1 IGCSE Economics Opportunity cost and the basic economic problem Definition Opportunity cost: the cost of any

activity measured in terms of the value of the next best alternative forgone (that is not chosen) Production: the act of creating output a good or service !hich has value contributes to the utility of others Producer: people !ho ma"e and sell goods#services Consumption: $he final purchase of goods and services by individuals Consumer: Individuals !ho purchase the good#services to satisfy their !ants and needs Consumption Expenditure : Spending of consumers Exchange: % mar"etplace in !hich securities commodities derivatives and other financial instruments are traded Trade: %n economic activity that involves multiple parties participating in the voluntary negotiation and then the exchange of one&s goods and services for desired goods and services that someone else possesses' Entreprenuers: individuals !ho rather than !or"ing as an employee runs a small business and assumes all the ris" and re!ard of a given business venture idea goods or service offered for sale' Human resources: the company department charged !ith finding screening recruiting and training (ob applicants as !ell as administering employee) benefit programs' %lso "no!n as Labor' Natural resources: resources occurring in nature that can be used to create !ealth %lso "no!n as Land' Examples include seas and rivers' actors of Production! Definition : inputs that are used in the production of goods or services in the attempt to ma"e an economic profit' $he factors of production include land labor capital and entrepreneurship' actors "# Land *and refers to the resources available including the seas nad rivers forests and deserts all manner of minerals from the ground+ chemicals from the air and earth,s crust' $# Labor

*abor refers to the physical and mental effort produced by people to ma"e goods#services' $he si.e and ability of a economy,s labor force are very important in determining the /uantity and /uality of the goods#services produced' $he greater the number of !or"ers the better educated and s"illed they are the more an economy can produce' %# Enterprise Enterprise refers to the ability to run a production process employ and organi.e resources in a firm (an organi.ation that o!ns a factory or a number of factories and even shops !here goods#services are produced)' &# Capital Capital refers to already)produced durable goods that are used in production of goods or services' It is not !anted for itself but for its ability to help in producing other goods' It is also "no!n as man'made resources# Di(ision of labor)*peciali+ation Definition: % system !hereby !or"ers concentrate on performing a fe! tas"s (instead of finishing the entire product by themselves) and then exchange their production for other goods#services ,d(antages "# -ore goods)ser(ices can be produced 0hen !or"ers become specialists in the (obs they do repetition of the same operation increases the s"ill and speed of the !or"er and as a result more is produced' $# ull use is made of e(eryone.s abilities 0ith the division of labor there is greater chance that people !ill be able to do those things at !hich they are best and !hich interest them the most'

%# Time is sa(ed $ime is !asted !hen a !or"er has to s!itch from one tas" to another' $ime can also be saved !hen training people' It !ould ta"e many years to train someone to be able to build a car for example but a person can be trained /uic"ly to fulfill one operation in the production process' &# /t allo0s the use of machinery %s labor is divided up into specialist tas"s it becomes !orth!hile to use machinery !hich allo!s a further saving in time and effort' 1or example cars are painted by machines instead of by hand' $his in turn allo!s machinery to ta"e over people,s (obs leaving many unemployed' Disad(antages "# 1or2 may become boring % !or"er !ho performs the same operation every day is li"ely to be unsatisfied#lo! morale' $o combat this many firms play music to their labor forces or allo! them to

2 have a rest during part of each hour' *onger rest hours and annual holidays may also be introduced although this !ill shorten the !or"ing !ee"' $# People become too dependent on each other Specialisation and divisiol of labour means that people come to rely on others for the provision of goods#services' 1or example people !ho produce food rely on the provision of tractors fertili.ers etc' %# 1or2ers may feel alienated 0or"ers may feel unimportant because they can no longer see the final result of their efforts' Some firms are trying to reverse this by introducing !or"ers to a greater variety of tas"s &# *tandardi+ation of goods Goods produced under a system of speciali.ation are usually turned out in vast numbers and share the same design' 0hether this is a disadvantage depends on people,s opinion' 1or example there is probably variation in the color and design in clothes to please most people' 3o!ever it is not possible to please everyone because in most factories it !ould be difficult and expensive to change the production process to suit one person,s !ants since most factories practice mass production in order to produce the greatest number of goods in the lo!est cost possible' 1hat is economics3 Economics is the social science that analy.es the production distribution and consumption of goods and services' It studies ho! individuals governments firms and nations ma"e choices on allocating scarce resources to satisfy their unlimited !ants' Economics can generally be bro"en do!n into: macroeconomics !hich concentrates on the behavior of the aggregate economy+ and microeconomics !hich focuses on individual consumers'

-ar2et *ystems Definition: -ar2et: 4ne of many varieties of systems institutions procedures social relations and infrastructures !hereby parties engage in exchange' It consists of all those people or firms !ho !ish to exchange a given good or service' -ar2et system: %ny systematic process enabling many mar"et players to bid and helping bidders and sellers interact and ma"e deals' It is not (ust the price mechanism but the entire system of regulation /ualification credentials reputations and clearing that surrounds that mechanism and ma"es it operate in a social context' Price mechanism: 5efers to the consumers and producers !ho negotiate prices of goods or services depending on demand and supply' $his is also "no!n as mar2et forces'

6 Types of mar2et systems

8ar"et system :efinition

1ree economy %n economy in !hich decisions regarding investment production and distribution are based on supply and demand and the prices of goods and services are determined in a free price system' Capital return# Capital flo!s to !here it !ill get the greatest return expanding the total si.e of the economy to its maximum level' *upply and Demand# Supply and demand are closely lin"ed: Someone !ho has a good idea or product can /uic"ly put it into the mar"et so that it is available to those !ho !ant it' Conversely !hen a certain type of product is desired by enough people it is a simple matter for someone to provide it' Economic freedom# In a mar"et economy it is easier for someone !ith initiative and virtue to create a better life for themself and their family+ economic freedom ma"es it eaiser to transform hard !or" and perseverance into material !ealth' 5ne6ual 0ealth distribution# a small percentage of society has the !ealth !hile the ma(ority lives in poverty' No economic stability# greed and overproduction

8ixed economy %n economic system in !hich 7 both the state and private sector direct the economy reflecting characteristics of both mar"et economies and planned economies' Pro(ides fair competition# $he presence of private enterprise ensures that there is fair competition in the mar"et and the /uality of products and services are not compromised' 1ell regulated# 8ar"et prices are !ell regulated' $he government !ith its regulatory bodies ensure that the mar"et price do not go beyond its actual price' Efficient use of resources# 4ptimum utili.ation of national resources' In a mixed economy the resources are utili.ed efficiently as both government and private enterprises are utili.ing them' It does not allo! monopoly at all' ;arring a fe! sectors a mixed economy does not allo! any monopoly as both government and private enterprises enter every sector for business'

9lanned economy %n economic system in !hich decisions regarding production and investment are embodied in a plan formulated by a central authority usually by a government agency' *tability' *ong)term infrastructure investment can be made !ithout fear of a mar"et do!nturn leading to abandonment of a pro(ect' -eeting collecti(e ob4ecti(es' 9lanned economies may be intended to serve collective rather than individual needs' $he government can harness 149 to serve the economic ob(ectives of the state' ,d(antages o(er free economy# It is not sub(ect to ma(or pitfalls of mar"et economies and mar"ed)oriented mixed economies' % planned economy does not suffer from business cycles does not experience crises of overproduction' It does not result in asset bubbles < massive misallocations of resources'

%dvantages

:isadvantag es

/nefficient' It&s efficiency property reduces in progressi(ely higher degree the more its mixed nature embraces more and more of government # state intervention and State planning and reduces

/nefficient resource distribution' 9lanners cannot detect consumer preferences shortages and surpluses !ith sufficient accuracy and therefore cannot efficiently co)ordinate

= $he o!nership of the factors of production controls: 1hat is produced 1here to produce Ho0 to produce < the method of production (labour intensive# capital intensive) Ho0 much goods and services to produce

Economic sectors Primary: $he extraction of natural resources e'g' oil drilling /uarrying forestry *econdary: $he manufacturing of goods using natural or man)made resources e'g' car assembling property construction toy manufacturing Tertiary: $he provision of services to consumers or producers e'g' education accounting mar"eting 7uaternary: $he provision of 5>: soft!are development and information processing e'g' research into fiber optics development of search engines' Production 8 Producti(ity 9 1ealth Definition Producti(ity: % measure of the efficiency of production' It is the amount of output that can be produced from a given amount of resources Labor producti(ity: the amount of goods and services that a !or"er produces in a given amount of time Production Possibility commodities rontier: % graph that compares the production rates of t!o that use the same fixed total of the factors of production' 9rofit ? 5evenue < Cost : Producti(ity :; CELL! OP< = Cost< Creation

Producti(ity Labor productivity = Output No. of workers o E'g' 1irm %: 1@ units of labor > -@ units of output 1irm ;: -@ units of labor > =@ units of output 0ays to increase productivity may mean: Asing same number of actors of Production to produce more output Asing less actors of Production to produce same amount of output' 0hat is increased productivity ? lo0er business cost Increased productivity means greater 0ealth for o0ners of firms and the economy (in general) 991 shift out!ards (economic gro!th)

Ho0

to

impro(e

producti(ity of land

Increased use of fertili.ers < 1ertili.ers allo! previously barren land to produce crops and fertile lands to improve higher yields Improved drainage < 5educes soil erosion and assists in the reduction of phosphorus in streams' It allo!s crops such as hay corn and soybeans to produce higher yields' Improved irrigation < In dry areas improved irrigation !ill allo! plants to receive more !ater and produce a higher yield' Increased use of machinery < 8achinery such as tractors help ta"e in the yields much more /uic"ly' Introduced genetically)modified high)yield crops < Genetically)modified crops produce higher yield as they can be altered to fight against pests herbicides cold disease or drought' ;uild multi)functioned buildings (e'g' s"yscrapers) ) ;y building multi)functioned buildings land can be allocated more efficiently as buildings such as s"yscrapers can accommodate a !ide range of business activities

Ho0 to impro(e producti(ity of labour Implement division of labor < :ivision of labor allo!s production to be more efficient' /ncrease use of machinery :to aid tas2s< < 8achinery allo!s the increase of production as !ell as the /uality of the finished product to be

C better' *peciali+ation < $here is a higher output' $otal output of goods and services is raised and /uality can be improved' % higher output at lo!er costs means more !ants and needs might be satisfied !ith a given amount of scarce resources'

S"ill training < S"ills training increase producti(ity' In addition to learning ho! to complete ne! tas"s and ta"e on more responsibility employees can learn advanced techni/ues to help those complete everyday tas"s more efficiently' %lso it impro(es 4ob satisfaction of the employee' Investing time and money in employees, s"ills ma"e them feel valued and appreciated and it challenges those to learn more and get more involved in their (obs' 3igher (ob satisfaction ultimately results in reduced turnover and higher productivity' 8otivate !or"ers !ith financial incenti(es (pay raises profit sharing) increase 4ob satisfaction (better !or"ing environment)

Nationali+ation Definition: $he process of ta"ing an industry or assets into government o!nership by a national government or state' It usually refers to private assets but may also mean assets o!ned by lo!er levels of government such as municipalities being transferred to the public sector to be operated and by the state' ,d(antages $he ability of the state to direct investment in "ey industries $he distribution of state profits from nationali.ed industries for the overall national good $he ability to direct producers to social rather than mar"et goals Greater control of the industries by and for the !or"ers $he benefits and burdens of publicly funded research and development are extended to the !ider populace Disad(antages Costly management# $he management of the nationali.ed industry is complicated and un!ieldy' $here are numerous departments and paid persons i'e' directorate regional office conduct its management'

D Lac2 of decision ma2ing# %ll the necessary matters are decided by various official and committees' In case of conflicting vie!s /uic" decision cannot be made for the urgent matters !hich are dangerous in business' Lac2 of efficiency# Eationali.ed industries are managed by salaried persons !ho are generally found less efficient as compared !ith privately o!ned concerns' $here is also lac" of flexibility and adaptability !hich are asset of private o!nership' >ureaucracy# $here is extensive and rigid procedure of the state machinery by !hich event is dealt' Such stipulated rules has made the process of !or" very complicated !hich results in delay and loss of initiative' ,bsence of profit moti(e# $he salaried persons are not concerned !ith profit' $herefore nationali.ed underta"ing hardly run successfully due to lac" of personal interest Chances of loss# $he loss of the nationali.ed enterprises is regarded as the loss of the nation' So the structure of nationali.ed economy !ill greatly affected by the failure of such scheme' Limited in(estment' Investors hesitate to invest large sum of money due to ris" of nationali.ation' $herefore the volume of investment remains limited in private sector'

Pri(ati+ation Definition: $he incidence or process of transferring o!nership of a business enterprise agency public service property from the public sector (the state or government) to the private sector (businesses that operate for a private profit) or to private non)profit organi.ations' ,d(antages /ncreased efficiency# 9rivate companies and firms have a greater incentive to produce more goods and services for the sa"e of reaching a customer base and hence increasing profits' % public organi.ation !ould not be as productive due to the lac" of financing allocated by the entire government&s budget that must consider other areas of the economy' *peciali+ation# % private business has the ability to focus all relevant human and financial resources onto specific functions' % state)o!ned firm does not have the necessary resources to speciali.e its goods and services as a result of the general products provided to the greatest number of people in the population' /mpro(ements# Conversely the government may put off improvements due to political sensitivity and special interestsFeven in cases of companies that are run !ell and better serve their customers& needs' Capital# 9rivately held companies can sometimes more easily raise investment capital in the financial mar"ets' 0hile interest rates for private companies are often higher than for government debt this can serve as a useful constraint to promote efficient investments by private companies instead of cross)subsidi.ing them !ith the overall credit)ris" of the country' Investment decisions are then governed by mar"et interest rates' State)o!ned industries have to compete !ith demands from other government departments and special interests' In either case for smaller mar"ets political ris" may add substantially to the cost of capital'

1@ Disad(antages ?ob Loss# :ue to the additional financial burden placed on privati.ed companies to succeed !ithout any government help unli"e the public companies (obs could be lost to "eep more money in the company' Natural monopolies# 9rivati.ation !ill not result in true competition if a natural monopoly exists' Profit# 9rivate companies do not have any goal other than to maximi.e profits' % private company !ill serve the needs of those !ho are most !illing (and able) to pay as opposed to the needs of the ma(ority' @oals# $he government may see" to use state companies as instruments to further social goals for the benefit of the nation as a !hole'

Demand theory Definitions Demand: $he ability and !illingness to pay a price to purchase a good#service 7uantity demanded: $he total amount of goods or services that are demanded at any given point in time' Ceteris Paribus: $he relationship bet!een both the price and the /uantity demanded of an ordinary good' Effecti(e demand: the demand for a product or service !hich occurs !hen purchasers are constrained in a different mar"et Notional demand: $he demand that occurs !hen purchasers are not constrained in any other mar"et /ndi(idual demand: $he ability and !illingness of a consumer to purchase a good#service Deri(ed demand: :emand for one good or service occurs as a result of the demand for another intermediate#final good or service Types of income Aeal' Income of an individual or group after ta"ing into consideration the effects of inflation on purchasing po!er' Disposable' %mount of money that households have available for spending and saving after income taxes have been accounted for' :isposable personal income is often monitored as one of the many "ey economic indicators used to gauge the overall state of the economy' Discretionary' %mount of an individual&s income that is left for spending investing or saving after taxes and personal necessities (such as food shelter and clothing) have

11 been paid' :iscretionary income includes money spent on luxury items vacations and non)essential goods and services' actors that affect the demand for goods)ser(ices @oodBs o0n price# $he basic demand relationship is bet!een potential prices of a good and the /uantities that !ould be purchased at those prices' Generally the relationship is negative meaning that an increase in price !ill induce a decrease in the /uantity demanded' $his negative relationship is embodied in the do!n!ard slope of the consumer demand curve' In other !ords the lo!er the price the higher demand ceteris paribus Price of related goods# $he principal related goods are complements and substitutes' % complement is a good that is used !ith the primary good' Examples include hotdogs and mustard beer and pret.els automobiles and gasoline' If the price of the complement goes up the /uantity demanded of the other good goes do!n' $he other main category of related goods is substitutes' Substitutes are goods that can be used in place of the primary good' If the price of the substitute goes do!n the demand for the good in /uestion goes do!n' Personal Disposable /ncome' In most cases the more disposable income (income after tax and receipt of benefits) you have the more li"ely you buy' %ny changes in the level of income tax rates and allo!ances are therefore li"ely to result in a change in the /uantity of goods#services demanded' In a normal good demand for a product tends to rise as incomes rise' If the demand tends to fall as incomes rise the product is said to be an inferior good' TastesC preference or habits# $he greater the desire to o!n a good the more li"ely you is to buy the good' $here is a basic distinction bet!een desire and demand' :esire is a measure of the !illingness to buy a good based on its intrinsic /ualities' :emand is the !illingness and ability to put one&s desires into effect' It is assumed that tastes and preferences are relatively constant' 1or example if consumers around the !orld are demanding good#services that are environmentally)friendly the derived demand for those goods#services !ill increase' %dvertising also plays a part' 9ersuasive and informative advertising tends to increase brand a!areness and as a result increase the demand for the good#service' Consumer expectations about future prices and income# If a consumer believes that the price of the good !ill be higher in the future he is more li"ely to purchase the good no!' If the consumer expects that her income !ill be higher in the future the consumer may buy the good no!' In other !ords positive expectations about future income may encourage present consumption' *easonal demand# % hot summer can boost sales of cold drin"s and ices !hile a cold !inter can boost the demand for fuel for heating' Higher interest rates can increase the demand for savings schemes but reduce the amount of money people !ant to borro! including mortgages for house purchases'

1 Population change# %n increase in population tends to increase the demand for many goods and services in a country' 1or example in a country !here there is an aging population demand for !al"ing stic"s and retirement homes may increase' Location of consumers# $here is une/ual distribution of income and !ealth in different areas of the country' In a richer area of the country the demand for superior goods !ill be higher in an area of lo! income' Price Elasticity of Demand Definition: demand curve !ill also affect the amount of revenue as the price changes 9E:' % measure used to sho! the responsiveness or elasticity of the /uantity demanded of a good or service to a change in its price' $he elasticity of the

ormula PED D E change in 7uantity Demanded E change in Price PED D :Ne0 7D 8 Old 7D< x"FF C :Ne0 P 8 Old P< x "FF

/nelastic : $he 9E: value is bet!een @ and )1' It tends to have fe! substitutes is necessities and#or can be addictive e'g' alcohol cigarettes or petrol' Elastic : $he 9E: value is bet!een )1 and )G' It has a lot of substitutes and may be an inferior good' Ae(enue Definition: 5evenue is the amount received by the producer from the sale of the goods or service' It is calculated by the multiplying the price charged by the /uantity sold :A D P x 7<' $he only difference bet!een revenue and profit is the costs Price elasticity of *upply Definition: 9ES: % measure used to sho! the responsiveness or elasticity of the /uantity supplied of a good or service to a change in its price' $he 9ES is al!ays a positive number ormula PED D E change in 7uantity *upplied E change in Price PED D :Ne0 7* 8 Old 7*< x"FF C :Ne0 P 8 Old P< x "FF

Inelastic : $he 9E: value is bet!een @ and 1' It tends to have fe! substitutes and ta"es time to alter the

12 /uantity of production' Elastic : $he 9E: value is bet!een 1 and G'

Note: The amount supplied is not al0ays e6ual to supply and may create shortages and surplus# Economies of scale Definition: Economies of scale: Diseconomies of scale: $he cost advantages that an enterprise obtains due to expansion' $he forces that cause larger firms and governments to produce goods and services at increased per)unit costs'

,d(antages of large'scale production /nternal Lo0er a(erage unit costs# Scale of production because of a change in the !ay a firm is run' 1or example larger firms can afford more effective advertising' $hey can spread the cost of advertising over a larger number of products' Efficiency# 1or example companies can shut do!n small firms and open one large firm and paying fe!er managers to run it' %nother is technological economies meaning that larger firms can buy more efficient and larger machinery and e/uipment leading to lo!er average unit costs Aesearch and De(elopment# 1irms can afford to spend large amounts on research and development Purchasing# $hey can afford to buy materials in bul" and therefore the unit costs are cheaper as they may be given discounts for buying in large /uantities'

External G @eographical ad(antage# %n area has an excellent reputation for producing a particular good#service or a pool of s"illed labour may develop in an area !here many firms are concentrated' $his helps reduce training costs and probably ma"es recruitment easier' Ais2'bearing economies# 0hen borro!ing from a large loan the company can use assets from profitable firms are collaterals and spread the ris" of the loan over several firms' irms may cooperate 0ith each other# *imilar and related firms# $here may be firms in the area in related industries !ith similar expertise and "no!ledge'

16 Disad(antages of large'scale production -anagerial deos# ;rea"do!n of communication as firms get too large' $his can lead to a delay in ma"ing decisions' Labor deos# :ecrease in staff morale as it is difficult to retain close personal contact !ith staff because of the si.e of the organi.ation Hobs may be bro"en do!n into specialist parts and the !or"ers may find their (obs too repetiti(e and boring#

,d(antages of small firms lexibility' Small firms can adapt readily to consumer needs designing products to meet individual re/uirements !hilst some products cannot be mass produced' /ndustrial relations# $he boss of the small firms tends to have a !ide general "no!ledge of the performance of their employees and may have a friendly relationship' $his could increase morale and motivation' $here is also less chance of poor productivity as there are less people in small firms' Customer relations# *i"e!ise small firms are more li"ely to "no! their customers and to be able to offer personali.ed services to their customers' 9ersonal attention is more feasible in small businesses such as private music#sports tuition' Local monopoly' Some firms supply only to a small mar"et and specialist businesses are not interested in these mar"ets'

Public and -erit @oods In a mixed economy the government exists alongside the free mar"et to provide certain goods and services' $hese tend to be public goods and merit goods because a free mar"et !ould either fail to provide them or not provide them in sufficient /uantities' Public @oods $hese are things li"e street lighting coast guard police fire brigade and the army' It is clear that people !ant streets to be lit and to be "ept safe from attac" so !hy doesn,t the mar"et react and satisfy these !antsI 0hy do you believe that private firms !ould be reluctant to provide theseI $hey have t!o distinctive features: $hey are non'ri(alryC meaning that anyone can use it and they are non'excludable meaning that they can,t stop people from using it and it is difficult to prevent Jfree ridersK'

-erit @oods 8erit goods are not pro(ided enough by the pri(ate sectors because it is not profitable# $hey are things li"e healthcare education libraries sports centers country par"s public housing and public hospitals' 9ublic housing and hospitals are public because the people !ho use these facilities have no or lo! income to afford it' %gain people !ant to be "ept !ell and !ant to be educated' $he mar"et can provide these goods+ ES1 is a private

17 education provider !hilst in the AS% healthcare is almost exclusively carried out by the private sector' 0hy then in many countries do governments step in and provide healthcareI Trade 5nions Definitions Trade 5nions: %n organi.ation of !or"ers that have banded together to achieve common goals promote and protect the interests of their member' Collecti(e bargaining: a process of negotiations bet!een employers and a group of employees aimed at reaching agreements that regulate !or"ing conditions and pay' Open shop : % firm that can employ unioni.ed and non)unioni.ed labour Closed shop : %ll !or"ers in a place of !or" have to be union members' $he closed shop is outla!ed in some countries because it gave unions too much po!er to dictate !ho a firm could employ *hop *te0ard: 4ne of the firm,s employees !ho is granted time off during !or"ing hours to deal !ith trade union matters' In some larger companies a shop ste!ard may be employed full)time on industrial relations' 3is or her 1age Councils: $hese organisations set minimum !ages (not Eational) for their relevant industries' 0age councils have declined dramatically in numbers since 1DBD' Employment La0s: *a!s passed by the government or the European Anion that set out rules of behaviour for !or"ers employers and trade unions !ith regard to employment *ingle union agreement: %n agreement bet!een an employer and a union such that the union !ill represent all the !or"ers at a particular !or"place' $his means that one union can represent all the !or"ers !hatever their occupation in the same !or"place' /ndustrial relations: $he relationships bet!een employees and employers Trade 5nions Past and Present 8 The change of trade unions Since their establishment the membership and influence of trade unions continued to gro! until the early 1DC@s' $he Conservative government at that time responded to public anger over stri"es by introducing la!s that restricted the unions, activities' In addition rising unemployment and the decline in the manufacturing industries (that formed the traditional base of the unions) have reduced union membership' $he increase in part)time (obs and the increased number of !omen !or"ing have also had an impact on union membership' In the past neither of these groups have been strong supporters of trade unions' In addition the 1DC@s and 1DD@s have seen a dramatic increase in the number of self)employed people ) !ho are not usually unioni.ed'

1= In response unions have tried to improve their image by ma"ing their services more appealing and relevant to today,s !orld ) e'g' the %$* union (%ssociation of $eachers and *ecturers) has a Jno stri"eK policy' 8any unions no! offer their members loans mortgages insurance credit cards discount holiday vouchers and discount car hire' $oday some trade unions also provide grants for college courses or arrange retraining programmes (the process of developing ne! s"ills) for their members !ho have been made redundant' In addition they also provide representatives for members in cases of redundancy grievance disciplinary hearings and legal action (e'g' on e/ual pay)' Trade 5nion -embership ,round the 1orld %ccording to the International *abour 4rganisation only -7L of the !orld,s 1'2bn !or"ers !ere members of trade unions in Eovember 1DDB' 3o!ever since the I*4 also concluded that trade unions are ad(usting to the realities of today it is li"ely that trade union membership !ill increase over the next ten years' In a recent I*4 survey of D- countries only 16 had a unionised !or"force of over 7@L (and 6C countries had less than -@L)' 5esults of selected countries are sho!n belo! Trade Union Density in selected countries (ILO): Country S!eden Italy South %frica %ustralia AN Germany Ee! Oealand Hapan AS% South Norea 1rance "HHI density D1'1 66'6 6@'D 27'2-'D -C'D -6'2 -6'@ 16'1-'B D'1 E change since "HJI MC'B )B'6 M12@'C )-D'= )-B'B )1B'= )77'1 )1='B )-1'1 M-'6 )2B'-

Source: adapted from ILO Labour Report 199 Types of Trade 5nions %lthough the number of trade unions and the number of members in unions have declined steadily since 1DBD !e can still distinguish bet!een four different types of trade unions: "# Craft 5nions $hese are the oldest type of unions !hich !ere formed originally to organi.e !or"ers according to their particular s"ill' 1or example engineers and printers formed their o!n respective unions' $oday the @P-5 :@raphicalC Paper and -edia 5nion< has members !or"ing in the printing paper publishing and media industries' $he decline in the demand for some particular crafts has led to many of the older unions to recruit semi)s"illed and uns"illed !or"ers' $# /ndustrial 5nions

1B $hese unions attempt to organise all !or"ers in their industry irrespective of their s"ills or the type of !or" done' $he National 5nion of -ine0or2ers :N5-< is an example' National 5nion of Teachers :N5T< Trade 5nion Congress :T5C< %# @eneral 5nions $hese unions are usually prepared to accept anyone into membership ) regardless of the place they !or" the nature of !or" or industrial /ualifications' $hese unions have a very large membership of uns"illed !or"ers' $he T@15 :Transport and @eneral 1or2ers 5nion< is a very large General Anion in the AN' $heir members include drivers !arehouse !or"ers hotel employees and shop !or"ers' &# K1hite Collar. 5nions %lso called non'manual unions and professional associations these recruit professional administrative and clerical staff (salaried !or"ers) and other non)manual !or"ers' $hey are very strong in teaching ban"ing the civil service and local government' The Aole) unctions),ims of Trade 5nions $he primary role of $rade Anions is to protect the 0or2ers. interests' Examples include: Collecti(e pay bargaining 8 trade unions are able to operate openly and are recogni.ed by employers they may negotiate !ith employers over !ages and !or"ing conditions' *ubscription 8 Early trade unions li"e 1riendly Societies often provided a range of benefits to insure members against unemployment ill health old age and funeral expenses' In many developed countries these functions have been assumed by the state+ ho!ever the provision of professional training legal advice support for members that are mad redundant and representation for members is still an important benefit of trade union membership' Political acti(ity 8 $rade unions may promote legislation favorable to the interests of their members or !or"ers as a !hole' $o this end they may pursue campaigns underta"e lobbying or financially support individual candidates or parties (such as the *abour 9arty in ;ritain) for public office' /ndustrial action 8 $rade unions may enforce stri"es or resistance to loc"outs in furtherance of particular goals'

,ims of the Trade 5nion :efending their employee rights and (obs Securing improvements in their !or"ing condictions including hours of !or" and health and safety of !or" Improving their pay and other benefits including holiday entitlements Improving sic" pay pensions and industrial in(ury benefits

1C Encouraging firms to increase !or"er participation in business decision ma"ing :eveloping and protecting the s"ills of Anion members' ,ims of the 0or2ers: 0or"ers !ill aim to maximi.e: 3igher 0ages < matching inflation (index)lin" salaries to C9I) Hob security < no sac"ing !ithout notice or reasons 0or"ing conditions ) 3ealth > Safety+ !or"ing hours Career progression opportunities: $raining and up)to)date information 3ealth and Safety at !or" 9er"s 3ealth insurance pensions car education allo!ance

,ims of the employers 1or the employer targets to maximise may include: 9rofits Sales *o!er costs

/ndustrial disputes Definition: :isputes !ith the !or"force and#or their representatives ) and any resulting industrial action ) are costly and damaging to both the business and !or"ers' Causes "# Economic Cause :emand for increase in !ages on account of increase in all)India Consumer 9rice Index for Industrial 0or"ers' :emand for higher gratuity and other retirement benefits' :emand for certain allo!ances such as: 3ouse rent allo!ance medical allo!ance demand for paid holidays and reduction of !or"ing hours ;etter !or"ing conditions etc' -' Personnel Causes# Sometimes industrial disputes arise because of personnel problems li"e dismissal retrenchment layoff transfer promotion and more vacations etc' 2' /ndiscipline# Industrial disputes also ta"e place because of indiscipline and violence on the part of the !or"force' $he managements to curb indiscipline and violence resort to loc")outs

1D 6' -isc# causes# Some of the other causes of industrial disputes can be !or"ers& resistance to rationali.ation introduction of ne! machinery and change of place non)recognition of trade union rumors spread out by undesirable elements !or"ing conditions and !or"ing methods lac" of proper communication behaviour of supervisors to inter)trade union rivalry' Ho0 collecti(e bargaining is organi+ed Definition: the process !hereby representatives of the !or"ers (in a particular industry) negotiate say pay settlements ) !ith representatives of the employers (in that industry)' Generally an individual !or"er is in a !ea" bargaining position ) the main purpose of a trade union is to remove this !ea"ness by JforcingK the employer to negotiate !ith the representatives of his#her !or" force' $rade unions are autonomous bodies ) they have complete freedom to act in their o!n interests' 8ost unions ho!ever are affiliated to the $rade Anion Congress ($AC) !hich is the largest trade union' It has an important role in bringing trade unions, points of vie!s on a national scale possibly affecting government decisions ) e'g' the $AC have been at the forefront of the Eational 8inimum 0age negotiations' If the more po!erful unions ma"e full use of their bargaining strength they could succeed in getting larger and#or more fre/uent !age increases than the !ea"er unions' $his highlights the importance of JunionisationK !ithin trade unions ) the larger and more united the union the better the bargaining position ceteris paribus' Ho0 is it organi+ed Collective bargaining is organi.ed depending on the relationship bet!een a union and firms that employ unioni.ed labor' In a open shop a firm can employ unioni.ed and non)unioni.ed labor In a closed shop all !or"ers in a place of !or" have to be union members' $he closed shop is outla!ed in some countries because it gave unions too much po!er to dictate !ho a firm could employ' % union could also call the entire !or"force in a firm#industry out on stri"e' In these !ays a union may act li"e a monopoly and restrict the supply of labour so as to force up the mar"et !age for a (ob#occupation' % single union agreement allo!s a union to represent all the !or"ers !hatever their occupation in the same !or"place' $his is usually in return for certain commitments from the union on pay or production levels and for agreeing not to ta"e stri"e action' Eegotiating !ith a single union rather than several at a time is much easier for a firm' The Challenges facing Trade 5nions :ecline of manufacturing industries Gro!th in part)time employment S!itch from male to female employment (in terms of percentage increases'

-@ Co)operation !ith management Government legislation (!hich see"s to reduce union influence)

The >asis for 1age Claims $rade union demands for higher !ages are normally based on one or more of the follo!ing: 1' -' 2' 6' % rise in the cost of li(ing (e'g' due to inflation) has reduced the real income of their members' 0or"ers in comparable occupations have received a !age increase' $he increased profits in the industry !ustify a higher return to labour' $he productivity of labour has increase Ho0 can Trade 5nions raise 0ages3 "# Aestricting the *upply of Labour Anions can restrict the supply of labour in an industry for instance by pushing for longer apprenticeships or tough examination (entry) re/uirements' $his increases the !age rate in the industry from "1 to "# in the diagram belo!'

001

S-

S1

P-

P1

$mployment

3o!ever a problem has arisen ) the /uantity of labour able to enter the industry is restricted by %1 to %#' $# /ncreasing the Demand for Labour Anions can influence the demand for labour by use of producti(ity deals' $hey try to persuade !or"ers to increase productivity (!hich in turn helps to increase the 8arginal

-1 5evenue 9roduct of *abour ) recall that the 859 * is the demand for labour)' In return trade unions negotiate !age increases for their members (ustified by their increased productivity' S* 001 :- ? 859*:1 ? 859*1 P1 P$mployment

9roductivity deals have the effect of raising the 859* curve from :1 to :thereby raising !ages from 01 to 0-' $he advantages of this method are that productivity deals help to increase the supply of and demand for labour'

Externalities Calculations Social Costs = Private + Exter al Costs Social !e efits = Private + Exter al !e efits Definition *ocial costs and benefits are therefore the costs and benefits incurred by the entirety of society :producerC consumer and third party< as a result of the production and)or consumption of a good or ser(ice# Pri(ate costs and benefits are the costs and benefits incurred by indi(iduals directly in(ol(ed in the production and)or consumption of a good or ser(ice#

0here no mar"et failure exists social costs !ould be e/ual to private costs' If external benefits exist more of the said good should be produced and consumed (it is being under)consumed or under)produced) thus the mar"et system is not supplying the optimum resource allocation' If external costs exist than less of the said good should be produced and consumed (it is being consumed or produced in excessive /uantities) thus the mar"et system is not supplying the optimum resource allocation' 1irms and individuals !ill not consume#produce any good or service unless the private benefit of their activity exceeds the private cost incurred in their activity'

The go(ernment 0ill ma2e sure that: 8erit goods (goods 0ith external benefits) are encouraged (to prevent under) consumption or under)production from occurring') :emerit goods (goods 0ith external costs) are discouraged (to prevent over) consumption or over)production from occurring') Demerit goods do not ha(e prices 0hich account for their external costs# Smo"ing and alcohol are examples of demerit goods'

-The go(ernment 0ill: Subsidi.e merit good producers to reduce the costs of production and thereby encourage production of such goods !hilst causing prices to be lo!ered as a result of the increase in supply and the decrease in prices of production caused by subsidi.ation' $ax demerit good producers to increase the costs of production and thereby discourage production of such goods !hilst causing prices to increase as a result of the decrease in supply caused by taxations as !ell as by the increase in the price of production' Sometimes the government may choose to nationali.e certain industries that are producing externalities to regulate and control them and so force them to produce at the socially optimum level' La0s and regulations <*imits on the level of emissions of certain chemicals through use of the la! and a fining system to punish firms for infringement' ;an on the use of certain chemicals !hich may result in significant external costs through use of the la! and a fining system to punish any infringement' orcing firms to internali+e all costs: 9ollution permits (these can be traded to firms !ho can then pollute more at a reasonable price)' 9ollution permits are given out to firms by the government before any trading is done' (E/uivalent and derived from the Carbon Credits used internationally to restrict national pollution)' ;ut this scheme is costly (administration costs are high) to implement it is difficult to measure pollution levels accurately rich firms may simply buy their permits off poorer firms and so pollution may not have been decreased at all it is hard to calculate ho! many pollution permits to give out' If external benefits exist then the public !ould be !illing to pay more for a certain good to assure that it is produced at the socially optimum level' (Increase in demand extension along the supply curve)' If external costs exist that the public !ould be !illing to pay more to assure that it is produced at the socially optimum level' (:ecrease in supply contraction along the demand curve') @o(ernment Aegulation These are used to: 9romote competition' 5esolve externalities !here mar"et failure exists: 9rovision of public goods' $axing demerit goods' Enforce la! and order' /nfluence the location of firms: 9revent overcro!ding in cities' 9revent regions from being neglected' @o(ernments do not desire oligopolistic or monopolistic mar2ets as such mar2ets are uncompetiti(e 0hen compared 0ith competition based mar2ets# OftenC a go(ernment 0ill restrict the formation of such mar2ets by:

;rea"ing up larger firms into smaller ones 9roviding incentive for other firms to set up in the mar"et 9reventing merges that may prove detrimental to competition

Ho0 does the go(ernment regulate pri(ate enterprises3

-2

Investigate existing monopolies and suggesting !ays in !hich competition may be introduced into these monopolist)dominated mar"ets' Investigate proposed mergers and prevent such merges from ta"ing place if they are believed to be detrimental to competition' irms:

/nfluencing the Location of

1hy is this done3 o Some regions may be economically depressed usually due to the decline of a traditional industry (this may lead to regional unemployment)' o Some regions may be overcro!ded !ith too much pollution traffic congestion insufficient housing and public services as a result of too many firms choosing to set up in the said regions' Ho0 is this done3 @i(e firms incenti(es to set up in depressed regions: *o! loan interest rates' Grants for the construction of infrastructure' Grants for the training of !or"ers' $ax holiday#allo!ance' *o! rent#free premises' ;y building and improving the infrastructure present in the said depressed region' 9ersuade firms in congested regions to move to depressed regions (stop granting licenses to operate in a congested region)' -onopoly Definition: % monopoly is a situation !here the mar"et is dominated essentially by one firm' $he legal definition of JmonopolyK is a firm that has -7L or more mar"et share in the mar"et' ,d(antages and Disad(antages of -onopolies ,d(antages 1irms usually ma"es higher profits $he firm can use profits to invest in ne! or improve upon existing products 9rice 8a"er because does not face any competitors Economies of *cale: Increased output !ill allo! average unit prices of production to drop' $his can be passed onto consumers in the form of lo!er prices so customers may be more inclined to buy the firms products in the future' % firm may become a monopoly through efficiency+ % monopoly is thus a sign of success and not inefficiency' Disad(antages Consumers may have to pay higher prices due to lac" of competition Consumers have less choice because mar"et is dominated by the monopolistic firm' *ess innovation of products 1irms may not be efficient !ith allocation and utili.ation of resources because they do not have any pressure to reduce costs'

-6 Oglipoly 1hat is it3 %n oligopoly exists !hen there are several dominate firms in one mar"et' If there are only t!o sellers in one mar"et than that the mar"et structure of the said mar"et is a duopoly !hich is a special case of an oligopolistic mar"et' Examples include the petroleum industry $Q broadcasting industry (duopoly in 3N) supermar"et industry and the ban"ing industry'

9lease note that as a general rule of thumb even if a mar"et has hundreds of providers if the top 2 <B providers together possess 7@L or more of the mar"et,s total mar"et share then that mar"et is said to be oligopolistic' eatures % fe! sellers dominate mar"et supply#or a fe! sellers supply a ma(or part of the total mar"et supply irrespective of the total number of smaller suppliers in the mar"et $he same goods but !hich are heavily differentiated by use of advertising branding and other such methods' $hese firms produce similar but heavily differentiated products+ this differentiation ma"es the goods loo" different to the consumer' (3eterogeneous goods) $hese firms engage in many forms of non)price competition but rarely deign to involve themselves in price based competition as such competition can lead to price !ars !hich only benefit the consumers and no one else' ;rand image is often very important for such firms' (Co"e and 9epsi test)'

-ain

1' 4ligopolistic firms !ill advertise a lot more than monopolists in the attempt to build a strong brand image and to differentiate their goods from the products of their competitors' -' If one firm has a better brand image even !ith an inferior product the said firm may be able to sell more of its product than another firm !ith a !orse brand image' Entry into such mar"ets is restricted either because of governmental decrees or because of the huge startup capital or technology re/uirements needed in order to open shop in the said mar"et' 1urthermore because of the furious level of competition bet!een existing oligopolistic firms these firms generally produce at a very lo! price a feat !hich !ould be very difficult for smaller firms !hich do not !ield the same level of economies of scale as the larger oligopolistic firms' 8ar"et information is restricted and often incomplete as no firm "no!s !hat another competitor !ill do' $o combat this such firms often collude to form cartels (trade agreements) and conduct themselves !ith all the advantages and disadvantages of monopolists' $hese agreements are generally illegal' $he actions of one firm !ill affect !hat the other competing oligopolistic firms !ill do as such firms !ill react very /uic"ly to the actions of a competitor' (Sellers are highly interdependent)' >arriers to Entry Existing firms are !ell established and have strong brand images' Existing firms en(oy economies of scale and are much more efficient' Existing firms en(oy customer confidence' $he government may have issued rules that govern entry sometimes for a certain number of years into a certain mar"et' $hese rules !ould have been put in place to encourage entrepreneurs to enter into a mar"et !here one !ould re/uire large startup capitals' (8obile phone industry in China)'

-7 Pricing *trategies: 9rice !ars' 9rice *eadership: 0hen the dominate firm in a mar"et determines the price of a good other firms have no choice but to follo! their example or lose mar"et share unless they choose to lo!er their prices even further and ris" a price !ar' Sometimes they !ill even collude to prevent price !ars from happening' Price collusion: 1orming a cartel' 9redatory pricing other!ise "no!n as destruction pricing' ,d(antages Economies of scale (lo! average cost achieved on account of a high level of output)' Excess (abnormal or supernatural) profits' 9romotes research and development because these firms can spread the potential costs involved in 5>: over a much larger range of income sources thus lo!ering the ris" of 5>:' Disad(antages *o!er output levels and higher prices as these firms control such things *ess choice for consumers' $he need for government regulation to prevent oligopoly firms from overusing their po!ers' Economic gro0th Definition Aeco(ery: $he period !here the economy moves bet!een a recession and a boom' >oom: $his period is fast economic gro!th' 4utput is very high due to increase in demand and unemployment is very lo!' %dditionally consumers may be confident about the economy so this may lead to extra spending Aecession: Economic Gro!th slo!s do!n and level of output may have a negative impact' Anemployment increases and consumers are li"ely to save instead of spend so there is less money circulating in the economy' *lump: % period !here output starts to decrease' Consumer confidence may also begin to deplete' @DP: $he total or national output of a country over a period of time'

@DP It measures the total amount of income earned in a macro economy < national income# Changes used to measure economic gro!th < Aeal change in @DP o(er time# National Output D National /ncome D National Expenditure $otal value of output produced by all domestic firms !ithin economy' @DP D Consumption L @o(ernment Expenditure L /n(estment L Net imports

-=

Some of the output income !ill flo! overseas as people from other countries may achieve output in your economy @DP is measured in terms of money' 3o!ever money is sub(ect to change in its value and inflation' $o solve this problem the real (alue of output or @DP is ad(usted for inflation so !e "no! ho! much is really generated from economic gro!th and ho! much is simply due to rising prices'

/nflation Definition /nflation: % general and sustained rise in the level of prices of goods and services < prices of vast ma(ority of goods and services on sale to consumers "eeps rising over time' *tagflation: 9ersistent high inflation combined !ith high unemployment and stagnant demand in a country&s economy' Hyperinflation: 9rices rise at phenomenal rates in short periods of time rendering money !orthless' Asually the inflation rate is in double digits Deflation: $he prices of goods and services fall' $his is usually negati(e inflation' Disinflation: 1all in the rate of inflation' /deas 9rice change over time (inflation) is al!ays given per period of time' :eflation can be a cause for concern < deflation !ill usually occur !hen demand for goods and services are falling causing firms to lose profits profits and reduce !or"force' $his !ill reduce household incomes causing further reduction in goods and services' $he value of debts held by people and firms !ill rise in real terms as prices fall and burden of ma"ing loan repayments rises' Eventually the economy goes into recession' Ho0 to measure inflation 8easured by M C9I (Consumer 9rice Index)

59I (5etail 9rice Index) 1' % base year or starting point is chosen' $his becomes the standard against !hich price changes are measured' -' % list of items bought by an average family is dra!n up' $his is facilitated by the *iving Costs and 1ood Survey' 2' % set of !eights are calculated sho!ing the relative importance of the items in the average family budget ) the greater the share of the average household bill the greater the !eight' 6' $he price of each item is multiplied by the !eight ad(usting the item&s si.e in proportion to its importance'

-B 7' $he price of each item must be found in both the base year and the year of comparison (or month)' $his enables the percentage change to be calculated over the desired time period'

Calculating the CP/)AP/:

Indices express change in prices of a number of different products as a movement in a single number' %verage of Rbas"et, of products in first year calculation or base year is given the number 1@@' If on average the bas"et rises overall by -7L next year then index becomes 1-7' If in second year it rises another 1@L then 1-7 x 1'1 ? 12B'7 < 2B'7 becomes average price rise in t!o year period' $o construct a C9I a sample of households are ta"en and surveyed < their spending patterns observed for 1- months !hich is the base year' $he proportion of income spent on each category is recorded' %verage prices of different goods and services (minus fuel and food) are recorded from a sample of shops' $he proportion of income spent on each category is used to !eight average prices of each type of good#service to find their !eighted average prices' $his sho!s ho! big an impact a change in price of a particular type of good or service !ill have on cost of living for the average household' $he proportional of household income spent on a certain type of good#service is multiplied by the average price of the good#service purchased in the category to generate its !eighted average price < these !eighted prices are then all added together !hich is the overall average price for goods and services in the bas"et' $he !eighted total price of the bas"et can be compared each year to !or" out percentage changes in average consumer prices'

5ses of CP/)AP/ Data: 1' ,s economic indicator 8 C9I is !idely used measure of price inflation and therefore is measure of changes in cost of living' Governments try to control inflation using macro) economic policies' $he C9I !ill be used by !or"ers to see" !age increases and used by entrepreneurs in business ma"ing concerning purchases and setting !age and prices' -' ,s a price deflator 8 5ising prices reduce purchasing po!er value of money' 5ising prices can therefore affect real value of !ages profits pensions savings interest payments tax revenues and other economic variables important to people and decision ma"ing' C9I therefore used to deflate other economic series to calculate real inflation) free values' i'e' !ages go up 1@L but inflation is 17L therefore real !ages fallen by almost 7L less' 2' /ndexation 8 involves tying certain payments to rate of increase in C9I' E'g' pensions may be indexed' Similarly savings may be index)lin"ed meaning interest rate is set e/ual to C9I protecting real value of people,s savings' 8any !or"ers may also be covered by collective bargaining agreements that tie !age increases to C9I changes' Government may also index threshold at !hich people start to pay tax or higher tax rates to stop people paying more or less tax'

Problems 0ith Price /ndices: 4ver time typical household bas"et of goods and services !ill change'

-C C9I needs to ta"e account of this but deciding ho! and !hen to ma"e them can be difficult' Changes due to: o 1ashion and taste o Introduction of ne! goods and services o Change in population and household si.e due to migration birth#death rates marriage timing and numbers etc' o Similarly C9I needs to ta"e into account changes in /uality of goods and services over time ho! and !here households buy goods and services such as internet and ne! shops' o International comparisons of C9Is are hard to ma"e due to different household compositions and spending patterns' o %rgued that exclusion of food energy house prices and income taxes means C9I cannot accurately measure change of living cost' /nflation Economists today tend to agree main cause of inflation is Ktoo much money chasing too fe0 goods#. $his means people are able to increase spending on goods and services faster than producers can supply goods and services boosting aggregate demand and forcing prices up' % government can allo! supply of money to increase in an economy by issuing more money or allo!ing ban"ing system to create more credit < lending more to people and firms' % government may do so to : o Increase total demand in economy to reduce unemployment' o In response to increase in demand for goods and services for goods' o In response to !or"ers demand for higher !ages or rise in other production costs' o %s money supply rises people,s purchasing po!ers rise and inflation can occur' o $o stop excessive inflation a monetary rule government,s should follo! is to only allo! supply of money to expand at same rate as increase in real output or real G:9 over time' o If money supply increases faster than output then inflation !ill occur' o *tagflation 8 !hen inflation and unemployment are both high and increasing < often due to rising living costs causing increased demand for higher !ages and less labour demand' Causes of inflation /ncrease in -oney *upply 8 an increase in money supply !ould increase the spending po!er of the average consumer thus increasing demand and hence pushing up prices' $his then causes inflation' Demand Pull /nflation 8 0hen aggregate demand is increased firms are no longer able to meet demand in production and thus prices inflate' $o finance this firms may borro! more or money supply increased' Cost Pull /nflation 8 0hen the cost of producing goods is increased firms may !ant to offset these increased costs to consumers to "eep a certain level of profit thus the extra cost is added to price of the good or service causing inflation' 1age Price *piral is !hen !or"ers demand higher and higher !ages causing cost push inflation and prompting them to as" for higher !ages again' /mported /nflation 8 rising prices in one country may be exported to another country through international trade in many different goods and services' 8any countries have

-D been able to en(oy stable inflation as China,s large supply of goods and services is produced through cheap labour' Conse6uences and Costs of /nflation:

Personal Costs: o 5educe purchasing po0er o Aeal income falls o 9eople li"e pensioners and students on fixed incomes !ill suffer from inflation' o *o! paid and non)unioni.ed !or"ers often fail to get sufficient rises to stop real income falling' o 9rofessional !or"ers may as" for !age increases that protect or cause increases in real !age levels' o Savers and lenders may be hurt by inflation rate if interest is less' o 9eople !ho borro!ed may benefit' o :emand)pull inflation increased spending can boost company profits !hile cost) push may reduce profits' 5ising profits could yield more tax ho!ever government may have to pay more for goods and services' o Economical Costs: 9ossible unemployment < purchasing po!er drops less demand Some people save more reducing economic activity and overall output Causes goods and services to become uncompetitive internationally >enefits: Economic gro!th 5educe debt values < falling value of money reduces real debt values 3igher stoc" value Qalues of fixed assets could rise < financial security 9ossible increased employment Stimulate technological advancement

Economic @ro0th and /nflation 8ost governments hope that they can achieve steady economic gro!th !ithout it causing acceleration in demand)pull and # or cost)push inflationary pressures' $he dangers of a booming economy is that inflationary pressures build and that the economy must slo! do!n or fall into recession for these inflation ris"s to be controlled'

2@

:uring the early part of the last decade the ;ritish economy en(oyed a period of steady gro!th and relatively lo! and stable inflation In -@@B)@C the trade)off bet!een gro!th and inflation !orsened Inflation surged higher < mainly because of external factors such as high food and oil prices $he economy suffered a steep descent into recession follo!ing the global financial crisis In early -@@D the economy experienced recession and higher inflation < some economists !arned of a lengthy phase of JstagflationK conditions Inflation fell bac" largely because of the recession' ;ut in -@1@ and into -@11 inflation has been rising again !hilst G:9 gro!th has been !ea" !ith the ris" of a second do!nturn (a Jdouble)dipK)

*tagflation Stagflation is a period of economic stagnation accompanied by rising inflation' In other !ords both of these "ey macro ob(ectives are !orsening' It can happen !hen an economy goes into a do!nturn or a recession but !hen other external forces are bringing out higher inflation' $he obvious example of this is !hen recession is afflicting a country but the prices of imported products are surging causing prices to rise and real incomes and profits to fall' $he rise in the cost of imports can be sho!n by an in!ard shift in the short run aggregate supply curve leading to a contraction in real national output and an increase in prices' 4ne of the dangers of stagflation is that the fall in real incomes causes consumer and investment spending to fall and thus the rate of economic gro!th suffers too (a deterioration in a third ob(ective of policy)' 0age demand may also pic" up as people experience rising prices' $he central ban" needs to consider appropriate policy responses to this' $oo severe a tightening of monetary policy for example !ill help to curb inflation but ris" causing a deep recession' $he combination of deflation and a sustained drop in economic output is termed an economic depression %n improvement in aggregate supply can help to resolve the gro!th < inflation trade off' 0e see in the diagram ho! aggregate supply has moved out!ards and this allo!s aggregate

21 demand (CMIMGMS)8) to operate at a higher level !ithout threatening a persistent increase in the general price level (inflation)' O(ercoming a conflict bet0een economic gro0th and inflation 8 increases in ,D and ,*

Conflicts bet0een ob4ecti(es 8 the economics of deflation

:eflation is a sustained fall in the prices of goods and services and thus the opposite of inflation' Increased attention has focused on the impact of price deflation in several countries

2in recent years < notably in Hapan (inflation )@'2L in -@1@) and in some Euro %rea countries such as Ireland Greece !here prices have been falling national output has dropped and unemployment has been rising' It is normally associated !ith falling level of %: leading to a negative output gap !here actual G:9 T potential G:9' ;ut deflation can be caused by rising productive potential !hich leads to an excess of aggregate supply over demand'

&reece 'as suffered from a se(ere rise in unemployment (ri)'t 'and scale) and is no* seein) 'er relati(e li(in) standards fall+ , deflationary depression is a ris- for &reece Possible damaging conse6uences of persistent price deflation Holding bac2 on spending : Consumers may postpone demand if they expect prices to fall further in the future' Debts increase: $he real value of debt rises !hen the general price level is falling and a higher real debt mountain can be a drag on consumer confidence and people,s !illingness to spend' $his is especially the case !ith mortgage debts and other big loans' The real cost of borro0ing increases : 5eal interest rates !ill rise if nominal rates of interest do not fall in line !ith prices' If inflation is negative the real cost of borro!ing increases and this can have a negative effect on investment spending by businesses Lo0er profit margins: *o!er prices hit revenues and profits for businesses ) this can lead to higher unemployment as firms see" to reduce their costs by shedding labour' Confidence and sa(ing: 1alling asset prices including a drop in property values hits !ealth and confidence < leading to declines in %: and the threat of a deeper recession' Aesol(ing the threat of price deflation 5sing expansionary -onetary Policy o Interest rates: :eep cuts in interest rates can be made to stimulate the demand for money and thereby boost consumption o Puantitative Easing < printing money in the hope that by in(ecting it into the economy people and companies !ill be more li"ely to spend' 5sing expansionary iscal policy

22
o o

Neynesian economists believe that fiscal policy is a more effective instrument of policy !hen an economy is stuc" in a deflationary recession and a li/uidity trap $he "ey Neynesian insight is that a mar"et system does not have po!erful self) ad(ustments bac" to full)employment after there has been a negative economic shoc"' Neynes tal"ed of persistent under)employment e/uilibrium < an economy operating in semi)permanent recession leading a persistent gap bet!een actual demand and the potential level of G:9'

Neynes argued that this (ustified an exogenous in(ection of aggregate demand as a stimulus to get an economy on the path bac" to full(er) employment and to prevent deflation' 5nemployment Definition rictional 5nemployment: 4ccurs as !or"ers change (obs and spend time !ithout (obs during this period' *easonal 5nemployment: 4ccurs !hen consumer demand for certain goods and services are seasonal and as a result people are only employed during periods of time' Cyclical 5nemployment: 4ccurs !hen there is too little demand for goods and services in the economy during a recession and firms are producing less as a result employing less labour as a result' *tructural 5nemployment: 4ccurs !hen the labour mar"et is unavailable to provide (obs for all !or"ers because of a mismatch bet!een the !or"er,s s"ills and the s"ill re/uirement of the (obs' It arises from long)term changes in the structure of the economy as entire industries close do!n due to lac" of demand for goods and services they produce' 0or"ers !ho become unemployed and have s"ills no longer needed are occupationally immobile# Noluntary 5nemployment: Qoluntary unemployment includes !or"ers !ho re(ect lo! !age (obs !hereas involuntary unemployment includes !or"ers fired due to an economic crisis industrial decline company ban"ruptcy or organi.ational restructuring' /nternational labour organi+ation $he International *abour 4rgani.ation (I*4) measure of unemployment assesses the number of (obless people !ho !ant to !or" are available to !or" and are actively see"ing employment' It is used internationally so comparisons can be made bet!een countries' It also enables consistent comparisons over time' $he I*4 measure is calculated using data from

26 surveys of a country,s labour force+ it can therefore be sub(ect to sampling differences bet!een one country and another' It differs from the claimant count unemployment tmeasure !hich only includes people claiming unemployment)related !elfare benefits' $he I*4 measure gives a higher figure than the claimant count measure as it includes those !ho are classified as available for !or" but !ho are not claiming (obless benefits' $he I*4 measure may include students !ho are actively see"ing !or" but may not /ualify for (obless benefits' Similarly second earners !ithin a household may be reluctant to claim (obless benefits but !ould be classified as unemployed under the I*4 measure as they are available for !or"' @o(ernment Policy Definition -onetary policy: $he process by !hich the government central ban" or monetary authority of a country controls the supply of money availability of money and cost of money or rate of interest in order to attain gro!th and stability of the economy' iscal policy: Government policy that attempts to influence the direction of the economy through changes in government taxes or through some spending' Expansionary policy: Contractionary policy: 8ost

@o(ernment macroeconomic ob4ecti(es and policies of the governments round the !orld have four main ob(ectives' $hese are Neep inflation under control 8aintain a lo! level of unemployment %chieve a high level of gro!th rate 8aintain a healthy balance of payments'

@o(ernment Economic Policies Government influences the economy through its economic policies' $hese are iscal Policy It is related !ith taxes and government spending' $his policy is there to control inflation and demand in the economy' Asually government collects money in the form of taxes and spends money through its development expenditure such as building roads bridge defense transports etc' Government constantly monitors the aggregate demand in the economy' Inflation rate gives the correct measure of the aggregate demand in the economy' 0hen the aggregate demand in the economy is high prices rise this sho!s that the economy is spending too much' In this case the government !ill lo!er is expenditure budget and cut bac" on investment spending such as on road construction and hospital e/uipment' 4n the other hand the government might also increase the taxes !hich !ould ta"e spending po!er out of the economy by leaving consumers and businesses !ith less income to spend' " t#e opposite sce ario !hen the economy is heading for a recession and unemployment is rising the government might increase its expenditure plans' $here might be a reduction in taxes so as to leave consumers and businesses !ith higher disposable incomes'

27 -onetary Policy 8onetary 9olicy is related !ith a change in interest rates by the government or the Central ban"' 0hen the forecast for inflation is that it !ill rise above the targets set by government then the Central ;an" !ill raise its base rate and all other ban"s and lending institutions !ill follo!' It is usually done !hen the economy is at the boom stage of the business cycle' $ #i%#er i terest rate will result i &business !ill not be able to expand as they have to pay more interest to the ban" for their loans and they have less profit left' ;usinesses that are planning to ta"e loan for expanding may postpone their decisions and !ait for a cut in interest rates' Consumers demand !ill also fall as they !ill not be getting cheap loans to pay for the buying ne! houses and luxury items' If inflation is lo! and is forecasted to remain belo! governments targets then the Central ;an" may decide to reduce interest rates' *upply side policies It includes all those policies !hich aim at improving the efficient supply of goods and services' $hese might include: 9rivati.ation Imparting training and improving the education level of the !or"force resulting in higher s"ills' Increase competition in all industries by removing entry barriers thus leading to more efficiency' actors causing a change in components of ,D Change in consumption % change in consumption is caused by any of the follo!ing factors Changes in income: Income increases consumption increases and vice versa' Changes in interest rates: 1all in interest rates !ill ma"e borro!ing money cheaper' Consumers !ill no! be tempted to ta"e loans and purchase goods and services' Consumption !ill rise' 4n the other hand if the interest rates increase borro!ing becomes expensive' Consumers !ill be more tempted to save rather than spend' Consumption !ill fall' Changes in 0ealth: % rise in house prices or the value of stoc" and shares ma"es a person feel !ealthy' Consumers feel more confident and tend to spend more ' Changes in consumer confidence: 3igher consumer confidence is li"ely lead to increased consumption' Change in /n(estment /nterest Aates: If interest rates are lo! firms !ill find it easy to borro! funds for investment' Investment increase !hen interest rates fall' Changes in National /ncome: If the national income increases firms !ill have to invest further to increase output (induced investment)' Technological change: 5egular changes in technological front demand firms to invest in order to "eep up !ith the changes and remain competitive' >usiness Confidence: $he economic environment in an economy is a ma(or factor in determining the investment level' 0hen an economy is sho!ing signs of healthy gro!th firms !ill have positive expectation and !ill invest in expanding their facilities and to meet higher demands in the future' :uring troughs firms !ill be more conservative in their investments and thus %: !ill be affected'

2= Change in @o(ernment Expenditure Government Expenditure depends on 8acroeconomics ob(ectives: If the government is considering increasing employment then it might increase its spending on public pro(ects' Condition of the economy: :uring phases of slo! economic gro!th government is more li"ely to increase its spending in order to stimulate the economy' Changes in net exports Exports are domestic goods bought by foreigners' Exports !ill rise !hen 1oreigners income rise Exchange rate of the exporting country is falling' $he economy follo!s a more liberal trade policy i'e' free trade increase Inflation rate in the economy is comparatively lo!er than its trading partners' /mports are the goods bought from foreign country' Imports !ill rise !hen :omestic income rises' $his is because people !ill increase their consumption and thus imports !ill increase' Exchange rate of the importing country increase' Eo! it becomes cheaper for the country to purchase from outside as their currency is stronger than their trading partners' If the economy is follo!ing a liberal trade policy i'e' free trade increases' Inflation rate is high Possible conflict bet0een macroeconomic ob4ecti(es It is rare for a country to achieve all of its main ob(ectives at the same time 1re/uently conflicts appear bet!een the different aims and as a result choices might have to be made about !hich ob(ectives are to be given greatest priority' $his !ill vary from one country to another since the needs of different nations !ill differ according to their stage of economic development' 3ere are some possible policy conflicts: /nflation and unemployment: 1alling unemployment mi)'t create demand)pull and cost)push inflationary pressures leading to a fall in the value of money Economic gro0th and en(ironmental sustainability : 5apid economic gro!th and development fre/uently puts extra pressure on scarce environmental resources threatening the sustainability of living standards in the future Economic gro0th and inflation < an overheating economy may suffer accelerating inflation !hich then has negative effects on trade performance business profits and (obs Economic gro0th and the balance of payments: Strong G:9 gro!th fuelled by high levels of consumer demand for goods and services might lead to a !orsening of the trade balance' $his is particularly true !hen an economy has a high marginal propensity to import'

2B 5nemployment and inflation 8 the Phillips Cur(e concept

1alling unemployment might cause rising inflation and a fall in inflation might only be possible by allo!ing unemployment to rise If a Government !anted to reduce the unemployment rate it could increase aggregate demand but although this might temporarily increase employment it could also have inflationary implications in labour and the product mar"ets' $he "ey to understanding this trade)off is to consider the possible inflationary effects in both labour and product mar"ets from an increase in national income output and employment' The labour mar2et: %s unemployment falls labour shortages may occur !here s"illed labour is in short supply' $his puts pressure on !ages to increase and prices may rise as businesses pass on these costs to their customers' Other factor mar2ets: Cost)push inflation can also come from rising demand for commodities such as oil copper and processed manufactured goods such as steel concrete and glass' 0hen an economy is booming so does the derived demand for components and ra! materials' Product mar2ets: 5ising demand can lead to suppliers raising prices to increase their profit margins' $he ris" of rising prices is greatest !hen demand is out)stripping supply)capacity leading to excess demand (i'e' a positive output gap')

2C

iscal policy $he t!o main instruments of fiscal policy are go(ernment spending and taxation' Changes in the level and composition of taxation and government spending can impact on the follo!ing variables in the economy: %ggregate demand and the level of economic activity' $he pattern of resource allocation' $he distribution of income' Ho0 fiscal policy 0or2 High rate of inflation 3igh rate of inflation is caused by too much aggregate demand in the economy' Government !ill use deflationary fiscal policy' Government !ill try to influence aggregate demand by reducing its public spending' $he government !ill spend less on construction of roads bridges and other public spending and thus aggregate demand !ill fall' 4n the other hand Government may increase the tax rates' %n increase in tax rates !ill ta"e a!ay the extra disposable income out people,s poc"et resulting in a lo!er demand'

2D

Lo0 rate of inflation In an economic recession aggregate demand output and employment all tend to fall' Eo! the Government !ants to increase employment in the economy it can attempt to do so by increasing aggregate demand' $he Government !ill increase the public spending resulting in a rise in aggregate demand' Government may reduce the tax rates so that people have more disposable income to spend and instigate demand in the economy'

Aole of fiscal policies $he t!o main instruments of fiscal policy are go(ernment spending and taxation' Changes in the level and composition of taxation and government spending can impact on the follo!ing variables in the economy: %ggregate demand and the level of economic activity' $he pattern of resource allocation' $he distribution of income' ,DDCL@L/L:O'-<

6@ %s !e can see in the above e/uation that G (Government Expenditure) is a component of %: it can be used by Government to influence %: in the economy' $he government can use expansionary or deflationary fiscal policy to get the desired results' *et,s discuss each policy in detail' Expansionary fiscal policy Expansionary fiscal policy is used to increase the %ggregate demand in the economy' If the economy is having a deflationary gap the government can use expansionary fiscal policy to reduce the gap or totally eliminate it' Deflationary gap :eflationary gap is the difference bet!een full level of employment and the actual level of output of the economy' 0e can see in the diagram belo! that the economy is operating a level Ra, belo! the Uf (full level of employment)'

$he conse/uence is that due to deflationary gap all the resources of the economy are not being used in the optimum level and they are idle' $his results in unemployment and lo! level of output' $his is not desirable for any government' In order to reduce#eliminate the deflationary gap the government uses expansionary fiscal policy# Government !ill either increase its spending or reduce taxes (or both) in order to stimulate the aggregate demand' Increase Government spending !ill result me more pro(ects being funded by the government and thus employment and output !ill increase' Even a lo!er tax rate !ill result in more disposable income for households and encourage consumption' Increased @ and C !ill lead to higher %:' 3o!ever this might also lead to higher prices#inflation in the economy'

61 Contractionary fiscal policy Contractionary fiscal policy involves the reduction of government spending and increase taxes as a measure to control inflation#%: in the economy' 0ith reduced government spending the %: !ill fall and thus reduce pressure on the economic resources and the average price level in the economy !ill come do!n' Similarly increased taxes !ill ta"e a!ay the excess disposable income from the households and result in a fall in %:' Contractionary fiscal policy is thus used to reduce the inflationary gap' /nflationary gap Inflationary gap is !hen the %ggregate demand exceeds the productive potential of the economy' %s !e can see through the diagram the economy is operating at a level above the full employment level of the output' :ue the limitation of the economy to fulfil this increased demand the average price level in the economy increases resulting in inflation'

Problems of fiscal policy Aeduce incenti(e to 0or2 5aising taxes on income and profits reduce !or" incentives employment and economic gro!th' %n effort to reduce aggregate demand may cause disincentives to !or" if this occurs there !ill be a fall in productivity and %ggregate supply could fall' ,d(erse effect of lo0ering Public *pending 5educed government spending to Increase %ggregate demand could adversely affect public services such as public transport and education causing mar"et failure and social inefficiency' KCro0ding out. effect 0ith an increase in government expenditure there !ill be greater competition for limited resources' $his !ill offset private investments resulting in shrin"ing of the private sector' /naccurate forecasting If the Government,s estimate or forecasting is !rong or inaccurate the fiscal policy !ill suffer' 1or example if a recession is expected and the government practices deficit budget and yet the recession turns out to be a boom this !ill cause inflation'

6/mplementation of the Policy 9lanning for the spending is done once by most of the governments' If there is a delay in the implementation of the fiscal policy it might reduce the effectiveness of the policy' $hus the time lag is important' Poor /nformation 1iscal policy !ill suffer if the government has poor information' e'g' If the government believes there is going to be a recession they !ill increase %: ho!ever if this forecast !as !rong and the economy gre! too fast the government action !ould cause inflation' Time Lags If the government plans to increase spending this can ta"e a long time to filter into the economy and it may be too late' Spending plans are only set once a year' $here is also a delay in implementing any changes to spending patterns' >udget Deficit Expansionary fiscal policy (cutting taxes and increasing G) !ill cause an increase in the budget deficit !hich has many adverse effects' 3igher budget deficit !ill re/uire higher taxes in the future and may cause cro!ding out (see belo! Other Components of ,D If the government uses fiscal policy its effectiveness !ill also depend upon the other components of %: for example if consumer confidence is very lo! reducing taxes may not lead to an increase in consumer spending' Depends on -ultiplier Change in in(ections may be increased by the multiplier effect+ therefore the si.e of the multiplier !ill be significant' -onetary Policy 8onetary policy is generally referred to as either being an expansionary policy a contractionary policy' or

%n expansionary policy increases the total supply of money in the economy and is traditionally used to combat unemployment in a recession by lo!ering interest rates' *o!ered interest rates encourage the household and the firms to increase their consumption and investment respectively' $his !ill shift the %: to the right and result in higher real output and more employment'

62

Contractionary policy decreases the total money supply and involves raising interest rates in order to combat inflation' $he result !ill be that investment !ill fall and consumption !ill fall' %ll of these changes !ill shift the %: to the left'

It is argued that an increase in the money supply causes an increase in the rate of inflation' 8aintaining a lo! and stable inflation is one of the main macroeconomic ob(ectives of the Government' Government does so by controlling the supply of money to the economy' $his policy is "no!n as monetary policy# 8onetary policy in any country is usually controlled by the Central ;an" of that country' $he Central ban" alters the interest rates in the economy after assessing the inflationary pressures in the mar"et' -onetary Policy tools Central ;an" has three tools of monetary policy: Open mar2et operations Open mar2et purchases: $he central ban" buys government securities to increase the monetary base' Open mar2et sales: $he central ban" sells government securities to decrease the monetary base' 4pen mar"et operations have a number of advantages:

66

$hey $hey $hey $hey

are under the direct and complete control of the central ban" can be large or small' can be easily reversed' can be implemented /uic"ly

Discount loans 0hen a ban" receives a discount loan from the central ban" it is said to have received a loan at the Jdiscount !indo!'K $he Central ;an" can affect the volume of discount loans by setting the discount rate: % higher discount rate ma"es discount borro!ing less attractive to ban"s and !ill therefore reduce the volume of discount loans' % lo!er discount rate ma"es discount borro!ing more attractive to ban"s and !ill therefore increase the volume of discount loans' :iscount lending is most important during Inancial panics: 0hen depositors lose conIdence in the Inancial system they !ill rush to !ithdra! their money' $his large deposit outIo! puts the ban"ing system in great need of reserves' $he central ban" stands ready to supply these reserves by ma"ing discount loans' In such situations the central ban" acts as a lender of last resort' Changes in reser(e re6uirements $he portion (expressed as a percent) of depositors& balances ban"s must have on hand as cash' $his is a re/uirement determined by the country&s central ban"' It affects the money multiplier+ changes in the re/uired reserve ratio can lead to changes in the money supply' $his is also referred to as the Pcash reser(e ratioP :CAA<# Ho0 money supply 0or2s 8oney supply includes all the notes and coins in circulation !ith the public plus the money !ith ban"s' It also includes the deposits in ban"s and building societies' $he later is more significant supply of money and is usually the target of Governments monetary policy' $he !ays through !hich Government controls the money supply are: Open mar2et operations Government usually sells treasury bills and bonds to raise money' 9rivate individuals invest in these bonds and bills in order to get a healthy rate of interest' $his reduces the deposits !ith ban"s and the money supply' Nariation of legal reser(e re6uirements Asually the commercial ban"s have to maintain a certain percentage of their assets as deposit !ith the Central ;an"' 0hen the Central ;an" !ants to reduce money supply it !ill increase the limit of the deposit "ept by the ban"s' $he commercial ban"s are left !ith less money to lend to their customers' Central ban2s Central ;an"s are charged !ith regulating the si.e of a nation,s money supply the availability and cost of credit and the foreign)exchange value of its currency' 5egulation of the availability and cost of credit may be designed to influence the distribution of credit among competing uses' $he principal ob(ectives of a modern central ban" in carrying out these functions are to maintain monetary and credit conditions conducive to a high level of employment and production a reasonably stable level of domestic prices and an ade/uate level of international reserves'

67 unction of a Central >an2 % central ban" usually carries out the follo!ing responsibilities: /mplementation of monetary policy# Controls the nation&s entire money supply' $he Government&s ban"er and the ban"ers& ban" (V*ender of *ast 5esortV)' 8anages the country&s foreign exchange and gold reserves and the Government&s stoc" register+ 5egulation and supervision of the ban"ing industry Setting the official interest rates) used to manage both inflation and the country&s exchange rate ) and ensuring that this rate ta"es effect via a variety of policy mechanisms Aole of taxation in promoting e6uity $ax is a fee charged (VleviedV) by a government on a product income or activity' 1hy taxes are imposed3 $here are different reasons for imposing taxes' $o finance government expenditure' 4ne of the most important uses of taxes is to finance public goods and services such as street lighting and street cleaning' $o reduce consumption of goods that creates negative externalities' $o control the amount of imported goods i'e' tariffs Ased as a part of fiscal policy to control aggregate demand in the economy' $o control income ine/uality' Classification of taxes Progressi(e taxes % progressive tax is a tax imposed so that the tax rate increases as the amount sub(ect to taxation increases' In simple terms it imposes a greater burden (relative to resources) on the rich than on the poor' It can be applied to individual taxes or to a tax system as a !hole' 9rogressive taxes attempt to reduce the tax incidence of people !ith a lo!er ability)to)pay as they shift the incidence disproportionately to those !ith a higher ability)to)pay' $he result is people !ith more disposable income pay a higher percentage of that income in tax than do those !ith less income' Aegressi(e Tax $he opposite of a progressive tax is a regressi(e tax !here the tax rate decreases as the amount sub(ect to taxation increases' It imposes a greater burden (relative to resources) on the poor than on the rich' 5egressive taxes attempt to reduce the tax incidence of people !ith higher ability)to)pay as they shift the incidence disproportionately to those !ith lo!er ability) to)pay' Proportional Tax % proportional tax is one that imposes the same relative burden on all taxpayersFi'e' !here tax liability and income gro! in e/ual proportion' In simple terms it imposes an e/ual burden (relative to resources) on the rich and poor' 9roportional taxes maintain e/ual tax incidence regardless of the ability)to)pay and do not shift the incidence disproportionately to those !ith a higher or lo!er economic !ell)being'

6= Types of taxes Direct Taxes It is a tax paid directly to the government by the persons on !hom it is imposed' Examples $ax imposed on peoples, income)Income tax $ax on !ealth < !ealth $ax $ax on firm,s profits') corporate tax /ndirect Taxes Indirect tax is a tax collected by an intermediary (such as a retail store) from the person !ho bears the ultimate economic burden of the tax (such as the consumer)' $he intermediary later files a tax return and for!ards the tax proceeds to government !ith the return' Indirect taxes are generally included in the price of goods and services so are less obvious to those paying the taxes than direct levies' $hus indirect taxes are also "no!n as expenditure tax or consumption based tax' Examples GS$ (Goods and service tax) Q%$ (Qalue added tax) Consumers are charged a percentage of tax !hile purchasing a good#service and then the seller pays the tax collected to the Government' Other measures to promote e6uity $he governments also underta"e expenditures to promote income e/uity' $hese include *ubsidies 9rovide directly or to subsidi.e a variety of socially desirable goods and services' $hese include health care services education and infrastructure that include sanitation and clean !ater supplies' Transfer payments Government provides various "ind of assistance to lo! income groups in the society' $he ob(ective is to support them in maintaining a reasonable standard of living and to lo!er ine/uality' $hese payments are given directly to these groups in the form of monetary help' Examples include Social Security unemployment compensation !elfare and disability payments' @o(ernment policy to control inflation Government uses a number of policies to deal !ith the different types of inflation' $hese are: Demand *ide policies'to control demand pull inflation Deflationary fiscal policy: $his involves an increase in taxes and lo!ering of government spending' Increasing taxes !ill result in lo!er disposable income for household and thus less consumption' 8oreover increased taxes !ill result in lo!er profits for firms and thus less investment by firms' %ll these factors !ill lo!er the %: in the economy' Deflationary monetary policy: It involves rising of interest rates and reducing money supply' 3igher interest rates mean higher loan and mortgage repayments' $his !ill deter households and firms to borro! leading to fall in consumption and investment respectively' *upply side policies'to control cost push inflation It includes all those policies !hich aim at improving the efficient supply of goods and services' $hese might include:

6B

9rivati.ation Imparting training and improving the education level of the !or"force resulting in higher s"ills' Increase competition in all industries by removing entry barriers thus leading to more efficiency'

Exchange rate policies to control imported inflation $his involves increasing the value of currency to reduce imported inflation' Increase currency rate !ill also lead to fall in demand for exports (component of %:)' /nternational aspects Definition Exchange rate: $he price of one,s currency in terms of another currency oreign exchange mar2et: $he mar"et !here currencies are bought and sold' Exchange control: *imits on the amount of foreign currency available to importers !hich conse/uently limit imports ,ppreciation: $he rise in value of a currency against others' Exports !ill become more expensive abroad and imports cheaper at home' Depreciation: $he fall in value of a currency against others' Exports !ill become cheaper abroad and imports expensive at home' De(aluation: :epreciation brought about the government normally by a government !hich fixes the value of its currency' Exports: $he movement of goods or commodities out of the country' /mports: $he movement of goods or commodities into the country' Protectionism: 9olicy of protecting domestic industries against foreign competition by means of tariffs subsidies import /uotas or other handicaps placed on imports' ree trade: % system of trade policy that allo!s traders to trade across national boundaries !ithout interference from the respective governments' @lobalisation 1hat is it3 It is the increasing integration of countries, individual economies' It is the global movement to!ards trade financial and communications integration through the development of free trade free flo! of capital and the freedom to tap into cheaper foreign factor mar"ets' (4fficial definition) >enefits -ost efficient form of production:

6C

;ecause firms !ill choose to produce !here costs are lo!est' Stimulates the economy particularly that of *E:Cs by dra!ing in more foreign direct investment' Employment opportunities 4pening (obs'

Training W Introduces s"ills and technology to nations through a company,s implementations of such: $his increases the productivity of a nation,s !or"force etc' W 4pening ne! industries in *E:Cs such as the !hite phosphorus mining industry in Uemen' W /ncreases competition: Lo0ers prices *ess inflation' ;etter /uality goods' ;etter efficiency' Costs W En(ironmental damage# ;ecause the company is so po!erful that it can afford to operate inefficiently for conveniences sa"e' W Creates uncertainty: 1oreign firms o!n most of the mar"et share in a country not domestic firms' W 8ay choose to source their resources from abroad and not from locally: $hus local resource producers !ill go out of business' W 3uman rights abuses' Infringements on indigenous rights' W $errorism' W Investments in nations facing political sanctions as a result of their !rong)doings' W Leaching from go(ernment funds: *arge 8ECs may be too important for a government to allo! to go ban"rupt thus !henever said 8EC is facing troubles they !ill be given aid by their government' W 9rice manipulation' W Labour abuse: Child labour' ;ad !or"ing conditions' 9oor healthcare' S!eat shops' ;ad !ages' 5estrictions to resting hours' %nti)*abour)Anion policies' W 5sing tactics detrimental to competition: 9redatory pricing' 8onopoly po!er' W Tax e(asion: $hrough transfer pricing' W Asing illegal methods and materials to produce goods and services' 4r to force people to buy their goods or services: Great %merican Streetcar scandal' W >loc2ing of technologies: ;ribery' ;loc"ing battery technology for hybrid cars so one can sell more oil' Concealment of imports'

6D Causing trade deficit: 0al)8art is accused of being one of the largest sources of the trade deficit in the AS%' Ob4ections Third 0orld debt# :ebt in the developing less developed or least developed third !orld countries in %frica %sia *atin %merica and the 8iddle East' Globali.ation is leaching resources from these countries and the revenue generated from this leaching is not fed bac" into these countries' 1urthermore !ith population gro!th causing the needs and !ants of these countries to also gro! these countries are falling into debt in order to pay for these needs and !ants' W %nimal rights' W Child labour' W %narchism' W %nti)capitalist

Exchange rates Demand for and *upply of a currency $his is !hat determines exchange rate in a free)floating exchange rate system: 0hen a currency has strong demand it !ill appreciate in value' In contrast !hen there is a large scale selling of a currency it !ill depreciate' Demand for a currency: Exports and imports of goods#services o If a country has a decline in export industries and earnings yet its people continue buying imports the exchange rate is li"ely to fall' $his is possibly not true for countries such as 3ong Nong !hich are dependent on imports of oil and food' o 1e!er exports !ill mean less demand for the currency to pay for them so the demand for the currency !ill decrease' o $his !ill lead to depreciation o 0hen a currency has depreciated this ma"es the countries, exports cheaper abroad' o $hus exports should become more competitive overseas' 9rice elasticity of demand for imports o 0hen a currency depreciates imports become more expensive' o If the demand for imports is price elastic this should lead to a fall in expenditure on imports o $his situation is found !here imports compete !ith home)produced alternatives' o 0hen countries import necessities such as food and oil demand tends to be price inelastic so expenditure rises !hen the currency falls' M 9ure speculative demand' o Speculators often purchase currencies that they thin" !ill appreciate in value against their o!n currency' M 4fficial buying of the currency by the central ban"' o $his might be done for investment or speculation or security or other reasons' M Comparatively higher domestic interest rate' o $hus savers !ill be li"ely to convert their o!n money into your currency to save in your nation and en(oy the comparatively higher domestic interest rates you offer' *upply of a currency Imports of goods and services'

7@

4utflo!s of direct investment' 4utflo!s of portfolio investment' Speculative selling of the currency' Official selling of the currency by the central ban2# Aate of interest abroad#

,ppreciation and Depreciation M 1oreigners !ill tend to save money in one,s nation' $hus the demand for one,s currency rises !hich can cause one,s currency to appreciate in general' M :epreciation means that the value of the currency in terms of other currencies goes do!n: M If the AS: depreciates against the 58; then it !ill ta"e fe!er 58; to buy each AS:' M If 1 Euro !as !orth 3N: 1@'- at the start of the year' M It may depreciate if the Gree" government declared that it !ould !ithdra! from the Euro.one and go bac" to using the :rachma in order to depreciate their currency' M $his !ill cause others to lose confidence in the Euro and speculation !ill cause people to sell the Euro' M $his may end up causing the Euro to depreciate to 3N: B per Euro' M In this case the Euro has depreciated against the 3N: because it no! ta"es more Euros to purchase each 3N:' M ;ut the 3N: has appreciated against the Euro because it no! ta"es fe!er 3N: to buy 1 euro ,d(antages of a *trong Currency *o!er import prices < $his boosts living standards of consumers' %n increase in the real purchasing po!er of 3N residents traveling overseas for business and leisure purposes' Cheaper to import ra! materials components and capital inputs < causes an out!ard shift in short)run aggregate supply' Improvement in the terms of trade (lo!er import prices)' 3elps to control 59I inflation < :omestic producers face stiff international competition and must "eep their prices do!n' *o!er inflation allo!s the 89C#3N8% to "eep nominal interest rates at a lo!er level than if the exchange rate !as !ea"' %n increase in a country,s relative position in international league tables sho!ing real G:9 per capita !hen expressed in a common currency: Even if one,s G:9 as measured in one,s o!n currency is no more than previously because one,s currency has appreciated in value the G:9 of one,s nation !ill also increase !hen it is translated into another currency' Disad(antages of a *trong Currency M Cheaper imports lead to rising import penetration and large trade deficit: M Import penetration means that a larger portion of the goods and services provided by a nation,s firms is no! provided by foreign firms' M Exporters also lose price competitiveness and mar"et share thus causing a trade deficit' M :amaged profit and employment in some sectors to !hich exporting is the "ey means of generating revenue' M Eegative impact on economic gro!th (exports < in(ections of aggregate demand imports ) lea"ages of !ealth form the circular flo! of income)' M Some regions !hich have a higher than average dependency on exporting industries are more affected than others'

71 >alance of Payments on Current ,ccounts 1hat is it3 It is a set of accounts that record a country,s international transactions and !hich (because double entry boo""eeping is used) is al!ays in balance !ith no surplus or deficit sho!n on the overall basis' It serves to highlight a country,s competitive strengths and !ea"nesses and helps in achieving balanced economic gro!th' >ecause the international mar2et is so large it is unli2ely to adhere to the business cycle# $herefore a country !hich has a healthy ;o9 account !ill li"ely have balanced gro!th because the levels of investment consumption and capital of the international mar"et is unli"ely to fluctuate much and !ill gro! steadily' $he demand from the international mar"et is unli"ely to fluctuate much and !ill gro! steadily therefore investment and capital !ill also gro! steadily (this gro!th happens because people are getting richer !orld population is gro!ing etc')' Capital in this case should indicate the money invested in businesses to generate income: If investments gro! so too !ill capital because capital is the money already invested and investments are the source of capital' The >alance of Payments ,ccount $he current account capital account and financial account' $he capital and financial accounts used to "no!n collectively as the capital account' The >oP is al0ays balanced 0hen the ne!s tal"s about a ;o9 surplus or deficit they are usually referring to the net transactions of the Current %ccount or (ust the ;alance of $rade' Calculated by subtracting the total value of imports from the total value of exports >oT is >alance of Trade 9ositive figure (surplus) < Qalue of imports T Qalue of exports' Eegative figure (deficit) < Qalue of imports X Qalue of exports' % negative ;o9 indicates that a country,s exports are not competitive enough to compete !ith those produced by other countries: $hus there is a net lea"age of !ealth from the country' Correcting trade imbalances *arge trade imbalances !hether a big deficit or a big surplus can cause problems for a national economy' Problems 0ith a trade surplus $here may be political and economic pressure on the government from other countries to reduce its trade surplus so they can reduce their trade deficits Exporting firms !ill en(oy significant overseas revenues < profits and !ages may rise < but the increase in demand may cause demand)push inflation % surplus causes the value of the currency to appreciate or stay high and may eventually reduce demand for exports and cause a loss of (obs' Problems 0ith a trade deficit If more money is paid out for imports than is earned from exports then this loss of money from an economy may mean less can be spent on domestic goods and services'

7:omestic firms facing a fall in demand for their products may cut bac" production and their demand for labour resulting in higher unemployment' $he value of the exchange rate !ill fall causing imports to become more expensive and resulting in imported inflation' If demand for price)inelastic goods or services falls more money !ill be paid out for imports and the demand for domestically)produced goods#services !ill decrease' $he trade deficit might be a symptom of a declining industrial base !ith fe!er firms in the economy over time producing goods and services for export'

Economic gro0th and trade balance % period of fast gro!th may come into conflict !ith the balance of payments' 8uch depends on the income elasticity of demand for traded goods and services' In the case the AN the evidence is that consumers have a high propensity to consume imports+ the income elasticity of demand is strongly positive' Say for example real disposable incomes gro! by 2L and that the income elasticity for imports ? M-'7' $hat !ould lead to a BL rise in the volume of imports' Anless there is a corresponding rise in exports !e expect to see a !orsening of the balance of trade (i'e' a !idening trade deficit)' In a recession this effect !or"s in reverse as demand for imported products including ra! materials components and ready to consume goods and services declines' $he trade balance !ill improve although the root cause is a drop in economic activity' Correcting trade balances 1' :o nothing as a floating exchange rate !ill correct it' $rade deficits and surpluses can be self)correcting if allo!ed to ad(ust freely' -' 1iscal policy % contractionary fiscal policy is !hen the government may cut public expenditure and raise taxes to reduce the total demand in their economy so people have less to spend on imports' $his !ill help reduce the trade deficit' 3o!ever a fall in demand may also affect domestic firms !ho may cut output and employment in response to the fall in demand %n expansionary fiscal policy is !hen the government lo!ers tax rates and raise public expenditure' $his boosts spending on imports and help to correct a trade surplus' 3o!ever it may also help domestic firms if demand for their goods and services also rises and may help to halt any decline in the industrial base' 2' 8onetary policy %n expansionary monetary policy is !hen the government attempt to attract more in!ards investments to their economy to help offset a trade deficit by raising interest rates' 3igher interest rates !ill also ma"e borro!ing more expensive and reduce the demand for loans by consumers and firms that may be used to pay for goods and services supplied overseas' % contractionary monetary policy is !hen the government lo!ers interest rates to help correct for a trade surplus by lo!ering the cost of borro!ing from firms and consumers and !ill lo!er the return overseas investors can expect on their in!ard investments in the economy so that they invest else!here instead' 6' 9rotectionism

72 $his is !hen a country uses trade barriers such as tariffs to ma"e imports more expensive or limit the amount of imports in order to correct a trade deficit' Nisible and /n(isible Nisible Trade Qisible trade involves trading of goods !hich can be touched and !eighed' Examples include trade in goods such as 4il machinery food clothes etc' Qisible $rade consists of Nisible exports: Selling of tangible goods !hich can be touched and !eighed to other countries' Nisible imports: ;uying of tangible goods !hich can be touched and !eighed from other countries' >alance of trade It is the difference bet!een the value of visible exports and value of visible imports of a country' If the value of visible exports is more than visible imports the country !ill have a surplus balance of trade' If the value of visible imports is more than visible exports the country !ill have an Anfavourable balance of trade' /n(isible trade Invisible trade involves the import and export of services rather than goods' Example include services such as insurance ban"ing tourism education' If a AN student comes to Singapore to study it !ould be invisible export for Singapore as it is earning foreign exchange by providing educational services' If a Singapore citi.en travels to AN for a holiday' It !ill be invisible import for Singapore and invisible export for AN' >alance of in(isible trade It is the difference bet!een the value of invisible exports and value of invisible imports of a country' Comparati(e ad(antage $he theory of comparative advantage states that a country should specialise in the production of good or service in !hich it has lo!er opportunity cost and it should import commodities !hich have a higher opportunity cost of production' Example Suppose for example !e have t!o countries of e.ual si/e Northland and *outhland' ;oth produce and consume t!o goods ood and Clothes' $he productive capacities and efficiencies of the countries are such that if both countries devoted all their resources to 1ood production output !ould be as follo!s: Eorthland: 1@@ tonnes Southland: -@@ tonnes If all the resources of the countries !ere allocated to the production of clothes output !ould be: Eorthland: 1@@ tonnes Southland: 1@@ tonnes %ssuming each has constant opportunity costs of production bet!een the t!o products and both economies have full employment at all times' %ll factors of production are mobile *it'in

76 t'e countries bet!een clothing and food industries but are immobile bet*een t'e countries' T'e price mec'anism must be *or-in) to pro(ide perfect competition ' Southland has an absolute advantage over Eorthland in the production of 1ood' ;oth countries are e/ually efficient in the production of clothes' $here seems to be no mutual benefit in trade bet!een the economies' $he opportunity costs sho!s other!ise' Eorthland&s opportunity cost of producing one tonne of 1ood is one tonne of Clothes and vice versa' Southland&s opportunity cost of one tonne of 1ood is @'7 tonne of Clothes' $he opportunity cost of one tonne of Clothes is - tonnes of 1ood' Southland has a comparative advantage in food production because of its lo!er opportunity cost of production !ith respect to Eorthland' Eorthland has a comparative advantage over Southland in the production of clothes the opportunity cost of !hich is higher in Southland !ith respect to 1ood than in Eorthland' $o sho! these different opportunity costs lead to mutual benefit if the countries speciali.e production and trade consider the countries produce and consume only domestically' $he volumes are: ood Northland *outhland 1orld total 7@ 1@@ 17@ Clothes 7@ 7@ 1@@

Production and consumption before trade $his example includes no formulation of the preferences of consumers in the t!o economies !hich !ould allo! the determination of the international exchange rate of Clothes and 1ood' Given the production capabilities of each country in order for trade to be !orth!hile Eorthland re/uires a price of at least one tonne of 1ood in exchange for one tonne of Clothes+ and Southland re/uires at least one tonne of Clothes for t!o tonnes of 1ood' $he exchange price !ill be some!here bet!een the t!o' $he remainder of the example !or"s !ith an international trading price of one tonne of 1ood for -#2 tonne of Clothes' If both speciali.e in the goods in !hich they have comparative advantage their outputs !ill be: ood Northland *outhland 1orld total @ -@@ -@@ Clothes 1@@ @ 1@@

Production after trade 0orld production of food increased' Clothing production remained the same' Asing the exchange rate of one tonne of 1ood for -#2 tonne of Clothes Eorthland and Southland are able to trade to yield the follo!ing level of consumption: ood Northland B7 Clothes 7@

77 *outhland 1orld total 1-7 -@@ 7@ 1@@

Consumption after trade Eorthland traded 7@ tonnes of Clothing for B7 tonnes of 1ood' ;oth benefited and no! consume at points outside their production possibility frontiers' ,ssumptions in Example $ T0o countriesC t0o goods o $he theory is no different for larger numbers of countries and goods but the principles are clearer and the argument easier to follo! in this simpler case' E6ual si+e economies o %gain this is a simplification to produce a clearer example' ull employment o If one or other of the economies has less than full employment of factors of production then this excess capacity must usually be used up before the comparative advantage reasoning can be applied' Constant opportunity costs o % more realistic treatment of opportunity costs the reasoning is broadly the same but speciali.ation of production can only be ta"en to the point at !hich the opportunity costs in the t!o countries become e/ual' $his does not invalidate the principles of comparative advantage but it does limit the magnitude of the benefit' Perfect mobility of factors of production 0ithin countries o $his is necessary to allo! production to be s!itched *it'out cost' In real economies this cost !ill be incurred: capital !ill be tied up in plant (se!ing machines are not so!ing machines) and labour !ill need to be retrained and relocated' $his is !hy it is sometimes argued that &nascent industries& should be protected from fully liberalised international trade during the period in !hich a high cost of entry into the mar"et (capital e/uipment training) is being paid for' /mmobility of factors of production bet0een countries o 0hy are there different rates of productivityI $he modern version of comparative advantage (developed in the early t!entieth century by the S!edish economists Eli 3ec"scher and ;ertil 4hlin) attributes these differences to differences in nations& factor endo!ments' % nation !ill have comparative advantage in producing the good that uses intensively the factor it produces abundantly' 1or example: suppose the AS has a relative abundance of capital and India has a relative abundance of labor' Suppose further that cars are capital intensive to produce !hile cloth is labor intensive' $hen the AS !ill have a comparative advantage in ma"ing cars and India !ill have a comparative advantage in ma"ing cloth' If there is international factor mobility this can change nations& relative factor abundance' $he principle of comparative advantage still applies but !ho has the advantage in !hat can change' Negligible Transport Cost o Cost is not a cause of concern !hen countries decided to trade' It is ignored and not factored in' ,ssume that half the resources are used to produce each good in each country# o $his ta"es place before speciali.ation Perfect competition

7=
o

$his is a standard assumption that allo!s perfectly efficient allocation of productive resources in an ideali.ed free mar"et'

,bsolute ad(antage % country has an absolute ad(antage over another in producing a good if it can produce that good using fe!er resources than another country' 1or example if one unit of labor in %ustralia can produce C@ units of !ool or -@ units of !ine+ !hile in 1rance one unit of labor ma"es 7@ units of !ool or B7 units of !ine then %ustralia has an absolute advantage in producing !ool and 1rance has an absolute advantage in producing !ine' %ustralia can get more !ine !ith its labor by speciali.ing in !ool and trading the !ool for 1rench !ine !hile 1rance can benefit by trading !ine for !ool' Example " Country % can produce one !idget using one unit of labour' Country ; can produce one !idget using t!o units of labour' Country % has an absolute advantage over Country ; in producing !idgets' Example $ Country % has 1@@ units of labour' It uses -@ to produce C@ units of 9arachutes and C@ to produce -@ units of ;arbie dolls' Country ; has 1@@ units of labour' It uses 6@ to produce 1@@ units of ;arbie dolls and =@ to produce -@ units of 9arachutes' If the countries maximi.ed their potential Country % could produce 6@@ units of 9arachutes and country ; could produce -7@ units of ;arbie dolls' $hrough trade the t!o countries !ould achieve a more efficient allocation of resources and increase their prosperity' ree trade Definition: International trade left to the mechanisms of demand and supply !ithout influence of protectionist methods' Aeasons for ree Trade Domestic Non'a(ailability o % nation trades because it lac"s the ra! materials climate specialist labour capital or technology needed to manufacture a particular good' $rade allo!s a greater variety of goods and services' Cost effecti(eness o It is cheaper to buy from other countries rather than producing themselves' >enefits of Trade Lo0er prices for consumers o 0hen there is free trade consumers can free to buy goods from the producer !ho is !illing to sell at the lo!est prices' 3ence consumers gain from lo!er prices' @reater choice for consumers o 0ith free trade consumers have access to variety of goods and services from different producers across the globe' $his means more choice' %bility of producers to benefit from economies of scale

7B 9roducers have access to a larger mar"et thus they can produce more at lo!er cost and benefit from economies of scale' %bility to ac6uire needed resources o $hrough free trade producers can not only sell in a large mar"et but also gain from purchasing from suppliers across the !orld' 8ore efficient allocation of resources o 0hen there is free trade the most efficient producers get the opportunity to produce due to their cost efficiency' $his leads to productive efficiency' /ncreased competition o In free trade producers from different regions can compete !ith each other in terms of price /uality and variety' Increased competition leads to efficient allocation of resources' *ource of foreign exchange o 1ree trade involves the transaction of goods and services bet!een nations' In order to purchase goods from abroad (imports) !e need foreign currency' $his is possible through exporting of goods to other countries' o

ree Trade diagrams

Protectionism methods $he chief protectionist measures government)levied tariffs raise the price of imported articles ma"ing them less attractive to consumers than cheaper domestic products' Import /uotas !hich limit the /uantities of goods that can be imported are another protectionist device' Tariffs % tariff is a tax on foreign goods upon importation' $ariff rates vary according to the type of goods imported' Import tariffs !ill increase the cost to importers and increase the price of imported goods in the local mar"ets thus lo!ering the /uantity of goods imported'

7C

7uotas %n import 6uota is a type of protectionist that sets a physical limit on the /uantity of a good that can be imported into a country in a given period of time' $his leads to a reduction in the /uantity imported and therefore increases the mar"et price of imported goods' Puotas li"e other trade restrictions are used to benefit the producers of a good in a domestic economy at the expense of all consumers of the good in that economy' ,dministrati(e >arriers Countries are sometimes accused of using their various administrative rules (eg' regarding food safety environmental standards electrical safety etc') as a !ay to introduce barriers to imports' Embargo %n embargo is the prohibition of commerce and trade !ith a certain country in order to isolate it and to put its government into a difficult internal situation given that the effects of the embargo are often able to ma"e its economy suffer from the initiative' *ubsidies Government subsidies (in the form of lump)sum payments or cheap loans) are sometimes given to local firms that cannot compete !ell against foreign imports' $hese subsidies are purported to VprotectV local (obs and to help local firms ad(ust to the !orld mar"ets'

7D

,nti'dumping legislation Supporters of anti)dumping la!s argue that they prevent VdumpingV of cheaper foreign goods that !ould cause local firms to close do!n' 3o!ever in practice anti)dumping la!s are usually used to impose trade tariffs on foreign exporters' ExternalitiesC -ar2et ailure and /mport Controls 9rotectionism can also be used to ta"e account of externalities and dealing !ith de'merit goods' Goods such as alcohol tobacco and narcotic drugs have adverse social effects and are termed de)merit goods' 9rotectionism can safeguard society from the importation of these goods by imposing high tariff barriers or by banning the importation of the good altogether' Non'Economic Aeasons Countries may !ish not to over)specialise in the goods in !hich they possess a comparative advantage' 4ne danger of o(er'specialisation is that unemployment may rise /uic"ly if an industry moves into structural decline as ne! international competition emerges at lo!er costs' $he government may also !ish to protect employment in strategic industries although clearly value (udgments are involved in determining !hat constitutes a strategic sector' $he recent trade dispute arising from the decision by the Anited States to introduce a tariff on steel imports is lin"ed to this ob(ective' $he AS steel tariff !as declared unla!ful by the 0$4 in Huly -@@2 and eventually the Anited States !as pressuri.ed into !ithdra!ing these tariffs in the late autumn of -@@2' $ariffs are not usually a ma(or source of tax revenue for the Government that imposes them' In the AN for example tariffs are estimated to be !orth only Y- billion to the $reasury e/uivalent to only around @'7L of the total tax ta"e' :eveloping countries tend to be more reliant on tariffs for revenue' Economic ,rguments against /mport Controls Protectionism 8 hurting customers $ariffs non)tariff barriers and other forms of protection serve as a tax on domestic consumers' 8oreover they are very often a regressive form of taxation hurting the poorest consumers far more than the better off' In the EA for instance the nature of existing protection means that the heaviest taxes tend to fall on the necessities of life such as food clothing and foot!ear'

=@ %ccording to 9rofessor Hagdish ;hag!ati Jthe fact that trade protection hurts the economy of the country that imposes it is one of the oldest but still most startling insights economics has to offer'K $he folly of protection has been confirmed by a range of studies from around the !orld' $hese indicate that that it has brought fe! benefits but imposed substantial costs' %mong the main criticisms of protectionist policies are the follo!ing: -ar2et distortion: 9rotection has proved an ineffective and costly means of sustaining employment' a' Higher prices for consumers : $rade barriers in the form of tariffs push up the prices faced by consumers and insulate inefficient sectors from competition' $hey penalise foreign producers and encourage the inefficient allocation of resources both domestically and globally' In general terms import controls impose costs on society that !ould not exist if there !as completely free trade in goods and services' It has been estimated for example that the recent tariff and other barriers placed on imports of steel into the AS increased the price of every car produced there by an average of Z1@@ b' Aeduction in mar2et access for producers: Export subsidies depressing !orld prices and ma"ing them more volatile !hile depriving efficient farmers of access to the !orld mar"et' $his is a ma(or criticism of the EA common agricultural policy' In -@@- the EA sugar regime lo!ered the value of ;ra.il $hailand and South %frica,s sugar exports by over ZB@@ million < countries !here nearly B@ million people survive on less than Z- a day' Loss of economic 0elfare: $ariffs create a dead!eight loss of consumer and producer surplus arising from a loss of allocative efficiency' 0elfare is reduced through higher prices and restricted consumer choice' Aegressi(e effect on the distribution of income: It is often the case that the higher prices that result from tariffs hit those on lo!er incomes hardest because the tariffs (e'g' on foodstuffs tobacco and clothing) fall on those products that lo!er income families spend a higher share of their income' $hus import protection may !orsen the ine/ualities in the distribution of income ma"ing the allocation of scarce resources less e/uitable Production inefficiencies: 1irms that are protected from competition have little incentive to reduce production costs' Governments must consider these disadvantages carefully Little protection for employment: 4ne of the (ustifications for protectionist tariffs and other barriers to trade is that they help to protect the loss of relatively lo! s"illed and lo! paid (obs in industries that are coming under sever international competition' $he evidence suggests that in the long term tariffs are a costly and ineffective !ay of protecting such (obs' %ccording to the :$I study on trade published in -@@6 since 1DDB AN employment in textiles manufacturing has fallen by 67L in clothing manufacture by nearly =@L and in foot!ear manufacturing by around 7@L ) and this despite the protection afforded to European Anion textile manufacturers' $he cost of protecting each (ob runs into hundreds of thousands of Euros for the EA as a !hole' 8ight that money have been spent more productively in other !aysI 4ften there is a huge opportunity cost involved in imposing import tariffs' Trade 0ars: $here is the danger that one country imposing import controls !ill lead to Jretaliatory actionK by another leading to a decrease in the volume of !orld trade' 5etaliatory actions increase the costs of importing ne! technologies Negati(e multiplier effects: If one country imposes trade restrictions on another the resultant decrease in total trade !ill have a negative multiplier effect affecting many more countries because exports are an in(ection of demand into the global circular flo!

=1 of income' $he negative multiplier effects are more pronounced !hen trade disputes boil over and lead to retaliation' $he diagram belo! sho!s the !elfare conse/uences of imposing an import tariff

In a ne! study of the benefits of global trade and investment published in 8ay -@@6 the AN :epartment of $rade of Industry outlined their opposition to import controls (protectionism) Higher taxes and higher prices 9rotectionism imposes a double burden on tax payers and consumers' In the case of European agriculture the cost to tax payers is about [7@ billion a year plus around [7@ billion a year to consumers via artificially high food prices < together the e/uivalent of over YC@@ a year on the annual food budget of an average family of four' 1urthermore huge distortions in international agriculture mar"ets prevent the !orld,s poorest countries from trading in the products they are best able to produce' Continuing barriers to trade are costing the global economy around Z7@@ billion a year in lost income' 9rotectionist policies rarely achieve their aims' $hey can be costly to administer and they nearly al!ays provide domestic suppliers !ith a protectionist shield that encourages inefficiencies leading to higher costs' 9rotectionism is a Rsecond best, approach to correcting for a country,s balance of payments problem or the fear of rising structural unemployment' %nd import controls go against the principles of free trade enshrined in the theories of comparative advantage' In this sense import controls can be seen as examples of government failure arising from intervention in mar"ets' Economic nationalism Economic nationalism is a term that has become used more fre/uently in recent years' It is used to describe policies !hich are guided by the idea of protecting a country&s home economy i'e' protecting domestic consumption (obs and investment even if this re/uires the imposition of tariffs and other restrictions on the movement of labour goods and capital' Economic nationalism may include such doctrines as protectionism and import substitution' Examples of economic nationalism include China&s controlled exchange of the yuan and the Anited States& use of tariffs to protect domestic steel production' $he term gained a more

=specific meaning in -@@7 and -@@= after several European Anion governments intervened to prevent ta"eovers of domestic firms by foreign companies' In some cases the national governments also endorsed counter)bids from compatriot companies to create &national champions&' Such cases included the proposed ta"eover of %rcelor (*uxembourg) by 8ittal Steel (India)' %nd the 1rench government listing of the food and drin"s business :anone (1rance) as a &strategic industry& to pre)empt a potential ta"eover bid by 9epsiCo (AS%)' *ample /@C*E 7uestions 1' 1hen the exchange rate of a currency depreciatesC the balance of trade impro(es# Do you agree 0ith this statement3 @i(e reasons for your ans0er# :Q< :epreciation is referred to as the decrease in the value of currency relative to another country' It is often lin"ed !ith the balance of trade the amount of exports subtracted by the amount of imports' 0hen the balance of the trade improves this means the value of exports is greater than the value of imports+ a trade surplus' $his means that the value of exports is cheaper overseas so people are able to buy more of the country,s exports so demand for the good increases and thus they !ould have higher purchasing po!er to buy your good' $his causes the country to export more' %nother reason is that because of depreciation imports become more expensive so demand for imports decreases as prices for imports rise' 3o!ever exports may not rise if another country has depreciated its currency even further or produced that good at a lo!er cost' Exports may not even increase if there are a lot of substitutes for the good such as coffee beans' If the exports are inelastic there is little change in /uantity demanded' Countries li"e 3ong Nong are dependent on food and oil they are forced to pay a higher price and /uantity demanded !ill not fall too much' In general currency depreciation should improve the balance of trade' $# ,part from depreciation of the currencyC identify and briefly explain t0o measures that a go(ernment may use to increase exports# :&< a' :emand)side policy promotion of products made in the country for example $he ;ritish Council has an annual trade fair on ;ritish goods to attract more buyers' Similarly for 3ong Nong it is the 3ong Nong $rade and :evelopment Council (3N$:C)' b' Supply)side policy Subsidies to export companies to lo!er production cost and increase supply' 1or example China,s subsidies to solar panel producers' %# To 0hat extent is international borro0ing by a de(eloping country li2ely to lead to an increase in the standard of li(ing3 @i(e reasons for your ans0er# :Q< International borro!ing is !hen countries or government borro!ing money from ban"s overseas' Standard of living is the !elfare of individuals' 4ne example of international borro!ing is !hen the Chinese government borro!ed from the International 8onetary 1und (I81) to build the $hree Gorges :am' ;y building this dam it allo!s people in China to have access to clean !ater !hich reduces cholera and other !ater)borne diseases outbrea"s and increases their health' %nother added benefit of building this dam is that it is a hydroelectric plant and produces a large supply of electricity to po!er businesses and therefore increase productivity' Irrigation can also be provided by the dam to improve the marginal agricultural areas' $hus farmers in these areas can

=2 produce more agricultural products and increase their standard of living' %nother important benefit is that by building this dam it creates (obs for construction !or"ers as !ell as engineers architects and many others' 3o!ever international borro!ing results in high interest rates and in the long)term debt' $he disadvantage of building a dam is that the surrounding !ildlife and habitat !ill be destroyed and some people !ill be relocated and thus this !ill decrease their standard of living' In conclusion for the ma(ority of the people the standard of living !ill increases due to international borro!ing' &# Ho0 does combatting inflation affect the exchange rates3 :Q< 5aising benchmar" interest rates is the preferred plan of action !hen it comes to the central ban"&s fight against inflation' It&s the easiest and simplest strategy and the results can sometimes be /uic"er compared to other methods' %ll a monetary body does in this instance is increase the benchmar" that most commercial and retail ban"s refer to !hen creating client loans' $hese products include mortgage student and car loans along !ith commercial loans for businesses' 4nce these rates rise the cost of money increases' $his isn&t a good thing for customers or companies' (1or more on the relationship bet!een interest rates and inflation' Global investors constantly search for high interest rate returns combined !ith relatively lo! ris"' $he same goes for foreign exchange investors' So !hen a central ban" elects to raise rates you can be sure that demand for that currency !ill rise' 1or example the %ustralian dollar benefited from this phenomenon beginning in Hune -@1@' $he central ban" of %ustralia raised rates several times bet!een late -@@D and early -@11' ;y Hanuary -@11 the %ustralian dollar had risen by -=L compared to the A'S' dollar in response %s the %ustralian economy rebounded /uic"ly amid a slumping global economy the country&s central ban" !as forced to raise rates more than once < by -7 basis points each time < in order to fight inflation' $he decisions led to higher demand for the %ussie especially against the A'S' dollar during that time' %n e/ually effective strategy for central ban"s is to raise the reserve re/uirements of ban"ing institutions' 0hen a central ban" elects to raise the reserve re/uirements is limiting the amount of money or cash in the system ) referred to as the monetary base' %n increase in the reserve re/uirement increases the minimum cash reserve that a commercial ban" is governed to hold so this ad(ustment prevents the ban" from lending out that cash' $his restriction of money !ill slo! the rise in prices as there !ill be less money chasing the same expensively priced goods (hopefully suppressing demand)' $he Chinese government favors this policy due to its o!n semi)fixed currency policy' Since the beginning of -@11 the 9eople&s ;an" of China has elected to raise the reserve re/uirement three times < increasing the rate by 7@ basis points each time' $he decision to raise reserve re/uirements should eventually slo! do!n the inflation of a nation&s currency' 8ore often than not such a decision also helps to fuel the foreign exchange rate&s up!ard trend in value due to speculators' So the central ban"&s decision holds significance for the foreign exchange investor' ;y increasing the reserve re/uirement the central ban" is ac"no!ledging that inflation is a problem and is aggressively dealing !ith it' 3o!ever this could increase a currency&s attractiveness to forex investors as they anticipate another round of reserve re/uirement increases' %s the supply of money thins ) a result of higher reserves held by ban"s ) speculation helps to support and even propagate a higher currency valuation (thus lo!ering inflation)' 5eferring bac" to the Chinese yuan the effects of speculative

=6 demand are apparent: $he currency gained by almost 6L follo!ing a series of reserve rate increases from Hune -@1@ to Hanuary -@11 as speculators anticipated further reserve /uota increases for Chinese domestic ban"s' I# Changes in rate of exchange meant that exports of good from Egypt decreased a they became more expensi(e in other countries a# Explain 0hat is meant by a rate of exchange# :%< % rate of exchange is the rate at !hich one currency can be exchanged for another on the global foreign exchange mar"et' It is therefore the mar"et price of one currency in terms of another currency for example the price of euros in terms of AS dollars b# /f exports from Egypt become more expensi(eC ho0 might that affect production and employment both in Egypt and in countries importing Egyptian goods3 :R< If exports from Egypt become more expensive global demand for them is li"ely to fall' Anless global demand is price inelastic this !ill lose revenue and their profits !ill fall' In response exporters may cut bac" their production and reduce their employment of labour' If exports are a ma(or source of revenue for Egypt this could result in a significant loss of income and high unemployment' In the country importing Egyptian goods there could be inflation especially if the Egyptian goods ma"e up a significant proportion of total imports and are used by firms in the production of other goods and services' 3o!ever consumers in this country may be able to buy similar products from domestic producers instead' :omestic firms are li"ely to respond by increasing their output and demand for labour rise' 3o!ever if consumers also s!itch some of their demand to other imported goods from other countries then the potential for gro!th and employment in their country !ill be reduced' c# Describe the structure of balance of payments on current account of a country :&< $he balance of payments of a country records international transactions !ith other countries' $he current account !ithin the balance of payments records payments made to other countries for visible and invisible imports and payments received from overseas from the sale of visible and invisible exports' $he balance of trade is therefore the difference bet!een the value of goods exported and the value of goods imported by a country' $he balance of invisibles is the difference bet!een the value of services purchased by overseas firms and residents and the value of services purchased from by domestic firms and residents' $he current account also records income flo!s into and out of a country including !ages earned by residents !or"ing overseas or paid out to migrant !or"ers from overseas and any international payments of interest profits and dividends' It also records current transfers including payments of taxes and excise duties by visiting residents of other countries or similar payments mad overseas' d# Discuss 0hat might lead to an impro(ement in the current account of a country :Q<