Economics Explained (Peter Maunder, Danny Myers, Nancy Wall, Roger Leroy Miller, 2000)

Introduction

• Resources are scarce
• Natural resources
• Human resources
• Manufactured resources
• Scarcity forces us to choose
• Economics is the study of how individuals and societies choose between the alternative use of scare resources to satisfy their innumerable wants.
• Opportunity cost is the highest-valued alternative that had to be sacrificed for the option that was chosen.
• Production possibilities curve: trade-offs.
• Law of increasing relative costs.
• Ceteris paribus assumption: other things constant
• Microeconomics is the study of individual decision-making by both individuals and firms.
• Macroeconomics is the study of economy-wide phenomena resulting from group decision-making in entire markets. As such, it deals with the economy as a whole.
• Positive economics indicates what is, whereas normative economics considers what ought to be.

Economics systems

• No matter what the economic system, the fundamental economic problem of scarcity must be solved. Every economic system faces opportunity costs in making decisions.
• Capitalism
• An economic system in which individuals privately own productive resources and possess property rights to use these resources in whatever manner they choose, subject to certain (minimal) legal restrictions.
• Limited involvement of government with free choice.
• Many participants, easy entry and exit
• Laissez-faire
• Socialism
• State owns major resources.
• Communism
• State owns all resources.
• Marxian economics
• Capitalist exploits workers but due to heavy competitions, workers have the last laugh.
• Resource allocation question
1. What will be produced?
2. How will it be produced?
3. For whom will it be produced?
• Closed economy does not interact with other economies while open economy does.
• Nationalisation
• Transform public own assets to the government own.

Demand and supply

• [Demand] At higher price, a lower quantity will be demanded than at lower prices, other things being equal. Or vice versa.
• Absolute price and relative price
• Absolute price is the number of dollars that can be exchanged for a specified quantity of a given good. Relative price is the quantity of some other good that can be exchanged for a specified quantity of a given good.
• Substitution effect
• Change of price forces consumer to seek alternatives.
• Real income effect
• Consumer change buying pattern resulted in the change of demand.
• Demand schedule
• Tabulation of the quantity of a good that all consumers in a market will purchase at a given price.
• Demand curve determinants
1. Income
2. Tastes
3. Prices of relative goods
4. Expectations of future relative prices
5. The population (buyers in the market)
• [Supply] At higher prices, a larger quantity will generally be supplied than at lower prices, all other things held constant. Or vice versa.
• There is always a relationship between price and quantity of a good supplied.
• Supply schedule
• The quantity supplied at different prices in the market.
• Supply curve determinants
1. Input costs
2. Technology
3. Taxes and subsidies
4. Expectations of future relative prices
5. The prices of related goods
• Market-clearing price (MCP) = stable equilibrium = supply meet demand
• Surplus: above MCP
• Shortage: below MCP

Price system

• Market system: exchanges take place in the market mechanism.
• Voluntary exchange: buyers and sellers freely and willingly engaging in market transactions
• Terms of exchange.
• Specialisation results in higher output.
• Comparative advantage: which activities have the lowest opportunity cost.
• Absolute advantage: the ability to goods more effectively than competitors.
• Division of labour: workers are assigned different tasks to produce a desired product.
• Relative price
• Prices change with time.
• Consumer sovereignty
• An economic concept where the consumer has some controlling power over goods that are produced.
• Technological efficiency: inputs are not wasted.
• Economic efficiency: resources directed to highest-value uses.
• Price system benefits
1. Efficiency
2. Individual freedom
3. Growth
• Price system limitations
1. Externalities
2. Public goods
3. Competition
4. Unequal income distribution
5. Factor immobility

Demand and supply elasticity

• Price elastic of demand = % Δ quantity demanded ÷ % Δ price
• The ratio of increase in price over the reduction of customer.
• Is always negative.
• Calculation of elasticity = (Δ quantity demand ÷ original quantity demand × 100%) ÷ (Δ price demanded ÷ original price demanded × 100%)
• Measurement of the Δ consumption of a product in relation to a Δ its price.
• Unit elastic
• A Δ one variable results in an equally proportional Δ another variable.
• Perfectly Inelastic Demand
• Quantity demanded for a good does not Δ response to a Δ price
• E.g. Life-saving drug.
• Perfectly elastic demand
• The % of Δ quantity demanded is ∞ even if the percentage of Δ price is 0.
• Cross-price elasticity of demand = Δ quantity demanded of good x ÷ Δ price of good y
• The price responsiveness of related goods.
• Income elasticity of demand = % Δ the amount of goods purchased ÷ % Δ income
• Consumption of goods.
• Elasticity of supply = % Δ quantity supplied ÷ % Δ price
• Higher price yields larger quantity supplied.

Demand and supply in an open economy

• Floating (flexible) exchange rate
• The supply of a currency will determine the equilibrium foreign exchange rate.
• A shift in demand for foreign goods will result in a shift in the demand for foreign exchange. The equilibrium foreign exchange rate will change.
• A shift in the supply of foreign currency will cause a Δ the equilibrium exchange rate.
• Devaluation
• When a country can no longer support the price of its currency and under a fixed exchange rate system.
• It is depreciation when exchange rates are floating.
• Balance of payment
• Value of all transactions in international trade.
• Current account
• Trade in goods and services.
• Financial account
• Investment flows from public and private sector.
• Comparative advantage
• Under free trade, an agent will produce more of and consume less of a good
• Free trade
• Infant industry argument (domestic development).
• National security (war goods).
• Protecting a way of life.
• Stability.
• Protecting jobs.
• Countering foreign subsidies and dumping.

The role of government in mixed economy

• Market failure
1. Market economies tend to experience business fluctuations.
2. The market system cannot deal effectively with the spill-over (3rd-party) effects of many economic activities, and therefore alternative systems of allocation need to be considered.
3. Market forces cannot provide public goods.
• Business fluctuation
• A typical modern economy.
• Booms and recessions
• The expansion and contraction have to be continuous for at least 6 months.
• Public goods
• It is a nation's standard of living. E.g. roads, bombs, defence.
• Jointly consumed, the principle of exclusion and rivalry.
1. They are indivisible.
2. No opportunity cost of additional consumers using them.
3. One's use of a public good does not deprive others of its simultaneous use.
4. There is difficulty in charging consumers on the basis of use.
• A fair government
• Lorenz curve: total money income by different proportions of the nation's families.
• Gini coefficient inequality = area between diagonal line and Lorenz curve of money income distribution ÷ triangular area under diagonal line
• The measurement of income inequality.
• Merit goods
• A commodity which is judged that an individual or society should have on the basis of some concept of need, rather than ability and willingness to pay.
• Market vs. collective decision making
1. Many government goods are provided at 0 price.
2. Collective action may involve the use of force.
3. The incentives are different.
4. Political voting is not the same as money voting.
• Taxation
• Proportional taxation.
• Progressive taxation.
• Marginal rate of taxation (MRT)
• Ad valorem tax: amount is based on the value of a transaction or of property.

Economic objectives and economic indicators

• Economic stability
1. Full employment
2. Stable prices
3. Equilibrium on the balance of payment
4. Steady growth
5. Maintenance of the environment
• Types of unemployment
• Frictional unemployment (under-informed on vacancies)
• Cyclical unemployment
• Seasonal unemployment
• Structural unemployment (permanent decreases for a demand)
• Technological unemployment
• Regional unemployment
• Inflation
• Sustained upward movement in the average level of prices.
• Demand-pull inflation
1. Total demand for goods and services rises faster than the rate of growth of supply.
• Cost-push inflation
1. Union power.
2. Big business power.
3. Raw material price increases.
• Price index (measuring inflation) = cost of today 'basket' ÷ cost of 'basket' in base year × 100%
• Gross domestic product (GDP)
• Retail price index (RPI)
• Retail price index excluding mortgage interest payment (RPIX)
• RPIX minus indirect tax (RPIY)
• Tax and price index (TPI)
• Producer price index (PPI)
• Harmonised indices of consumer price (HICP)
• Indicators for forecasting
• Exogenous variable: one whose value is determined outside the model and is imposed on the model.
• Endogenous variable: a statistical model that's changed or determined by its relationship with other variables within the model.
• Leading indicators: a piece of economic data that corresponds with a future movement or Δ some phenomenon of interest.
• Lagging indicators: a measurable factor that changes some time after the economic, financial, or business variable it is correlated with changes.
• Coincident indicators: the present condition of the economy for a given state or nation.

Government intervention in markets

• Government need to take care of farmers because food is a necessity.
• Farmers generally make low income but is crucial to the economy.
• Price supports can give farmers a stable price but leave a problem for the government to dispose of surplus stocks at the supported price.
• Guaranteed prices ensure that each farmer will receive the price determined by the government and thus qualify for a subsidy or deficiency payment in excess of the newly determined market prices.
• A guaranteed price system has an impact on the use of resources as well as on the levels of domestically produce output, domestic consumption and share of the market accounted for by imports.
• A farm-support system can be based on making food imports more expensive by imposing levies or taxes. This system means that consumers bear the burden of the policy rather than taxpayers.
• The income elasticity of demand is very much below 1.
• As income goes up, the % of total consumer expenditures going to food falls.

Environmental issues

• Environment in a nutshell
1. Resources
2. Production
1. Land
2. Labour
3. Capital
4. Entrepreneurship 
3. Consumption
4. Waste
• Total (social) cost = internal (private) costs + external costs
• Total (social) benefits = internal (private) benefits + external benefits
• Pollution
• Private cost = explicit cost borne directly by consumers
• Social cost = private cost + other costs that are external to decision-maker
• If private cost ≠ social cost, externalities exist
• If social cost > private cost, pollution
• No incentives to discourage the care for environment.
• Recycling also have to consider the pollution during its process (e.g. sludge from de-inking paper).
• Precycling is the design of packaging before production.
• Externalities
• A cost or benefit that is imposed on a third party who did not agree to incur that cost or benefit.
1. Contigent valuation
2. Travel cost
3. Hedonic pricing
• Cost-benefit analysis
• Analyse monetary value of a project to give the total (social) a price.
• Problems of cost-benefit analysis
• What to be include as 'relevant' externalities
• How to quantify the externalities in monetary terms
• How to effectively 'discount' the criteria to judge the value in today's terms.

Welfare issues

• Health care
• Paying for health care by insurance is not likely to be efficient in part because of third-party payment problem.
• More health care competition may not necessary bring the cost down.
• Preventive medicine will help to reduce the need to active health care.
• Education
• Schools are mainly subsidised.
• The subsidy will reduce according to how much monetary benefit to the individual.
• Education is both a consumption and investment good.
• Investment good is due to student loan.
• Housing
• The perfect scenario is one house per family.
• To encourage owner-occupied house, there is tax relief.
• The burden of housing benefits falling has risen sharply.
• Surplus
• Consumer surplus: buying above market price.
• Producer surplus: selling above market price.
• The surplus area will draw attention to the government on imposing or reducing taxes.

Employment, unemployment and income distribution

• Demand deficiency unemployment: insufficient demand in the economy to maintain full employment.
• Income differential: the relationships of exploitation and class inequality.
• Employment could be protected or allow the employers to more easier hire and fire.
• Supply constraint in employment market: insufficient skilled workers.
• Income factors
1. Innate abilities and attributes.
2. Education.
3. Experience and training.
4. Capital invested per employee.
• Wealth is unevenly distributed and leads to further inequalities in incomes.
• Wealth ≠ income. Wealth is a stock.
• Stocks ≠ flow. Flows are measure overtime, e.g. savings per month into your account.
• Training policy to overcome mismatch.
• Training policy is difficult to evaluate and further evidence is awaited.

National income accounting

• Total income ≡ total production ≡ total expenditure
• All economies tend towards an equilibrium.
• Circular flow model
1. Households sell factor services to business that pay for those factor services, the receipt of these payments generating total income.
2. Business sell goods and services to households that pay for them, the total output being thus absorbed by total expenditure.
• Leakage
• Imports, savings and tax represent.
• Injection
• Exports, investment and government spending.
• GDP
• The total money value of final goods and services produced in an economy during a 1-year period.
• The flow production over 1 year period.
• To avoid double-counting, transfer payment will be excluded, these are merely transfers of monies which do not correspond to any type of productive economic activity.
• Buying and selling shares.
• Government transfer payment.
• Private transfer payment.
• The transfer of used goods.
• Expenditure approach
• GDP = consumers' expenditure + government expenditures + investment expenditures + export expenditures - import expenditures
• Income approach
• GDP = add up all incomes earned by residents in the production of goods and services.
• Output approach
• Gross value added at basic price = GDP at market prices - taxes on expenditure + subsidies
• Gross national income (GNI) = GDP + net property and employment income from abroad
• Net national income (NNI) = GNI - depreciation (capital consumption)
• To make comparisons between countries and across time.
• For planning and evaluation by government, business people and related parties.
• Gross investment = replacement investment + expansion investment
• Economic growth = (GDP of year to be measured - GDP of previous year) ÷ GDP of previous year × 100
• Real gross domestic product: an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year (expressed in base-year prices) and is often referred to as constant-price GDP, inflation-corrected GDP, or constant dollar GDP.
• RGDP per capita = RGDP ÷ total population
• GDP deflator: measure of the level of prices of all new, domestically produced, final goods and services in an economy in a year.
• Black economy: the amount of unrecorded or unofficial economic activities.
• Economia sommersa: submerged economy where activities are not being recorded.

Aggregate supply and aggregate demand

• Aggregate demand
• Sum of all planned expenditures for both consumption and investment purposes.
• Curve slopes down
1. Interest rate effects
2. Wealth effects
3. Substitution of foreign-produced goods
• Aggregate supply
• The relationship between price level and total output.
1. Large amount of unused capacity and significant unemployment
2. Full capacity
3. An intermediate range between the 2
• In long run, the growth of output depends on the level of investment and the state of technology.

Aggregate demand: consumption, savings and investment

• Keynes' masterwork: the general theory of employment, interest, and money.
• Income model assumptions
1. There is no government, that is no taxes and no government expenditure.
2. Firm distribute all of their profits to shareholders.
3. There is no depreciation (capital consumption allowance) so that gross domestic investment = net investment.
4. The economy is closed, that is, there is no foreign trade.
• Saving = disposable income - consumption
• Saving is a flow concept, it happen over a period. It is considered a stock.
1. Rate of interest.
2. Rate of inflation.
3. Expectations about future economic well-being.
• Consumption function: relationship between consumption and disposable income.
• Autonomous consumption: the consumption expenditure that occurs when income levels are 0.
• Average propensity to consume (APC) = consumption ÷ real disposable income
• Average propensity to save (APS) = savings ÷ real disposable income
• Marginal propensity to consume (MPC) = Δ planned consumption ÷ Δ real disposable income
• Marginal propensity to save (MPS) = Δ planned saving ÷ Δ real disposable income
• APC + APS = 1, MPC + MPS = 1
• Non-income determinants of consumption
1. Wealth
2. Expectations
3. Interest rates and the east which credit can be obtained
4. Distribution of income
• Any Δ these factors will shift the consumption function up or down.
• Permanent-income hypothesis: people will spend money at a level consistent with their expected long-term average income.
• Investment function
1. Profits or expectations about future profitability.
2. The cost (supply price) of capital.
3. The cost of investment relative to that of labour.
4. Changes in technology and profits tax.

Income and employment determination: a simple model

• 45° shows planned expenditures = real national income
• Planned expenditures = planned consumption + planned investment
• Total planned expenditure > real nation income
• Decreases in stocks
• Size of the circular flow of income will increase
• Economy expand
• Planned expenditure < real national income
• Increase in stocks
• Size of the circular flow shrink
• A low equilibrium level of real national income
• Bathtub theorem: an analogy that explains the effects of exports and imports on national income.
• 45° also shows planned saving = planned investment
• Planned savings > planned investment
• Unplanned increase in stock
• Income will fall and economy contract
• Planned savings < planned investment
• Unplanned decrease in stock
• Income will rise and economy expand
• Multiplier
• The amount by which we would multiply an initial Δ expenditure to find the ultimate Δ income.
• The smaller the marginal propensity to save, the greater is the multiplier.
• If the MPC = 1/2, the multiplier = 2. $1 billion decrease in autonomous investment will elicit a $2 billion decrease in the equilibrium of real national income.
• Δ equilibrium level of real national income = multiplier × Δ expenditure
• Paradox of thrift: an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will in turn lower total saving.
• Outputs
• Expansionary (or inflationary) gap exists = planned expenditure > full capacity output.
• Output (or deflationary) gap exist = planned expenditure < full capacity output.
• There are unemployed resources in the economy.
• Investment will fluctuate more sharply than output.
• The accelerator and multiplier together can help to explain cyclical changes in output and employment.
• Acceleration principle: draws a connection between changing consumption patterns and capital investment.

Income and employment determination: government and trade

• Government spending is politically determined and is therefore autonomous, that is, determined outside the model.
• Planned injection = planned leakage
• Government spending + investment = savings + tax revenue
• Fiscal policy: regulate the level of expenditure in the economy.
• Demand-deficiency unemployment can be reduced by increasing government spending or reducing taxes.
• Inflationary pressures can be reduced by increasing taxes or reducing government spending.
• Built-in stabilisers automatically moderate changes in disposable income resulting from changes in overall business activity.
• Public sector net cash requirement (PSNCR, annual deficit) = expenditure - tax revenue
• Public sector debt repayment (PSDR, surplus) = tax revenue > expenditure
• National debt
• Phillips curve: an inverse relationship between rates of unemployment and corresponding rates of rises in wages that result within an economy.
• Trading
• Imports = induced = depend on the level income = leakage in circular flow
• Export = autonomous = wide range of factors = injection in circular flow
• Government spending + investment + export = savings + tax revenue + import
• Total expenditure = consumption + investment + government spending + (export - import)

Money and financial institutions

• Money
1. Medium of exchange
2. Unit of account
3. Store of purchasing power
4. Standard of deferred payment
• Currency is a liquidity
• Monetary systems are fiduciary: it is not convertible to gold
• Based on public's confidence
• The value of money will fall if there is a rise in the price level
• Measuring money supply
• M0, narrow money
1. Notes and coin
2. Bank balance
• M4, broad money
1. All of M0
2. Sight deposits, current account
3. Retail deposits, general account
4. Wholesale deposits, certificate of deposit
5. Time deposits, require a period of notice before withdrawal
• Lending
• Money-at-call: short-term interbank transaction.
• Bank bills: short-term finance for company.
• Treasury bills: short-term finance for government.
• The maximum money multiplier is the reciprocal of the reserve asset ratio.
• Capital adequacy requirements should ensure that banks do not overlend.
• Monetary policy limits credit creation.
• Central bank functions
1. To control the issue of notes
2. To be a bank for the financial community
3. To be the government's bank
4. To control foreign exchange affairs
5. To decide upon and implement monetary policy
• Fractional reserve banking
• Holding a % of deposits as reserves.
• Liquidity of banks's assets are inversely related to their profitability.
• Increase in reserves = expansion in lending
• Increase in money stock.
• Central bank can increase the banks' reserves by buying bills from them.

Consumer choice

• Utility theory: to model worth or value.
• A property common to all desired goods and services.
• Utils: measure of utility.
• Total utility: total satisfaction derived from the consumption of a given quantity of a good.
• Marginal utility: the Δ total utility due to a 1-unit Δ the consumption of the good.
• Diminishing marginal utility: extra utility added by the marginal unit of a good consumed falls.
• Consumer equilibrium = marginal utility of 1 good = marginal utility on all other goods.
• Price relates to consumption
• Quantity demanded is inversely related to price
• Diamond-water paradox (the paradox of value): the contradiction that, although water is on the whole more useful, in terms of survival, than diamonds, diamonds command a higher price in the market.
• Indifferent curve: combinations of the two commodities that leave the consumer equally well off or equally satisfied.
• The commodities cannot intersect with another.
• It reflects diminishing marginal rates of substitution between the relevant 2 items.
• Income-consumption curve: combinations of two goods that maximize a consumer's satisfaction at different income levels.
• Price-consumption curve.
• Demand curve.
• Snob effect: a phenomenon described in microeconomics as a situation where the demand for a certain good by individuals of a higher income level is inversely related to its demand by those of a lower income level.

Businesses and their costs

• Profits
• Accounting profit = economic profit + normal profit
• Normal profit (NROR) = opportunity cost of capital
• Economic profits = total revenues - total costs
• Economic cost = accounting cost + NROR
• Profit maximisation is regarded as the main objective in a firm's behaviour.
• Law of diminishing returns: if all factors of production are held constant except one, equal increments in that one variable factor will eventually yield decreasing increments in output.
• Law of diminishing marginal returns: adding an additional factor of production results in smaller increases in output.
• The technological relationship between output and input is called the production function. It relates output per unit time period to the several inputs, such as capital and labour.
• Costs
• Short-run cost: short-term implications in the production process.
• Total costs = total fixed cost + total variable costs
• Average total costs (ATC) = total cost ÷ output
• Average variable costs (AVC) = total variable cost ÷ output
• Average fixed costs (AFC) = total fixed cost ÷ output
• Marginal cost = Δ total cost ÷ Δ output
• Long-run average total cost (LRATC): the average cost per unit of output over the long run.
• Economies of scale
1. Technical economies (machineries)
2. Managerial economies (multi-roles)
3. Commercial economies (bulk purchase)
4. Financial economies (larger loans for larger firms)
5. Risk-bearing economies (less risks for larger firms)
6. External economies of scale (expansion of whole industry)
• Minimum efficient scale: The lowest point where the plant can produce such that its long run average costs are minimised.
• Diseconomies of scale: cost disadvantages that economic actors accrue due to an increase in organisational size or in output.

Pricing and output decisions in perfect competition

• Perfect competition
1. Homogeneous product
2. Easy entry and exit to the industry
3. Large number of buyers and sellers
4. Complete information on the price
• The demand curve is a horizontal line at the going market price.
• Short-run
• Short-run profits and losses are determined by comparing average total costs with price at the profit-maximising rate of output.
• Short-run breakeven occurs where the marginal cost curve intersects the average total cost curve.
• The firm will continue production at a price that exceeds average variable costs even though the full opportunity cost of capital is not being met; at least some revenues are going towards paying some rate of return to capital.
• At the short-run breakeven price, the firm is making 0 economic profits, which means that is is just making a normal rate of return in that industry.
• Long-run
• The competitive price is determined by the intersection of the market demand curve with the market supply curve.
• Competitive firms make 0 economic profits because of the entry and exit of firms into and out of the industry whenever there are industry-wide economic profits or economic losses.
• Competitive pricing is essentially marginal cost pricing, and therefore the competitive solution is efficient because marginal cost represents the social opportunity cost of producing 1 more unit of a good.
• If consumer in all markets faced a price equal to the full opportunity cost of the products there were buying, their purchasing decisions would lead to Pareto optimality; the economy would be at its most efficient.

Pricing and out decisions in monopoly

• Pure monopolist: single supplier
• Barriers of entry
1. Lack of available inputs
2. Government regulations and exclusivity agreements
3. Patents
4. Brand image
5. Problem in raising adequate capital
6. Economies of scale
• Demand curve facing a monopolist is downward.
• For perfect competitor, marginal revenue is always less than price because of the downward slope of the demand curve.
• The price elasticity depends on the number and closeness of substitutes.
• Monopolist will never produce in the inelastic portion of its demand curve.
• Monopolist profit
• An assumption the monopolist will maximise profits.
• Monopolist faces a downward-sloping demand curve with marginal revenue is less than price as compared to a perfect competition.
• A monopoly does not necessarily mean profit, if the average total cost lies above the monopoly demand curve, it will not pay to produce because there will be losses.
• Price discrimination
• Identical or largely similar goods or services are sold at different prices by the same provider in different markets.
• Necessary conditions
1. The firm has some market power
2. The firm must be able to separate markets
3. Buyers in different markets have different price elasticities of demand
4. Resale of the product or service must be preventable
• X-inefficiency: Raising price and restricting output, resources are spent to obtain and maintain monopoly, organisational slack within.
• Predatory pricing: using the method of undercutting on a larger scale, where a dominant firm in an industry will deliberately reduce its prices of a product or service to loss-making levels in the short-term.

Pricing and output decisions in monopolistic competition and oligopoly

• Monopolistic culture
• Product differentiation by advertising and sales promotion.
• Each have a small share of the market and collusion is difficult..
• Proponents of advertising argue that it leads to increased sales, which allow firms to take advantage of economies of scale.
• Short run make money, long run make 0 economic profit.
• Excess capacity: monopolistic competitor has higher average total costs per unit than a perfect competitor would have. 
• Oligopoly
• Just a few firms which are highly interdependent.
1. Returns to scale
2. Barriers to entry
3. Horizontal mergers
• Branding is an important aspect of non-price competition.
• Merger
• Vertical mergers
• Vertical integration
• Conglomerate mergers
• Horizontal integration

Demand and supply in the labour market

• Marginal physical product (MPP): the change in the quantity of total physical product resulting from a unit change in a variable input.
• Marginal revenue product (MRP): the marginal revenue created due to an addition of one unit of resource.
• Also a demand for labour curve.
• Perfectly competitive firm will hire workers up to the point where the additional cost of hiring one more worker is equal to the additional revenues generated.
• Factors for the price elasticity of demand for labour
• The easier it is to substitute other inputs for the input under study, the more price elastic will be that input's demand.
• The greater the price elasticity of demand for the final product, the greater the price elasticity for demand for the variable input.
• The smaller the proportion of total costs accounted for by the variable input under study, the lower its price elasticity of demand.
• The greater the time allowed for adjustment, the greater the price elasticity of demand for an input.
• The supply of labour is affected by the population and age or entering and leaving the labour force.
• When the supply of labour is inelastic, a part of earnings is termed economic rent, being that part which is in excess of transfer earnings.
• The opportunity cost of earnings in an alternative occupation.
• Labour demand curve shift
1. The demand for final product shifts.
2. The price of a related (substitute or complementary) factor of production changes.
3. Labour changes in its productivity.
• Alternative wage rate offered in other industries changes and if the non-monetary aspects of the job change.
• Abrupt changes in demand in a particular industry may lead to temporary 'shortages' as wages rates move gradually to their long-run equilibrium level.
• General equilibrium analysis attempts to take into account the interrelationships between different markets.
• Partial equilibrium analysis does not take account of interrelationships between markets.
• Unions
• Negotiate minimum wage rate and working conditions.
• Can increase productivity by acting as a collective voice for their members.
• May reduce employee turnover, thus adding to productivity.
• May have become less significant in the recent years.
• Exploitation may occur if there is a monopoly or a single employer (buyer of labour).
• Bilateral monopoly exists when a single employer deals with a single union, so that there is one buyer and one seller.
• Income differences
• Marginal revenue productivity theory of wages: wage levels set to match to the marginal revenue product of labor, MRP (the value of the marginal product of labor), which is the increment to revenues caused by the increment to output produced by the last labourer employed.
• Marginal revenue product rises when the price of the product rises.
• Marginal productivity dependents
1. Innate abilities and attributes
2. Education
3. Experience and training
4. Capital invested pre employee
• Other affecting factors
• Labour market imperfections and trade union.

Rent, interest and profit

• Rent
• The share of income from employment and profits in total GDP can give an idea of the returns to labour and capital.
• Pure economic rent is defined as any payment to a factor of production that is completely inelastic in supply.
• Pure economic rent is a payment to a resource over and above what is necessary to keep that resource in existence at its current level in the long run.
• Economic rent serves an allocative function by guiding available supply to the most efficient use.
• Quasi-rent: additional income which is similar to rent.
• Factors of production other than land can earn pure economic rents if their supply is complete price inelastic.
• Interest
• The price paid for the use of capital and also the cost of obtaining credit.
• Interest rate depends on the tenure, risk and administrative charges.
1. Supply of credit.
2. Loanable funds.
3. Demand for credit.
• Present value is calculated by discounted future sum.
• Nominal, or market, interest rates adjust to take account of inflation.
• Real interest rates: nominal interest rate - anticipated rate of inflation.
• Profit
• The reward to entrepreneurial talent, 4th factor of production.
• Accounting profits = total revenue - all explicit costs
• Economic profits = total revenue - total opportunity costs - all factors of production
• Why profit exist
1. A reward to risk-taking.
2. A result of disequilibrium in the market-place.
3. A result of imperfect competition.
• Function of profit in a market economy is to allocate scarce resources to where profits are highest.

Competition and industrial policies

• Competition
• Price fixing through trade associations.
• Resale price maintenance (RPM): the practice whereby a manufacturer and its distributors agree that the distributors will sell the manufacturer's product at certain prices (resale price maintenance).
• Privatisation
• Transfer of assets from the public sector to the private sector.
• Once privatised, firms are directly affected by market forces in both the capital and the product markets, and consequently it is argued that they should become more efficient.
• Managers and employers may have greater freedom.
• It can be contracting-out (market testing) or deregulation.
• It will stimulate competition and eliminate inefficiency in former nationalised industries.
• Industrial policy affects the structure and performance of industry and include regional assistance, help for small firms and also R&D policy.

Money, monetary policy and inflation

• Money
• Why we hold money (Keynes)
• Transactions demand
• Precautionary demand
• Speculative demand
• Inflation can cause problems because it increases uncertainty and reduces the real value of assets denominated in money terms.
• Money is an asset that is desired because of the services of liquidity that it provides.
• The opportunity cost of holding money is the interest forgone.
• The demand of money is inversely related to the rate of interest.
• Keynesian approach to alternative money is other financial assets only, such as bonds.
• The interest rate is inversely related to the market price of bond.
• Inflation
• Keynesian theory is the underutilisation of labour and capital. Increase demand for all capacity production will lead to rising price rather than output.
• Money transmission mechanism
1. A change in monetary policy.
2. A change in the interest rate.
3. Bank make more of fewer loans.
4. A change in investment.
5. A multiple change in income.
• The intersection of the demand-for-money function and the supply-of-money function generates the equilibrium rate of interest.
• A decrease in interest rate increases the quantity of investment spending, leading to a multiple expansion in output, income and employment.
• Increase demand may lead to increased output, but only if suitable unemployed resources are available. Otherwise it will lead to accelerating inflation.
• Only when expectations of inflation have been reduced will the rate of inflation actually fall.
• The relationship between inflation and unemployment is complex and depends greatly on people's expectations of inflation.
• Quantity theory of money
• Total money supply × velocity of circulation = gross national product = average price of final product × real quantity of final outputs
• A contractionary monetary policy will lead to a fall in aggregate demand and in output and employment.

Fiscal policy

• Taxation
• Public sector net cash requirement (PSNCR) covers government's deficits. It is the amount which the government must borrow in any given year to cover the difference between expenditure and tax revenue.
• PSNCR may rise in recession and fall in a boom because of automatic stabiliser
• Large PSNCR may require higher interest rates
• If tax revenue exceeds government expenditure, there will be a surplus or public sector debt repayment (PSDR).
• National debt
• Accumulated total debt of the government.
• Borrowing to finance investment generates income in the future.
• Fiscal policy may be affected by attitudes in the financial markets.
• Ageing populations lead to increased demands on social security and health spending.
• Fiscal expansion
• In a close to full capacity output, it can cause excess demand and accelerating inflation.
• It can create jobs if there is demand-deficiency unemployment.
• Government deficits have mostly been financed in non-inflationary ways.
• Taxes can sometimes act as a disincentive, especially for people on low incomes or benefits.
• Tight fiscal and monetary policies can reduce inflation, but the loss of output can employment may be substantial.

Economic policy in an open economy

• Globalisation
• Economies tends to become more open with time.
• Change patterns of trade lead to exchange rate changes, as do capital movements.
• Trade and exchange rate changes affect the domestic economy and interact with interest rate changes.
• The effect of exchange rate changes on the trade balance will depend upon price elasticities of demand and supply.
• A depreciation may initially cause the trade balance to worsen, but eventually it will usually improve.
• World organisations
• IMF exists primarily to help countries deal with balance of payments deficits. It provides a forum for international discussion.
• The World Bank lends on commercial terms for major projects in developing countries.
• G5, G7, G8 allow for possible cooperation in economic policy matters for interdependent countries.
• The EU exists to increase specialisation and competition within member countries and by so doing to promote economic growth.
• The WTO works to encourage the reduction of all trade restrictions and to resolve disputes between member countries.
• Also to keep trade restriction to a minimum.
• Bretton Woods system
• Fixed exchange rates worked well until 1971.
• Changing inflation rates brought a shift to floating exchange rates.
• Floating exchange rates are less stable than fixed rates but allow easier adjustment to balance of payments problems.
• Deficits
• Import controls can be used to protect domestic producers from foreign competition.
• Tariffs are a tax on imports and raise the price of imported goods to consumers.
• Quotas impose a physical limit on the quantity of certain imported goods, and usually lead to higher prices.
• Short-run current account deficit: borrowing foreign currency, usually from banks.
• Persistent deficit: expenditure-switching policies or expenditure-reducing policies.
• Expenditure switching: exchange rate depreciation or import controls.
• Expenditure reducing: increment of taxes or interest rates or cutting government expenditure.

Economic development

• Less-developed country (LDC)
• Level of literacy
• Education
• Infant mortality
• Life expectancy
• The Human Development Index (HDI): a statistic composite index of life expectancy, education, and per capita income indicators, which are used to rank countries into four tiers of human development.

Economic growth

• Economic growth is the increase in an economy's real level of output over time. It is measured by the annual rate of change of real output.
• Also can be defined as the increase in real per capita output measure by its annual rate of change.
• Benefits and costs of rapid economic growth
1. Reduction in illiteracy, poverty and illness.
2. Pollution, stress and urban congestion.
• A nation's % growth rate will always be relative to the size of its total GNP.
• Growth: an outward movement in the production possibilities curve for the entire economy.
1. Through increased productive capacity
2. By utilising existing capital equipment more fully.
• Physical capital accumulation is a major determinant of growth.
• Natural resources are not sufficient to guarantee economic growth.
• Envisaged growth
1. Promoting savings
2. Promoting mobility
3. Promoting education and training (human capital)
4. Promoting research and development
5. Promoting the supply side of the economy
6. Promoting the importance of technology and change
• Pollution
• Pollution and resource depletion are by-products of growth.
• The marginal benefit of environmental cleanliness falls as we have more of it.
• Pollution abatement is a trade-off, the trade-off being goods and services for cleaner air and water, and vice versa.