Professional Documents
Culture Documents
Revision Guide:
Unit 1
Markets at Work
Name:
Form:
(A)
What is it?
The basic economic problem is the fact that RESOURCES are SCARCE (limited in
supply) but WANTS are INFINITE (never ending). As a result of this, consumers,
producers and the government have to make CHOICES about how to ALLOCATE
scarce resources.
When we choice one thing, we often sacrifice or give-up something else.
OPPORTUNITY COST is the highest valued alternative that we forego because
scarce resources allocated elsewhere.
What are resources?
Resources are all the elements that go into the production of goods and service. Resources
are often known as the FACTORS OF PRODUCTION. There are 4 factors of production:
(a)LAND: All natural resources used in production, for example building land,
oil, water, wheat, apples
(b)LABOUR: The human contribution to production- i.e. workers!
(c) CAPITAL: Capital refers to man-made equipment that is developed to aid the
production of other goods and services. For example machines, computers,
vehicles, shop fixtures, tills
(d)ENTERPRISE: The person(s) who has the initial business idea, raises the
money and organises the other factors of production.
Economic Systems
All economies face the basic economic problem. However, they may have different
approaches to addressing it and allocating resources. The approach they choose is known as
an economic system
(a) PLANNED ECONOMY: All resources are owned by the PUBLIC SECTOR (the sector of
the economy owned and controlled by the government). The public sector determines
what goods and services are made and how. Goods and services are shared out
amongst the population
(b) FREE-MARKET ECONOMY: All resources are owned by the PRIVATE SECTOR (the
sector of the economy owned and controlled by private individuals). Goods and
services are allocated via the MARKET MECHANISM, that is via demand and supply
(prices)
There are pros and cons of planned and free-market economies:
Planned Economy
Pros
It is fair, everyone will get
something
Theoretically, everyone can be
given a job
The government can provide
merit goods such as health and
education, and public goods
such as defence
There is competition- this is
good for consumers (Low prices,
better quality, more choice,
more innovation)
There is more incentive to be
efficient as low costs can allow
Cons
There is no incentive to be
efficient
There will be little choice for
consumers or workers
There may be corruption
Economic growth tends to be
great low because of the lack of
profit incentives
Inequality- there will be absolute
and relative poverty- poor
people will be reliant on charity
and will have no choice
Public and merit goods may not
be provided/will be under
produced/consumed- eg not
enough access to education and
health care
Environmental costs (eg
pollution) is likely and there is no
incentive to look at sustainable
use of resources
In reality, most economies are mixed. This means there is a mixture of a public sector and a
private sector owning and allocating the scarce resources. The UK has a mixed economy that
is moving towards being more free market:
Public Sector: Education, Health, Police, Defence
Private Sector: Water, Electricity, Gas, Rail, Airlines, Supermarkets, Clothes stores
Examples of how the UK has become more free-market: Privatisation; deregulation; contracting out; Free Schools and Academies
Understanding the key differences between the public and private sector
This can be summarised below:
Public Sector
Private Sector
Ownership
The government
on behalf of the
people (tax
payers)
Private
individuals from:
Sole Traders (1)
Partnerships (220)
Private and
Public limited
companies
(shareholders)
Control
A government
minister will
oversee control
Owners/Sharehol
ders will lead the
strategic
direction.
Managers will
exercise control
on a day to day
basis
Aims
To provide a
good quality
public good or
service
To allow as many
people as
possible access
to the good or
service
Mainly to make a
profit (unless it
is a charity)
Wider aims and
objectives (see
later notes)
Finance
Money will be
raised from the
taxpayer.
Any losses will
be funded by the
taxpayer.
The
business/area
could continue
even if it was
loss making
Finance will be
from:
Savings
Loans
Redundancy
payments
Share issue
Definition
The sector of the economy
Examples
Fishing, mining, farming
Secondary Sector
Tertiary Sector
The UK now has a very large tertiary sector having been through a period of DEINDUSTRIALISATION. This is the process by which the secondary sector of the economy
shrinks so that it produces less and employs fewer people.
Specialisation
Faced with the basic economic problem, it is important that scarce resources are used as
efficiently as possible.
It can be argued that using resources in a more specialised way is more efficient and
increases production. There are different types of specialisation:
What is it?
Specialisation of
labour (division of
labour)
The production
process is organised
so that workers all
have a very specific
(and often quite
narrow) job role so
that they repeat a
particularly task often
Potential
Advantages
Increased
productivity as a
result of expertise
and repetition. Time
is not wasted moving
from one job to
another
Potential
Disadvantages
Repetition leads to
boredom, demotivation and a
reduction in
productivity
A break/weakness in
the chain (eg a an
unproductive worker)
could affect the whole
production process
Product
specialisation
are unskilled
Regional
specialisation
A particular region is
focussed on
producing a particular
good or service. This
means that a lot of
the jobs in that area
are provided by the
specialist industry
Eg historically:
Sheffield Steel
Lancashire- textiles
West Midlands- Cars
East Anglia- Shoes
International
specialisation
Countries specialise
in producing goods in
which they have an
absolute or
comparative
advantage
industry (roads
etc)
Local banks are
financially
supportive of
the industry
Suppliers move
to the region,
reducing
transport costs
and making
supplies more
flexible
World output of goods
is increased as all
countries focus on
what they are
good/efficient at and
then trade
Because Average
Costs are lower,
prices may be lower
Encourages free
trade, competition
and choice- good for
consumers
Takes account of the
fact that climates and
resource endowments
vary between
countries
Increased social
problems
New firms are
reluctant to locate to
the area because of
the above problems
There is a cycle that
leads to absolute and
relative poverty
Requires trade to
allow the exchange of
goods and servicesthis may be affected
at times of war/unrest
Countries may be
unable to access
certain G&S if trade is
disturbed
Some products (such
as primary products)
have lower prices and
more unstable prices.
Countries specialising
in these find it hard to
develop and grow
(LDCs)
Countries will be
vulnerable if there is
a downturn in world
demand for the
products that they
specialise in
Trade and
international
competitiveness may
be undermined by
fluctuations in
exchange rates
Historically, this was done by BARTER and SWAPPING goods, but this was difficult for a
number of reasons. MONEY allows exchange to take place.
The Functions of Money (what it does)
A means of exchange
A unit of account
A store of value
A method of deferred
payment
Example
I have a mountain bike to sell
but want a racing bike.
I sell the mountain bike for
money.
I use the money to buy a
racing bike
My racing bike was 500
Your racing bike was 100
My racing bike is 5 times
more valuable than your bike
I sell my mountain bike but
cannot find a racing bike I
like. I put the money I earn
from the mountain bike in the
bank and save it until I can
find what I want
The shop allows me to buy
the bike on 12 months credit
(B)
Potential Gains
To Consumers:
Prices will be low
There will be more
Potential Losses
To Firms:
Prices are likely to be
driven much lower
Monopolies
choice
Quality may be
improved
There may be more
innovation and new
products as firms try
and stay ahead of
competitors
To Firms:
It may be easier to
attract workers as
there are lots of
workers doing similar
jobs. This high supply
of labour may keep
wages down
To the Economy
Competition
encourages firms to be
more efficient and to
keep their average
costs as low as
possible because
prices will be lower.
Firms are likely to make
more careful/efficient
use of scarce resources
To Consumers:
Firms are large and
may benefit from
economies of scale.
Firms MAY choice to
pass on the benefits of
this to consumers in
the form of lower
prices
Product quality and
range may be higher
than in competitive
markets. This is
because (a) The
monopolies have the
profits to re-invest in
the business and in
product development
and (b) They have the
incentive to do so
because they want to
maintain their
monopoly power and
keep barriers to entry
as high as possible
than in less
competitive marketsthis may reduce profit
margins
Lower profit margins
may mean that there
are less funds available
for re-investment
Their products are
likely to be more price
inelastic
There is a constant
pressure to cut costs
and be efficient. This
means that firms have
to spend a lot of time
managing resources
and ensuring labour
productivity is as high
as possible. This could
cause conflict
They may lose workers
to competitors if
competitors offer
better wages/working
conditions/training etc
To Consumers
Less competition is
likely to mean higher
prices
There will be less
choice
Product
quality/customer
service may decline
because the monopoly
has a captured market
(especially if it is a
natural monopoly)
To the Firm
The lack of competitive
pressures may make
the firm become stale
and unresponsive to
consumer demand. If
the product is not a
necessity, consumers
may move away from
the product over time
To the Firm
Prices are likely to be
more price inelastic.
This means that they
can keep prices higher
The lack of competition
means higher prices
and hence higher profit
margins
The lack of competition
means that the
monopoly does not
need to be as careful
about minimising costs
The monopoly does not
have to spend as many
resources on
advertising and
marketing
The financial position
of the monopoly will be
quite stable, this may
attract more
investors/finance
To the Economy
Economic resources
are focussed on
production and not on
marketing/advertising
To the Economy
The lack of incentive to
be efficient may mean
that scarce resources
are not being used as
well as they would be
under a competitive
market. The output of
goods and services
may be lower than in a
competitive market
The lack of competitive
forces may mean that
scarce resources are
not being used to
respond to consumer
demand and to make
the goods and services
that consumers most
want/value
How it works
Firms are not allowed
to own more than
25% of market share
Advantages
Removes the
disadvantages of
monopolies (see
above)
Privatisation
See also:
Contracting Out
De-Regulation
Disadvantages
There is no incentive
for firms to be
efficient, innovate,
get better because
success is penalised!
Loses the potential
gains of monopolies
(see above)
Concern that
consumers would be
exploited by private
companies
Worry that some
industries are
natural monopolies
Concern that non
profitable
products/services will
go
The government
helps to break
down barriers to
entry
Removal of barriers
to entry, naturally
encourages
competitive forces
It is very difficult to
do this in some
industries where
there are very high
natural and technical
barriers to entry. It is
easier to do it when
the main barrier to
entry is legal (ie a
previous law
protecting the
monopoly power)
Potentially allows us
to keep the benefits
of monopoly without
having the costs
Regulators may be
expensive and
bureaucratic
Eg: De-regulation:
Takes away laws that
previously gave firms
monopoly power- eg
Opticians
Regulation of
Monopolies
The demand curve is downward sloping from left to right because it shows that quantity
demanded usually rises and price falls.
A change in price causes a MOVEMENT along the demand curve.
When price changes from $8 to $12 we will move up the demand curve and there is a
CONTRACTION in quantity demanded.
When price changes from $8 to $4 we will move down the demand curve and there is an
EXTENSION in quantity demanded.
The Conditions of Demand
These are the non-price factors that influence the demand for goods and services.
(1)INCOME
For NORMAL goods, a rise in income will lead to a rise in demand (and vice versa)
For INFERIOR goods, a rise in income will lead to a fall in demand (and vice versa)
(2)PRICE OF RELATED GOODS
Substitutes: Goods in rival demand (Pepsi v Coke). A rise in the price of a substitute, may
lead to a rise in the demand for our good and vice versa
Complimentary Goods: Goods in joint demand (CD and CD player). A rise in the price of a
complimentary good may lead to fall in the demand for our good and vice versa
(3)TASTE AND FASHION
This may be positive (a fashion craze) or negative ( a health scare, bad publicity, downturn in
demand)
(4)ADVERTISING
Advertising can be persuasive and informative. Advertising is designed to stimulate the
demand for a good or service
(5)THE SIZE AND STRUCTURE OF THE POULATION
Size: How many people there are. The more people, the higher demand may be
Structure: The age distribution of the population. This may influence which products are
demanded. For example, an ageing population may lead to a rise in the demand for health
care and SAGA holidays but a fall in the demand for education and nightclubs!
Changes in the conditions of demand cause the whole demand curve to SHIFT
Elasticities of Demand
There are 3 key elasticities of demand:
(1)Price elasticity of demand: Measures how responsive quantity demand is to a
change in the price of the product
(2)Income elasticity of demand: Measures how responsive demand is to a
change in income
(3)Cross elasticity of demand: Measures how responsive the demand for a good
is to the change in the price od a related good (substitute or compliment)
Price Elasticity of Demand
There are 3 alternatives.
(1) Demand is price elastic: A % change in price leads to a bigger % change in quantity
demanded
(2) Demand is price inelastic: A % change in price leads to a smaller % change in quantity
demanded
(3) Demand has unitary price elasticity of demand. Any % change in price leads to an
identical % change in quantity demanded.
Supply
Supply is the amount of a good or service that a producer is WILING and ABLE to
produce over a SPECIFIED PERIOD OF TIME
Supply and Price
There is a positive relationship between price and supply.
When price rises, producers are willing and able to supply more of a good or
service because the potential to make profit is greater
When price falls, producers are less willing and able to supply a good or service
because they will make less profit from it. They may wish to re-allocate their
scarce resources into more profitable uses.
This can be shown is a supply schedule and a supply curve
A tax is a sum of money that a business has to pay to the government. Tax acts like an extra
cost of production. If taxes rise, profits fall and supply will decrease. If taxes fall, profits will
increase and supply will increase
A subsidy is a sum of money that the government gives to a business. This is usually to
encourage the firm to do something that brings external benefits, for example training or relocating in an area of high regional unemployment. A subsidy is an additional source of
revenue for the firm. It therefore increases profit and increases the willingness to supply
(3)TECHNOLOGY
Technology means new capital. New capital can increase supply because it makes firms more
physically able to produce more AND because it might make production cheaper, thus
increasing profits and willingness to supply
(4)NATURAL FACTORS
Primary products will be particularly affected by things such as climate and natural disasters
Changes in the conditions of supply cause SHIFTS in the supply curve:
Prices, and equilibrium outputs will only change when there are changes in market conditions.
This means that there are changes in demand and supply.
Examples
Introduced when the government feels that market prices are too high
The government introduces a maximum price, above which prices are not allowed to go
For example, the government has, in the past, set a maximum price for rented
accommodation to ensure that everyone has access to shelter
Potential Problems
May make the situation worse. At the lower
price, landlords are less likely to provided
rented accommodation (supply falls) but
more people want it. This creates excess
demand (a shortage)
Introduced when the government is concerned that market prices may go too low
The government introduces a minimum price, below which the market price cannot go
(C)
Maximising profit
Increasing sales
Growth
Diversifying into new markets/expanding oversees
Survival
Providing a good quality customer service
Key Term
Definition
The amount of money earned from selling
your product.
Average Revenue
Profit
Total Costs
Fixed Costs
Variable Costs
Average Costs
Break-even point
TR= TC
How well a firm is able to compete with other
firms. To be competitive firms need:
Low prices; good investment to improve
product quality; innovation so that new
products are constantly being developed
Why is it important for firms to make profit?
Competitiveness
To
To
To
To
On the other hand, firms can survive for short periods of time without making profit
The
firm
Land, labour, capital and enterprise
(Goods and Services)
Productivity
Output
Productivity is the RATE at which production occurs. A rise in productivity will occur if:
(a) A firm can produce more output with its existing resources
(b) A firm can produce its existing output with less resources
Labour productivity refers to how much output can be attributed, on average, to a unit of
labour (ie one worker) Labour Productivity can be calculated by: Output/Number of workers:
Output of cakes
100
120
150
200
Numbers of workers
10
10
10
10
Labour productivity
10
12
15
20
Labour productivity has clearly increased over the time period shown
It produces more output. If sold, this will contribute to more revenue and profit
Rising productivity allows firms to operate at lower average costs. This MAY allow them
to reduce prices and become more competitive, thus increasing demand and market
share
If a firm is producing at a lower average cost, it will be increasing its profit per unit.
This will provide more funds for re-investment and growth (see above)
Rising productivity may allow a firm to finance wage increases. This will secure worker
morale and further productivity. It will also allow the firm to attract the best quality
workers
In the globalised economy, UK firms are competing with firms from the BRIC economies
which have very low costs and high productivity. If UK firms cannot match this, they
will be uncompetitive and lose sales/market share
To
To
To
To
To
To
To
External Growth
What is it?
When a firm increases its
output on its own
Example
The firm could:
Take on more workers
Take on a new shop
Hire bigger premises
Buy new capital
Buy in more supplies
One bank merges with
another bank
another firm
There are different types of
mergers/integration- see
below
Mergers/Integration
Lateral Merger
Conglomerate Merger
range slightly
Can take advantage of links between
products in marketing campaigns
Complete diversification and risk
spreading
Between 0 and Q2 the firm is encountering economies of scale. The increase in output has
lead to a reduction in Average Costs.
There are a number of types/sources of Economies of Scale:
Explanation
Large firms can benefit from cheaper loans
and wider sources of cheap finance
(investment from shareholders)
The advantages that large firms get in
relation to buying and selling. Large firms
can attract specialist buyers who dont waste
money buying stock that will not sell. They
also have specialist sellers/marketing staff
who ensure that goods will sell. Big firms
benefit significantly from being able to buy
in bulk
These are the advantages that large firms
have when it comes to the production
Diseconomies of Scale
Diseconomies of Scale is the idea that it is possible for some firms to become TOO large, such
that a rise in output begins to lead to an increase in average costs. This can be shown on the
diagram below, where diseconomies of scale set in when output increases above Q2
As the firm increases, factor inputs (resources) become more scarce and hence more
expensive
As the firm grows, communication and decision making becomes more difficult,
contributing to inefficiencies and rising costs
As the firm grows, worker morale and motivation declines as they feel like a small cog
in a big wheel. This may contribute to reduced productivity and higher average costs
The area will have a pool of skilled labour. Local colleges/training providers will offer
courses to meet the needs of the industry. This will reduce firms training costs and
labour will be more productive and efficient
Suppliers are likely to move into the area to support the area. This will reduce
transport costs and allow firms flexible access to supplies
Local banks and financial institutions are more likely to be financially supportive of the
industry because they know that the local economy depends upon it- this may lead to
lower interest rates and cheaper loans/overdrafts
The local infrastructure (roads, rail and communication networks) are likely to receive
the investment necessary so that they support the development of the industry
An example:
Labour Markets
In a free market economy, wages are determined by the interaction of the demand for labour
and the supply of labour. Wage differentials (differences in wages) between jobs and
locations occur because of differences in the levels of demand for/supply of labour
Measures how responsive the demand for labour is to a change in wage levels
If demand is wage elastic it means that a % change in wages will lead to a bigger %
change in the demand for workers. This is most likely to be the case when labour costs
contribute to a high proportion of the firms costs, where it is easy to substitute capital
for labour and when the product has price elastic demand (making it difficult to simply
pass on the wage increase to consumers in the form of higher prices)
If demand is wage inelastic it means that a % change in wages will lead to a smaller %
change in the demand for workers. This is most likely to be the case when labour costs
are a small proportion of total costs, when labour cannot be easily replaced by capital
and when the price of the product is price inelastic (making it possible for the employer
to pass on the wage increases in the form of higher prices so not reducing profits)
Labour demand (1) has wage inelastic demand. Labour demand (2) has wage elastic
demand.
Factors causing a shift in the demand for labour
Whilst changes in wages cause a movement along the D(L) curve, other factors will cause the
whole curve to shift position. These other factors are:
(1) The demand for the product that labour produces. Labour is an example of derived
demand- this means that its demand comes from the demand for the product that it
makes. For example, during the recession there has been an increase in the demand
for fast food such as McDonalds. This will have led to an increase in the demand for
McWorkers!
(2) Productivity. The higher labour productivity, the more workers that employers want to
take on. This is because workers are contributing to increased rates of production
which become increased revenue and profit.
Wage Determination
Wages are determined by the interaction of the demand and supply of labour. This will
determine the equilibrium wage rate and the equilibrium number of workers employed.
The equilibrium wage and number of workers employed will change if there are shifts in the
demand and /or supply of labour:
A minimum wage works by guaranteeing that all workers receive at least a minimum
wage rate
The aim of this is to avoid the exploitation of workers and to provide a financial
incentive for people to work
A minimum wage will only affect those industries where free market wages would fall
below the level set. These are most likely to be jobs involving unskilled workers
In the diagram, the free market wage is W0. However the minimum wage is set above
this at W1
Firms
Potential Gains
Low paid workers achieve a
higher wage, thus reducing
relative poverty and
increasing living standards
Potential Losses
The worker may lose his/her
job if the employer responds
to the minimum wage by
laying off workers (E1-E2
above)
Even if the worker earns a
higher wage, they will be no
better off in real terms if
minimum wages lead to
higher prices and inflation
Higher costs lead to lower
profits and less funds for reinvestment
May have to compensate by
putting prices up- this will
make them less competitive
compared to foreign
competitors (BRIC)
Consumers
Definition/Explanation
Total income before taxes are removed.
Total income after taxes are removed
Money income, not taking into account
inflation
Money income is adjusted to take account of
inflation. For example if inflation has been
2%, money income needs to be reduced by
2% to reflect the fact that real purchasing
power has been reduced