ECONOMICS
Definitions
1. Economics: It is the study on how human kind fulfills its wants which are unlimited with the resources that are limited.
2. Scarcity and choice: Human wants are unlimited but resources to satisfy those wants are scarce therefore we have to make a choice between our wants and desires.
3. Opportunity cost: the next best alternative sacrificed .Example if a man has to choose between a mobile and a laptop both costing the same, and he chooses the laptop, then his opportunity cost is the mobile phone.
4. Consumer goods-those goods that give us direct satisfaction or We buy them for their own sake
5. Capital goods: Those foods that give us indirect satisfaction. We buy them for the sake of other goods example factory machinery.
6. Merit goods: Those goods which are beneficial not only for their consumer but also for third parties e.g. Vaccines against contagious diseases.
7. Demerit goods: those goods which are harmful for third parties e.g. Tobacco alcohol.
8. Giffen goods: Those goods those demand rises when price rises e.g. Luxury cars, shares, land etc.
9. Inferior goods: Those goods whose demand falls when income rises eg Public transport.
10.Normal goods: Those goods whose demand falls when price rises and demand rises when income rises. They have a negative P.E.D and a positive Y.E.D
11.The stages of production:
Primary production: The extraction of raw materials from natural resources e.g. agriculture, fishing , mining
Secondary Production: the processing of raw materials into finished goods e.g. Food processing, garments, manufacturing, construction.
Tertiary production: the production of services e.g. Transportation, banking, insurance etc.
12.Public goods: those goods which are free for all, non excludable and non rivaled e.g. street lighting.
13.Factors of production
Land: All natural resources e.g. fields, lakes mines etc The cost of land is known as rent
Labor: All human efforts both mental and physical e.g. doctors, fisherman. The cost of labor is known as wage
Capital: All man made resources e.g. buildings and machinery. The cost of capital is known as interest rate.
Entrepreneur/enterprise: The risk bearer of production: who
monitors and supervises production, work e.g. sole-proprietor. The reward for entrepreneur is known as profit.
14.Labor intensive industries: Those industries which are highly dependent on labor e.g. agriculture
15.Capital intensive industries: Those industries which are highly dependent upon capital e.g. textiles.
16.Automation: The transition from labor intensive to capital intensive industries.
17.Investment: The creation of capital
18.Savings: An increase in one’s wealth which normally occurs when income exceeds expenditure.
Economic Growth
1. Economic Growth :A rise in living standards which is measured by the annual % increase in the real GDP
2. Standard of living: The quality of life enjoyed by an average individual in terms of income, consumption etc.
3. Recession: A fall in the living standards which is measured by the annual % decrease in real GDP
Methods of achieving Economic growth
1. Education 2. Investment 3. Technology
4. Healthcare facilities
5. Others: There are many other ways of achieving economic growth such as exploitation of natural resources, reduction in corruption etc.
Advantages of Economic growth
1. Rise in living standards 2. Rise in government income
Disadvantages of Economic growth
1. Rise in social costs (public nuisances) e.g. pollution congestion, deforestation etc.
2. It might lead to unemployment: (Technology and inferior goods) 3. Rise in imports: Money goes out of the respective countries.
Privatization
Privatization: The transfer of property from the public sector to the private
sector e.g. British Airways
Advantages of Privatization:
1. Rise in government income: When the government privatizes something the government receives money from the people who buy it. The government can use this money for the country’s welfare
2. Improvement of quality of output: Advantageous for consumers
3. Wages are normally higher in private sector: advantageous for employees
Disadvantages of privatization
1. For the government :It loses control over key resources 2. For consumers: Prices are higher due to profit motive 3. For employees :Jobs are less secure and more stressful
Private Sector Public Sector
Ownership →owned by individuals
Owned by the government
Controlled by board of directors Controlled by cabinet of ministers Financed by owners through
shares
Financed by government through taxes
Profit maximization is the primary motive. Public welfare is
secondary
Social welfare is primary. Profit is secondary
Quality of output is better due to profit making motive
Quality of products is arguably poor
Externalities
1. Externalities: The effects on third parties
External cost (or negative externality)
1. Private costs: When an individual performs an economic activity he or she incurs certain costs known as private costs
2. External cost: The cost incurred by a third party is known as external cost
3. Social cost :the cost incurred by the whole society is known as the social cost Social cost = Private Cost + External Cost
External benefits or positive externalities
1. Private benefit: When an individual performs an economic activity he or she enjoys certain benefits known as private benefit
2. External benefit: The benefit enjoyed by a third party is known as external benefit
3. Social Benefit: The benefits enjoyed by the whole society are known as a social benefit. Social benefits =Private benefits + External Benefits
Remedies to externalities
1. Legalization: Making certain rules in order to prevent external cost.
2. Indirect taxes 3. Fines
4. Subsidies for goods which have external benefits
Multinational Companies (MNC)
1. MNC : A company that operates in more than one country e.g. KFC
Advantages of MNC locating in other countries
1. Cheap raw materials 2. Cheap/Skilled labor 3. Larger Market
Advantages enjoyed by the country
1. Rise in country’s output: There is no taxes or import cost 2. Creates employment
3. Rise in government income
4. Rise in competition which will result in lower price and better quality
Disadvantages to a country
1. Domestic firms suffer from foreign competition 2. Rise in social costs
3. Profits are remitted abroad
Reasons for government intervention in the location of a firm
1. To reduce social costs 2. To reduce unemployment
Productivity: The output for a given amount of input Ways to improve productivity of a firm
1. By training the workers 2. Better technology
4. Better Working conditions
(The same way we increase economic growth example education, health care and investment)
Inflation
Inflation: A persistent and general increase in the price level
Inflation rate: The percentage amount by which the price level rises in a
year
Real Income: Income adjusted with the rate of inflation e.g. If a man's income rises by 10% and the inflation rate is also 10% then his real income remains unchanged.
Effects of inflation
1. Fixed income earners suffer from poor living standards (less consumption results in low standards of living)
2. Fall in the real savings and investment 3. Fall in exports and rise in imports
4. Money loses its value. At times of inflation money loses its value for which it cannot fulfill its functions properly. It cannot measure the value of other goods accurately. People feel reluctant to give loans because debtors gain and creditors lose.
5. Investors benefit from higher profit
Causes of inflation
2. Cost pulled inflation: When basic costs of production rise, the price of finished goods are also increased, leading to inflation. As a result workers demand higher wages causing inflation to rise further.
Monetary policy: The government’s policy in which it uses interest rates to
manage the economy
Fiscal policy: The government’s policy in which it uses its income and
expenditure to manage the economy.
Remedies to inflation
Monetary policy:
1. By raising interest on savings 2. By raising interest on loans
Fiscal policy:
1. By increasing direct tax(this method is very popular for the government)
2. By reducing indirect taxes(this method is very unpopular for the government)
3. By giving subsidies in order to reduce prices(this method is very unpopular for the government)
Formulas
CPI = Consumer price index
Rate of inflation: CPI1-CPI2 ×100%
CPI1
Real income: CPI1× Present income
Real income: Present income × 100 100+r
(Where “r” is the rate of inflation)
Construction of the RPI/CPI/price index:
1. The basket of 650 goods must be determined.
2. The weitages must be assigned to each good depending upon how frequently we use them.
3. A base year is selected and the weighted average price is calculated after collecting price from sellers
Unemployment
Unemployment: Unemployment occurs when those who are eligible to
work are not engaged in productive activity
Types/Causes of unemployment
1. Structural unemployment: Caused by the decline of a major industry. 2. Cyclic unemployment
Recession/Poverty→Fall in demand→Fall in production→Unemployment 3. Frictional unemployment: One might be temporarily unemployed
when switching from one job to the other.
4. Voluntary unemployment: Some people are unemployed simply out of reluctance to work.
5. Seasonal unemployment: Certain occupations have seasonal demand. 6. Residual unemployment: Some people are unable to work due to
physical or mental handicaps.
Effects of unemployment
1. Fall in living standards
2. Fall in government income and rise in government expenditure 3. Rise in social problems such as crime
4. Wages will fall
Methods of measuring unemployment
1. Labor force survey/ILO method: A survey is taken on a quarterly basis to count the number of people unemployed.
2. Claimant count method: Those who come to collect JSA are counted as unemployed. This is done on a monthly basis
Remedies to unemployment
Monetary policy
2. By reducing interest on loans Fiscal policy
1. By reducing direct taxes 2. By reducing indirect taxes
Specialization
Specialization/Division of labor: When large complex operation is broken down into smaller simpler tasks, and each task is performed by an individual worker, the division of labor is said to occur. Example in a pin factory one worker cuts the wire, another straightens it, and another sharpens it and so on until a complete pin is made
Advantages of specialization
1. Greater skill through practice
2. No time is wasted since tools are switched over and over again 3. Less training time required
Disadvantages of specialization
1. Monotony and boredom 2. Interdependence
Globalization
Globalization: The integration and interdependence between economies
Reasons for Globalization
1. Growing MNC’s
2. The development of technology 3. Better transportation networks
4. Removal of trade barriers: rise in imports and exports thus leading to more interaction
Disadvantages of globalization
1. Rise in social costs 2. Interdependence
3. Exploitation of underdeveloped countries
Advantages of globalization (for developed countries)
1. Higher GDP and employment 2. Lower prices
3. Greater choice of goods
Advantages of globalization (for underdeveloped countries)
1. Higher GDP and employment 2. Higher taxes for the government 3. Transfer of technology
Foreign aid: Money given to a country on generous terms. These are of few
types
1. Grants. Money given to a country which is not taken back
2. Tied aid: Money given to a country subject to certain conditions 3. Low interest loans :Loans given with little or no interest
Population
1. Optimum population: An ideal population size at which the country’s resources are properly utilized
2. Life expectancy: The average number of years a person is expected to live.
3. Working population: those who are eligible to work and are above school leaving age(15 years) and below retirement age (60 years) 4. Dependant population: Those who are not eligible to work and have to
depend upon the working population. They are normally below school leaving age and above retirement age.
5. Dependency ratio: The average number of people dependent upon each worker
Dependency ratio: Dependant population Working population
6. Ageing population: When the average age of a country’s population rises it is said to have an ageing population.
7. Birth rate: The average number of births for a thousand people in a year.
8. Death rate: The average number of deaths for a thousand people in a year.
Causes of a rise in population
1. High birth rate: Poor family planning, early marriages, less use of contraceptives.
2. Low death rate: Better medical facilities, better living standards, lower crime rates.
3. High immigration: Better living standards, lower unemployment, lower inflation etc.
4. Low emigration: Better living standards, lower unemployment, lower inflation etc.
Causes of a fall in population
1. Low birth rate 2. Low death rate 3. Low immigration 4. High emigration
Effects of a rise in population
1. Rise in demand: Causing Inflation
2. Rise in congestion and crowd leading to housing shortages and utility shortages
3. Unemployment causing wages to fall
Causes of high dependency ratio
1. High birth rate 2. Low death date
3. Low immigration of young workers 4. High emigration of young workers
Effects of high dependency ratio
1. Change in pattern of demand: Those goods demanded by youngsters and elders will rise in demand
2. Labor shortages causing wages to rise 3. Fall in government income
Underdeveloped country Developed country
1. High birth rate 2. High death rate
3. High dependency ratio
1. Low birth rate 2. Low death rate
3. Low dependency ratio 4. Ageing population
Taxation
1. Direct taxes: Tax on ones income e.g. Income tax, corporation tax etc. 2. Indirect taxes: Tax on one's expenditure e.g. VAT, sales tax, tariffs etc. 3. Disposable income: Income remaining after compulsory deductions
such as direct taxes
4. Progressive tax: A tax system in which the rich pay a higher rate of tax, direct taxes are normally progressive
Example of progressive tax
When income: £10,000; Tax rate: 15% When income £15,000; Tax rate: 20%
5. Proportional tax: When the rich and poor pay the same amount of tax. Direct taxes sometimes can be proportional
When income £10,000; Tax 20% When income £20,000; Tax 20%
6. Regressive tax: When the rich pay a lower rate of tax than the poor e.g. indirect taxes are normally regressive
When income £10,000; Tax 20% When income 20,000; Tax 10%
7. The national budget: The government’s financial plan for the forthcoming year.
8. Budget surplus: When the governments income exceeds its expenditure for the year
9. Budget decficit: When the government’s expenditure exceeds its income.
10.National debt: The total amount of money the government owes
Main sources of government income
1. Indirect taxes: More than half of government income in Bangladesh come from indirect taxes
2. Direct taxes: Almost three fourths of the government income in Bangladesh comes from direct and indirect taxes combined. The
largest taxpayer in Bangladesh is Telenor, previously however it was British American tobacco
3. Revenue from sale of services: 4. Foreign aid
Main forms of government expenditure
1. Education 2. Defense 3. Health care 4. Infra structure 5. Agriculture
GDP
1. GDP: the total money produced by a country in a year.
Drawbacks of GDP:
1. It focuses on the money value of output rather than the quality of output. The quality of output is a major factor affecting living
standards. A country can have a high GDP even when its goods are of low quality because of the high price.
2. Distribution of income: The GDP shows the overall income of a country but it doesn’t show the distribution of income without which living standards will be difficult to assess country may have a high GDP but an uneven distribution of income. In such cases some will have a high living standard while some would have a low living standard.
3. Other aspects of life: Literacy rates aren’t included in the GDP.Isssues such as theses are not addressed by the GDP for which we cannot fully comprehend a country’s living standards.
HDI: It is the indicator of living standards which is constructed by
Economies of Scale
Economies of Scale: Advantages enjoyed by a firm through growth
normally such advantages lead to a fall in long term average costs
Examples of internal economies of scale
1. Purchase in economies: When a firm grows in size it requires large amount of raw materials. As a result it can obtain bulk purchase discounts
2. Technical economies: As a firm grows it uses moiré technical machinery. Such machinery makes the firm more productive. For example a machine may cost 5 times as much than a simple
machine but it is 20 times more productive. As a result production becomes comparatively cheaper
3. Financial economies: A large firm can normally obtain finance at a lower cost. For example they can obtain bank loans at cheaper interest rates because of their reputation and reliability
4. Managerial economies: A firm’s success often depends on the quality of its mangers. Larger firms normally attract better managers and thus can become more successful.
5. Risk bearing economies: When a firm diversifies into the
production of various types of goods, its risk of losses will reduce. This is because if it suffers losses from one product it can recover that loss from the profit of another product.
Diseconomies of scale: The disadvantages of growth of a firm. As a result
of this it faces a rise in long run average costs
Internal economies of scale: The advantages which arise from the growth
of a firm itself
External economies of scale: These are those advantages which arise from
the growth of a whole industry.
Problems of growth (Diseconomies of scale)
2. Regulators: When a firm grows in size it may become a threat to other firms, for this reason the OFI may intervene to rectify the problem. For example if a merger exceeds 25% market share it might be blocked by the competition commission
Horizontal merger: When two or more firms producing related
goods and operating at the same stage of production come under unified control. The merger of two banks
Vertical merger: When two or more firms producing related goods
but operating at different stages of production come under unified control. For example the merger of an oil extraction company and oil refining company
Conglomerate/diversification: When two or more firms producing
unrelated goods come under unified control e.g. a Garments manufacturer merging with a bank.
Advantages of Horizontal merger:
1. Economies of scale 2. Fall in competition
Advantages of vertical merger
1. Economies of scale
2. Better control over sources of supply: Vertical merger normally consist of two firms who are at different stages of production. Quite often these firms are supplying raw materials to each other, thus if they merge they are having control over their own raw materials
Advantages of conglomerate
1. Economies of scale
Advantages of small firms
1. Requires less capital 2. Requires very little space
Advantages of the economy (small firms)
1. They are normally labor intensive 2. Creates less social costs
Competition
Competitive markets: A market in which there are many buyers and sellers,
the goods do not differ much and there are no entry barriers
Advantages of competition
1. Low price 2. Better quality 3. Wider choice
Disadvantages of competition
1. Wastage of expenditure through advertisement, packaging etc. 2. Uncertainty for producers
Monopoly: A single firm dominating the whole market. This can even
happen if a firm has 25% of the market or more. Monopoly often setup entry barriers to prevent firms from entering into the market
Advantages
1. Economies of scale
Disadvantages
1. Exploitation of customers through higher prices and poor quality 2. Lack of innovation
Oligopoly: When few firms dominate the industry, they also setup certain
entry barriers to prevent other firms from entering. If the firms get into collusion/conspiracy they can charge higher prices from their customers
Advantages of oligopoly
1. Stable prices(Only possible if there is no collusion) 2. Better in quality
1. Danger of collusion
Production Possibility Frontier (PPF)
PPF: It is a diagram that shows a country’s productive potential with its existing resources
The PPF shifts outward if there is an increase in the country’s resources or if there is an increase in the efficiency of existing resources e.g. Investment, technology, education
In other words the PPF will shift outward if there is economic growth in the country
Draw what will happen to the PPF if
1. There is a rise in the resources used to produce tanks
2. Fall in the efficiency of the use of resources used to produce roses 3. There is a rise in the resources for roses and a fall in the resources for
producing tanks
4. There is a fall in the level of education 5. There is a rise in capital investment
Costs and revenues
Total cost: The total expenditure incurred in producing a certain level of
output
Fixed Cost + Variable cost
Average cost: The cost Per Unit
AC = TC Q
Fixed Cost: The cost that remains constant whatever the level of output.
E.g. Rent, depreciation
Variable Cost: The cost that varies with the level of output e.g. wages, raw
material costs etc.
Average cost: Average Fixed Cost + Average Variable Cost
Total revenues: The total income earned selling a certain level of output
Average revenue: The income per unit
Average revenue = Total Revenue
Quantity
Fixed cost Variable cost
Average Cost Example
From the Example diagram, calculate 1. Fixed Cost
2. Variable Cost for 100 units 3. Average cost for 100 units 4. Average Variable cost ANSWERS
2. 15,000
3. 25,000/100 = 250 4. 15000/100 = 150
Total Revenue Average Revenue
1. Fixed cost 2000
2. Average cost 5000-2000/1000 = 3 3. Average cost : 5000/1000 = 5
International Trade
1. Dumping: To sell goods to foreign countries below the cost price. The EU dumps sugar to Africa.
Advantages of free trade
1. The country earns money from abroad 2. Creates jobs
3. Economies of scale
4. Wider variety of choice: A country cannot produce all sorts of goods. So it has to import goods to satisfy people
5. Rise in competition
Disadvantages of free trade
1. Depletion of a country’s resources 2. Outflow of money to other countries 3. Competition is harmful for domestic firms
Trade Barriers/restrictions/anti dumping measures
1. Tariffs: It is a tax imposed upon imported goods. E.g. in Bangladesh Tariffs are unto 300% upon imported cars. This is the most popular trade barrier
2. Quotas: Physical limit on the level of imports entering a country. 3. Trade embargo: A complete ban on imports e.g. a trade embargo exists
between Israel and Arab countries.
4. Subsidies: The government can give subsidies to domestic industries. So that the price of domestic goods fall. As a result people will import less. However this is unpopular for the government
Balance of payments, current account: A record of the inflow and outflow
of money of a country, arising from trade
Visible trade: Export of goods – Import of goods
#The UK has a deficit on its visible trade but yet a surplus on in Balance of payments current account, explain why?
ANSWER: The Surplus in invisible trade was so much that it covered the deficit.
Exchange rates: The price of one currency in terms of another
Effects:
World trade Organization
The WTO is a multi lateral body who aims to promote trade within its member country. It forms trade agreements between countries and resolve trade disputes. In other words it aims to increase trade liberalization (free trade)
Trade blocs: A group of countries who form an agreement to promote trade
among each other. They do this by removing tariffs among each other, imposing common external tariffs against outsider countries allowing the free movement of labor e.g. the European Union, ASEAN, NAFTA etc
#In the following examples which currency has depreciated
1. 2007 £1 = € 1.7 2008 £1 = €1.8 €, Euro depreciated 2. 2002 $1 = DM 0.67 2003 $1 = DM 0.58 $, Dollar depreciated 3. 2010 €2 = ¥3.8 2010 €1 = ¥2.2
¥, Yen depreciated
Demand and Supply
Certain Factors that affect demand
1. Population 2. Income
3. Price of substitutes 4. Price of complements
5. Other factors such as weather, fashion events
Certain factors affecting supply
1. Change in cost of production 2. Entry/exit of firms
3. Indirect taxes/VAT 4. Subsidies
5. Others such as weather, technology
Price Elasticity of Demand (PED): The responsiveness of demand to a
change in price
PED = %Change in demand %Change in Price
Income elasticity o demand: The Responsiveness of demand to a change in income
YED: %Change in demand %Change in income
Price Elasticity of supply (PES): The responsiveness of supply to a change
in price
PES % Change in Supply %Change in Price
If elastic If Inelastic
1. The Demand curve is flat 2. When price rises revenue falls 3. When price falls revenue rises
1. The demand curve is steep 2. When price rises revenue rises 3. When price falls revenue falls
Indirect taxes
The VAT per unit is the vertical distance between the two supply curves
#what is the VAT per unit = £7
#What is the:
a) Previous price and new price b) The VAT per unit
c) The total income of the government d) PED when the price is rising
e) The total revenue previously f) The total revenue presently
g) Using your answers from ‘e’ and ‘f’ say whether price is elastic or inelastic
ANWERS
a) Pervious price : £40 New price: £50
b) Vat per unit : 50-35=15 c) 1050 d) %change in demand = -30 %change in supply = 25 = -1.2 e) Total revenue = 40×100 = £4000 f) Total revenue = 50×70 = £3500
Subsidies
Factors determining the exchange rate
1. The level of exports: When we export goods foreigners demand our currency to pay for the exports as a result when our exports rise the exchange rate rises and when our exports fall the exchange rate falls. 2. Tourism: When tourists enter our country they demand our currency
because whatever they buy in our country has to be paid in our currency. Thus if the number of tourists rise the exchange rate will also rise and when the number of tourist fall the exchange rate will also fall.
3. Interest rates: If the interest rate rises in our country then people from all over the world would like to save in our country. But to do this they have to first convert the money into our currency. Thus the demand for our currency will rise and the exchange rate will also rise. Likewise when the interest rate falls the exchange rate will also fall.
Economic Systems
1. Planned/ Command Economy: It is an economic system in which the government takes the major economic decisions on what to produce, how to produce and how to distribute. Distribution is normally done on an equal share basis
This system is strongly criticized because it lacks freedom of choice and enterprise and the level of motivation is low e.g. The USSR
2. Free market economy: It is an economic system in which the people have the freedom to choose what to produce, how to produce and how to
distribute. Production and distribution is normally done according to the price mechanism
However market failures may arise, market failure means the price mechanism is unable to allocate the resources efficiently, this happens due to externalities.
3. Mixed economy: It is an economic system where both the government and market forces play important roles. Certain resources are controlled by the government (the public sector) which is used to provide social welfare, on the other hand certain resources are owned by individuals (the private sector) which are allocated according to the price
mechanism. Here competition takes place and owners try to maximize their products.
