A2 economics

participation rate

the proportion of the population which is either in employment or officially registered as unemployed

returns to scale

the relationship between the level of output produced by a firm and the quantity of inputs required to produce that output

average costs

the total cost of employing all the factor inputs divided by the number of units produced; also known as average total cost (ATC)

broad money supply

total purchasing power that is available in an economy at a particular time. It is often termed M4 and includes the notes and coins plus all bank and building society deposits.

external diseconomies of scale

when costs of production rise because of developments outside a particular firm. Competition for inputs: The increase in the size of firms, and indeed the whole industry, can lead to greater competition for a limited number of productive inputs and, as a result, the cost of these inputs may increase. For example, there could be an increase in the cost of labour or land. Congestion: If a number of firms tend to be located in a particular area, this can lead to greater congestion, reducing the efficiency and effectiveness of the transport system and leading to an increase in costs.

economies of scale

where output can be increased using proportionately fewer inputs; also known as increasing returns to scale

diseconomies of scale

where the same proportional increase in productive factors gives rise to decreasing additions to total output; also known as decreasing returns to scale

closed shop

a requirement that all employees in a specific workplace belong to a particular trade union

x-inefficiency

a situation where average cost is not at its lowest point because monopoly power has given rise to inefficiency

wage drift

a situation where the average level of wages in an industry tends to rise faster than the supposed wage rates

benefits of economic growth

● Economic growth will lead to an increase in the standard of living of a country, resulting from the greater number of goods and services produced in the economy. ● An economy that is growing shows that the economy is doing well; this greater confidence in future economic prospects can encourage investment. ● Economic growth is likely to lead to a decrease in the level of unemployment in the country, although this will depend on the extent to which the extra output is produced through labour-intensive or capital-intensive methods of production. ● An increase in output, much of which is exported to other countries, may lead to the reduction, or possibly the elimination, of a deficit in the balance of payments.

Derivation of an individual demand schedule and curve

'Utility' refers to the satisfaction that is derived from the consumption of a particular product. Marginal utility is the additional satisfaction that is gained from consuming an additional unit of a product, whereas total utility is the total satisfaction obtained from the consumption of a given number of units of a particular product. The law of diminishing marginal utility states that the consumption of successive units of a product will eventually lead to a fall in marginal utility — that is, as a person consumes more units of a product, the satisfaction provided by each unit will be progressively less and less. There is a relationship between the law of diminishing marginal utility and the derivation of an individual demand schedule and curve. If the marginal utility of consuming an extra item of a product falls continually, a consumer will be unwilling to pay as much for each successive unit consumed. This explains why a demand curve is downward sloping from left to right.

Gini coefficient

A Gini coefficient is a way of measuring the extent of inequality in the distribution of income in an economy. It is measured as the ratio of the area between the diagonal line of total equality and the Lorenz curve to the total area under the diagonal. The bigger this area, the more unequal is the distribution of income. In this way, the Gini coefficient measures the extent to which the distribution of income in an economy diverges from the position of total equality. The lower the value of the coefficient, the more even is the distribution of income. The higher the value of the coefficient, the less even is the distribution of income.

closed and open economies

A basic approach is to consider the circular flow of income in a closed economy. In a closed economy, it is assumed that a country does not trade with any other countries in the world. If the circular flow of income is limited to the movement of incomes between households and firms, it is known as a 'two-sector economy'. If government is then added to the circular flow, it becomes a 'three-sector economy'. A more realistic approach would be to consider the circular flow of income in an open economy. In an open economy, it is assumed that a country does trade with other countries in the world. The circular flow of income, therefore, involves four groups: households, firms, the government and the goods and services that are exported to, and imported from, other countries. This is why such an open economy is known as a 'four-sector economy'. The basis of aggregate demand in an economy is consumption expenditure by households, and then the injections can be added to, and the withdrawals or leakages taken from, this expenditure.

role of the central bank

A central bank may wish to control the ability of commercial banks to lend money, such as through open market operations. This is the process of buying or selling government securities — that is, bonds and/or shares that are issued by the government. If a central bank wants to encourage bank lending, it will buy government securities.

deadweight loss

A deadweight loss occurs when there is a monopoly situation leading to a higher price and a lower quantity compared to the situation that would exist in a perfectly competitive market. In this sense, a consumer is worse off and so there is said to be a welfare loss.

deflationary gap

A deflationary gap shows a situation where equilibrium income is less than the full employment equilibrium — that is, aggregate demand in an economy is less than aggregate supply

abnormal (or supernormal) profit

A firm may, however, wish to make a profit that is above normal profit. This level of profit over and above normal profit is known as abnormal (or supernormal) profit.

inheritance and capital taxes

A government may decide to intervene in an economy to try to bring about a more equitable distribution of wealth, as well as income. Examples of taxes that can achieve this objective are inheritance tax and capital gains tax.

licence

A licence is where suppliers are given permission by a government to produce or sell something. The use of a licence gives the government some degree of control because it can limit the number of licences that it issues.

Rational economic model

A major assumption that underpins marginal utility theory is that consumers can always be expected to act rationally. Rational behaviour essentially means the following: ● Individuals will take decisions to maximise their own utility or satisfaction. ● Individuals have access to all the information that they need to make a decision at zero cost. ● Individuals take decisions that are based on a very careful comparison of the benefits and costs to achieve the optimum outcome. ● Decisions will be taken by individuals based on changes at the margin. ● The preferences of individuals and their attitude to risk are assumed to be fixed.

narrow money supply

A narrow money supply is mainly the cash that is available in an economy at a particular time. It is often termed M0 and includes the notes and coins held by the general public, in cash machines and in balances that the financial institutions have with a country's central bank. This narrow money supply is also sometimes known as the monetary base.

natural monopoly

A natural monopoly exists where a single supplier has a very significant cost advantage as a result of being in a monopoly situation. If there were competition, with other producers in the market, the costs of production would actually increase. In such a situation, the monopoly can be described as natural because it avoids the extra costs that would come about as the result of a duplication of resources. It may well be the case in a natural monopoly that one firm will have sufficient economies of scale to satisfy market demand more efficiently than two or more firms.

negative externality

A negative externality refers to the disadvantage that can affect a third party — that is, someone who is not directly involved in a transaction. Like a positive externality, a negative externality can be seen in relation to either consumption or production. For example, a third party might be negatively affected by the consumption of a loud music system by a neighbour. In terms of production, a third party might be negatively affected by pollution caused by a factory in the neighbourhood.

Role of the IMF and the World Bank

A number of organisations have been established since 1944 to encourage free trade and to reduce the extent of trade protectionism in the world market. These include the International Monetary Fund (IMF), the World Bank (formerly known as the International Bank for Reconstruction and Development) and the World Trade Organization. Policies have aimed to reduce the extent of protectionism, such as through the reduced use of tariffs, quotas and subsidies

pollution permits

A pollution permit, or tradable permit as it can also be called, is a particular example of a licence that can be issued by a government. The permit allows a firm to pollute the environment in some way, but only up to a certain level. This level will be less than the pollution that is taking place when the permit is first issued. The aim is that over time a number of permits will be issued, each one allowing a lower level of pollution than the previous one. It may not be possible to eliminate the pollution completely, but issuing pollution permits should bring the level of pollution down over a period of time.

positive externality

A positive externality refers to the benefit that can be gained by a third party — that is, someone who is not directly involved in a transaction. A positive externality can be seen in relation to either consumption or production.

poverty trap analysis

A potential problem with means-tested benefits is that, as people receive money in the form of benefits, they may no longer be entitled to as much support as before. This gives rise to what has been termed the poverty trap.

prohibition

A prohibition refers to a ban on certain products being supplied in an economy — a product subject to prohibition would be made illegal and consumers would be banned from the consumption of it.

property rights

A property right is the right of an owner of an economic good to decide how such a good is to be used. Market failure can occur in an economy because of the absence of clear property rights. This could apply, for example, to certain open spaces where there are common or community, not private, property rights. In such situations, a government could decide to extend property rights through the encouragement of a voluntary agreement. If, however, such a voluntary agreement was not successful, a government could, for example, introduce a system of pollution permits to deal with the market failure.

Regulations and regulatory bodies

A regulation refers to a law or rule that can be used by a government to reduce the extent of market failure in an economy. There are many examples of such regulation in different countries. In some countries, for example, a government may establish regulations to control monopolies. If a firm has too much monopoly power in a market, it can be referred to a commission (a body that can look into a monopoly situation), which can investigate whether the monopoly is acting against the public interest. Proposed mergers or acquisitions might also be referred to such a regulatory body whenever it is thought that they might be against the public interest, limiting the degree of choice for consumers. Regulations could also exist in relation to consumer protection. In many countries, regulations have been passed which give certain rights to consumers. For example, one regulation could cover the description of a product that is being sold to ensure that consumers are properly informed. A regulatory body will usually exist to ensure that such regulations are adhered to. In some countries, regulations could be used to protect the environment, such as through controls on the level of pollution. Regulatory bodies could be given the power to fine those who are responsible for the pollution of the environment. Regulations also exist in many countries to control the transportation systems. There will be a regulatory body to enforce these regulations.

Relationship between balance of payments and rate of inflation

A relatively high rate of inflation in a country will make exports more expensive, and therefore demand for them is likely to fall, but the demand for imports may remain unchanged, as many countries have a relatively high marginal propensity to consume imported products. In such a situation, the balance of payments is likely to deteriorate

disadvantages of cost benefit analysis

Absence of market prices: Cost-benefit analysis takes into account all costs and benefits, but not all of these will have a market price. For example, it is difficult, if not impossible, to establish the price of pollution. Need to use shadow prices, i.e. prices that are estimated rather than accurately calculated: In the absence of market prices, values will need to be estimated through the use of shadow prices, but this will not always be accurate, e.g. the valuation of time or an accident. The future: The costs and benefits of any project, such as the building of a road or a runway, will be spread over a long period of time, so it will be difficult to compare the interests of present and future generations. Discounted values: Future costs and benefits will need to be converted into present values through discounting, but this is quite a complex process. Spillover effects: It is recognised that a project will have spillover effects, but it may be difficult to establish what these are and how far they extend. Political versus economic decisions Cost-benefit analysis may produce a decision in favour of a particular project, but it may still be rejected because of political decisions

aggregate expenditure

Aggregate expenditure (AE), or aggregate demand, refers to the total demand for, and expenditure on, all that is produced in an economy. It can be represented in the following way: AD = C + I + G + X - M

externalities and market failure

An externality arises if a third party is affected by the actions and behaviour of others. A third party can be regarded as someone who is not directly involved. An externality can also be described as a situation where there is a spillover effect. An externality is external to a market transaction and so is not reflected in market prices. It can occur in relation to consumption or production. It is a form of market failure because if the cost or benefit is not reflected in market prices, it cannot be taken into account by all the parties involved in a transaction.

mutual interdependence

Another characteristic of firms in an oligopoly market structure is mutual interdependence. Firms in oligopoly take into account expectations about the behaviour of other firms in the market and it is this which gives rise to the kinked demand curve, a unique characteristic of oligopoly. This consideration of the behaviour of other firms in a market is an important feature of game theory.

vertical integration

Another form of external growth is vertical integration. This is where two or more firms at different stages of the production process join together. If this is going back to an earlier stage in the production process, such as a tyreproducing country taking over rubber plantations, this is known as backward vertical integration. If it is going forward to a later stage in the production process, such as a car producer taking over a chain of petrol stations and garages to act as distributors of the vehicles, this is known as forward vertical integration

Working population

Another way of expressing the number of people in a country who are available to work is to refer to the working population. There will always be some people who are too young to work, or who stay on in education beyond the school leaving age, or who are too old, or who are too disabled. All these people determine the dependency ratio of a country

using withdrawal/injection to calculate level of income

Another way of showing equilibrium income in an economy is through the withdrawal/injection approach. For income to be in equilibrium in an economy, the injections into the circular flow of income need to be equal to the withdrawals from the circular flow of income.

negative income tax

the payment of money to those people on low incomes instead of taking part of their income from them through income tax

Role of multinationals and foreign direct investment (FDI)

As has already been indicated, much of the investment in economically developing economies has come from multinational corporations. This investment is known as foreign direct investment (FDI). There are both advantages and disadvantages to the role of multinational corporations in developing economies. Advantages include the following: - They can bring jobs, creating more income, which can contribute to a multiplier effect. - They can provide more choice for consumers, leading to a higher standard of living. - They can lead to an increase in tax revenue for the domestic government, such as from taxes paid on profits. - They can bring technical knowledge that could lead to higher levels of productivity. - They can stimulate economic growth. - If the output produced is exported, this could lead to an improvement in the current account of the balance of payments. Disadvantages include the following: - They may use capital-intensive methods of production, which means that not many local jobs are created. - The jobs that are created may be relatively unskilled. - Much of the profits may be repatriated back to the home country and not re-invested in the local economy. - They may damage the environment. - They may try to influence the government of the country, leading to the possibility of corruption

Other indicators of living standards and economic development

As stated above, differences in real GDP are the most established way of comparing standards of living in different countries, but they are not the only method used to make such comparisons. Other approaches have been used, many of which combine both monetary and non-monetary elements, and these include the following composite measures: - Net Economic Welfare (NEW), also known as Measurable Economic Welfare (MEW) — this approach includes such elements as leisure hours, crime rates and levels of pollution. - Human Development Index — this takes into account real gross national income per head (at purchasing power parities in US$), life expectancy and years of schooling. - Human Poverty Index — this measures longevity, adult literacy and deprivation; in 2010, it was replaced by the Multidimensional Poverty Index. - Multidimensional Poverty Index — like the Human Poverty Index, which it has replaced, this focuses on the extent of deprivation in different countries

autonomous investment

Autonomous investment refers to expenditure on capital investment that is not the result of any changes in the level of national income in an economy — in other words, it is independent of any such changes. An increase or decrease in autonomous investment can be shown in a diagram by the aggregate expenditure line shifting upwards or downwards.

Behavioural insights and 'nudge' theory

Behavioural economics is the idea that consumers do not always act in what could be regarded as a rational manner. Behavioural insights into economic decision making stress the importance of understanding the actual behaviour of people in an economy, in contrast to the traditional approach which emphasises the importance of acting rationally. Nudge theory is an example of this behavioural insight into economic behaviour. The theory is based on the idea that the behaviour of consumers can be 'nudged' in a particular way. An example of this would be in discouraging the consumption of demerit goods. Medical evidence is very clear about the damage that tobacco can cause and yet millions of people carry on consuming tobacco. A government could decide to 'nudge' people away from the smoking of this harmful product. This could take the form of a moderate 'nudge', such as a government health warning which states that 'smoking can damage your health'. If this moderate 'nudge' did not appear to be working as effectively as had been hoped, a government could make the wording of the warning stronger, such as by changing it to 'smoking can kill'. Alcohol consumption is another appropriate example for the application of 'nudge' theory. Medical evidence is clear about the health dangers of excessive alcohol consumption, and so a government could decide to try to discourage the consumption of alcohol through warnings, such as 'drink sensibly'. In some countries, a government may decide to launch a 'Drink Awareness' campaign with the intention of making as many people as possible aware of the possible dangers of excessive alcohol consumption.

behavioural economic model

Behavioural economics, on the other hand, stresses that the behaviour of individuals may differ greatly from these assumptions — in other words, it is often irrational rather than rational. Behavioural economics attempts to explain behaviour that may appear as 'irrational'. It is not limited to economics, but also brings in concepts and theories from sociology and psychology. It is assumed that individuals take optimal decisions based on the information that is available to them, but behavioural economists suggest that there may be so much information available that individuals often take the same decision that they always have — that is, they often base decisions on past experience. In this sense, individuals are 'creatures of habit' and are strongly influenced by brands and the uses made of branding in marketing. The individual's ability, and indeed willingness, to act in a rational manner is therefore restricted in certain ways.

Diversification and conglomerate integration

Both horizontal and vertical integration (whether backward or forward) involve mergers of firms operating in the same market. In contrast, conglomerate integration is where two or more firms join together even though they are operating in entirely different markets that do not have any relationship with each other. Although this may appear illogical, it has the benefit of spreading risks in different markets through the process of diversification. For example, the brewing company Guinness diversified into publishing, producing the Guinness Book of Records among other titles.

budget lines

Budget lines show the possible combinations of two products that a consumer is able to purchase with a given income and fixed prices. Each of the combinations would cost the same total amount. Any point along the line will show the maximisation of consumption at the given income level.

paradox of value

Certain products that are vital to our survival, such as water, are not as expensive as products that are less crucial, such as diamonds. This is known as the paradox of value. The explanation of this paradox can be seen in terms of marginal utility and total utility. People will consume water up to the point where marginal utility is zero and total utility is high, whereas people will demand diamonds where marginal utility is high, but total utility is low.

Difficulties involved in measuring unemployment

Claimant count: The claimant count is one method of measuring unemployment in a country. This is where the number of people who officially register as unemployed is counted; they register so that they are eligible to claim any benefits (known as transfer payments) that the state may provide for those people who are unemployed. Labour force survey: An alternative way of measuring the number of people who are unemployed in a country is to take the claimant count and then add to it those people who are able and willing to work, but who have not officially registered themselves as unemployed. This is known as a labour force survey

constant returns to scale

Constant returns to scale indicate a situation where average costs remain the same even as the output produced increases. In this situation, a firm will add factors of production in the same proportion so that there are constant additions to total output.

components of aggregate expenditure and their determinants

Consumption: Consumption refers to the expenditure by households in an economy over a period of time. The main influence on consumption is the level of disposable income in an economy and the consumption function shows the relationship between income and consumption. Average and marginal propensities to save and consume: The proportion of income that is spent on consumption can be measured in two ways. The first way is the average propensity to consume. The average propensity to consume refers to the average proportion of income that is actually spent on buying goods and services in an economy. The proportion of income that is not spent is saved, so it is also possible to refer to the average propensity to save. It is possible that consumption actually exceeds income and so would need to be financed by using past savings. This is known as dissaving. Saving is generally regarded as a good thing for an individual, providing the person with the opportunity to buy something in the future, but it is also possible to view it in a negative way for society as a whole because it is a leakage or withdrawal from the circular flow of income and so could contribute to a fall in national income. This contradiction is known as the paradox of thrift. The second way of measuring the proportion of income that is spent on consumption is the marginal propensity to consume. Whereas the average propensity to consume is concerned with a given income, the marginal propensity to consume is concerned with a change in income and, in particular, with the proportion of that extra income that is spent. The proportion of the extra income that is not spent is saved and so it is possible to refer to the marginal propensity to save. Although the main influence on consumption is the level of disposable income in an economy, there are other possible determinants. These include: - the distribution of income and wealth - the rate of interest - the availability of credit - expectations about future economic prospects Investment: refers to the expenditure by firms in an economy over a period of time, such as expenditure on factories, machinery and equipment. There are many influences on the investment decisions of firms, but the main determinants are: - the rate of interest - changes in technology - the cost of capital goods - changes in consumer demand - expectations about future economic prospects - government policies, such as in relation to taxes and subsidies Government spending: This can include government spending on the wages and salaries of people who work in the public sector and on investment projects, such as a new road. There are many influences on the spending decisions of a government, but the main determinants are: - government policies on particular aspects of society - tax revenue - demographic changes Net exports: The determinants of net exports can include the following: - a country's GDP - the GDP of other countries - the relative prices of a country's exports - the quality, reliability and reputation of a country's exports - exchange rate movements

cost benefit analysis

Cost-benefit analysis provides a framework where all the costs and benefits of an investment project can be analysed, not only private ones. It is a particular feature of major transportation projects, such as the building of a road, a runway or a railway line. Its key feature is that the full social costs and the full social benefits are taken into account before a decision is made as to whether a particular investment project should go ahead. The advantage of cost-benefit analysis is that it takes a wide view of a project, considering its full impact on an economy and society over a period of time.

reasons for small firms

Despite the potential advantages of economies of scale, small firms continue to exist in many economies. The reasons for their continued survival include the following: ● The size of the market is small. ● The firm may be in a very specific niche market. ● The firm is providing customers with a service that requires personal attention. ● The firm may have only just started and so is relatively small at present. ● The owners of the firm prefer it to remain small. ● Small firms may receive specific financial support from government. ● Small firms may be more flexible in responding to changes in demand. ● Small firms may be more innovative and pioneering. ● The small firm may not be able to grow because of difficulties in raising the necessary finance. ● In some industries, there has been an increase in the process of 'contracting out' and small firms may benefit from this. ● A small firm may be more efficient — for example, its labour relations and levels of motivation may be better than in a large firm.

Shape of short-run average cost (SRAC ) curve

Each of these is U-shaped and shows the relationship between output and cost on the basis that capital is fixed in the short run. If a firm wishes to change output, it will have to change the amount of the variable factor being used, such as labour. The position of the average cost curves in the short run will therefore depend on the quantity of capital being used in the production process — in other words, there is a short-run average cost curve for each level of output.

factors contributing to economic growth

Economic growth in an economy can be brought about by a number of factors, including the following: - an increase in the number of workers - an improvement in the quality of labour — for example, the acquisition of new skills leading to a higher level of productivity - a greater commitment to research and development, in terms of both invention (the discovery of new products and new methods of production) and innovation (the bringing of these inventions to the marketplace) - an improvement in the state of technology - investment in capital stock - a move towards more capital-intensive production - increased mobility and flexibility of factors of production - a more efficient allocation of resources - development of new markets for exports - a reduction in taxes on company profits to allow firms more funds to finance investment - an upturn in the trade (or business) cycle

Actual versus potential growth in national output

Economic growth in an economy can come about by using the existing factors of production more effectively, such as by reducing the number of people unemployed. This can be shown by a movement from within a country's production possibility curve or frontier to a position on the curve or frontier. This is known as actual growth in the national output of an economy. It is also possible for the production possibility curve or frontier to shift outwards. This would be due to an increase in the quantity of the factors of production available in an economy and/or an increase in the quality of those factors. This is known as potential growth in the national output of an economy.

economic growth

Economic growth is defined as the increase in national output of a country over a period of time. It is usually measured in terms of a change in gross domestic product. It is important to distinguish between two types of growth in national output: actual growth and potential growth

Characteristics of developed, developing and emerging (BRICS) economies

Economic: Differences in the balance of the economic structure, i.e. the proportion of output produced in the primary, secondary and tertiary sectors of production Monetary: Differences in the level of income, usually measured by GDP per capita; countries can be divided into high income, middle income and low income Non-monetary: Differences in social factors, e.g. the percentage of GDP spent on education and health, the rate of adult literacy, the number of doctors per thousand of population, the number of hospital beds per thousand of population and the quality of water Demographic: Differences in terms of population growth rates, birth rates, death rates, fertility rates, average age and life expectancy

problems with trade and investment

Economically developing economies, however, have experienced particular problems, which means that they have not gained from international trade as much as might have been expected. These problems include the following: - Whereas economically developed economies have tended to specialise in the production of manufactured goods, economically developing economies have tended to specialise in the production of primary products; some economically developing economies rely on a single commodity for over half of their export earnings. The problem is that the prices of primary products have, on the whole, declined relative to the prices of manufactured goods, although many economically developing economies are now much less dependent on the exports of primary products than used to be the case. - Primary production is likely to be more volatile in terms of supply conditions, with the effect that prices for primary products are usually less stable than for manufactured goods; a key issue is that the demand for, and the supply of, primary products is more price inelastic than is the case with secondary products. - It is also the case that the demand for many primary products, such as different types of food, is more income inelastic than the demand for manufactured goods. - Much of the investment in economically developing economies has come from multinational corporations; much of their profit is repatriated back to their home countries. A number of economically developing economies, given these problems, have introduced a number of different forms of trade protection to bring about import substitution in their economies, aiming to replace imports with domestically produced goods. Some economically developing economies, however, recognising the enormous potential offered by free trade, have taken a different approach and have aimed for an export-led strategy in order to benefit from free trade.

Commercial banks and credit creation

Financial institutions are able to create 'new' money as a result of additional cash deposits. They know from experience that only a certain proportion of customers will want to take out money at any particular time; this means that a large proportion of money deposited can be loaned to people through a process known as fractional reserve banking — the requirement that such institutions only need to hold a certain percentage of their total liabilities, say 10%, in the form of cash reserves. The ratio of new money created to the initial money deposited is known as the credit multiplier.

Policies to correct unemployment

Fiscal policy: fiscal policy, used to correct unemployment, will involve the reduction of taxation, both direct and indirect, to increase the level of consumption. Taxes on companies can also be reduced to encourage greater investment. Government expenditure can also be increased. A reduction in taxation and/or an increase in government expenditure will increase the level of aggregate demand in an economy and this is likely to reduce the level of unemployment. Monetary policy: Interest rates could be lowered and/or the money supply increased to encourage spending in an economy. If the cost of borrowing is reduced, this will encourage people to spend more and save less. Also, if interest rates in an economy are lowered, this is likely to lead to a fall in the exchange rate; if this happens, it will make a country's exports more price competitive in international markets and this could lead to an increase in demand for them and therefore an increase in the demand for labour to produce them, assuming that the demand for them is price elastic. Supply-side policy: Whereas fiscal policy and monetary policy operate to influence the level of aggregate demand in an economy, it is also possible to correct the level of unemployment in an economy through the use of supply-side policy. Any policies that could help markets to work more efficiently would be likely to increase the number of workers employed. For example, policies to make the labour market more flexible, such as restrictions on trade unions, would be likely to lead to greater employment. Training and retraining schemes would help to make workers more employable.

Factors affecting supply of labour

For the industry as a whole, however, the supply curve of labour will be upward sloping from left to right because more people will make themselves available for work when the wage is increased. For an individual worker, an increase in wages may persuade that worker to work fewer hours in order to enjoy more leisure time. This situation gives rise to a backward-bending supply curve for a particular individual.

government macro policy aims

Governments generally have a wide range of objectives in relation to macroeconomic policy, but in most cases they tend to focus on a combination of the following six objectives: ● a relatively low and stable rate of inflation ● full employment ● a rate of economic growth and development that is regarded as sustainable ● equilibrium in the balance of payments over a period of time ● the avoidance of extreme fluctuations in the exchange rate ● the redistribution of income and wealth At any one moment in time, the government of a particular country may have certain priorities in relation to the achievement of these objectives, but over a period of time all governments will aim to achieve a degree of success in each of them.

gross domestic product

Gross domestic product (GDP) refers to all that is produced within the geographical boundaries of a particular country. It does not matter whether the productive assets are owned locally or foreign owned. There are three different ways of measuring the value of a country's GDP — the output method, the income method and the expenditure method. However, all the different methods will produce the same figure because they all measure the flow of income in an economy over a particular period of time.

gross national product

Gross national product (GNP) is calculated by adding net property income from abroad to the figure for gross domestic product. Net property income from abroad takes into account the total interest payments, profits and dividends, both coming into, and leaving, a country. Generally, the figure for net property income from abroad tends to be positive for developed countries and negative for developing countries.

multidimensional poverty index

Health: ● Child mortality ● Nutrition Education: ● Years of schooling ● Child school attendance Living standards: ● Electricity ● Sanitation ● Drinking water ● Type of floor ● Type of cooking fuel ● Ownership of assets

deficit financing

If a government does have a budget deficit, it will need to think how it is going to finance that deficit. There are likely to be three possibilities. - If the budget deficit is successful in stimulating the level of aggregate demand in the economy, this is likely to increase the revenue received from taxation and this will contribute towards financing the deficit. - A country may have had a budget surplus in recent years, and the accumulated surpluses could be used to contribute towards financing the deficit. - It is possible that both of these approaches will not bring in sufficient funds to finance the deficit and in this case the government will need to borrow money; this will lead to an increase in the national debt. A government may need to borrow in order to finance a budget deficit and if money is borrowed from the commercial banks or the central bank, this will have the effect of increasing the money supply. This is because the liquid assets of the banks will be increased, which will increase their ability to lend.

Price stabilisation

If left to free-market forces, there is always a chance that prices will fluctuate widely in those markets where there can be great variations in supply over a period of time. This is especially the case with agricultural markets. In such a situation, a government could intervene through what is called a buffer stock scheme. When supply is very high, the government purchases some of the stock and stops it from entering the market; the effect of this is to prevent the price going too low. When supply is very low, the government releases some of this stock; the effect of this is to prevent the price going too high.

Influence of government on wage determination

In a free market, there would be no government intervention, but governments do intervene in economies, including in labour markets. For example, a government might decide to introduce a minimum wage to prevent employees being paid below a certain level.

government budget

In each economy in the world, the government will produce its accounts in the form of a summary of its income and expenditure. In any economy, there will be one of three types of budget. First, there is a balanced budget. In a balanced budget, the projected revenue, such as from taxation, is exactly equal to the government's planned expenditure. In this sense, where both sides of the budget are equal, it is neutral. Second, there is a budget surplus. In a budget surplus, the projected revenue is greater than the planned expenditure — that is, less money is spent than is received. on such a situation, the government is taking more out of an economy than it is putting in and this is likely to be a deliberate policy to reduce the level of aggregate demand (known as deflation) in the economy — for example, where there is a situation of high inflation. Third, there is a budget deficit. In a budget deficit, the projected revenue is less than the planned expenditure — that is, more money is spent than is received. In such a situation, the government is putting more into an economy than it is taking out and this is likely to be a deliberate policy to increase the level of aggregate demand (known as reflation) in the economy — for example, where there is a situation of high unemployment.

Shape of long-run average cost (LRAC ) curve

Just as the short-run average cost curve is U-shaped, it is the same with the long-run average cost curve. As output increases, there is initially a decrease in the average cost of production and this is shown by the falling part of the LRAC curve. The curve reaches its minimum point at Q* and then starts to rise again, indicating an increase in the average costs of production. The level of output where the LRAC is first at its lowest point is known as the minimum efficient scale.

monopsony

In terms of wage determination, it has been assumed so far that the industry demand curve is made up of a number of firms in an industry. It could be the case, however, that there is just one firm in the market to employ a factor of production. Such a firm is known as a monopsony. In a competitive market, there will be many firms in an industry and so each firm must accept the prevailing market wage. If a firm is a monopsonist, however, the situation will be different. If the market was a competitive one, the equilibrium position would be where demand is equal to supply. A monopsonist, however, would be at an equilibrium position where marginal cost was equal to demand.

Law of diminishing returns or law of variable proportions

In the short run, the production process involves the combination of fixed and variable factors. Additional units of a variable factor, such as labour, could be employed and combined with a fixed factor of production, such as capital equipment. The law of diminishing returns states that, although the total output (or total product) is still increasing, it will increase at a diminishing rate. This is because the extra output, resulting from the employment of the additional worker, will eventually diminish. The law of diminishing returns is also known as the law of variable proportions.

Fixed and variable factors of production

In the short-run period of the production process, at least one factor of production or resource input will remain fixed. For example, it will be difficult to change the number of machines in a factory in the short run. It will be possible, however, to change the quantity of variable factors of production in the short run. For example, it will be relatively easy to buy in more component parts and raw materials in the short run. the production function shows the relationship between inputs and output over a given time period. It indicates how a given level of output is produced as a result of using the various factors of production involved in the production process.

indifference curve

Indifference curves show the possible combinations of two products between which a consumer is indifferent. They slope downwards from left to right and are convex to the origin. The slope of an indifference curve shows the marginal rate of substitution: that is, the number of one good that an individual is prepared to give up in order to obtain additional items of the other good.

mergers and cartels

Integration can come about as a result of a merger of two or more firms. Such mergers can give rise to horizontal, vertical or conglomerate integration. Cartels have already been referred to in the context of oligopoly. This is a situation where a group of firms do not merge, but agree to limit output to keep prices higher than they would otherwise be if there was competition between the firms.

GDP deflator

It has already been pointed out that it is important to distinguish between nominal value and real value. If a country is experiencing inflation, the value of its GDP will rise, but this increase could be due solely to the rise in prices — in other words, there may not have been a real increase in value if the effect of inflation is eliminated from the figures. This is a limitation of any data that is expressed at current prices. Economists usually produce national income statistics at constant prices, so that changes in real output can be identified rather than changes in value that are purely due to the inflation that exists in a country. The GDP deflator is a price index that is used to convert the figures into real GDP. It measures the prices of products produced in a country and not the prices of products consumed. It therefore includes the value not just of consumer products but also of the capital used in the production of the products. It includes the prices of exports, but not the prices of imports.

Impact of corruption and importance of the legal framework

It has already been pointed out, in connection with the possible disadvantages of multinational companies, that they may try to influence the government of a country, leading to the possibility of corruption. It is certainly the case that corruption has occurred in many countries, although its impact will vary enormously from one country to another. It can undermine the process of development in a country, leading to lower levels of economic growth than would otherwise be the case. One way to reduce the potential impact of corruption is to ensure that there is a respected and well-established legal framework in an economy which will minimise the opportunities for corruption to occur. An economy will be better able to function effectively if legal rights, especially property and contractual rights, are legally enforced and properly protected. The International Monetary Fund has stressed that countries with strong legal frameworks have performed better, in terms of economic growth and development, than those without such frameworks.

Fixed and variable costs of production

It has been pointed out that it is important to be able to distinguish clearly between fixed and variable factors of production. It is also important to distinguish between fixed and variable costs of production. Variable costs are costs that vary with changes in output. If output is zero, there will be no need to pay for raw materials or component parts, so these are examples of variable costs. On the other hand, even if output is zero, there will be some costs of production, such as the cost of renting a factory or the interest payments on a loan; these are fixed costs, which remain constant at all levels of output.

profit

It is generally assumed that the main objective of a firm is to maximise its profit. Profit is defined as the difference between the total revenue received by a firm and the total costs involved in producing what is sold — in other words, it is equal to total revenue minus total costs. Profit maximisation is achieved where marginal cost is equal to marginal revenue. It is important, however, to distinguish between normal profit and abnormal profit.

Concepts of firm and industry

It is important to distinguish between a firm and an industry. A firm is a distinct organisation that is owned separately from any other organisation. In a firm, an entrepreneur will bring together factors of production in order to produce particular products. An industry, on the other hand, involves a number of firms which produce broadly similar products.

Marginal, average and total revenue

It is important to distinguish between the different forms of revenue. Marginal revenue refers to the additional revenue received when one more unit of a product is sold. Average revenue indicates the total revenue obtained from selling a product divided by the number of units sold. Total revenue refers to the money received from the sales of a product.

Relationship between internal and external value of money

It is important to distinguish between the internal and the external value of money, but it should also be recognised that the two values are interrelated. For example, if the internal value of a currency falls as a result of a high rate of inflation in a country, exports too will become more expensive. If demand is price elastic, the demand for these will fall, as will the demand for the currency to pay for them. In this situation, there will be a depreciation in the external value of the country's currency

Total product, average product and marginal product

It is important to distinguish between these three different types of product. Total product is the total output resulting from the use of the factors in the production process. Average product is the output per unit of the variable factor, such as the output per worker per period of time. This is also known as productivity. Marginal product refers to the additional or extra output that is produced as a result of employing one more variable factor, such as one more worker.

marginal cost and average cost

It is important to distinguish clearly between average cost and marginal cost. Average cost is the total cost of producing something divided by the number of units that are being produced. Marginal cost is the addition to the total cost of producing one additional unit and can be calculated by dividing the change in total cost by the change in output. In diagrams, the marginal cost curve will always cross the average cost curve at the latter's lowest point. When marginal cost is less than average cost, average cost will be falling; when marginal cost is more than average cost, average cost will be rising.

Problems arising from conflicts between policy objectives

It is not always easy for a government to achieve success in all its policy objectives because there may often be a conflict between them. For example, a depreciation or devaluation of an exchange rate could be used to increase the demand for exports and decrease the demand for imports, thus reducing the size of a balance of payments deficit. If, however, the price elasticity of demand for imports is relatively inelastic, as it often is in many countries, the demand for the more expensive imports will not be affected very much. The consequence of this is that it will contribute to inflation in an economy, both in terms of the import of raw materials and component parts and in relation to the import of finished goods. The possible trade-off between inflation and unemployment has already been pointed out. Policies to control unemployment will usually have a positive effect on the rate of economic growth in an economy, but there may then be a conflict between the goal of economic growth and the need to protect the environment. Economists have certainly pointed out that a very high rate of economic growth may not be sustainable — that is, it may lead to a depletion of resources that does not take the needs of future generations into account.

Influence of trade unions on wage determination

It may be the case that workers belong to a trade union which is involved in collective bargaining with employers on behalf of the workers. A trade union may insist on the existence of a closed shop to increase its bargaining power with employers. The trade union can reduce the supply of labour — for example, by pressurising the government and/or employers into making entry into particular employment more difficult — and this will have an effect on wages.

Factors affecting demand for labour

Labour is not demanded for its own sake, but for what it can contribute to the production process. This is known as derived demand. The demand for labour is closely linked to the marginal physical product of labour. This refers to the additional output produced if a firm increases the labour input by one unit. Firms are interested not only in the extra output that is produced by employing one more unit of labour, but also in the revenue obtained from selling the additional output that has been produced. The marginal revenue product of labour is obtained by multiplying the marginal physical product of labour by the marginal revenue received by a firm.

labour productivity

Labour productivity is the measurement of the efficiency of labour in terms of the output per worker per period of time, such as 1 hour, 1 day or 1 week. The productivity of workers can vary for a number of reasons, including differences in: ● education ● training ● skills ● experience ● technical knowledge ● level of capital available ● working methods and practices ● motivation

limit pricing

Limit pricing refers to a situation where a price is selected below the profit-maximising price. A firm may decide to price in this way to discourage new firms from entering an industry. This will help to protect the competitive position of the firm that adopts this pricing strategy.

Laffer curve

a way of showing the relationship between changes in the rate of tax and changes in the revenue gained from the tax; when the tax rate is increased, the revenue first begins to rise and then falls

information

Market failure can be caused by inadequate information. A government could therefore aim to increase the availability of appropriate information to consumers in order to try to influence their economic behaviour. It is assumed that consumers will always aim to maximise their utility or satisfaction, but they will only be able to achieve this objective if they are in possession of the necessary information. If this information is not available, it is unlikely that they will be able to make rational decisions. Information failure is a major cause of market failure and so a government will need to take measures to improve the accuracy and availability of information that consumers need. This will help them make rational decisions and ensure that scarce resources are allocated as efficiently as possible. For example, a government could aim to make people as well informed as possible about the potential advantages of the consumption of merit goods, such as education and healthcare. It could also aim to make people as well informed as possible about the potential disadvantages of demerit goods, such as alcohol and tobacco. A particular example of such an approach in relation to the consumption of demerit goods is 'nudge' theory.

Behavioural analysis approach to the decision making of a firm

Oligopoly has already been referred to in this unit and the kinked demand curve is an example of how the behaviour of firms can be analysed when there is no collusion between them. The prisoner's dilemma is a game theory idea, based on the situation of two prisoners who must decide whether to confess, without knowing whether the other will confess or not, and where a confession carries the possibility of a lighter punishment. This is similar to an economic situation where two firms exist in a market— that is, there is a duopoly. The two player pay-off matrix is another example of a behavioural analysis approach to the decision making of a firm. The actual outcome will depend on whether two firms can trust each other. A Nash equilibrium occurs in game theory when no particular firm can improve its position, given the strategy of the other firms. It is an equilibrium position because no one firm has an incentive to change.

main reasons for market failure

Merit goods: These are goods which are regarded as socially desirable and which would be underproduced and underconsumed in a free market. Demerit goods: These are goods which are regarded as socially undesirable and which would be overproduced and overconsumed in a free market. Public goods: These are goods which would not be provided at all in a free market because it would be impossible to charge a price for them. Externalities: Externalities are costs and benefits which affect third parties. Negative externalities may result from the overproduction of a good and positive externalities may result from the underproduction of a good. Information failure: There may be a lack of full information and so the allocation of resources may not be as efficient as it otherwise would be. Government failure: A government can intervene in a market to try to overcome a market failure, but there is always a chance that such intervention will create further distortions in the market. Imperfect competition: This occurs when there is a departure from the situation of perfect competition. There can be different market imperfections and one of these is the existence of monopolistic elements in an economy, where one firm can have monopoly power in a market. Inequality in the distribution of income and wealth: A free market may lead to a very unequal distribution of income and wealth, giving some people more influence in a market than others. Factor immobility: In a perfect market, the factors of production would be able to move easily from one market to another, but the existence of occupational and geographical immobility of factors means that this does not always happen. Price instability: This occurs where prices can change rapidly in a relatively short period of time. In some markets, there can be a great deal of price instability, especially in agricultural markets.

National income statistics as measures of economic growth and living standards

National income statistics are used as measures of economic growth and living standards. Gross domestic product is the value of everything that has been produced in a particular economy over a given period of time, usually a year. It is therefore the main statistic used in many countries as a measure of economic growth. Gross national product gives a clear indication of the total spending power in a particular economy over a given period of time, usually a year. It is therefore the main statistic used in many countries as a measure of the standard of living.

net national product

Net national product is calculated by deducting the value of capital depreciation from the gross national product. As with net domestic product, this is done to take into account the money that will need to be spent on replacing machinery and equipment that has worn out during the course of the year

normal profit

Normal profit refers to the amount of profit that needs to be made by a firm to stay in a particular market. It is actually included in the average cost curve of a firm.

horizontal integration

One form of external growth is horizontal integration. This is where two or more firms at the same stage of the production process join together, such as two banks or two car manufacturing companies.

aid

One policy approach towards economically developing countries is the provision of aid. Aid from economically developed to economically developing economies can come in various forms, including grants and loans. Sometimes the aid is bilateral, involving just two countries, and sometimes it is multilateral, involving a number of countries and/or agencies.

productive efficiency

One way of measuring productive efficiency is in terms of the average cost (or average total cost) of production. Productive efficiency can be defined as the *minimum average cost* at which output can be produced. Productive efficiency involves two elements. Technical efficiency is where the best possible use is made of the inputs, or factors of production, used in the production process. This means that *as much output as possible* is produced from given inputs. Cost efficiency relates to whether the best set of inputs has been used in the production process; this will be influenced by the relative costs of different inputs, such as labour and capital. As well as being seen in the micro context of a particular firm, the concept of productive efficiency can also be seen in the macro context of the whole economy.

characteristics of economically developing countries

Population growth: There will typically be a relatively high rate of population growth, resulting from the difference between the birth rate and the death rate, i.e. the natural increase in a country's population; this means that, in many developing countries, the size of the population is well above the optimum population. Population structure: There is likely to be a relatively high proportion of young people, creating a high dependency ratio, i.e. a high proportion of people who are reliant on others in an economy, such as pensioners. Income level and distribution Income levels tend to be lower than in economically developed countries, and there is usually a great deal of inequality in the distribution of that income. Economic structure: In many economically developing countries, there is a relatively large proportion of workers employed in the primary or extractive sector and a relatively low proportion of workers employed in the tertiary or services sector. Employment composition: In many economically developing countries, there are social, cultural and religious reasons why a smaller proportion of women work compared with the situation in economically developed countries. External trade: Many economically developing countries depend on the exportation of primary products and these often experience greater price variations than is the case with manufactured goods, creating greater instability. Urbanisation: The proportion of people who live in rural areas tends to be higher in economically developing countries than in economically developed countries, and where there has been rural-urban migration, this can put pressure on resources in the urban areas. Dependency: Many developing countries have become dependent on economically developed countries, and the role of multinational corporations has been significant in this; although they bring employment to the economically developing countries, much of the profit made is repatriated to the home country External debt: Many developing countries have a high level of external debt and debt repayment is a major burden; in some countries, the debt is over 100% of the gross national product. Social: Many economically developing countries have greater social problems than is the case in economically developed countries, as can be seen through such indicators as life expectancy, literacy rate, the number of doctors per thousand of the population and access to good-quality water.

dynamic efficiency

Productive efficiency and allocative efficiency can both be considered as examples of static efficiency. This means that they are concerned with the allocation of scarce resources at a particular moment in time. Dynamic efficiency, on the other hand, is concerned with changes in the allocation of scarce resources over a period of time. It can occur as a result of new products appearing through research and development, invention and innovation. It is also possible for new methods of production to be introduced as a result of developments in technology. There could also be changes in techniques of management as a result of investment in human capital.

price discrimination

Price discrimination occurs when different prices are charged to different customers. This can happen where there are different price elasticities of demand and where the differences in price are not a reflection of differences in the costs of production. price discrimination is possible in a situation of monopoly where the firm is able to keep different markets separate. This separation could involve different geographical regions, different times of the day or different ages.

Income, substitution and price effects

Price effect: A price effect refers to a change in the consumption of a product as a result of a change in its price. A change in the price of a product can actually bring about two effects: an income effect and a substitution effect. Income effect: An income effect refers to the situation where a change in the price of a product brings about a change in real income. Although there is no change in nominal income, a rise or fall in the price of a product will have a real income effect — a person will be able to buy more or less of a product, and other products, as a result of the change in price of the product. Substitution effect: The second effect of a change in the price of a product relates to the utility or satisfaction obtained from the consumption of the product. A substitution effect means that a rational consumer will substitute in favour of a product which has now become relatively cheaper; this means that the substitution effect is always negative.

other objectives of a firm

Satisficing: Where there is a distinction between ownership and control, managers may just want to deal in an appropriate manner with all of the stakeholders involved in a firm, so that all stakeholders are satisfied. In such a situation, satisfactory profits, rather than maximum profits, may be the aim. Revenue maximisation: This is likely to be the objective where the salaries of managers are linked to revenue rather than to profits. Sales maximisation: In this situation, managers aim to maximise the volume of sales rather than the revenue resulting from such sales. growth maximisation: This refers to a situation where managers aim to increase the size of the firm because this will make it less vulnerable to a takeover or merger and it is possible that salaries of managers may be linked to the size of a firm. Survival: An objective of a firm, particularly in the first few years of its existence, may simply be to survive. This is especially the case in those markets where firms do not tend to survive for very long. Strategic objective: A firm may establish its objectives within a broad strategic approach, such as in relation to 'corporate social responsibility' and the aim to operate without causing any environmental problems. Game theory also offers scope for firms to behave in a strategic way.

means tested benefits

Sometimes a government will provide universal benefits to people, which do not take into account people's individual level of need. But a government could also decide to prioritise the provision of benefits to those people who are less well-off through means-tested benefits. An example of a means-tested benefit is tax credits, which are paid to those people who have children or who have a job that pays a very low wage.

induced investment

Whereas autonomous investment refers to expenditure on capital equipment that is unrelated to changes in income in an economy, induced investment refers to such expenditure that is directly related to changes in income. For example, a rise in national income will bring about an increase in induced investment. Induced investment is an important part of the accelerator theory of investment.

Causes and different types of unemployment

Structural: Workers lose their jobs as a result of the changing conditions of demand in an economy; this creates a change in the country's economic structure, and the declining industries will not need to employ as many people, causing a loss of jobs. Regional: Sometimes these declining industries are concentrated in particular areas of a country and this can contribute to regional unemployment; this is especially the case where workers lack the skills and training to move from one job to another. Cyclical (or demand deficiency): Whereas structural unemployment tends to be concentrated in particular industries, cyclical unemployment tends to be more widespread in an economy; this is because it is associated with the trade cycle and periods of economic downturn. When the level of aggregate demand in an economy is low, this can lead to a recession, defined as two successive quarters of negative growth. Frictional: At any one moment in an economy, some people will be between jobs, i.e. they have left one job and are waiting to start another; this type of unemployment reflects dynamic change in an economy, with some sectors expanding while others are declining. It is possible to distinguish between three different types of frictional unemployment: ● search unemployment, where people are prepared to keep looking for the best possible job rather than take the first one offered ● casual unemployment, where certain types of work are not regular and so at any one time some people will be out of work, e.g. in the acting profession ● seasonal unemployment, where people are out of work when it is 'out of season', e.g. in the tourism or agriculture industries technological: A situation where people lose their jobs because there has been a move away from labour-intensive towards capital-intensive production, i.e. machinery and equipment can be used instead of workers. Real wage (or classical): This is where people are out of work because real wages in an economy are too high, e.g. because of the power of trade unions. Disguised: This is where there are people who do not have a job, but who are not registered for unemployment benefits; they are not included in the claimant count of the number of unemployed people in a country. Voluntary: This describes those who are out of work but who have refused to take a job which is available, perhaps because they are waiting to be offered a better-paid job; the existence of unemployment benefits means that some people are rather selective in deciding which job to accept

non price competition

The conduct of firms can also be compared in relation to whether they rely on pricing policies or non-price policies. In most markets, firms compete in terms of price, but in monopolistic competition and oligopoly there is a great deal of non-price competition — rather than using changes in price to compete, the firms use other ways to compete with each other. Non-price competition involves any form of competitive activity, other than changes in price, and can include the following: ● advertising and product promotion ● branding and the creation/maintenance of brand and customer loyalty ● sales promotions — for example, through such special offers as BOGOF ('buy one, get one free') ● distribution — for example, controlling the distribution of products to particular retail outlets ● distinctive/exclusive packaging ● differences in quality or design

liquidity preference theory

The Keynesian approach to the demand for money and the determination of interest rates is based on three motives for holding money. First, there is a transactions demand for money. This is where money is used to pay for everyday purchases. This is an active balance and is interest inelastic — in other words, this demand for money does not respond to changes in interest rates. Second, there is the precautionary demand for money. This is where money is used to pay for unexpected expenses. Like the transactions demand for money, it is an active balance and is interest inelastic. Third, there is the speculative demand for money. This is where money is used to buy government bonds. Unlike the transactions and precautionary demand for money, it is regarded as an idle balance and one that is interest elastic. An important influence on the demand for a bond is the yield, which is the annual income obtained from the bond as a proportion of its current market price. The price of government bonds and the rate of interest will move in opposite directions because if the interest rate is high, this will reduce the desire to hold money. On the other hand, if the interest rate is low, there will be less of an incentive to switch out of money into other assets. Another distinctive feature of speculative demand for money, unlike the other two motives, is that the demand curve is downward sloping. In fact, at low rates of interest, the liquidity preference (or demand) curve becomes horizontal, indicating that a change in the money supply will have no effect on the rate of interest. At this point, the demand for money is perfectly elastic. This is known as the liquidity trap.

Lorenz curve

The Lorenz curve is a graphical representation which shows the extent of inequality in the distribution of income in an economy. The more unequal the distribution of income in an economy, the more divergent the Lorenz curve will be from the diagonal line of total equality.

net advantages (overall advantages of employment)

The backward-bending supply curve of a particular worker reflects the importance of the pecuniary advantages of work to that employee — the reward or benefit that is paid to them in the form of money. Of course, there are also non-pecuniary reasons why people work — that is, reasons other than a financial reward. The balance between the pecuniary and the non-pecuniary advantages of employment is known as the net advantages.

business (trade) cycle

The business or trade cycle refers to the fluctuations in output and employment which take place in an economy over a period of time. The cycle varies in length and its seriousness, but it tends to mirror the process of economic growth. The cycle involves four stages in a sequence: - boom - recession - slump - recovery

circular flow of income

The circular flow of income refers to the flow of income around an economy. At any one time, there will be a number of injections into the economy and a number of withdrawals or leakages out of the economy.

accelerator

The concept of the accelerator is based on the link between changes in the level of national income in an economy and changes in induced investment. It states that investment is a function of a change in national income. It also assumes a fixed capital : output ratio. It is important to understand that the accelerator is concerned with the relationship between investment and the rate of change of output — it is not the level of output that is important, but the rate of change of that output.

transmission mechanism of monetary policy

The concept of the transmission mechanism (also known as the monetary transmission mechanism) refers to the theoretical process connecting changes in the stock of money in an economy to changes in the level of income and output. The mechanism shows how increased lending by banks leads to an increase in both investment and consumption. This then leads to an increase in the level of aggregate demand and then finally to an increase in the level of production. This link between changes in the money supply and changes in aggregate demand is stressed by monetarists, who believe that the link is very strong

use and conservation of resources

The contrast between the potential benefits and costs of economic growth can also be seen in relation to the use or conservation of resources. The use of resources can contribute significantly to economic growth, but it needs to be remembered that many natural resources are finite in supply — they will eventually run out. This is why it is strongly argued in many economies that there should be conservation of resources. It is stressed that this is a more sustainable approach, taking into account the needs not only of the present generation, but also of future generations.

Monetarist approach

The control of inflation is seen as the priority for a government; inflation is largely seen as the result of an excessive growth of the money supply in an economy. It is therefore necessary for a government to intervene in an economy to control the rate of growth of the money supply. Attempts by a government to reduce unemployment through an increase in spending will only bring about a greater rate of inflation in the long run. Markets clear relatively easily and quickly, so it is appropriate to rely on market forces. On the whole, monetary policy is a more effective approach to demand management in an economy than fiscal policy.

principal agent problem

The distinction between the ownership and the control of a firm has already been referred to and it is important to take into account the divorce of ownership from control. The shareholders may own a firm, but they will not be in day-to-day control of it. This gives rise to the principal-agent problem. The principal is the owner and he or she will hire an agent — that is, a manager — to run the firm on an everyday basis. The problem is that the agent may not run the firm in exactly the way that the principal would like. For example, the principal may have the objective of profit maximisation but the agent may have the objective of salary maximisation.

Economist's and accountant's definitions of profit

The economist's definition of normal profit includes within it a rate of return that is needed for the firm to remain in that particular market or industry. An accountant, however, takes a different view, pointing out that this assumed rate of return cannot be formally and explicitly identified in the accounts of a firm. An accountant is concerned with the actual figures that are produced by a firm as a result of its various trading activities. An economist, on the other hand, is prepared to build into their assumptions that a firm will need to make a certain profit that is just enough to keep it in its present line of business. For an accountant, the fact that it is impossible to say precisely what the size of this normal profit needs to be is sufficient for such a figure not be included in any accounting data.

effectiveness of government policies

The effectiveness of government policies, however, will depend on a number of factors, including the following: ● information — a government's policy will be effective only if the government has all the necessary information, but this isn't always possible: for example, it is not easy to place a monetary value on a negative externality, such as pollution ● incentives — a government may decide to use a progressive income tax to bring about a more equitable distribution of income, but if the top rate of tax is very high, there may be a disincentive for the higher paid to work as much; some workers may even decide to leave the country and seek employment elsewhere. It is possible to consider a situation of government failure where a government intervenes to correct market failure but, as a result of doing so, creates other distortions or imperfections in the market.

equi-marginal principle

The equi-marginal principle shows the relationship between the marginal utility obtained from the consumption of different products and the prices paid for those products. To maximise their utility or satisfaction, it is assumed that consumers will consume up to the point shown above — that is, the extra satisfaction, in relation to the money spent, on the last unit of product A will equal the extra satisfaction, in relation to the money spent, on the last unit of product B and so on.

inflationary gap

The equilibrium level of income in an economy may not necessarily be at the full employment level of income. An inflationary gap shows a situation where equilibrium income is greater than the full employment equilibrium — that is, aggregate demand in an economy is greater than aggregate supply.

external debt

The existence of external debt can be a significant obstacle to the economic growth and economic development of a country. The repayment of the debt can become a major burden and there is an opportunity cost involved: the funds used to pay the debt could have been used in other ways that would have been more productive, such as spending on healthcare and education. It is as a result of the problems caused by the repayment of external debt that institutions such as the International Monetary Fund and the World Bank have been established.

Problems in using real GDP to compare living standards

The hidden, informal or underground economy: These terms refer to economic activity that is not declared and so will not be included in the official GDP data, e.g. it may be illegal. The level of literacy: The literacy rate can vary a great deal between countries and those countries with a relatively low rate of literacy may not produce very accurate data. Non-marketed goods and service: The GDP data are likely to be reasonably accurate when the vast majority of economic output is recorded through market transactions, but in many economies there is a lot of economic activity that is not marketed, i.e. there is no price attached. The difficulties of measuring government spending: In some countries, it can be difficult to measure spending by the government because it is not always easy to value the output of something that is not sold in a market, e.g. defence. Sustainability: A country may have a relatively high rate of economic growth, but this will not necessarily be regarded as good if the needs of future generations are not sufficiently taken into account, i.e. if the growth is not sustainable because natural resources are depleted and an unacceptable level of pollution is created. Unequal distribution of income and wealth: Real GDP can be divided by a country's population to give an indication of the average standard of living, but this average may be misleading if there is an unequal distribution of the GDP. The products produced: An increase in a country's real GDP may indicate economic growth and a rise in living standards, but this will not necessarily be the case, e.g. if a substantial proportion of the increase in GDP is the result of an increase in weapons. The contrast between increases in consumer goods and increases in capital goods: A rise in living standards will come about as a result of an increase in consumer goods available, but in the short run there may be an increase in the production of capital goods which will eventually help to make this possible. The quantity and quality of output: GDP statistics measure the quantity of a country's output, but they do not take into account the quality of that output. The effect of exchange rate changes: When comparing standards of living between people in different countries, it is necessary to take into account the effect of changes in the exchange rates between countries, which would otherwise distort any comparison; economists achieve this through the use of purchasing power parities. Working hours and working conditions: The GDP data record the quantity of output produced in different countries, but they do not take into account the way in which that output is produced, e.g. a country's output may have increased substantially, but only at a cost of a significant increase in working hours and a deterioration in working conditions. Political freedom: Although not directly an economic factor, it could be argued that political freedoms and civil/human rights also need to be taken into account when assessing the quality of life in different parts of the world.

contestable markets

The idea of contestable markets is based on a number of assumptions, including the following: ● There are no barriers to entry; entry into an industry is relatively easy. ● Firms already in the market continually face the threat of competition. ● This puts pressure on the firms to be efficient. ● Abnormal profits are made in the short run, but only normal profits are made in the long run. ● There are degrees of contestability; a perfectly contestable market will have no sunk costs — costs that a firm paid when it entered the market, and which are non-recoverable when it leaves, such as research and development. The key feature of a contestable market is that because it is relatively easy for a new firm to enter a market, the existing firms in the market are continually influenced by the threat of the possible entry of such firms, making them behave as if these potential firms were actually already operating in the market.

internal and external growth

The internal growth of a firm comes about as a result of a firm increasing in size through producing and selling more products; the extent of this growth can be measured by volume of sales, sales revenue (turnover), the number of employees, market share and the size of profits. The external growth of a firm comes about as a result of a merger, takeover or acquisition where two or more firms combine together — a process known as integration. A merger is where firms combine as a result of mutual agreement, whereas a takeover or acquisition usually involves some form of hostile bid by one firm for another.

Size and components of labour force

The labour force refers to all the people in a country who are employed or who are looking for work. It therefore consists of both the employed people and the people who are unemployed. The best way of defining it is as the number of people in a country who are available for work. The size of a country's labour force depends on a number of factors, including the following: ● the total size of the population ● the birth rate ● the death rate ● the school leaving age ● the number of people who stay in full-time education after leaving school ● the retirement age ● the availability and value of welfare benefits to those who do not have a job ● the availability and cost of childcare ● the attitudes in the society to women working ● the state of the economy

limitations of marginal utility theory

The law of diminishing marginal utility is based on a number of assumptions, and if these assumptions do not apply, there are clear limitations to the theory. The assumptions include the following: ● the idea of utility or satisfaction that a consumer gains from the consumption of particular items of a product — but this assumes that satisfaction can be easily measured ● the idea that consumers behave in a rational way — but is this always the case? ● the idea that consumers have limited incomes — but it is possible that incomes may rise significantly over a period of time ● the idea that consumers aim to maximise their total utility — but is this always going to be the case? ● the idea that prices are constant — but it may be the case that the prices of products are continually changing ● the idea that consumer tastes and preferences remain constant — but this may not always be the case

using aggregate expenditure to calculate level of income

The level of income in an economy is determined at the point where aggregate expenditure is equal to output.

monopolistic competition

The market structure of monopolistic competition is based on a number of assumptions, which include the following: ● There are a large number of firms. ● Products are differentiated — they are not homogeneous. ● Each firm faces a demand curve that is downward sloping from left to right. ● Demand for a product is relatively price elastic, but not perfectly elastic. ● Great use is made of advertising brand images to build up brand loyalty. ● There are no barriers to entry and exit, so firms can enter or leave the industry in the long run, if they so wish. ● Firms aim to maximise profits. ● Only normal profits can be earned in the long run. In the short run, a firm could make abnormal/supernormal profits, normal profits or subnormal profits. As there are few barriers to entry or exit, this will enable firms to leave or enter the industry in response to these profits. The profit maximisation position, where MC equals MR, is at output Q and price P. AR is above AC and so the firm is making abnormal profits, shown by the shaded area. In the long run, if a firm makes abnormal/supernormal profits, new firms will be attracted into the industry. If, however, a firm makes subnormal profits — that is, where AC is greater than AR, it will decide to leave the industry. As a result of such changes, only normal profits will be made by the firms in the industry in the long run. Monopolistic competition is generally regarded as a more realistic model of the behaviour of firms because it is often the case that there is a great deal of competition between firms that are selling products that are similar, but not identical.

monopoly

The market structure of monopoly is based on a number of assumptions, which include the following: ● There is one firm in an industry — that is, just one single seller. ● Legally, a monopoly can also be defined in terms of a percentage of market share — for example, in the UK this is 25%. ● The monopoly is a price maker. ● There are no substitutes for the product. ● Barriers to entry make it virtually impossible for new firms to enter the market. ● Abnormal/supernormal profits can exist in both the short run and the long run. ● The demand for the firm's product is also the market or industry demand, so the demand curve is downward sloping from left to right. ● Marginal revenue is always less than average revenue. ● The firm aims to maximise profits. A particular feature of monopoly is high barriers to exit and entry, which make it very difficult for new firms to exit or enter an industry. For example, where a firm is benefiting from technical economies of scale, it may be difficult for a new firm to enter the industry because its average costs of production will be much higher. Another reason might be because a firm already has legal control of production of a product through a patent. An example of a barrier to exit is where a firm has already invested heavily in capital equipment and would be reluctant just to 'write off' this expenditure. A monopoly is generally regarded as a market structure that has disadvantages for the consumer, but this need not always be the case, as in the case of a natural monopoly. Monopoly power is regarded as a market imperfection because the equilibrium price is likely to be higher and the equilibrium quantity lower than would be the case in perfect competition. Unlike the situation in perfect competition, the abnormal profits are not competed away in the long run because there are significant barriers to entry, which make it very difficult, if not impossible, for new firms to enter the market. A particular form of inefficiency that can exist in monopoly is when a firm's average cost curve is not at its minimum level; monopoly power can mean that the lack of competition reduces the level of efficiency, so that unit costs of production are not minimised. This form of inefficiency is known as X-inefficiency. A particular example of such a market imperfection is the existence of deadweight losses.

oligopoly

The market structure of oligopoly is based on a number of assumptions, which include the following: ● There are a small number of firms. (If there are only two firms, it is called a duopoly.) ● There are differentiated products. ● Great use is made of advertising brand images to build up brand loyalty. ● Barriers to entry make it difficult for new entrants to enter the market. ● Firms can make abnormal/supernormal profits in the long run, as well as the short run. ● There could be a mixture of price makers and price takers. ● The firms are interdependent. ● There could be a degree of collusion between firms operating in a cartel. ● There is a kinked demand curve. ● There is a great deal of price stability/rigidity. There are usually only a few large firms in an oligopolistic market structure — in other words, the concentration ratio of the largest firms is usually very high. An important distinctive feature of oligopoly is the existence of a kinked demand curve. This results from the fact that firms in an oligopolistic market structure try to anticipate the reactions of rival firms to their actions. It is assumed that if an oligopolistic firm increases its price, other firms in the market will not follow and so demand above the kink is elastic. It can also be assumed that if an oligopolistic firm reduces its price, other firms in the market will follow and so demand below the kink is inelastic. Another important distinctive feature of oligopoly is that firms may sometimes act together - that is, there might be collusion between two or more firms, such as through price agreements, giving rise to the existence of a cartel. Oligopoly can sometimes also give rise to predatory pricing. This is where a firm charges a price that is lower than those of competitors in a deliberate attempt to force other firms out of the industry. Oligopoly is generally regarded as a reasonably realistic model of the behaviour of firms, but it is more complex than the other market models because there are many ways in which firms in such a market may interact with each other.

perfect competition

The market structure of perfect competition is based on a number of assumptions, which include the following: ● There are many buyers and sellers. ● The buyers and sellers are price takers — that is, they just have to accept the price that prevails in the market and are unable to influence it in any way. ● There is perfect knowledge among producers and consumers, so the buyers and sellers know which products are for sale and at what price. ● The product is homogeneous, so there is no possibility of product differentiation. ● There are no barriers to entry or exit, so firms can enter or leave the industry in the long run, if they so wish. ● There is perfect factor mobility in the long run. ● There are no transport costs. ● All producers have access to the same technology. ● Each firm faces a perfectly elastic demand curve for its product (although the demand curve for the whole industry is downward sloping from left to right). ● Firms aim to maximise profits. ● Only normal profit can be earned in the long run. In the short run, a firm could make abnormal/supernormal profits, normal profits or subnormal profits (that is, losses). If it were unable to cover its short run average variable cost, it would need to exit from the market. The profit maximisation position, where MC equals MR, is at output Q, but at this point the price is shown by P and the average cost by AC. At this point, AR is greater than AC and this explains the existence of abnormal/supernormal profits in the short run, shown by the shaded area. In the long run, if a firm makes abnormal/supernormal profits, new firms will be attracted into the industry. If, however, a firm makes subnormal profits (that is, where AC is greater than AR), it will decide to leave the industry. As a result of such changes, only normal profits will be made by the firms in the industry in the long run. Perfect competition is very much a theoretical model of the behaviour of firms, based on a number of assumptions. It has therefore been criticised for being unrealistic, but it is still useful as a model of economic behaviour.

allocative efficiency

The most efficient allocation of resources in an economy will be the one which fits the needs and wants of consumers most closely. The more that firms in an economy can respond effectively to changes in the demand of consumers, the closer the economy can get to a situation of allocative efficiency. This can be clearly seen in the relationship between price and marginal cost. The marginal cost of production is the cost of producing one more product. When *marginal cost is equal to product price*, there is a situation of allocative efficiency. This is because the value that is put on the resources used to produce the product by the producer is equal to the value put on the product by the consumer. If a greater or lesser amount of the product were produced, price and marginal cost would no longer be equal.

multiplier

The multiplier is an important concept in the determination of the level of income in an economy. It measures the extent to which an increase in an injection into the circular flow of income brings about a magnified effect on the level of income. An increase in injections, however, is also likely to have an effect on the withdrawals out of the circular flow of income in an economy. Each successive increase in aggregate demand will therefore become progressively less

national debt

The national debt refers to the total of all debt that has been accumulated over a period of time by the government or the public sector of a country.

Existence of government failure in macroeconomic policies

The possibility that a government may fail in its microeconomic policies has already been considered. It is also possible that a government may fail in its macroeconomic policies. For example, a government may use taxation to try to bring about a more equitable distribution of income and wealth in an economy, but a number of people may decide to leave a country as a direct result of such a policy, especially if income tax becomes so progressive that people believe that they are paying too much of their income to the government in tax. Information failure was referred to in the consideration of microeconomics, and it is also the case that information failure could have an impact on the success or otherwise of a government's macroeconomic policies. For example, there may be a time lag between the decision to introduce a policy and the time when that policy begins to take effect, but in the meantime, the economic situation may have changed. For example, a decision could have been taken to raise interest rates to control the level of inflation in an economy, but by the time that this began to have an effect, inflation had been replaced by unemployment as the main economic problem.

quantitative easing

The process of the central bank buying government securities, such as bills and bonds, is known as quantitative easing. These securities are bought by the central bank, leading to an increase in bank deposits, and this creates more liquidity in the system. In some countries, it is known as credit easing

quantity theory of money

The quantity theory of money shows the relationship between the money supply, the general price level and the level of output in an economy. it is usually expressed in terms of MV = PT, where M is the quantity of money, V is the velocity of circulation, P is the general price level and T is the number of transactions. V and T are assumed to be constant over a period of time because it is unlikely that there is going to be a great deal of difference in the velocity of circulation or in the number of transactions in an economy from one year to the next. In this case, M and P are directly linked. This means that if the money supply rises, people will have access to more funds, giving them greater purchasing power, and as a result of this, the general level of prices in the economy will rise — that is, a situation of inflation will exist. The theory has been widely discussed over the years, especially in relation to whether it is correct to assume that V and T are constant over a period of time. It has also been criticised for being less of a theory and more of an identity that is necessarily true — in other words, MV represents total spending in an economy and PT represents the total money received for the goods and services. It is the same situation, but looked at in different ways.

reasons for growth of firms

The reasons for the growth of firms include the following: ● to take advantage of possible economies of scale, leading to a decrease in the costs of production of a firm ● to be stronger and therefore safer from a hostile takeover or merger proposal (in the case of a firm becoming larger through internal growth) ● to take advantage of opportunities to gain from a larger market share, such as through greater profitability ● a possible desire of owners and/or managers to expand

Trade-off between inflation and unemployment

The relationship between the level of inflation and the rate of unemployment in an economy can be seen in the Phillips curve. Such a curve shows the trade-off between inflation and unemployment — as the rate of inflation increases, this will be accompanied by a fall in the rate of unemployment, and as the rate of inflation decreases, this will be accompanied by a rise in the rate of unemployment. For example, if a government deliberately aims to bring down the rate of aggregate demand in an economy, such as through an increase in taxes or interest rates, this is likely to put some people out of work.

trade and investment

The theory of comparative advantage indicates that all countries can benefit from free trade as long as there are differences in opportunity cost ratios. International trade will therefore lead to an increase in world output and this will ultimately lead to an improvement in the quality of life and economic welfare in all countries, including economically developing economies.

total currency flow

The total currency flow is a part of a country's balance of payments and shows the total inflow and outflow of money resulting from a country's international transactions with the rest of the world. If the flow is positive, it is likely to increase the foreign exchange reserves of a country. This net inflow of money into a country will have the effect of increasing its money supply.

optimum resource allocation

The word 'optimum' means the best possible outcome in a given situation. Optimum resource allocation refers to a situation where the best possible allocation of scarce resources exists. This is when *both productive efficiency and allocative efficiency* occur. The idea of an optimum, or optimality, is an important concept in economics, given that resources are scarce; when resources are allocated in an optimum way, it means that they are used in the most efficient way possible.

Long-run supply of labour

There are a number of factors that can influence the long-run supply of labour and these include the following: ● the size of the population of a country ● the labour participation rate ● the tax and benefits levels ● the extent of immigration and emigration

problems with aid

There have, however, been a number of problems in relation to such aid, contributing towards a dependent relationship between developing and developed economies, including those listed below: - Some aid has been used in investments which have become relatively unsuccessful. For example, some major construction projects, such as dams, have been criticised for not being in the long-term interests of particular countries. There is also some evidence that expenditure on aid has actually been spent on defence projects. - Some of the aid has been 'tied' in some way — that is, there are conditions attached to the aid and so the receiving country has not been totally free to decide how to spend the money. - In some cases, there has been corruption in the receiving country, with the result that much of the money has been kept in the hands of a few, rather than spread across the whole economy. - There have been some examples of the aid money being spent on defence, rather than on, say, education, healthcare or improving the water supply. - Some aid has actually been counterproductive and has made the situation worse — for example, supplies of large amounts of food to some countries have reduced the prices in the local economy, lowering incomes and making it difficult for local farmers to survive. - While in some cases the interest charged on the aid has been at a lower rate — that is, concessional — in many cases it has been at market rates of interest. - The loan repayments have, in many cases, been difficult for the economically developing countries to pay, although some debts have been rescheduled or cancelled; organisations such as Jubilee 2000 and Make Poverty History have been active in trying to persuade lenders to cancel, or at least reschedule, the debts.

Keynesian approach

There is no guarantee that an economy, if left to market forces, will be able to achieve a full employment level of GDP; the reduction of unemployment is seen as the top priority in an economy. It is therefore necessary for a government to intervene in an economy to influence the level of economic activity, e.g. by using a budget deficit to increase the level of aggregate demand in the economy. Markets, such as the labour market, do not clear easily and are slow to adjust; this is why an economy can be in an equilibrium position below full employment, and why a government needs to intervene to expand demand. On the whole, fiscal policy is a more effective approach to demand management in an economy than monetary policy.

price leadership

This can happen in an oligopoly market structure where there is informal or tacit collusion between firms in the market. In this situation, firms in the market will follow the price leadership of one firm. The aim is to maximise the profits of all the firms by behaving as if they were a monopolist — that is, a single seller. As stated above, this agreement on price or output gives rise to a cartel arrangement.

Full employment and natural rate of unemployment

Unemployment refers to the situation which occurs when people are able and willing to work, but are unable to find employment. There is some debate as to what actually constitutes a situation of full employment in an economy, but is generally taken to be a situation where everyone who wants a job has a job, with the exception of those who are frictionally unemployed. In many economies, it is about 4-5% of the working population. The natural rate of unemployment stresses the link between the level of unemployment and the rate of inflation in an economy. It is that level of unemployment which contributes towards a rate of inflation that is nonaccelerating. It is essentially an equilibrium situation where the aggregate demand for labour is equal to the aggregate supply of labour at the current wage rate; as a result of this situation of equilibrium, there is no upward pressure on the level of prices in the economy

external economies of scale

Whereas internal economies of scale involve a movement down a long-run average cost curve, external economies of scale involve a downward shift of the whole long-run average cost curve. Concentration: If a number of firms are located in a particular area, this may encourage the development of specialist ancillary or support firms in the area that supply component parts to the firms, reducing the average costs of production. Specialised labour: A pool of specialised skilled labour may be available in a particular area, which all firms in that industry in the area can benefit from. Knowledge: Firms in an industry may benefit from specialist research or marketing agencies, and so be able to reduce the costs of acquiring and using this information.

economic development

a broad perspective that goes beyond increases in national output to take into account factors that influence the quality of life of people in particular countries

Kuznets curve

a curve which shows that as an economy develops, economic inequality first increases and then decreases

national income

a general term for the total income of an economy over a particular period of time

market failure

a market imperfection which gives rise to an allocation of scarce resources which is not as efficient as it might otherwise have been

quality of life

a wider concept than the standard of living to compare living conditions in different countries; it could take into account such criteria as the number of doctors per thousand of population, the quality of drinking water and the average size of school classes

welfare gain

an additional benefit resulting from more being produced in a market

transfer earnings

earnings that are the minimum that would be necessary to keep a factor of production in a particular use.

third party

individuals or groups that are not the main parties in a transaction, but are still affected by it

efficient resource allocation

optimal use of scarce inputs to produce the largest possible output

internal economies of scale

the advantages of a firm growing in size in the form of a reduction in the average cost of production. Financial: Larger firms may be able to benefit from negotiating a loan at a lower rate of interest than a smaller firm, largely because financial institutions regard them as less of a risk. Purchasing: Larger firms are often able to take advantage of their size by negotiating favourable terms with suppliers as a result of bulk buying. Managerial: As a firm increases in size, its employment of managers does not usually need to grow at the same rate, and so the cost of management per unit of output is likely to fall. It is also the case that larger firms can employ specialist managers and this is likely to increase the efficiency of a firm. Technical: Economies of increased or large dimensions can come about more easily in a large firm, reducing costs of production, e.g. if a firm doubles the size of containers that it uses, it is not likely to lead to a doubling of the cost. Marketing: A larger firm may be better able to negotiate a lower rate, e.g. in relation to buying advertising time on television. Risk bearing: A larger firm is likely to be more diversified, spreading risks across a wider range of markets. This enables average costs to be reduced. For example, diversification will lead to more stable and predictable demand, and this means that a firm will not need to keep as much stock as before, reducing the costs of stockholding.

depreciation (of capital)

the amount of capital that is needed to replace equipment that has worn out over a year

money supply

the amount of money available to the general public and the banking system in an economy

Pareto optimality

the best possible allocation of scarce resources existed when it was impossible to make one person better off without making another person worse off. This is known as Pareto optimality. In such a situation, there must be an optimal allocation of resources — that is, the inputs or resources are used in the most efficient possible way (productive efficiency) and the output produced by the resources provides the maximum possible utility or satisfaction to consumers (allocative efficiency)

sustainability

the capacity to endure; it is the potential for the long-term maintenance of well-being in an economic environment so that the interests of future, as well as present, generations are taken fully into account

inter-generational equity

the degree to which differences in income in an economy can influence the incomes of generations of people in the future

output gap

the difference between the actual output and the potential output of an economy

internal diseconomies of scale

the disadvantages of a firm growing in size, resulting in an increase in the average cost of production. Communication: there may be poorer communication in a large firm, which adversely affects efficiency. Motivation: There may be lower levels of motivation in a large firm, with some employees feeling alienated. This may lead to a greater likelihood of industrial disputes. Management: Problems of poor communication and low levels of motivation can lead to difficulties in managing a firm effectively. Flexibility: Larger firms may become less flexible, making it more difficult to respond to changing market conditions.

spillover effect

the effect of certain decisions which have an impact on third parties, i.e. those who are neither the producers nor the consumers of a particular product

economic rent

the extra payment received by a factor of production above what would be needed to keep it in its present use. The amount of economic rent that a worker is able to obtain is limited by the fact that there is not usually a high level of mobility of labour; in fact, in many labour markets, there is a high degree of immobility of labour.

net domestic product

the gross domestic product of a country minus depreciation or capital consumption

equity

the idea of fairness or justice, e.g. in relation to the distribution of income and wealth in an economy

net property income from abroad

the interest and profits on foreign investments — the total interest, profits and dividends received by the residents of one country on their foreign investments, minus the total interest, profits and dividends paid to foreign residents on their investments in this particular country

consequences of unemployment

● Economic resources are said to be scarce, and so any unemployment is a waste of scarce resources; an economy will be underperforming and the level of national output produced will be lower than would otherwise have been the case. ● A government will lose out on potential tax revenue, in terms of both direct taxes, such as income tax, and indirect taxes, such as goods and services tax. ● A government will also find its fiscal situation worsened, not only because of the likely reduction in revenue from taxation, but also because of the money that will need to be paid out in the form of benefits to those who are unemployed and the cost of training that a government might need to provide in order to make unemployed people more employable in the future. ● Higher levels of unemployment can be associated with a number of social problems, such as an increase in the crime rate of a country

costs of economic growth

● There can sometimes be a shift away from consumer goods to capital goods in order to bring about economic growth; this will be good in the long run, but not necessarily in the short run. ● Economic growth may lead to a depletion of natural resources and damage to the environment in terms of various forms of pollution; it is in this sense that a high rate of economic growth is sometimes said to be unsustainable. ● The benefits of economic growth may not always be shared evenly among different people in the country. ● There may be a reduction in the quality of life in the country, e.g. working hours may be longer, reducing the amount of leisure time.