Cambridge

ECONOMICS

Revision Notes
 3

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Fixed Costs. - Costs that do not vary with output; e.g. cost of a factory
Variable Costs: - Costs that do vary with output; e.g. electricity, materials
Total Costs: - Fixed + variable costs
Marginal Cost: - This is the cost of producing one extra unit.
Sunk Costs: - These are costs that are not recoverable e.g. advertising.
Average Total Cost (ATC) = TC / Q
Average Variable Cost (AVC) = VC / Q
Average Fixed Costs (AFC) = FC / Q

Diagram of Cost Curves

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Total Product (TP) This is the total output produced by workers.

Marginal Product (MP) This is the output produced by an extra worker.
 4

Diagram of Diminishing Returns

After Q1 the MP of an
extra worker falls.

After Q1, the MC of

producing more goods
increases.

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In the Long Run all factors of production (both capital and labour) are variable.
A firms long run cost curve (LRAC) is constructed by using the point of tangency
with its short run cost curves.
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Economies of scale occur when average costs fall with increasing output. Therefore,
increasing production leads to increasing returns to scale and there is greater
efficiency.

Economies of Scale occur for various reasons:

1. Specialization and division of labour: In large scale operations workers can

do more specific tasks. With little training they can become very proficient in
 5

their task; this enables greater efficiency. A good example is an assembly line
with many different jobs.
2. Bulk buying: If you buy a large quantity then the average costs will be lower.
3. Technical. When a firm benefits from increased scale of production. For
example, a large machine (e.g. blast furnace / combine harvester) would be
inefficient for small-scale production; for higher rates of production, the firm
gains a better rate of return.
4. Financial economies. A bigger firm will find it easier to get a loan and can
get a better rate of interest than small firms.
5. Marketing. A national TV advertising campaign is more efficient for a large
firm with national sales.
6. Risk Bearing. A larger firm can diversify and has bigger resources to absorb
an unexpected shock.
7. External economies of scale: This occurs when firms benefit from the whole
industry getting bigger. E.g. if the industry gets bigger all firms will benefit
from better infrastructure, access to specialized labour and good supply
networks.

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This occurs when Long Run Average Costs start to rise with increased output.
Therefore there will be decreasing returns to scale. Diseconomies of scale can occur
for the following reasons:

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If the MES was 10,000 cars a week and the total industry demand was 40,000.
This would mean that the optimal number of firm would be 4.
 6

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Total Revenue (TR): This is the total income a firm receives.
This will equal Price * Quantity
Average Revenue (AR): TR / Q
Marginal Revenue (MR) - The increase in revenue from selling an extra unit,
Profit = Total revenue (TR) Total Costs (TC) or (AR AC)* Q

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Profit maximisation occurs when the difference between TR TC is the
greatest.

Profit maximisation will also occur at an output where MR = MC

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Normal Profit. This occurs when TR = TC. This is the breakeven point for a
firm. It is the min profit level to keep the firm in the industry in the long run.

Supernormal Profit. This occurs when TR > TC

 7

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1. Profit Satisficing. Managers making enough profit to keep the owners happy.
In many firms there is separation of ownership and control.
This is a problem because although the owners may want to maximise
profits, the managers have much less incentive to maximise profits
because they do not get the same rewards.
In this situation of separate ownership and control, managers may create a
minimum level of profit to keep the shareholders happy, but then
maximise other objectives such as enjoying work.

2. Growth Maximisation. Firms often seek to increase their market share, even
if it means less profit. This could occur for various reasons:
Increased market share increases their monopoly power and may enable
them to put up prices and make more profit in the long run.
Managers prefer to work for bigger companies, as it tends to lead to
greater prestige and higher salaries.
Increasing market share may force rivals out of business.
Diagram Showing different objectives

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 8

3. Social / Environmental concerns. A firm may incur extra expenses to choose

products which dont harm the environment or choose products not tested on
animals. This has actually proved quite a good marketing strategy, e.g. for firms
like the Body Shop. Not all production decisions are based on profit and sales.

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1. Productive efficiency. Productive efficiency occurs when the economy is on
the PPF. It will also occur at the lowest point on the firms SRAC curve.

2. Allocative efficiency. This occurs when goods and services are distributed
according to consumer preferences. This occurs at an output where (P=MC)

3. X efficiency. This occurs when firms have incentives to cut costs and use the
optimal combination of factor inputs. Therefore actual costs are as low as
possible. X-inefficiency means actual costs are higher than potential.

4. Efficiencies of scale This occurs when a firms produces on the lowest point of
its long run average cost, and therefore benefits fully from economies of scale.

5. Dynamic efficiency This refers to efficiency over time; for example, it is

necessary for firms to constantly introduce new technology and reduce costs
over time.

6. Social Efficiency. Includes all external costs and benefits. Where social
marginal cost = social marginal benefit.

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A competitive market is one where no one firm has a dominant position, but the
consumer has plenty of choice when buying goods or services. Therefore in
competitive markets we would expect:

1. Firms to have a small share of the market

2. Few barriers to entry
3. Low prices for consumers
4. Allocative efficiency
5. Incentives for firms to cut costs and develop new products
6. Profits will be lower than in markets with Monopoly power

Perfect Competition is a theoretical market structure which occurs when there are no
barriers to entry and perfect information
 9

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1. This is an industry which is dominated by a few firms. The UK definition of

an oligopoly is a five firm concentration ratio of more than 50%. This means
the combined market share of biggest 5 firms is greater than 50%
2. Interdependence of firms: firms will be affected by how other firms set price.
3. Barriers To Entry. (but less than monopoly)
4. Differentiated products. Advertising is often important in oligopoly.

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Firms in Oligopoly will compete in different ways. It depends upon factors such as:

The objectives of the firms - e.g. profit max or sales max?

The degree of contestability e.g. amount of barriers to entry.
Government regulation e.g. preventing collusion and price fixing.

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This model assumes firms seek to maximise profits. It is one possible
explantion of Oligopoly behaviour (but, importantly not the only one).
If a firm increases price, then they will lose a large share of the market
because they become uncompetitive compared to other firms, therefore
demand is elastic for price increases.
If firms cut price, then they would gain a big increase in market share.
However it is unlikely that firms will allow this. Therefore, other firms follow
suit and cut price as well. Therefore, demand is inelastic for a price cut.
This suggests that increasing or decreasing prices will lead to lower revenue
and therefore prices will tend to be rigid in oligopoly.
 10

Diagram of Kinked Demand Curve

Limitations of this model

1. The model does not explain how prices were set in the first place
2. Price stability may be due to other factors
3. In the real world firms often do cut or increase price. E.g. if firms are
seeking to maximise market share they may cut prices anyway.

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If prices are rigid and firms have little incentive to change prices they will concentrate
on non-price competition. This occurs when firms seek to increase revenue and sales
by various methods such as:
1. Advertising. This creates product differentiation and brand loyalty.
Advertising can also be used as a barrier to entry.
2. Product Development. This could be an effort to improve the quality of the
product such as mobile phones with more features.
3. Loyalty Cards. A reason for customers to come back.
4. Quality of Service. Increasing loyalty through better quality.
5. Location. Better location for firms

6. After sales service. Offering good service after buying the good.
 11

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Firms may not seek to maximise profits but have other aims such as increasing market
share and expanding the firm. This can explain why firms seek to reduce prices and
start price wars.

Price wars are more likely in a recession when demand is falling and
markets become more competitive.
Price wars tend to be short term because otherwise firms will make a loss.
Price wars are often selective, e.g. tour operators have selective price cuts on
certain package holidays and then try to make more profit on extras like
insurance and car hire.
A multinational will often subsidies a price war by cross subsidising the
price war from different markets in different countries.
Price wars can be in the public interest, but only if firms dont get forced out
of business by the low prices.

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This occurs when a firm lowers price in some sections of the market with
the intent of forcing another firm out of business.
This is clearly against the public interest because the dominant firm can
increase prices when its rival has left. Therefore there is legislation to make
predatory pricing illegal.

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This depends upon the way that firms compete and behave.
1. In collusion the industry acts like a monopolist therefore there will be:
Allocative inefficiency P > MC
Productive inefficiency; production is not at the lowest point on SRAC.
X inefficiency, there is less incentive for firms to cut costs

2. Oligopolies means that there are a few large firms, therefore they are likely to
be benefiting from economies of scale, leading to lower average costs,

3. If there are low barriers to entry in an oligopoly it will be more contestable,

therefore firms have incentives to cut costs and be productively efficient.
Also prices are more likely to be competitive and therefore closer to MC.
 12

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A pure monopoly occurs when there is only one firm in the industry.
A natural monopoly occurs when the most efficient number of firms in
industry is one. (e.g. provision of rail network)
Monopoly power occurs if a firm has more than 25% of the market share.
A dominant monopoly has more than 40% market share.

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A monopoly needs barriers to entry, otherwise new firms can enter.

1. High Fixed Costs.

This enables the incumbent firm to benefit from Economies of scale. If a new
firm entered the market it would likely have higher average costs.
2. Vertical Integration.
This occurs when a firm has control over raw materials and other supplies
necessary for the good. For example, a new newspaper may find it difficult for
retailers to take and sell it in their shops.
3. Legal Monopoly.
For example, a patent on an invention stops other firms using it.
4. Advertising.
If a firm engages in saturation advertising then consumers may develop very
strong brand loyalty to a particular firm.
5. Predatory Pricing.
When a firm cuts price to force a rival out of business.
6. Being the first firm in the industry:
For example, a local football team has an effective monopoly because of the
strong brand loyalty to that team.
7. Geographical Barriers
For the production of raw materials, you cannot produce them if they do not
have property rights. For example, diamond producation is limited to Russia
and South Africa.
 13

Diagram of Monopoly

A Monopolist maximises profit where MR = MC

Therefore it sets Price = Pm and Quantity = Qm
Firm makes Supernormal profit = (AR- AC) Q

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1. Economies of Scale.
If the industry has high fixed costs and economies of scale, then a large
monopolist can bring benefits of lower average costs.

Economies of scale will occur most in industries with high fixed costs or
scope for specialisation. E.g. airlines and train companies tend to have a high
fixed costs and therefore there tends to be a small number of large firms.

2. Research and Development

A monopolist can use its supernormal profits to invest in developing new
products which may require high investment. This is very important for
industries such as rail transport, where there is a necessity for long term
investment.

3. International Competition
A domestic monopoly may be necessary to compete internationally. For
example, Sky has a strong local monopoly power. But, if cable TV became
more international it would face more international competition.

4. Monopolies May be Efficient.

A firm may gain monopoly power because it is efficient and innovative, e.g.
Google. A monopoly isnt necessarily inefficient.
 15

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A perfectly contestable market has the following three features:

1. Absence of sunk costs

2. Perfect information
3. Freedom to advertise and a legal right to enter the market

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If there are low entry and exit costs then firms can engage in hit and run
tactics. This means that if an industry is making supernormal profits then a
firm can enter and take advantage of high prices.
If prices fall and the industry is no longer profitable, then the firm will leave.
Therefore, in a contestable market a firm should be satisfied with normal
profits otherwise it would encourage hit and run tactics from other firms.

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Contestable markets can bring the benefits of competitive markets such as:
Lower prices (allocative efficiency)
Increased incentives for firms to cut costs (x efficiency)
Increased incentives for firms to respond to consumer preference.
However there could also be significant economies of scale because the theory
of contestable markets doesnt require there to be many firms.

Therefore, policy makers should not just look at the degree of concentration, but also
the degree of contestability and how easy it is to enter the market.

Regulators in the privatised industries have often focused on removing barriers to

entry, rather than breaking up big firms.

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Remove legal barriers to entry

Force firms to allow competitors to use its network
Legislation against Predatory Pricing
OFT can legislate against abuse of Monopoly power
 16

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Monopolistic Competition is a market structure with the following features:

Many Firms
Freedom of Entry and Exit
Brand Differentiation
Examples include: restaurants, hairdressers.
Diagram Monopolistic Competition Short Run

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In the long run, new firms are able to enter the market because there is freedom of
entry. As new firms enter, the demand curve for the initial firms shifts to the left until
normal profit is made (where AR=AC).

Diagram Long Run Monopolistic Competition

A Monopolist maximises profit where MR = MC

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 19

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!""#$%&'%()*&!+%
Higher wages usually will encourage a worker to supply more labour because
work is more attractive compared to leisure.
Substitution effect of a rise in wages: Workers will tend to substitute
income for leisure as leisure now has a higher opportunity cost. This effect
leads to more hours being worked as wages rise.
Income effect of a rise in wages: This effect involves workers working less
hours when wages increase. This is because workers can get a higher income
by working less hours.

Backward bending
supply curve.

After a certain point,

higher wages may lead
to lower labour supply.
 20

Different workers will have different preferences. A worker with little expenses may
find the income effect soon dominates and higher wages encourage him to work less
and choose more lesiure time.

!"#$%&'())*+&,-&.!/,("&0$)$123&(),1&
1. Wage rate.
2. The number of qualified people and difficulty of getting qualifications.
3. The non-wage benefits (non-pecuniary) benefits of a job. This includes status,
job security, danger of job, how enjoyable job is, length of holidays and fringe
benefits.

.!/,("&0$4!12&
Marginal Revenue Product (MRP) MRP = MPP * MR.
.
This is the increase in revenue a firm gains from employing an extra worker
Marginal Physical Product (MPP)
This is the increase in output that an extra worker produces.
Marginal Revenue (MR)
This is the revenue that a firm gains from selling the last unit of output.
!"#$!%& !'()%* !"# $#%&'$ ()* +&,)-* $#.#'$/ )' 0"# $#%&'$ ()*
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.)0#'06&; *#$-'$&'32 .&24

8*!3%696%+&,-&0$4!12&-,"&.!/,("&

The elasticity of demand for labour measures how responsive demand for labour is
after a change in wages. Elasticity of demand for labour depends on:

B): #//#'06&; 6/ 0"# :)*?#*C >( 0"#*# &*# ') /-,/060-0#/ ()* ;&,)-*<
$#%&'$ :6;; ,# 6'#;&/063
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,# /-/,060-0#$ ;&,)-* :6;; ,# %)*# #;&/0634
E-%,#* )( .#).;# :60" F-&;6(63&06)'/ &'$ /?6;;/4 >( /%&;; '-%,#* )(
:)*?#*/ "&7# F-&;6(63&06)'/ $#%&'$ :6;; ,# %)*# 6'#;&/0634
 21

!"#$%#&!'()$*+$,-#$.-'&,$,#&"/$(#"0+($1'&$203'4&$5!22$3#$!+#20.,!6)$
7'5#8#&/$',-#&$,!"#$!,$3#6'"#.$#0.!#&$,'$.43.,!,4,#$203'4&$1'&$609!,02$.'$
(#"0+($3#6'"#.$"'&#$#20.,!6)$
%&'9'&,!'+$'1$50:#$6'.,.)$*1$203'4&$!.$0$-!:-$;$'1$,',02$50:#$6'.,./$,-#$1!&"$
5!22$3#$"'&#$.#+.!,!8#$,'$0$&!.#$!+$50:#.)$

Workers with inelastic demand are hard to replace. Therefore they tend to have
greater bargaining strength and can demand higher wages.

!"#$%#&#'()*!&)+*$)*$,+(-#&)&).#$/!'0#&1$
Wage
Wage

S = AC = MC
We We

D = MRP D

Q1 Q Q1 Q

2)'($ Industry

The equilibrium wage rate in the industry is set by the meeting point of the
industry supply and industry demand curves.
In a competitive market firms are wage takers because if they set lower wages
workers would not accept the wage.
Therefore they have to set the equilibrium wage We.
Because firms are wages takers the supply curve is perfectly elastic, therefore
AC = MC
The firm will maximise profits by employing at Q1 where MRP of Labour =
MC of Labour .
 22

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.(!)+'#($/!()&)"+$!)0$/*1)12&*$3#)-$

!"#$%&!' ("!#)#*$" (*%" #$%" +'!'+1+" '!5,+%" !%5%00(*3" #," %!5,1*()%" ("
:,*8%*"#,"#(8%"("2(*#'51-(*"9,46"
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#$%"(&&'#',!(-"'!5,+%"(":,*8%*"*%5%';%06"
 23

!"#$%#&'()*+,(*,'-#,./0)1$,2/$3#',

2)*)"+)*45,
This occurs when there is just one buyer of labour in a market or if the firm has
market power in employing workers.

The marginal cost of employing one more worker will be higher than the
average cost because, to employ one extra worker, the firm has to increase the
wages of all workers.
To maximise the level of profit the firm employs Q2 of workers where MC =
MRP. Therefore the firm only has to pay a wage of W2. This is less than the
competitive wage.

6$/7#+,8*()*+,

Trades unions seek to represent workers on pay, conditions and employment.

!"#$%&!%'#!()*+,)#

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 24

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'2"!%%&)/$&+,3.%)"*4&&
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,-!(."/010/'%()#$*%2%,)-3!-4#5")%-)$#/)(%&#'+&;+,#+,(&<'*&)!&
<"!3.2)+7+)*&!"&<$":!"8',2$&+%&'&(!!3& '*&!:&=.%)+:*+,(&/+(/$"&<'*4&9)&
8$',%&+:& !"#$"%&+,2"$'%$&)/$+"&8'"(+,'6&"$7$,.$&<"!3.2)4&

Diagram of Trade Union in Competitive Market

This increase in wages will cause a fall in employment. Thus in competitive

labour markets, trades unions can cause unemployment.
Trades Unions could increase wages to W2. This would reduce demand to Q2.
The level of unemployment would be Q3-Q2.

!"!#$%&'(#')*+,!&'-"$("&'

Can counteract a Monopsonistic employer. In this case they can increase

wages without causing unemployment.
They can help to increased productivity. Often known as productivity deals
unions can bargain for higher wages in return for increased productivity.

./+"0$"0'1+%2*!'(#')*+,!&'-"$("&'
9,&)/$&<!%)& '"&<$"+!3>&)"'3$&.,+!,%& $"$&<! $":.6&',3&/'3&)/$&'1+6+)*&)!&
,$(!)+')$&%.22$%%:.6&<'*&"+%$%4&?! $7$">&+,&<'%)&2!.<6$&!:&3$2'3$%&)/$+"&
+,:6.$,2$&/'%&3$26+,$34&
@$26+,$&+,&A,+!,%&+%&3.$&)!B&
 25

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&'(+#4,5."#"#46,.)#%0)7'%("#48,3)9!,$!7*"#!$,*!)$"#4,'+,$!7*"#!,"#,
%#"+#&,*"1!,:;<=,
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2+(10+(7!,"&,.+(!,0()4.!#'!$,23!#,'3!/,2+(1,?)(','".!,)#$,3)9!,
'!.?+()(/,7+#'()7'&=,B3!/,)(!,*!&&,*"1!*/,'+,@+"#,%#"+#&=,
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*"1!,&!7+#$)(/,?"71!'"#4,"**!4)*=,

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&!7'+(,2+(1!(&,+0'!#,0"#$,"',.+(!,$"00"7%*','+,&'("1!,5?+*"7!6,#%(&"#46,7"9"*,
&!(9)#'&8,

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1. Discrimination. Firms may not be rational, but pay some workers different
wages on the grounds of age, race, or gender.
2. Difficult to measure productivity. The theory of MRP assumes firms can
measure the MPP of a worker; however, in practice, this is difficult
because in many jobs, e.g. the service sector, productivity cannot be
measured precisely .
3. Firms may be Non Profit Maximisers. If demand for a product falls, MRP
theory suggest wages are likely to fall; however firms may be reluctant to
cut wages or make people redundant, therefore they may keep paying high
wages despite this.
4. Geographical Immobilities: Workers and firms will find it difficult to move
because of geographical immobilities. For example, it may be difficult for
workers to buy a house in London, therefore they may be stuck living in
areas of higher unemployment.
5. Poor information Workers or firms may suffer from poor information, e.g.
workers may be unaware of better paid jobs elsewhere.

6. Skill Shortages. Often vacancies remain unfilled because unemployed

workers have inadequate skills. A shortage of skills may be more common
in an economy facing rapid technological change. Government education
and training may fail to keep pace with changes in economy.

7. Economic Inactivity. For various reasons, workers may leave the labour
market. This could be early retirement, disillusionment with labour
market. Availability of sickness and disability benefits also make
economic inactivity easier.
 26

!"#$%&'#"!()
Unemployment is caused by a variety of factors such as lack of aggregate demand.

The Natural Rate of Unemployment is the rate of unemployment when the

labour market is in equilibrium (difference between Q2 and Q1).
This is the difference between those who would like a job at the current
wage rate and those who are willing and able to take a job.
The Natural Rate of Unemployment includes frictional and structural
unemployment. It is caused by supply side factors and not demand side
factors.

Real wage AS L
N = labour Force

We

AD L
Q Labour
Q1 Q2
Monetarists argue that the Natural Rate of Unemployment occurs when the
Long Run Phillips Curve crosses the x axis

The Natural Rate of Unemployment is also known as the NAIRU

Inflation The Phillips Curve

LR Phillips Curve illustrating the
NAIRU
8%
SR Phillips Curve
6%

4%

2%

0% Rate of
1% 2% 3% 4% 5% Unemployment
 27

!"#$%&#&'()*&+$#!&$,"#-'".$/"#&$01$2*&(3.04(&*#5$

1. Availability of job information

2. Level of benefits. Higher unemployment benefits may cause voluntary
unemployment as people lack the incentives to get work.
3. Quality of education and retraining schemes
4. Degree of labour mobility, e.g. is it easy for workers to move from one area of
high unemployment to another?
5. Flexibility of the labour market, e.g. powerful trades unions may be able to
restrict the supply of labour to certain labour markets.
6. Hysteresis. A rise in unemployment caused by a recession may cause the
natural rate of unemployment to increase. This is because when workers are
unemployed for a time period they become deskilled and demotivated.

673.")*)*8$9!"*8)*8$,"#-'".$/"#&+$01$2*&(3.04(&*#$
It has been argued that the UK has seen a fall in the natural rate of unemployment
since the 1980s. This has been explained by:
1. Increased labour market flexibilities, e.g. unions less powerful.
2. Privatisation has helped increased the competitiveness of industry leading to
more flexible labour markets.
3. Better education and training.
4. Recent changes to benefits has made it more difficult to remain on JSA.

6-'03&"*$2*&(3.04(&*#$

Various countries in the EU, such as Spain and Portugal have a high natural rate of
unemployment, this could be caused by:

1. Rigidity in EU labour markets e.g. minimum wages, maximum working weeks

and difficulty in firing workers discourage firms employing workers.
2. Restrictions on closing factories and mandatory severance pay for workers
made unemployed; this makes firms more reluctant to set up in these
countries.
3. High degrees of unionisation resulting in wage rigidity.
4. Generous benefits which lessen the pain of unemployment, but reduce the
incentive to take a job.
5. Hysteresis effects. Long periods of unemployment, especially amongst the
youth has had long lasting effects in discouraging people applying for jobs.
6. Growing competition from Asian countries
7. Disillusionment amongst young immigrant populations, especially in inner
cities.

However, recently the rising EU unemployment may not just be due to the Natural
rate increasing, but also due to below trend economic growth. Therefore, part of the
unemployment could be cyclical (due to deficiency of demand).
 28

!"#$%&'
Absolute Poverty: This measures the number of people living below a certain
income level, which is necessary to be able to afford basic goods and services
Relative Poverty: This occurs when the income of a household is low
compared to others; e.g. one definition of relative poverty is income below
50% of the national average.

(#)*+$,-.' !"#$%&'

The Lorenz curve measures the degree of income inequality. The further the Lorenz
curve is from the 45 degree line of perfect equality, the more inequality in society.

In the below diagram the poorest

50% of the population have 27%
of total income.

Meaning the richest 50% have

73% of total income.

Gini Coefficient is a measure of inequality based on the Lorenz curve

!"#$%&%#'("))%'%"&*#%+#,-",#.#/#.012#
!"#$%&&"'#('"(#)#%*+#,!"#-.'"#%/"01(2%,3#"4%*,*5#
6%/%#7."88%7%"/,#9#:#;#<"'8"7,#"01(2%,3#=::#;##<"'8"7,#%/"01(2%,35#

In the 1980s, the UK saw a

significant rise in inequality
which has been maintained
in the past two decades.
 29

!"#$%&'% ()%
Progressive Tax: This occurs when those on higher income levels pay a
higher % of their income in tax, e.g. top rate (50%) of UK income tax is
progressive.
Regressive Tax. This occurs when an increase in income leads to a smaller %
of their income going on the tax; e.g. excise duties and VAT take a bigger %
of low income earners.

*(+$#$%&'%,#-(./0#%1&0#2.!%

1. Inequality in Wages and Earnings Growth. Workers with high levels of

skills will be able to gain higher wages. However those with low skills will
find themselves in low paid jobs
2. Falling Relative value of State Benefits. Pensions and other benefits are
index linked. (rising in line with inflation) This will be less than wages which
increase faster than inflation.
3. Unemployment. High levels of structural and long term unemployment is the
biggest cause of poverty in the UK because the unemployed rely only on
government benefits.
4. Regressive Taxes. Tax changes in the 1980s and 1990s have put a higher
burden of tax on the poor. There has been a shift in taxes from progressive
income tax to regressive indirect taxes, therefore causing an increase in
inequality.

5. Reluctance to Claim Benefits. Not everyone is happy to claim benefits they

are entitled to. Also some people may have poor information about available
benefits. (For example additional benefits for pensioners.)

1&-/3/#$%.&%4#-"%,#5+3#%.4#%12&6-#7%&'%1&0#2.!%

1. Sustained Economic growth. More wealth is created which can be used to

redistribute income within society. However it is not necessarily the case that
the wealth will trickle down. Growth may benefit the rich the most.
2. Reduce Unemployment.This can be done through both Supply Side policies
(e.g. education and training) and Demand side policies (expansionary fiscal
and monetary policy)
3. Progressive Taxes Increasing progressive taxes such as the higher rate of
income tax from 40% to 50% will take more income from those on high
income levels. This enables cuts in regressive taxes or increased benefits
which benefit the poor

4. Reducing Poverty trap Cutting the bottom rate of income tax creates a bigger
incentive for people to move out of benefits and into work.
 30

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Poverty Trap: This occurs when poor people are discouraged from working because
any extra income they earn will be taken away in lost benefits and higher taxes.

5. Pension Reform State pensions could be linked to earnings and not inflation. This
would increase pensioners income and reduce inequality as poor pensioners would
have more income. However, this could be very costly because of the increased
number of old people.

Means tested pensions enables more money to be targeted to those who need it
However it may discourage people from putting money into private pensions
 31

!"!#$#%&'()*%
A legal minimum wage. In 2011 the UK minimum wage was 5.93 for people over
21. There are lower rates for people under 21.

+)"),!-*%.,%'% !"!#$#%&'()%

1. Increase the wages of the lowest paid workers.

2. Higher wages can increase the incentive for people to work harder and
therefore increase productivity.
3. Increase the incentives for the unemployed to accept a job. With a minium
wage, the gap between benefits and wages grows.
4. If firms have monopsony power they can drive wages down by employing less
workers. In this case a minimum wage is likely to have a positive effect on
wages and employment.

/!*'01'"-'()*%.,% !"!#$#%&'()%

1. If labour markets are competitive a minimum wages could cause

unemployment
2. A minimum wages can cause cost-push inflation. This is because firms face an
increase in costs which are likely to be passed on to consumers. This is more
likely if wage differentials are maintained.
3. A minimum wage may increase the number of people working on the black
market (avoiding legal minimum).
4. A limitation of the minimum wage is that it doesnt increase the incomes of
the lowest income groups. This is because the poorest have to rely on benefits
and are therefore not affected by the minimum wages.
5. Also, many who benefit from the min wage are second income earners and,
therefore, the household is unlikely to be below the poverty line.

21'3$'-!."%.,% !"!#$#%&'()*%
1. The effect of a min wage on unemployment is uncertain. It depends upon the
structure of the labour market and whether the increased costs can be passed
on to consumers.
2. Empirical evidence from the US and the UK suggests that a moderate increase
in the min wage doesnt cause a fall in employment. Therefore the key
question is how high the min wage can rise before causing unemployment.
3. The effect on wage differentials is important. For example skilled workers just
above the min wage may feel they deserve more. However, there doesnt
appear to have been much of a knock on effect.
4. There may be a good case for a regional minimum wage because wages tend
to be lower in the north than the south. In London, very few workers benefit
from the minimum wage and in this region the Min wage could increase.
 32

!"!#$%"&'#(!)%*#%+,%-'./01%2'13!$)%
%

%
This graph shows a significant decline in manufacturing jobs. This has been replaced
by jobs in the service sector and public sector

1. De industrialisation. This involves a decline in the relative size and

importance of the manufacturing sector. Therefore it has caused the following
effects:
i) Less full time manufacturing jobs
ii) Decline in Trades Unions.
iii) Structural unemployment; especially amongst low skilled workers

2. Increase in Service Sector The service sector is now the biggest source of
labour employment. This has caused the following effects:
i) Unions less influential.
ii) Increase in part time and flexible working hours
iii) Increase in proportion of women in the labour force because they
tend to prefer service sector jobs to manufacturing

3. Increase in % of Retired People

This leads to an increase in the dependency ratio; fewer workers have to
support more economically inactive people leading to a higher tax burden

4. Increase in Labour Market Flexibility

 33

!"#$%!"&'(%)*+&,(+-"./&
Different Types of Labour market flexibility include:

!"#$%!"& '()$'"& )*& ()+,-& .& *,)/& 01,2& 2$/"& 2)& *+!!& 2$/"3& 4!-)& 2("& 1%$!$25& 2)&
'())-"&6("7&2)&6),83&93:3&*$22$7:&6),8&1,)+7;&-'())!&()+,-3&
!"#$%!"&!)'12$)7&&<&"3:3&:,)62(&$7&6),8$7:&*,)/&()/"=&>?()/"6),8$7:@A&&),&
6),8$7:&+-"&2("&$72",7"2&B&2"!"0()7"3&>87)67&1-&?2"!"6),8$7:@A&
C(),2& D",/& E)72,1'2-& .& 0")0!"& 6),8$7:& *),& -(),2& 2$/"3& 91-5& 2)& ($,"& 17;&
*$,"&6),8",-&
F,"12",&*!"#$%$!$25&$7&015&1,,17:"/"72-3&G15&/15&%"&/),"&'!)-"!5&!$78";&2)&
0,);+'2$H$253&4&*$,/&/15&'+2&1&6),8",-&()+,-&$*&;"/17;&$-&!)6&.&2($-&')+!;&
!"1;&2)&!)--&)*&$7')/"&*),&6),8",3&&

!"#$%!"&'(%)*+&,(+-"./&+"0*$+"&

C8$!!";&6),8*),'"&6($'(&$-&)''+012$)71!!5&/)%$!"3&D($-&,"I+$,"-&1&($:(!5&
-8$!!";=&";+'12";&17;&*!"#$%!"&6),8*),'"3&
F"):,10($'1!&/)%$!$253&4&-2,)7:&,"72";&-"'2),=&/18$7:&$2&"1-5&*),&0")0!"&2)&
/)H"&%"26""7&;$**","72&1,"1-&)*&2("&')+72,53&
!"#$%!"&()+,-&17;&6),8$7:&')72,1'2-&"3:3&/),"&2"/0),1,5&"/0!)5/"72&
F)H",7/"72&$72",H"72$)7&;)"-&7)2&;$-2),2&2("&/1,8"23&4&J$7$/+/&)*&,+!"-&
17;&,":+!12$)7-3&

123&2(/&.2"+"&%""4&(4&$45+"(/"&$4&'(%)*+&,(+-".& !"#$%$!$.36&

1. Globalisation has opened the UK to more international competition therefore

to remain competitive firms have to keep labour costs relatively low. For
example some firms have been outsourcing labour intensive jobs abroad.
E.g. call centres in India.
2. Technological change has made it easier to have flexible labour markets. For
example the internet has increased the provisions of information better and
makes it easier to work from home.
3. Privatisation. Private firms have sought to increase profitability by cutting
excess workers
4. Reduced power of trades unions such as banning closed shops and
limitations on the right to picket.

7)8&5(4&9):"+4;"4./&,(-"&'(%)*+&,(+-"./&;)+"&<!"#$%!"6&

1. Reduce Minimum wages and the power of trades unions.

2. Improve Information about job availability.
3. Better education and training. This will enable workers to be more skilled and
will help to reduce immobilitys in the labour market.
4. Legislation to outlaw discrimination
5. Improve child care facilities to encourage women to work
 34

!"#$%&'()*")'+!,-'.!/$0%'1!%,-#&'2345-6*/5-'

1. Minimum Wages, high redundancy payments.

2. Social Chapter of the EU this includes
i) Maximum working week
ii) More legal protection for workers such as part time workers

!"#$%#&'#()"*+,*-.)/!0.)*1#0+23*4#35)'"*

1. Part time and Temporary staff may not get sufficient training from firms
because they only have short term contracts. Therefore many low skilled
workers will remain low skilled.
2. Greater job insecurity and stress. Job security is often as important to workers
as the level of wages. This could lead to lower morale and lower productivity.
3. Rising inequalities as non-unionised part-time workers get low pay.
4. Flexible contracts may leave workers short of money.

6$%#&'#()"*+,*-.)/!0.)*1#0+23*4#35)'"*

1. Firms will be more efficient and competitive.

2. With increased labour productivity there could be an increase in output and
exports. There could be a lower rate of natural unemployment and lower
inflation
3. Many workers will prefer flexible employment patterns because it suits their
life style.

6(!&(*7+82.#'!+&*
The UK has experience an aging population. The % of the population over 65 is
increasing. This has various impacts on labour and product markets.

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$&#!,$3';!,:&%6$,,!#&$6*.(3&*+&'("*6!&3$<&$(7&1$%&3*&4$:&6*#!&-!(!+'3%&
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=1$(5'(5&7!6$(7&8'31'(&4#*7."3&6$#>!3%/&?#!:&4*.(7&'("#!$%'(5,:&
'(+,.!(3'$,/&@/5/&6*#!&7!6$(7&+*#&A$5$&1*,'7$:%&31$(&:*.(5&4!*4,!B%&
1*,'7$:%/&
9("#!$%!&7!6$(7&+*#&"!#3$'(&3:4!%&*+&,$-*.#C&!/5/&(.#%'(5&3*&7!$,&8'31&
$5'(5&4*4.,$3'*(/&
However, the impact of an agining population can be offset by net migration,
declining number of young people in schools and plans to raise retirement age.
 35

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-03),(&0*<"*'4%*'3'/4"64">?"50*"),.(%-"&'-40*"C0.&;"4$'"102'*/3'/4"-0,(+"
'/-0,*61'"1*'64'*"5('D%.%(%4<!"E!1!":0*='*&"02'*">?"-0,(+".'"'/-0,*61'+"40"
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 36

!!"#$%&"'()"(&')*+)

)
Due to the expansion of the EU and the process of globalisation, many foreign
workers have been attracted into the UK. Immigration accounted for 46% of net
population growth in 2008

!,%-&)'.)/0&)1"#$%&"'()"(&')*+)

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"+$%!(!5:'.#)(4'*(";(!50'
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#$"$(8$'*$!&(-!&0'
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2$'340!5)'.)/0&)1"#$%&"'()

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7(!(7)7'@%5$&0''
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 37

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"'()*,'!+$9!:&;$"*.#$,6'-$4)!1&#"$<!)-#2$$
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-364/03&1#023%4&
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'(+'%'9*+,$1*))'#)-$,!$#+,)5$'+$-#,,'+($:4$*$+*,'!+*&$BC$+#,<!).2$E*))'#)-$
,!$#+,)5$'+9&:;#$+*,'!+*&$'+%)*-,):9,:)#$!%$1)!*;9*-,'+(8$#9!+!"'#-$!%$
-9*&#$*+;$1)*+;$&!5*&,52$
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;#()##-$!%$"!+!4!&5$4!<#)2$

Holidays and Leisure Travel

?/6'1',-$%#*,:)#-$!%$H&'(!4!&52$D!"'+*,#;$15$1'($,!:)$!4#)*,!)-2$=!<#>#)8$
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'+;'>';:*&$#+,)#4)#+#:)$#+,#)4)'-#2$I!<$1*))'#)-$,!$#+,)5$"*.#$"*).#,$
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 38

!"#$%&'()*')*+!',#-!*.%-/!&,*
Regulation involves government intervention to deal with abuses of monpoly power
or collusive behaviour.

.!-"!-*0($'12*

In markets with a high market concentration ratio, the government regulator will
consider closely the merits or demerits of a merger. The Competition Commission
will consider:

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