rise in govt
spending will mean people expect AD to rise, they will also expect inflation to rise, and
hence they demand higher wages to counter that, which leads to increase in firms’ costs
and that may cause cost push inflation.
Unit 4.4: Monetary Policy

It is a policy through which the govt tries to achieve its macro aims by influencing aggregate
demand through the tools of money supply (open market operations), interest rates and in
turn, exchange rates.
Open market operations are when central banks buy or sell govt bonds to change money
supply in the economy. There are two types of OMO: quantitative easing, which refers to
the central bank buying govt bonds from the public to increase money supply in the
economy, and quantitative restriction, which refers to the central bank selling govt bonds
from the public to decrease money supply in the economy.
70
Expansionary (AD↑) Contractionary (AD↓)
➢ ↑in MS or ↓ in IR and ER ➢ ↓ in MS or ↑ in IR and ER

➢ ↑in AD as borrowing ↑ and saving ↓ ➢ ↓ in AD as borrowing ↓ and saving ↑
and ↑ in exports and ↓ in exports
➢ Rightward shift in AD ➢ Leftward shift in AD
➢ Same diagram as XFP ➢ Same diagram as CFP

Similar to XFP Similar to CFP
➢ Which aims are achieved? ➢ Which objectives achieved?

↑ in employment, eco growth ↓ in inflation, environment improves, ↑
in BoP as imports ↓
➢ Which aims are not achieved? ➢ Which aims are not achieved?
↑ in inflation, ↓ in BoP as imports, ↓ in employment & eco growth
environment worsens
➢ CONFLICT IN AIMS (Problem) ➢ CONFLICT IN AIMS (Problem)

High employment and eco growth is Low inflation and improved BoP
conflicted by high inflation and low BoP conflicted by low employment and eco
Inflation is always and everywhere a growth
monetary phenomenon
Unit 4.5: Supply-side policy

These are policies that aim to increase aggregate supply of the economy by making markets
and industries operate in a more efficient manner in order to expand the productive
potential of an economy and increase its output. The biggest advantage of supply side
policies is that over the long run, they eliminate all conflicts in policy aims between
inflation, employment, economic growth and BoP, and achieve all the aims simultaneously.
Key point 1: As the diagram below shows, increased AS will mean higher output and hence
subsequently higher employment, and high AS also means lower price level, which improves
BoP as well.
71
Types of supply side policies
1) Tax incentive to a firm: tax rebates/holidays may be given to firms if they acquire new,
efficient technology, or if they train their workers etc.
2) Subsidies: it may be done by, for instance, providing
AS1 AS2
raw material subsidies to firms that may hire
greater environment friendly machines.
Price level
3) Improving education and training of labor
force: this increases labor’s productivity
which increases capacity to produce. CPI1
4) Labor market reforms: making sure neither the
trade unions nor the employers are too powerful so CPI2
that they do not exploit each other.
5) Competitive policies: anti-trust laws to enhance AD
competition which increases AS
6) Privatization: since private sector is more efficient,
Y1 Y2 Output/RGDP
privatizing public sector firms will increase AS.
Problems with supply side policies

1. Expensive to implement: the govt needs to spend a lot of money, which leads to debt
burden as well as opportunity cost
2. Lagged effects, i.e. takes 1-2 years for policies to be effective, and hence is extremely
useful in the long run, but not in the short run.
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Unit 4.6: Economic growth
The circular flow of income in macroeconomics dictate that:
National output = national income = national expenditure
Where national output of an economy is the total value of output of goods and services
produced in the economy, national income is the total amount of income earned by the
factors of production, and national expenditure is what people and organizations spend on
goods and services.
Gross Domestic Product
GDP: market value of the final output produced within an economy over a given time period.
There are 3 methods of calculating GDP:
1. Output Method: this involves adding up the value of output produced in each period by
every firm in every industry in an economy. However, only the final outputs are counted
otherwise double counting of the value of some outputs can occur.
2. Income method: all income earned by the factors of production while producing output.
Transfer payments are not included in GDP (welfare payments )
3. Expenditure method: spending by consumer + spending by organization + spending by
government + (exports – imports).
Real vs Nominal GDP

Nominal GDP : the value of total output in terms of its current market value is known as
nominal GDP. NGDP = Pc Qc
Real GDP : it measures changes in total output assuming prices are unchanged over time.
RGDP = Pb Qc ; where Pc is current year price, Qc is current year output, and Pb is base year
price.
Key point 2: RGDP is the value of output adjusted for inflation, hence using base year price.
RGDP is a better measure of output and hence economic growth than NGDP as RGDP shows
actual output figures.
For example, if Pakistan’s nominal GDP for 2013 was Rs 100b and in 2014 it became Rs110b,
while inflation in the economy for 2014 was 10%, nominal GDP would’ve risen by 10% but
real GDP did NOT rise at all (0% growth). This is because all the increase in the value of
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output (increase in NGDP) is attributed to an increase in prices of the goods in the country.
The ACTUAL output in terms of goods has NOT increased. However, if inflation had increased
by 7%, then the real GDP would have increased by 3%.
Change in Real GDP = Change in Nominal GDP – Inflation
Economic Growth
It is defined as an increase in RGDP of an economy over a time period. There are two types
of economic growth.
Actual Growth Potential Growth
➢ This is when an economy’s RGDP, or ➢ This is when an economy’s potential

actual output rises. to produce/capacity increases
➢ This can occur due to expansionary ➢ This occurs due an increase in

demand side policies pursued by the quantity and/or quality of FoPs
govt
➢ This is shown by a movement towards ➢ This is shown by a shift outward shift
the PPC in PPC
K
K
C
C
Factors that cause economic growth

➢ The discovery of more natural resources
➢ Investment in new capital and infrastructure
➢ Technical progress, e.g. technological advances
➢ Increasing the amount and quality of human resources through education, healthcare
➢ Reallocating resources to industries which are more productive and efficient, e.g. away
from primary sector to the tertiary sector.
74
Recession
Recession is when a country faces negative
growth rates and thus falling output for two
successive quarters (6 consecutive months).
The graph shows growth and recession
cycle of the US between 1949-2011. There
are four periods of recession faced by the
US during this time: 1973-74, 1980-81,
1990-91 and 2008-2009 (when growth rate
is below zero or negative).
During recession, the economy produces at
a point below its PPC (point A in the
diagram on the previous page).
Key point 3: Economic depression or slump may
last several years during which there is a
continuous fall in real GDP. So, it is a prolonged
recession
Consequences of recession
➢ Fall in output
➢ Fall in profits of firms
➢ High unemployment
➢ Fall in world trade
➢ Crisis in financial markets
➢ Fall in incomes and living standards
Why is GDP statistics useful?

1. Measures standard of living
2. Measures economic growth
3. Compare standards of living and economic performances with other countries
75
Business Cycles
Ups and downs in the economy are called business cycles. They are explained under:
➢ Boom: a time period, where businesses are earning huge profits and employment is very
high
➢ Depression: a time period in which profits start falling, output falls and employment
declines
➢ Slump or recession: a time period in which businesses are facing huge losses, production
is at its lowest and unemployment is at its peak
➢ Recovery: a time period where businesses and economy start recovering from slump,
output starts rising and unemployment rate falls
Benefits of economic growth

➢ Greater availability of goods and services
➢ Increased employment opportunities
➢ Increased sales and profits
➢ Low and stable price inflation if growth in output matches increase in demand
➢ Increasing tax revenue for govt
➢ Improved living standards and economic welfare
Negatives of economic growth

➢ May lead to massive income inequality as benefits of growth concentrated with the elite
➢ Technical progress may replace workers with machines leading to unemployment
➢ May use scarce resources at a fast rate which adversely affects future generations
➢ May increase air, noise and water pollution due to more energy used and output
produced
76
The best type of growth is known as sustainable growth which involves reducing the rate at
which we use up natural resources, reducing waste in production and consumption and
reducing harmful emissions by changing the way we produce and consume goods, and saving
resources for future generations.
Policies to promote economic growth
➢ Demand side policies (short run):

Expansionary fiscal policy through increased govt spending and reducing taxes increase
AD which leads to increase in output and employment.
Expansionary money policy through increased money supply, reduced interest rates and
exchange rates increase AD which leads to increase in output and employment
➢ Supply side policies (long run):
- Investing in education and training increases labor productivity
- Investing in economic infrastructure e.g. roads and dams improves economic capacity
- Giving tax cuts and subsidies lowers costs and increases willingness to enterprise
- Encouraging multinationals to establish plants in domestic country
All these policies lead to increase in output and employment
Key point 4: see diagrams in 4.3 and 4.5 for impact of the above policies on growth.
Unit 4.7: Employment and unemployment

Key employment terms
1. Labor force: it is the working population or economically active population of an
economy. It consists of all people who are willing and able to work. Hence:
Labor force = employed + unemployed
Key point 5: People not part of labor force include students undertaking education, retired
people, stay-at-home parents e.g. housewives, people in prisons, disabled people, and all
others who simply do not want to work.
2. Labor force participation rate: it measures the percentage of the working-age population
that is either in work or are looking for work.
3. Employment by industrial sector: this measures the number/proportion of people
working in agricultural and manufacturing sector, compared to services sector. In
developed countries, employment in services sector is high due to higher skills and higher
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demand of services industries due to higher incomes. This is opposite to the case of
developing countries where primary sector employment is high. As countries develop,
employment moves towards manufacturing and even services sector, as development
means change in a country’s economic structure.
4. Employment status: this shows the number of people employed full time, part time, or in
temporary work. Most workers, especially males, are in full time employment, while part
time employment has shown an increasing trend due to greater involvement of females
in labor force, while services sector e.g. education is also leaning more towards part time
workers.
5. Unemployment: it measures the number of people who are willing and able to work but
cannot find a job in an economy. Level of unemployment refers to the number of people
who are unemployed, while rate of unemployment refers to the proportion of labor force
that is unemployed.
𝑻𝒐𝒕𝒂𝒍 𝒖𝒏𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅
Unemployment rate = 𝒙 𝟏𝟎𝟎
𝑻𝒐𝒕𝒂𝒍 𝒍𝒂𝒃𝒐𝒓 𝒇𝒐𝒓𝒄𝒆
Causes of unemployment
Frictional unemployment: this occurs when a person is in between different jobs, or when a
person has just completed education and is looking for jobs.
Seasonal unemployment: this occurs due to change in demand for workers during different
times/seasons of the year, e.g. guides in the northern areas are employed during the
summers and unemployed during the winters.
Cyclical unemployment: also known as demand-deficient unemployment, it occurs when
there is too little demand for goods and services in the economy during an economic
recession. When there is a fall in demand, stock of unsold goods rises which lowers profits,
firms lower their demand for labor and off-load its current workers as well which increases
unemployment and lowers incomes which further lowers demand and hence creates greater
unemployment, and so on. This process is known as the multiplier effect.
Key point 6: whenever an economy has any cyclical unemployment, the economy is not
experiencing full employment. Hence if cyclical unemployment is zero, the economy is in full
employment.
Structural unemployment: arises when there is a long-run change in the structure of the
economy as the entire industry in an economy closes down because of a lack of demand for
such goods. Thus, such workers’ skills become redundant and they have to learn new skills to
find jobs again, e.g. producers of typewriters have had to learn different software
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programming and new computer production techniques to find jobs again as typewriters
became obsolete.
Technological unemployment: this occurs when new and inventive and effective technology
like robots and machines start replacing workers in the production of goods and services.
Imperfections in labor market

Imperfections in labor market, where demand for labor doesn’t equal supply of labor, can
lead to unemployment in a country. Reasons for such imperfections are:
➢ Powerful trade unions may force up wages which lowers labor demand
➢ Unemployment benefits may reduce incentive to work, lowering labor supply
➢ Other employment costs can reduce demand for labor, e.g. Medical insurance for labor
➢ Lack of information can prevent people from finding jobs
➢ Minimum wage legislation may reduce labor demand
➢ Labor immobility prevents workers from finding new jobs
Costs of unemployment
➢ Loss in incomes and increase in poverty
➢ Fall in health resulting from mental stress and depression
➢ De-skilling: loss of skill due to long term unemployment
➢ Increase in crime rates and social unrest
➢ Govt’s opportunity cost rises as it has to pay unemployment benefits
➢ Fall in govt’s revenue
➢ Fall in GDP and exports
Policies to reduce unemployment

➢ Demand side policies (short run):
Expansionary fiscal policy through increased govt spending and reducing taxes increase
AD which leads to increase in output and employment.
Expansionary money policy through increased money supply, reduce interest rates and
exchange rates increase AD which leads to increase in output and employment
79
➢ Supply side policies
Investing in education and training increase labor productivity.
- Investing in economic infrastructure e.g. roads and dams improve economic activity.
- Giving tax cuts and subsidies lower costs and increases willingness to employ.
- Encouraging multinationals to establish plants in domestic country
- Labor market reforms by restricting the power of the employer and trade union.
- Reducing unemployment benefits to increase willingness to work.
Unit 4.8: Inflation and deflation

Inflation is the persistent rise in the general price level over time in a given economy.
Different degrees of inflation are:
Creeping inflation: low inflation of 1-5%. Ideal for an economy
Walking inflation: inflation between 5-10%
Running inflation: inflation between 10-20%. Noticeable and unbearable for people
Hyperinflation: above 100%. When value of money is negligible. E.g. 100% inflation means
value/purchasing power of money halves. This destroys an economy.
Stagflation: when price level and unemployment are both increasing. Economy’s GDP
becomes stagnant.
Disinflation: When inflation is falling, but prices are rising at a decreasing rate, e.g. inflation
in Pakistan in 2013 was 17%, but it came down to 10% in 2014.
Deflation: when price level is falling, or when inflation is negative, eg. -5% inflation in 2015.
Table 1:
Year 2010 2011 2012 2013
Inflation 5% 10% 7% -3%
Impact on Price by 5% Price by 10% Price by 7% Price by 3%

price
Degree of Inflation Rising Inflation Disinflation Deflation (price
inflation (price rising at a (price rising at a falling)
rising rate) decreasing rate)
80
% change in price (inflation)
8
7
6
5
4
3
2
1
0
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
-1
-2
-3 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
The above diagram shows the inflation data of a country for 7 different years.
➢ Year 0-1 (grey line): Inflation = 3%. Inflation constantly increased till the end of the 1 st
year, and hence prices rose at an increasing rate in the 1st year at 3%.
➢ Year 1-2 (orange line): inflation = 3%. Meaning prices increased at a constant rate of 3%.
Key point 7: a common mistake made by students is that they think that prices remained
constant in the 2nd year. That is NOT true. Prices increased, but at a constant rate of 3%.
➢ Year 2-4 (red line): Inflation rose from 3% to 7%. Meaning prices increased at an increasing
rate during these two years (same as point 1),
➢ Year 4-5 (yellow line): Disinflation. Inflation fell consistently from 7% to 0%. Meaning
prices increased this year at a decreasing rate, till they became constant at the end of the
year.
Key point 8: another common mistake students make is that they think prices are
decreasing during the 5th year. That is NOT true. Prices are increasing, but at a decreasing
rate.
➢ Year 5-6 (black line): Inflation = 0%. This means prices are constant, as there is no inflation
is the economy.
➢ Year 6-7 (green line): Deflation of 2%. Meaning prices are decreasing at 2% by the end of
the year.
Key point 9: Keep in mind: highest price level in this time period was in year 5 as in the 1st,
while minimum price level in this time period was in year 1 (excluding yr 0)
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Measurement of inflation through CPI
Rate of inflation in an economy is calculated by calculating the average percentage change
in the price level of an economy, calculated through the Consumer Price Index (CPI) or Retail
Price Index (RPI). CPI/RPI is the average price level of all the goods and services in the
economy, and is known as the cost of living index. It includes indirect taxes on all goods and
services.
Steps of calculating CPI/RPI

1. Base year is determined in which key macroeconomic variables fluctuate at their
minimum
2. Categories of goods and services are chosen which are normally purchased by a ‘typical’
household in an economy in that base year.
3. Prices of each good in these categories are monitored over that time period and an
average price of each good is determined in the base year.
4. Assign weights to all the goods chosen in the basket, which is determined by calculating
the proportion of income spent by an average household on each good in the base year
5. Calculate Weighted Average Prices (WAP) of each category, and adding all the WAP
values to calculate the price of the entire basket in the base year. The formula of WAP is:
WAP = Avg price of each good x Weight of each good (step 3 x step 4)
6. Repeat the entire process to calculate the price of the basket of the current year (the year
of which we care calculating our CPI)
7. Calculate the Consumer Price Index of that particular year through the following formula
𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝒕𝒉𝒆 𝒃𝒂𝒔𝒌𝒆𝒕 𝒐𝒇 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒚𝒆𝒂𝒓
CPI current year = x 100
𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝒕𝒉𝒆 𝒃𝒂𝒔𝒌𝒆𝒕 𝒊𝒏 𝒕𝒉𝒆 𝒃𝒂𝒔𝒆 𝒚𝒆𝒂𝒓
8. Calculate inflation through the following formula:

𝑪𝑷𝑰 𝒐𝒇 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒚𝒆𝒂𝒓−𝑪𝑷𝑰 𝒐𝒇 𝒑𝒓𝒆𝒗𝒊𝒐𝒖𝒔 𝒚𝒆𝒂𝒓
Inflation of current year (year t) = 𝐱 𝟏𝟎𝟎
𝑪𝑷𝑰 𝒐𝒇 𝒑𝒓𝒆𝒗𝒊𝒐𝒖𝒔 𝒚𝒆𝒂𝒓
Uses of CPI
➢ As an economic indicator: As it is widely used to measure inflation, CPI is used as an
indicator of cost of living and hence purchasing power of people in an economy. It is also
used to calculate the real value of many economic series like incomes or GDP etc.
➢ Indexation: Indexation involves tying certain payments to the rate of increase in price
inflation to keep their real value constant. E.g. a worker demands that the employer
indexes his wage to the rate of inflation. So, if the inflation rate is 10%, his annual wage
increase will be 10%, while if it is 15%, his wage increase will be 15% as well.
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Problems with calculating CPI
➢ allocating weights can be a very difficult job
➢ collection of information on prices very difficult
➢ quality of goods cannot be identified through indexing
➢ selection of base year complex
➢ very difficult to compare different index between different countries
Types of inflation
1. Demand pull inflation: it occurs when the aggregate demand of an economy rises which
pushes prices up as supply cannot meet the rise in demand.
AS
Price level
CPI2
CPI1
AD2
AD1
Y1 Y2 Output/RGDP
One of the biggest causes of demand-pull inflation is monetary inflation. A rise in money
supply raises aggregate demand as people have more money in their pockets to spend but
the output hasn’t increases as much. This leads to increase in prices to equate aggregate
demand and aggregate supply again.
Monetarist economists argue that a simple way to control monetary inflation is through the
monetary rule, which states that increase in money supply should only equal increase in real
GDP, which will keep inflation constant.
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2. Cost-push inflation: it is caused by a rise in the cost of production which lowers aggregate
supply and hence increases prices and lowering output. One of the biggest causes of cost-
push inflation is known as wage-price spiral, which occurs when an increase in price leads
to workers demanding higher wages, which increases costs, which pushes prices up
further, and so on.
AS2 AS1
Price level
Key point 7: cost-push inflation is the

biggest cause of stagflation in the
economy, as seen on this diagram
CPI2
CPI1
AD
Y2 Y1 Output/RGDP
3. Imported inflation: when price level rises due to a rise in prices of goods imported from
abroad. This may be due to inflation in trading partners or depreciation of local currency.
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Inflation: good or bad?
Good for… Bad for…
➢ firms when the economy is experiencing ➢ consumers with fixed income when
creeping demand-pull inflation as profits inflation is high e.g. pensioners
rise while purchasing power remains ➢ consumers with low/medium incomes as
strong their purchasing power/real income falls
➢ unemployed as they will get more job ➢ firms especially in case of high cost-push
opportunities as businesses expand in inflation
case of creeping demand-pull inflation ➢ workers as real incomes fall and chances of
➢ govt as incomes and profits rise so does its unemployment are high if high cost push
tax revenue inflation
➢ borrowers as real interest rate falls ➢ Govt as revenue might fall while burden on
the govt of unemployed/poor due to
inflation also increases
➢ Exporters suffer as goods become
expensive in foreign markets, also
negatively affecting BoP
➢ Savers/lenders as real interest rate falls
Key point 8: Real interest rate = Nominal interest rate – Inflation rate.
Policies to control inflation
➢ Government announcing a long-term inflation target: if people believe that govt will
keep inflation low in the future, they are less likely to demand higher wages, which
reduce the chances of cost-push inflation
➢ Demand-side policies: to reduce demand-pull inflation, the govt should:
tighten/contract fiscal policy by reducing govt spending or raising direct taxes to reduce
spending
tighten/contract monetary policy by reducing money supply or raising interest rates to
reduce spending
➢ Supply-side policies: expanding productive capacity of an economy can reduce
inflationary pressures due to rising demand and production costs through policies like
improved training of workers, cutting corporation taxes, providing subsidies to firms, etc.
➢ Direct controls: govts may directly control prices and wages through:
limiting wage increases of public sector workers to reduce purchasing power and thus AD
capping the prices firms can charge from their customers through regulations e.g.
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maximum price laws
limiting the rate at which public sector enterprises can raise their prices
Policy choices and their effectiveness

➢ Demand-side policies: contracting AD is ineffective if inflation is caused by global factors
e.g. rising food and oil prices, or by cost-push factors. Contractionary policies can also
hurt low income people and create unemployment (conflict in aims).
➢ Supply-side policies: they are only effective in the long run
➢ Direct controls: limits on public sector wages will reduce incentive to work for the govt.
Cutting prices of private sector goods will reduce their profits and reduce incentive to
enterprise.
Deflation
Deflation is when the price level of an economy falls, and it experiences negative deflation.
There are two types of deflation:
Good deflation Bad deflation

• This occurs due to increase in aggregate • This occurs due to decrease in aggregate
supply of the economy. demand of an economy
• This results in price stability, and may even • This results in fall in spending and hence
lead to fall in prices in the long run, while profits, which leads to low demand for
economy’s productive capacity and output workers, which increases unemployment
rise and lowers wages, which causes further
• This occurs in the long run when the reduction in spending and living standards,
economy’s structure is strong which lowers investment in the economy,
• Supply-side policies can cause this and all of this results in a fall in
output/RGDP, or recession
AS2 • It signals the beginning of a recession, if it
AS1
lasts for a few months
Price • Govt tries to correct this deflation through
level expansionary fiscal (lowering taxes) and
monetary policies (lowering interest rates)
Price AS1
level
AD
AD1
AD2
Output/RGDP
Output/RGDP
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Past paper practice (M2016-N2018)
1. Analyse what can cause deflation. [6]

2. Discuss whether or not government policy measures to reduce unemployment will cause
inflation. [8]
3. Analyse how a high rate of inflation affects the functions of money. [6]
4. Explain two benefits to a government from a fall in unemployment. [4]
5. Discuss whether a decrease in income tax would reduce deflation. [6]
6. Analyse the effects of an increase in unemployment on inflation. [6]
7. Analyse how an increase in the rate of interest could increase unemployment. [6]
8. Discuss whether a government should increase tax rates during a recession. [8]
9. Analyse the causes of unemployment. [6]
10. Explain two costs of long-term unemployment to those who are unemployed. [4]
11. Discuss whether increasing government spending will reduce poverty. [8]
12. Analyze how inflation is calculated. (6)
13. Discuss whether a cut in the rate of interest would end deflation. [8]
14. Analyse how an increase in bank lending can increase economic growth. [6]
15. Explain the difference between demand-pull inflation and cost-push inflation. [4]
16. Explain the difference between direct and indirect taxes. [4]
17. Analyse how a fall in unemployment can increase tax revenue. [6]
18. Discuss whether a government should increase tax rates. [8]
19. Discuss whether the aims of low inflation and unemployment always conflict. (6)
20. Discuss whether inflation is worse than deflation. (8)
Answers to be discussed in my classes
87
Chapter 5
Unit 5.1: Development
Economic development involves an increase in the economic welfare or well-being of

people through growth in the productive scale and wealth of an economy.
A Developed country is generally thought of as having the following characteristics:
1. Large, efficient firms
2. Wide range of industries/firms
3. Availability of wide range of qualities goods
4. Good, well-developed infrastructure
5. Higher GDP per capita and HDI
6. Greater life expectancy but low birth rates
7. High quality education and health care
8. Good sanitation and sewerage facilities
9. Greater standards of living
10. Greater wealth/low poverty levels
11. More reliance and employment in the tertiary sector, and less in primary sector
A less developed country has normally the opposite characteristics mentioned above.
Lesser developed
countries
Under/Least Developing
developed Characterised by
Everything either growth in some sectors
static or worsening, and society getting
eg Zimbabwe more
prosperous/better off
:
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Comparing economic development in different economies
Developed economies Developing economies Least developed
economies
Industrial structure Largest sector in terms Secondary sector is Most employment in
of employment and expanding along with primary sector, while
output is tertiary, while tertiary industries, tertiary sector is small
primary is small while employment is
falling in primary
Educational High number of people Investment in Provision of education
attainment either undertaking and provision of schools poor and literacy
finished full-time and colleges rates very low
education from primary increasing, while
to higher education quality also improving
Healthcare Mostly access to free or Improving quality and Provision of
subsidized access to access to healthcare healthcare limited and
high quality healthcare quality poor
Factor productivity Most industries are Labor skills and Most industries are
capital intensive, while productivity improving labor-intensive and
labor and capital while increasing use of labor productivity is
productivity high capital poor
Saving and Virtuous cycle of Improvements in Vicious cycle of
investment growth: Banking banking systems and poverty: Poor banking
systems are well improving incomes are systems mean poor
developed which means improving savings and savings schemes, and
better savings schemes, investment prospects, as incomes are low,
causing greater savings and to a lesser extent this causes low
as incomes are high due are leading to virtuous savings, which creates
to high productivity, cycle of growth low funds for
which leads to greater investment, which
investment lowers growth and
opportunities for investment, which
private sector, causing further lowers
high investment, which incomes, etc
causes economic
growth, which causes
higher incomes, etc
Population Growth rates slow as Growth rates high but Growth rates very
birth rates are less slowing down high as birth rate high
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Reasons for low economic development
➢ An over-dependence on agriculture to provide incomes and jobs
➢ Domination of international trade by developed countries which means that the rich
countries buy their natural resources at cheaper rates and they use these resources to
produce better quality output and sell these countries at high prices
➢ Lack of capital, which means such countries cannot produce products that they need and
which they can export
➢ Insufficient investment in education, skills and health-care
➢ Low levels of investment in infrastructure e.g. roads, dams
➢ High population growth
➢ Rapid corruption at govt level and infighting
Indicators of standards of living and development

It is an important objective of the govt to not only increase economic growth but also
improve standards of living for its citizens. Measure of living standards of a country are:
Gross Domestic Product (GDP)

It measures the market value of the final output produced within an economy over a given
time. It is also an approximation of overall income levels in the economy. The pace of
economy growth and development is measured by the rate of growth in the total output of
the economy, or real GDP growth rate.
GDP and RGDP are calculated as follows:
GDP = Pc Qc
RGDP = Pb Qc ; where Pc is current year price, Qc is current year output, and Pb is base
year price. Note RGDP is the value of output adjusted for inflation, hence using base year
price.
However, measuring and monitoring growth in RGDP reveals little about living standards and
economic welfare. There are other important indicators besides incomes like population,
purchasing power of each person, education, healthcare etc. that are not incorporated here.
GDP per capita

It measures average income per head or per person. E.g., if GDP of a country is 100m, and
population is 5000, then per capita GDP is 20,000. Changes in GDP per capita are a better
measure of welfare than total GDP because it takes account of changes in the population.
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However, nominal GDP per capita takes no account of impact of inflation on real value of
incomes. An even better measure of living standards is real GDP per capita, which takes into
account inflation. This measures the average purchasing power of each individual in an
economy.
𝑹𝑮𝑫𝑷
RGDP per capita = ( )
𝑷𝒐𝒑𝒖𝒍𝒂𝒕𝒊𝒐𝒏
However, is it the best measure of welfare? No, because it has a lot of weaknesses:
➢ Income inequality cannot be measured as it is an average measure. So even if real GDP per
capita is high, it might be because the rich are very rich, while a sizeable population lies
below the average per capita income level
➢ It excludes the activities of the informal/underground sector of the economy which can be
an important sector of some 3rd world economies
➢ It takes no account of impact of growth on environment
Human Development Index

It provides a wider measure of living standards and economic welfare than GDP per capita
and is used by the UN to make comparisons between different countries. It combines three
different measures into a single index with a value between 0 and 1, 0 being the least
developed countries and 1 being the most developed countries with high living standards.
The three measures are:
1. GDP per capita: it measures the average income each household has in an economy.
Hence it measures people’s incomes
2. Year of schooling: it measures the average number of years each child spends in school. It
is a measure of literacy or education of a country
3. Life expectancy at birth: it measures the number of years an average individual lives in a
country. It is a measure of healthcare in a country.
With 3 different measures combined in one, it is a much more comprehensive measure of

welfare. However, there are a couple of weaknesses of HDI as well. Firstly, since it is a
composite index, it might not show an accurate reflection of welfare in a society. E.g., it is
possible for a country to have a high HDI value if average incomes are high, but a lot of
people might nevertheless be poor and have low life expectancy. Secondly, it fails to take
account of social factors like environment, political freedom and crime rates which are
important for the determination of living standards. Hence it too is not a perfect indicator,
though it is better than GDP indicators.
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Measures of poverty
➢ Absolute poverty: it is the inability to afford basic necessities needed to live well, e.g.
food, water, shelter etc. According to the UN, people earning less than $1 a day are
considered to be under absolute poverty
➢ Relative poverty: it is measured by the extent to which a person’s or a household’s
financial wealth falls below the average income level in an economy. It usually measures
income inequality in a country
In developing countries, absolute poverty is used as a measure of development. However,

since poverty is very low in developed countries, they use relative poverty as a measure of
development.
What causes Poverty?

1. Lack of resources: Many underdeveloped countries lack productive resources like skilled
labor, latest technology and efficient natural resources that hinder progress and job
creation, which lower incomes and food in such countries
2. Lack of education: low education standards create unskilled labor which is unproductive,
causing low incomes and poverty
3. Low wages and high unemployment: same as above
4. Old age, disability and ill health: these factors prevent workers from finding jobs and
creates greater burden on others for support which increases dependency burden and
poverty
5. Corruption: this leads to inefficient and unfair allocation of resource and govt’s revenue is
wasted instead of helping the poor, which causes high poverty
Measures to reduce poverty

➢ Reduce unemployment through expansionary fiscal/monetary/supply side policies
➢ Progressive taxation: taxing the rich and spending the revenue on the poor
➢ Provide welfare services and income support for people on very low incomes
➢ Provide low cost homes to the poor
➢ Minimum wage laws so that unskilled workers get enough wages to afford basic
necessities
➢ Improve quantity and quality of education for better job opportunities
➢ International aid, e.g. food and technological aid, by the developed countries to assist
developing countries
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Unit 5.2: Population
Causes of change in population

Three ways in which a country’s population grows:
1. The number of babies born increases
2. The number of people dying falls
3. More people arrive from overseas to become residents of a country (immigration) than
there are people leaving the same country (emigration)
The natural rate of increase in a population is the difference between the birth rate and
death rate of a country. In 2010, this figure was above 150 for developing countries and less
than 30 for developed countries.
Factors affecting birth rates

The average number of children born in a country each year compared to the total
population is known as birth rate, expressed as the number of births per 1000 people in the
population. Factors affecting birth rates are:
➢ Living standards: With better healthcare and living standards in the developed countries,
there have been fewer babies dying in developed countries and hence lower birth rates.
In developed countries though, as more babies die due to poor living conditions, birth
rates are high
➢ Contraception: increased used and knowledge have decreased birth rates in developed
countries, which is not the case in developing countries.
➢ Customs and religion: discouraged use of birth control by some religions and customs in
developing countries increase birth rates there
➢ Changes in female employment: in developing countries women employment is still low
while in developed countries female employment is continuously increasing, thus
decreasing birth rates there
➢ Later marriages: in developed countries, hence lower birth rates
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Factors affecting death rates
The average number of people who die each year compared to every 1000 people measures
death rate. Factors affecting death rates are:
➢ Living standards: better living conditions have significantly lowered death rates in
developed countries, which is not the same for developing countries
➢ Medical advances and health care: life expectancy at birth is low in developing countries
due to poor health care and many diseases that are widespread in these countries, while
in developed countries medical advances have reduced death rates significantly
➢ Natural disasters and wars: in many African countries such wars and disasters have
meant higher deaths
Net migration
It measures the difference between immigration (people coming in) and emigration (people
going out). If immigration > emigration, it is known as inward net migration or net
immigration, while if immigration < emigration, it is known as outward net migration, or net
emigration.
Increasing migration from less-developed to developed countries has helped boost their
working population, but it has also increased demand for housing, education and welfare,
while it has also increase govt’s burden, while lesser-developed countries lose skilled
workers although overpopulation decreases.
Consequences of population growth in developed and developing countries

In developing countries, rapid population growth puts greater pressure on the economy,
leading to higher unemployment, greater poverty, higher illiteracy rate and worsening living
standards. Some people, especially skilled workers, will move abroad for better jobs which
will decrease the availability of skilled workforce in such countries, thus lowering output and
economic growth.
In developed countries, eg. Scandinavian countries, population is usually quite low, and
hence growth in population means resources are better utilized and the economy will move
closer to its optimum level.
However, if population is already quite high, greater population growth due to inward
migration may lead to greater pressure and burden on resources and may even lead to
greater unemployment and lower incomes. However, if the inward migration is mostly of
skilled workers, then output may rise which may lead to high economic growth and better
living standards, but that may lead to unemployment experienced by locals.
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Dependency Ratio
It compares the number of people in the dependent population, which is that part of the
population that does not work and relies on others for goods and services, with the working
population of the country.
𝒅𝒆𝒑𝒆𝒏𝒅𝒆𝒏𝒕 𝒑𝒐𝒑𝒖𝒍𝒂𝒕𝒊𝒐𝒏
Dependency ratio =
𝒘𝒐𝒓𝒌𝒊𝒏𝒈 𝒑𝒐𝒑𝒖𝒍𝒂𝒕𝒊𝒐𝒏
Dependent population includes young schoolchildren, students, housewives and old-age

pensioners.
What increases dependency ratio?
1. Illiteracy
2. Unemployment
3. Increase in school leaving age
4. Fall in retirement age
5. Increase in birth rates
6. Greater elderly population, which has been increasing recently particularly in the
developed countries
Pros and cons of high elderly population

Pros Cons
• They provide greater experience for a • They increase the dependency ratio which
country’s labor force lowers living standards and increases
poverty
• They can be used to train younger workers • Greater opportunity cost for the govt and
burden for the govt as the govt has to spend
more on their pensions and health care
• It is an indicator of high life expectancy •

which means better living standards, as HDI
value rise
Optimum population
A country is considered underpopulated if it does not have enough human resources to
make the best use of its other natural and man-made resources. A country is overpopulated
if there are too many people and too few resources to support them. Optimum size of
population is that which will allow a country to maximize output per head of the population
from its existing resources.
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The structure of population
Demography involves studying the characteristics of and changes in population. There are
characteristics of population relevant to our course:
Age distribution: it refers to the percentage of population in each age group. With falling
birth and death rates, there are growing number of people in developed countries of middle
aged and elderly people. However, in developing countries, more than one third of the
population is under age 15, hence the high dependency ratio as they are too young to work,
while elderly population is very low. This is because such countries have high birth and death
rates
Sex distribution: the ratio of males to females in a population is called sex distribution. On
average, the world’s sex ratio is around 1:1 which means that males and females are ore or
less similar in number. However, in developing countries, this ratio is unevenly distributed
among different age groups. Males are greater in number at low age groups as people tend
to prefer more male children in such countries which leads to female infanticide (female
children are aborted). However, females tend to live longer than males and hence females
are more in number than males in the older age group.
Population pyramid
The age and sex distribution of a population is displayed on a population pyramid. The
pyramid bulges in the middle for a developed country due to low birth and death rates,
while in contrast, many lesser developed countries have wide bases and narrow tops
because of high birth and death rates, as shown below:
Developed country’s pyramid
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Lesser developed country’s pyramid
Geographic distribution: it refers to where people live in a country. Around half of the
population of the world lives in urban areas, which is expected to rise further. Increasing
rural-urban migration gives rise to production, employment opportunities and living
standards. However, it has also resulted in increased consumption of scarce resources and
greater pollution and slums and congestion.
Occupational distribution: it refers to the types of jobs people do. As a country develops,
secondary and tertiary sectors flourish more and greater population tends to work in
tertiary/service sector especially. This is because, in such countries, people acquire more
skills and hence they are more suited to work in the tertiary sector, while they also prefer to
work in tertiary sector as it offers greater wages/rewards for their skills and productivity.
This is completely opposite in a lesser developed country where primary sector plays a much
more important role as people lack skills and education while resources are more directed
towards primary sector e.g. agriculture etc., and hence economic growth and standards of
living are low.
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1. Explain two reasons why a government would want to turn its country from a developing
into a developed country. [4]
2. Discuss whether or not developing countries benefit from producing mainly primary
products. [8]
3. Discuss whether or not a rise in the birth rate will benefit an economy. [8]
4. Discuss whether or not having more of its workers employed in the tertiary sector would
benefit the Liberian economy. [6]
5. Discuss whether or not a high rate of unemployment would always cause emigration. [6]
6. Discuss whether or not people in developed countries are likely to save more than people
in developing countries. [8]
7. Analyse why the elimination of absolute poverty would not solve the economic problem.
[6]
8. Discuss whether Gross Domestic Product (GDP) per head is the best measure of
comparative living standards. [8]
9. Discuss whether an ageing population benefits an economy. [8]
10. Discuss the economic arguments for and against a government raising the school-
leaving age. [8]
11. Discuss whether having a relatively small population is an advantage or a disadvantage
for an economy. [8]
12. Explain two causes of an increase in living standards. [4]
13. Discuss whether producing more food will increase living standards. [8]
14. Discuss whether developing countries should encourage foreign tourism. [8]
15. Discuss whether the Human Development Index is a good measure of living standards.
[6]
16. Discuss whether countries with high population growth have high economic growth. [6]
17. Explain the difference in age and occupational distribution among developed and
developing countries. (6)
98
Chapter 6
Unit 6.1: International specialization
Globalization
Globalization refers to economic, cultural, social, technological and political changes that are
increasing interactions and inter-dependence between people, firms and entire economies.
Why is globalization increasing?
➢ Improvements in international communication and transport and lower costs have
increased trade and specialization
➢ Increase in global economy with a high number of consumers demanding a wide range of
products from multiple countries
➢ Easier movement of workers from one country to another due to presence of
multinationals
International specialization
International specialization is when countries focus on the production of those goods and
services in which they are more efficient, rich and productive. This is because each country
has a specific set of resources that are more adept and skilled to produce a certain type of
good or service.
Advantages of int. specialization Disadvantages of int. specialization
• Higher level of output is produced as • It may lead to structural

countries specialize in those goods in unemployment as some industries may
which they are more efficient shut down as the economy focuses on
• Increased employment and income as more productive industries
higher output creates more business • Risk of over-specialization, which
opportunities which creates jobs means that the country will be highly
• Greater opportunities of international dependent on other countries for many
trade can result in higher export goods in which it isn’t specialized and
revenue and can also lead to better that can lead to high import burdens
product quality from abroad • Risk of over-exploitation of resources
• Higher economic growth and better such as oil and mineral deposits
standards of living
99
Multinationals
These are firms that run business operations in more than one country but will usually have
their headquarters based in their country of origin. Globalization has increased the success
of multinationals as well.
Advantages of being a multinational

1. Reach many more consumers and earn much more revenue
2. Avoid trade barriers by setting plants inside other countries
3. Minimize transport costs
4. Minimize wage costs
5. Raise capital for business expansion, R&D etc.
Advantages for host nation of MNC Disadvantages for host nation of MNC
1. Increase investment in new business 1. Exploitation of workers with low wages
premises, modern technology in developing countries compared to
2. Provide jobs and income, with MNCs their origin country
offering better wages than local firms 2. Natural resources exploited and
3. Bring into a country, knowledge and environment damaged as a result
skills, which other firms can use as 3. Profits switched to other countries to
well avoid taxes
4. Pay taxes which raises govt revenue 4. Local competition forced out as they
5. Increase export earnings for country may not be able to compete with
MNCs
5. May interfere in government decision-
making.
Unit 6.2: Free trade and protectionism

International trade
International specialization requires international trade, which involves the movement and
exchange of goods and services, and money across international boundaries. The sale of
goods and services (inflow of money) is known as exports while purchase of goods and
services (outflow of money) is known as imports.
Key point 1: 3/4th of trade is accounted for by developed countries.
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Advantages of free trade Disadvantages of free trade
➢ International trade allows countries to ➢ Less developed countries may suffer

benefit from specialization, through which due to free trade as it is very difficult
they produce a higher output of those to compete in world markets with
goods in which they are good at and trade developed countries, which can
with other countries, leading to higher create unemployment and decrease
GDP, incomes and living standards domestic growth in such countries
➢ It increases consumer choice as products ➢ Rapid resource depletion due to
that are not available in the domestic rapid trade and adverse climate
markets can be imported from abroad change
➢ It increases competition and efficiency ➢ Exploitation of workers and scarce
which improve quality of products resources
➢ It creates additional business ➢ May result in a loss in output,
opportunities for local firms to expand incomes and living standard if there
into foreign markets is over-reliance of imported goods
➢ It enables firms to use the best resources,
labor force and technology from all over
the world
➢ It increases economic interdependency
and reduces potential for conflict
Barriers to trade
In order to overcome the disadvantages of free trade, countries try to enforce barriers on
free trade to protect local firms and resources from exposure. Types of trade barriers are:
➢ Tariffs: these are indirect taxes on the price of imported goods to make them more
expensive to discourage domestic consumers from buying them.
➢ Subsidies: these are grants paid to domestic producers to help reduce their production
costs and sell their products at lower prices than the imported goods.
➢ Quotas: these are physical limits imposed on the number of imports allowed into a
country each month or year.
➢ Embargo: it is a complete ban on the importation of a particular product, or on all imports
from a particular country, e.g. Pakistan’s embargo of Israeli goods
➢ Excessive quality standards: high quality requirements on specific goods coming from
certain countries, e.g. EU’s quality standards on Pakistani mangoes.
101
➢ Exchange controls: this is a restriction imposed on the amount of foreign currency that
individuals can buy over a given time period.
Advantages of trade barriers Disadvantages of trade barriers
➢ To protect infant industries. Infant or ➢ They restrict consumer choice as

sunrise industries are those which have foreign products are imported in
been newly formed, having new, unique scarce quantity
technologies and firms have a lot of ➢ They restrict new revenue and
potential to grow. But initially, since they employment opportunities as firms
are weak, they can’t survive fierce foreign cannot expand to new markets and
competition supply may be short
➢ To protect sunset industries, which are ➢ They protect inefficient domestic
declining. But since they still provide firms which should in essence shut
employment to large number of people, down
they need to be protected from foreign ➢ Other countries might retaliate
competition which may cause conflicts
➢ To protect strategic industries like defense,
agriculture, energy
➢ To limit over-specialization so that the
country doesn’t produce very narrow range
of products which might be very risky
➢ To correct trade imbalance and lower
deficits
➢ In retaliation of other countries using trade
barriers
➢ Protects a country from dumping (an
activity in which a country may export a
good in surplus in their country to another
country and selling the product at a price
below average cost, so that they can
expand in that other country as well. This
will adversely affect local firms in the other
country where dumping is taking place)
102
Unit 6.3: Exchange rates
The external value of one currency in terms of another currency is that country’s exchange
rate. It can also be defined as the equilibrium price of one national currency in terms of
another. Eg, 1 US $ = Rs 155. This means that to buy one dollar, we need to pay 155 rupees.
What determines the exchange rate of a currency?

Just like the price of any good, the exchange rate of a currency is determined by the demand
and supply of that currency. Equilibrium exchange rate is where the currency’s demand
equals its supply.
Exchange SRs
This diagram shows
rate equilibrium exchange rate
of the rupee, where
demand for rupee and
ER1
supply of rupee are equal
and intersect
DRs
Q1 Quantity of
the rupee
Factors affecting demand and supply of a currency
Factors increasing demand of Rs Factors affecting supply
• Demand for exports (goods and • Demand for imports (goods and
services) increase services) increase
• Investment prospects in Pakistan rise • Investment prospects abroad rise
• Savings from abroad increase in Pak • Savings from Pak to foreign countries
• Positive speculation rise
• Negative speculation
103
Changes in Exchange rates
There are two types of changes in exchange rates.
Appreciation Depreciation
• It is when the ER of a currency • It is when the ER of a currency
increases in value and the currency decreases in value and the currency
becomes more expensive becomes cheaper
• E.g. Last month, $1 = Rs 150, but this • E.g. this month, $1 = Rs 150, but the
month $1 = Rs 155, this means that next month $1 = Rs 145, this means
the dollar has appreciated and rupee that the dollar has depreciated and
depreciated rupee appreciated
• Due to increase in demand or • Due to decrease in demand or
decrease in supply of the currency increase in supply of the currency
S2 S1
S1 S2
ER2 ER1
ER1 ER2
D2 D1
D1 D2
Reasons for changes in exchange rate

Reasons for appreciation Reasons for depreciation
• in exports in demand for local • in imports in demand for foreign

goods in demand for local goods in supply of local currency
currency in ER in ER
• in inflation in local country in • in inflation in local country in
price of local goods compared to price of local goods compared to
foreign goods in demand for local foreign goods in demand for local
goods and thus exports in goods and thus exports in
demand for local currency in ER demand for local currency in ER
• In interest rates in local country • In interest rates in foreign country
savings in local country in savings in foreign country in
demand for local currency in ER supply of local currency in ER
104
• Positive speculation (when people • Negative speculation (when people
expect ER to appreciate in future) expect ER to depreciate in future)
in demand for local currency in ER in supply of local currency in ER
• Entry of multinationals in local country • Exit of multinationals from local
in exports increase in demand country in imports increase in
for local currency in ER supply of local currency in ER
Consequences of Exchange Rate Appreciation
Remember: appreciation in ER leads to exports becoming expensive and imports becoming

cheaper.
When is ER appreciation beneficial?

In the short run. This is because in the short run, exports and imports are inelastic, so as
exports become expensive and imports become cheaper due to ER appreciation, the
demand for exports falls but by very little, while the demand for imports rises but by very
small amount, which means that export revenue increases (as in P X > in QX and XR = PXQX),
while import expenditure decreases (as in PM > in QM and ME = PMQM). Therefore,
country’s current account, or net exports (X – M) improves.
An improvement in current account or net exports means an increase in aggregate demand
(AD = C+I+G+X-M), and an increase in AD leads to an increase in GDP and a fall in
unemployment.
When is ER appreciation costly?

In the long run. This is because in the long run, exports and imports are elastic, so as exports
become expensive and imports become cheaper due to ER appreciation, the demand for
exports falls by a lot, while the demand for imports rises by a lot, which means that export
revenue decreases (as in PX < in QX and XR = PXQX), while import expenditure increases (as
in PM < in QM and ME = PMQM). Therefore, country’s current account, or net exports (X – M)
worsens.
A worsening of current account or net exports means decrease in aggregate demand (AD =
C+I+G+X-M), and a decrease in AD leads to a decrease in GDP and a rise in unemployment.
105
Consequences of Exchange Rate Depreciation
Remember: depreciation makes exports cheaper and imports more expensive.
When is ER depreciation beneficial?

In the long run. This is because in the long run, exports and imports are elastic, so as exports
become cheaper and imports become expensive due to ER depreciation, the demand for
exports rises by a lot, while the demand for imports falls by a lot, which means that export
revenue increases (as in PX < in QX and XR = PXQX), while import expenditure decreases (as
in PM < in QM and ME = PMQM). Therefore, country’s current account, or net exports (X – M)
improves.
An improvement in current account or net exports means an increase in aggregate demand
(AD = C+I+G+X-M), and an increase in AD leads to an increase in GDP and a fall in
unemployment.
When is ER depreciation costly?

In the short run. This is because in the short run, exports and imports are inelastic, so as
exports become cheaper and imports become expensive due to ER depreciation, the
demand for exports rises by a small amount, while the demand for imports falls by a small
amount, which means that export revenue decreases (as in PX > in QX and XR = PXQX),
while import expenditure increases (as in PM > in QM and ME = PMQM). Therefore,
country’s current account, or net exports (X – M) worsens.
A worsening of current account or net exports means decrease in aggregate demand (AD =
C+I+G+X-M), and a decrease in AD leads to a decrease in GDP and a rise in unemployment.
Exchange rate systems
➢ Floating exchange rate: when exchange rate is determined by the forces of demand and
supply with no government interference. Currency appreciates and depreciates
frequently on its own with no outside interference.
➢ Fixed exchange rate: when exchange rate is decided and fixed by the government at a
particular point, with complete interference and control of the govt, e.g. if demand for
their currency rises, that country’s govt will increase its currency’s supply to maintain
same the same ER
106
Pros and Cons Of Floating Exchange Rate
➢ The exchange rate automatically ➢ May cause instability of value of

adjusts, moving current account currency which could discourage trade
position to equilibrium/ eliminating and investment
deficits or surpluses ➢ May cause speculation, causing
➢ No need for the central bank to keep movements in value which lead to
reserves, foreign currencies/gold can be current account deficits or surpluses.
used for other purposes ➢ May cause imported inflation in case of
➢ Governments can pursue other depreciating pressures on currency
objectives more easily e.g. changing
interest rates to influence inflation
Pros And Cons Of Fixed Exchange Rate
➢ May be a greater degree of certainty ➢ Need to keep reserves, to intervene to
and stability, may promote trade and protect the exchange rate, involves an
investment opportunity cost
➢ May be less speculative ➢ Exchange rate may not be set at an
➢ Lessens imported inflation in case of appropriate level, if too high will
depreciating pressure on currency discourage exports, if too low, may
increase import prices – causing
inflation
➢ Policies taken to maintain the exchange
rate may conflict with other objectives
e.g. raising the interest rate may
increase unemployment/reduce
economic growth
107
Unit 6.4: Structure of the Current Account of the Balance of Payments
Balance of payments (BoP) records all the international transactions that a country is
involved in. It is divided into three categories: current account, capital account and financial
account. In O levels, we will be focusing on current account.
Exports and imports

Goods and services made by producers in one country and supplied to consumers in other
countries are exports. It involves the inflow of money into that country (credit item in BoP).
On the other hand, goods and services purchased by consumers in a country from the
producers located overseas are imports. It involves the outflow of money from that country
(debit item in BoP).
Visible trade involves trade in physical products, i.e. trade in goods. Invisible trade,
however, involves international trade in services, eg banking, insurance etc.
Current account
Current account is divided into four main components:
1. Trade in goods: it records all the receipts from exports of tangible goods and payments
for imports of tangible goods to and from the country.
2. Trade in services: it records all the receipts from exports of services and payments for
imports of services to and from the country.
These first two sections of the current account are accounted for in the balance of trade
of a country. This is calculated by adding all the exports of goods and services and
subtracting it with all the imports of goods and services.
3. Income account (primary income): it records all the income that local factors of
production earn abroad minus all the income the foreign factors of production earn
locally. It records all the income inflow and outflow to and from the country.
4. Current transfers (secondary income): it records all the transfer of money or benefits
between residents and non-residents. They are not payments for goods or services or for
the use of FoPs. This will include pensions, charity, social contributions, welfare
payments, foreign aid, gifts, etc.
Calculating Current account = Trade in goods + trade in services + income account + current
transfers.
108
Problems with trade deficit
Trade deficits are often sign of economic expansion. However, significant trade deficits can
cause some economic difficulties:
➢ If more money is paid out for imports, then this loss in money from the economy means
less is available to spend on local goods, which lowers firms’ profits and can cause higher
unemployment
➢ As the supply of currency increases to buy foreign currency to buy imported goods, the
exchange rate depreciates, making imports more expensive, thus increases imported
inflation
➢ To pay for deficits, govts need to borrow money from overseas which increases debt
burden of the country
Ways to correct trade deficit

1. Do nothing, because a floating ER should correct it. If deficits are high, this means imports
and greater than exports, meaning that the supply of currency is high this lowering the
currency’s ER. As the ER depreciates, exports become cheaper and hence the demand for
exports rises which starts to lower trade deficits
2. Use contractionary fiscal policy like increase taxes to reduce total demand in the economy
so that imports fall
3. Raise interest rates
4. Introduce trade barriers
Problems with trade surplus

➢ There may be political and economic pressure on the govt from foreign countries to
reduce surplus, as one country’s surplus is the other country’s deficit
➢ Higher exports increase local incomes which can increase aggregate demand of the
economy, causing demand-pull inflation.
➢ Due to higher exports, demand for the currency will exceed its supply and therefore the
value of currency will appreciate and stay high, which may lower demand for local goods
➢ Rather than having large surplus, the country can spend the surplus money on goods in
foreign markets that are not available in local country to increase consumer choice
Ways to correct trade surplus

1. Do nothing, because floating exchange rate should correct it. In surplus, exports are
greater than imports, so the demand for local currency is high. This causes the national
currency to appreciate, making exports expensive and thus lowering the demand for local
goods, which lowers surplus
2. Use expansionary fiscal policy
109
3. Lowering interest rates
4. Remove trade barriers
1. Explain how a country could have a trade in goods surplus, but a deficit on the current
account on the balance of payments. [4]
2. Analyse how a recession may reduce a country’s imports. [6]
3. Discuss whether or not a developing country will benefit from the removal of trade
restrictions. [8]
4. Discuss whether or not a fall in its foreign exchange rate will benefit an economy. [8]
5. Explain two reasons why a government may impose a tariff on imported gold. [4]
6. Analyse how a fall in the rate of interest may affect a country’s exchange rate. [6]
7. Analyse why a country could have lower production costs for a particular good than
another country. [5]
8. Discuss whether low unemployment in a country will encourage multinational companies
(MNCs) to set up there. [8]
9. Explain how two methods of trade protection may reduce imports. [4]
10. Explain two reasons why a country may stop exporting a product. [4]
11. Analyse how a country could reduce its reliance on imports. [6]
12. Discuss whether free trade always benefits producers. [6]
13. Discuss whether a country’s economy would be harmed if multinational companies
moved out. [8]
14. Discuss whether consumers would benefit from an increase in imports. [8]
15. Analyse how a fall in the value of a currency may increase a current account surplus on
the balance of payments. [6]
16. Discuss whether developing countries should encourage foreign tourism. [8]
17. Discuss whether protectionism saves jobs. [8]
18. Analyse the advantages that a country may gain from specialising in a product such as
smartphones. [6]
19. Discuss whether an increase in tariffs on imports would reduce unemployment. [8]
20. Discuss whether a government should devalue the country’s exchange rate. [8]
Answers will be discussed in class
110
Exam pointers
Exam pointer 1 is in chapter 1 (pg and exam pointer 2 is in chapter 2
Paper 1
Exam pointer 3: There are 30 MCQs in paper 1, which need to be completed in 45 minutes.
Exam pointer 4: It is advisable that you spend a maximum of 1 minute on questions that do
not include graphs or calculations. These are on average above 20 MCQs in any exam paper.
Exam point 5: As for the 8-10 questions that require calculation or have diagrams, spend
around 1.5-2 minutes.
Exam pointer 6: Above 70% (20+ MCQs) of the paper will come directly from these notes.
Such questions may include diagrams as well. The other 8-10 MCQs that do not directly come
from these notes will either be calculation questions using the formulas in these notes, or
some scenario/example related questions which will require evaluations on the spot. But
such questions will also indirectly require thorough understanding of the topics covered in the
notes.
Exam pointer 7: Calculation questions require you to memorize the formulas in these notes.
Exam pointer 5a: Some MCQs on demand and supply won’t have diagrams drawn in them, so
in such a case draw a rough demand and supply diagram on the side space to give yourself a
better chance of choosing the correct option
Paper 2
Exam pointer 8: There are two sections in paper 2, with a total of 2 hours and 15 minutes
required to attempt the entire paper.
Section A
Exam pointer 9: In section A, students are given an extract, and then there are approximately
6-8 data-response questions, from part (a) to (g)/(h). Questions range from minimum 2
marks to maximum 6 marks. Total marks equal 30.
Exam pointer 10: Read through the extract carefully. Spend around 3-5 minutes reading
through the extract and underline important information/data/economic terms so that you
can refer to them once you attempt questions.
Exam pointer 11: Any question that includes ‘using information from the extract’ means that
you are supposed to the refer to the extract for the answer. Any point that you write that is
not in the extract will NOT be considered correct.
111
Exam pointer 12: Question starting with ‘identify’ of 2 marks, usually part (a), does not
require any explanation. Just state the 2 points asked in the question, with no description.
Exam pointer 13: There is usually a calculation question worth 2-3 marks in this section,
which requires information/data given in the extract. Read through the data carefully and
memorize the formulas to attempt such questions. And do not be scared of these questions,
just because there is maths involved in such questions. Be confident.
Exam pointer 14: There is usually a 4-5 mark question that requires interpretation of a table
given in the extract. E.g. the question states whether the table supports economic
relationship between GDP per capita and HDI. In such questions the mark distribution is as
follows:
1 mark for stating the economic relationship that is being talked about in the question, e.g.
as GDP per capita rises so does HDI
2 marks for stating the country with the maximum and minimum values
1-2 marks for exception to the relationship. There will always be an exception to the trend,
e.g. there will be a country that may have a low GDP per capita but a high HDI.
Exam pointer 15: Remember there will be two discuss questions in section A. usually the 3 rd
last question, worth 5 marks, and last question, worth 6 marks. The strategy for discuss
questions will be explain later (in exam pointer 23)
Exam pointer 16: Do NOT spend more than 45 minutes on this section.
Section B
Exam pointer 17: In the new exam format from M/J 2020, this section has four questions, out
of which you are supposed to do 3 questions.
Exam pointer 18: each question is worth 20 marks and is divided into four parts, from part (a)
to part (d).
Exam pointer 19: The amount of points you are required to write in each part of a question
depends on the marks of the part. Divide the marks of any part by two. This is the number of
points you’re supposed to write, and then each point needs to be explained. So if a part is
worth 4 marks, 2 marks are for 2 separate points for that question, and 2 marks are for
explaining each point.
Exam pointer 20: Part (a) is worth two marks. This part is either a ‘define’ question in which
you’re supposed to define the stated term (all definitions in notes), or it is an ‘identify’
question, in which you’re asked to state any two things, with no explanation required.
Exam pointer 21: Part (b) is worth four marks. This part is an ‘explain’ question, in which
you’re supposed to write two points and explain those two points reasonably. No details
needed.
112
Exam pointer 22: Part (c) is worth six marks. This part is an ‘analyze’ question. Normally,
you’re supposed to write three points and explain each point. But sometimes, this question
specifically asks for two points. In such a case, your answer should be explained in detail with
a longer chain to construct any point.
Exam pointer 23: Part (d) is worth eight marks. This part is a ‘discuss’ part. This is the most
important part in any question. In any ‘discuss’ question, you’re supposed to write both sides
of the argument, or a ‘yes’ part of the answer and a ‘no’ part of the answer. I call this the
‘flip-side’ of an answer. Write 2-3 ‘yes’ points, and 1-2 ‘no’ points, and explain each point.
Make sure the total points should be at least four, but not of one single side. That will get you
no more than five marks. Ideal distribution is 2 ‘yes’ and 2 ‘no’ points.
Exam pointer 24: While selecting the questions that you will attempt in the exam, make sure
you focus on parts (c) and (d). This is because there are 14 marks for these two parts, and if
you know the answers of these two parts, there are greater chances of getting higher marks.
So, focus on these two parts, and attempt those questions who’s last two parts are your
strongest.
Exam pointer 25: Spend no more than 30 minutes on each question, and no more than 1 h 30
mins for this entire section.
Exam pointer 26: The questions that specifically ask you to draw a diagram means that the
majority of the marks will be allocated for the diagram. E.g. if the question is worth 6 marks,
4 marks will be allocated for the diagram and 2 marks for explanation. For detailed notes on
how these marks are distributed, look at exam pointer 1 in chapter 1 and exam pointer 2 in
chapter 2.
Exam pointer 27: Never write your answer in points. Always write in continuous
pros/paragraphs.
113
Formula Index
1) PED Q2 − Q1
%change in QD × 100
Price Elasticity Of Q1
Demand %𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
𝑃2 − 𝑃1
× 100
𝑃1
Δ𝑄 𝑃1
= × (note formula of PES
Δ𝑃 𝑄1
is same as this)
2) Total Price × Quantity

Revenue/Total
expenditure
3) Total Cost Fixed Cost+VariableCost
4) Profit Total Revenue – Total Cost
5) Average Fixed 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡

Cost 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
6) Average Variable 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡

Cost 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
7) Average Total cost 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡

𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
8) Average Revenue 𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
114
9) Productivity 𝑇𝑜𝑡𝑎𝑙 𝑂𝑢𝑡𝑝𝑢𝑡
𝑇𝑜𝑡𝑎𝑙 𝑤𝑜𝑟𝑘𝑒𝑟𝑠
10) Aggregate Demand C+I+G+X-M
11) Tax Revenue 𝑇𝑎𝑥 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 × 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
12) Consumer Price

Index (CPI) 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑏𝑎𝑠𝑘𝑒𝑡 𝑜𝑓 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟
× 100
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑏𝑎𝑠𝑘𝑒𝑡 𝑜𝑓 𝑏𝑎𝑠𝑒 𝑦𝑒𝑎𝑟
13) Inflation 𝐶𝑃𝐼𝑡 − 𝐶𝑃𝐼𝑡−1

× 100
𝐶𝑃𝐼𝑡−1
14) Unemployment 𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡

Rate × 100
𝐿𝑎𝑏𝑜𝑟𝐹𝑜𝑟𝑐𝑒
15)Labour Force Employed+Unemployed
16)Nominal GDP ∑ 𝑃𝑐 × 𝑄𝑐
17) Real GDP ∑ 𝑃𝑏 × 𝑄𝑐
18) % Change in Real % Change in Nominal GDP− 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛

GDP
19) Real Interest Rate Nominal Interest Rate−Inflation
20) Current Account Trade in goods+Trade in Services +

Income Account + Current Transfers
115
21) Dependency Ratio Dependant Population
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛
22) Current Account as a 𝐶𝐴

× 100
% of GDP 𝐺𝐷𝑃
23) GDP per capita 𝐺𝐷𝑃
𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛
Bibliography/References
• Baloch, Q. (2012). Comprehensive Economics IGCSE & O level .
• Grant, S. (2018). IGCSE and O level Economics, 2nd edition. Cambridge University Press.
• Latif, I. (2016). O level Economics, Teachers notes series. Read and Write publications.
• Moyinihan, D., & Titley, B. (2018). Complete Economics for Cambridge IGCSE & O level, 3rd
edition. Oxford University Press.
• CIE official site
116

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COMPREHENSIVE O’LEVEL ECONOMICS

2020 onwards CURRICULUM

Limited /Finite Wants are

1. Consumer good: goods that satisfy consumer wants.

Opportunity cost: next best alternative forgone

Link between scarcity, choice and OC

Conservation refers to saving of resources of an economy for future use.

Economy is an area in which economic activities of production, exchange and consumption

Use of PPC to depict resource allocation and Opportunity Cost

Use of PPC to depict efficiency/full employment and unemployment

Point B: full employment

Movement from A to B shows an economy’s

Inward shift in PPC due to decrease in quantity or

Reallocation from consumer to capital goods or primary to tertiary sector

1: When an economy decides to reallocate

Consumer goods The same is the case when resources are

Answers will be discussed in my classes

Microeconomics: it is a study of economic decisions and actions of individual consumers,

• How firms organize production

• What determines the total output of an economy

Unit 2.2: Resource allocation and markets role

What How for Whom

Market eco Mixed eco Planned eco

• Everything produced • Combination of pvt. firms • Everything owned and

Price mechanism: it is a way used by the private sector to allocate resources.

Step 1: for some reason demand for potatoes increase

Unit 2.4: Supply

Factors shifting supply curve rightwards (increase in supply to S2)

Unit 2.5: Market equilibrium

Price Excess supply S

Tabular example of equilibrium

Price Demand Supply

Shift in both curves at the same time

Quantity rises, Price uncertain Price rises, Quantity uncertain

Price controls (govt intervention in market)

Price Excess supply S

Which can be simplified into:

This can be further simplified into an easier formula

Year Price Quantity

Calculate PED? 0.5. Attempt it.

3 Type of goods Luxuries eg car, ACs - Necessities, addictive

4 Shape of demand Flatter, as ∆P < ∆Q Hyperbola, as ∆P = ∆Q Steeper, as ∆P > ∆Q

5 Relationship between In price in As ∆P = ∆QD, TR/TE In price in

Extreme types of elasticities

Uses of PED for firms and governments

% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒔𝒖𝒑𝒑𝒍𝒊𝒆𝒅

Burden of indirect tax and its revenue in graphical terms

Advantages of free markets Disadvantages of free markets

Government’s role in market economy

Market failure: inefficiency resulting from over or under allocation (misallocation) of

Reasons for Market Failures

2. Merit goods: definition already covered in unit 1

4. De-merit goods: definition already covered in unit 1

Unit 2.11: Mixed economic system

Why should there be nationalization?

Answers to be discussed in my classes

Unit 3.1: Money and banking

Functions of money: Money overcomes problems of barter by performing the following

A deposit account is a current account, savings An overdraft allows bank customers to