AS and A Level Economics A

Transcription

1 AS nd A Level Economics A Getting Strted Guide Person Edexcel Level 3 Advnced GCE in Economics A (9EC0) Person Edexcel Level 3 Advnced Susidiry GCE in Economics A (8EC0)

2 Getting Strted: AS nd A level Economics A Contents 1. Introduction 1 2. Wht s chnged? How hve AS nd A level chnged? 4 Chnges to AS nd A level qulifictions 4 Chnges to suject criteri 4 Chnges to Assessment Ojectives Chnges to the Person Edexcel AS nd A level Economics A specifictions 7 Specifiction overview 7 Chnges to specifiction content 9 Chnges to ssessment Plnning Plnning nd delivering liner AS nd A level courses Delivery models Co-teching AS nd A level Suggested resources Content guidnce 15 Introduction 15 Theme 1: Introduction to mrkets nd mrket filure Economics s socil science Positive nd normtive economic sttements The economic prolem Production possiility frontiers Specilistion nd the division of lour Free mrket economies, mixed economy nd commnd economy Rtionl decision mking Demnd Price, income nd cross elsticities of demnd Supply Elsticity of supply Price determintion Price mechnism Consumer nd producer surplus Indirect txes nd susidies Alterntive views of consumer ehviour 25

3 1.3.1 Types of mrket filure Externlities Pulic goods Informtion gps Government intervention in mrkets Government filure 30 Theme 2: The UK economy performnce nd policies Economic growth Infltion Employment nd unemployment Blnce of pyments The chrcteristics of ggregte demnd (AD) Consumption (C) Investment (I) Government expenditure (G) Net trde (X-M) The chrcteristics of AS Short-run AS Long-run AS Ntionl income Injections nd withdrwls Equilirium levels of rel ntionl output The multiplier Cuses of growth Output gps Trde (usiness) cycle The impct of economic growth Possile mcroeconomic ojectives Demnd-side policies Supply-side policies Conflicts nd trde-offs etween ojectives nd policies 46 Theme 3: Business ehviour nd the lour mrket Sizes nd types of firm Business growth Demergers Business ojectives Revenue Costs Economies nd diseconomies of scle Norml profits, supernorml profits nd losses Efficiency Perfect competition 54

4 3.4.3 Monopolistic competition Oligopoly Monopoly Monopsony Contestility Demnd for lour Supply of lour Wge determintion in competitive nd non-competitive mrkets Government intervention The impct of government intervention 65 Theme 4: A glol perspective Glolistion Specilistion nd trde Ptterns of trde Terms of trde Trding locs nd the World Trde Orgnistion (WTO) Restrictions on free trde Blnce of pyments Exchnge rtes Interntionl competitiveness Asolute nd reltive poverty Inequlity Mesures of development Fctors influencing growth nd development Strtegies influencing growth nd development Role of finncil mrkets Mrket filure in the finncil sector Role of centrl nks Pulic expenditure Txtion Pulic sector finnces Mcroeconomic policies in glol context Assessment guidnce Implictions of liner ssessment AS level ssessment A level ssessment Question types Quntittive skills Appliction of quntittive skills 91

5 7. Trnsferle skills The need for 21st century skills Cognitive skills Interpersonl skills Intrpersonl skills Economics nd the EPQ 100

6 1. Introduction 1. Introduction 1.1 Reserch nd key principles Our new AS nd A level Economics specifictions re designed to support rnge of student interests, lerning styles nd spirtions for progression. The specifictions hve een developed in consulttion with the teching community, higher eduction, lerned societies nd suject ssocitions. Techers from rnge of schools nd colleges in focus groups, surveys, phone interviews nd fce-to-fce converstions hve provided feedck t ech stge nd hve helped us to shpe the specifictions. Acdemics in UK universities hve helped us understnd how to uild on the strengths of the 2008 AS nd A level Economics specifictions nd dvised on how progression to undergrdute study could e improved. We hve commissioned nd conducted our own reserch projects, including interntionl enchmrking. The specifictions re lso ligned with our World Clss Qulifiction principles to ensure they re pproprite for rnge of lerners. Drwing on feedck from ll prts of the Economics suject community, the 2015 specifictions hve een designed to support students in developing the following skills tht hve een identified s key for progression in this suject: Thinking like n economist. The ppliction of economic concepts nd theories to rel-world contexts. The ppliction of pproprite quntittive skills to relevnt economic contexts. Enggement with economics through wider reding nd n wreness of the current issues impcting on the suject. The 2015 specifictions hve een uilt on the following key principles: Cler specifictions. Cler guidnce on wht students need to lern, providing clrity for plnning, teching nd ssessments. The chnges we hve mde to the structure of the specifictions re explined in Section 2.2, pge 7. Co-techle AS nd A level courses. The AS level is emedded in the A level to llow co-techility. The reltionship etween AS level nd A level qulifictions nd considertions for co-teching the qulifictions re detiled in Section 3 (pge 13). Historicl context nd dete. The specifictions select spects of economic history to inform mcroeconomic dete nd provide context to economic issues. This content is integrted throughout the themes nd the course overview cn e found on pge 8. The rtionle for including this new content is outlined in the tle on pge 9. Reflect tody s glol economy. Building on the strengths of The Glol Economy unit in the 2008 course, the new specifictions ensure students develop n understnding of current glol issues nd development economics. The overview for the glol theme cn e found on pge 8 nd the chnges mde to this theme (compred with the 2008 specifiction) re summrised in the tle on pge 10. Mpping documents from the 2008 to 2015 specifictions re ville on the Economics pges of the Edexcel wesite. Person Eduction Ltd This mteril is not copyright free. 1

7 1. Introduction Reflect developments in economics. The specifiction content hs een updted to reflect developments nd current issues in economics. The introduction of the finncil sector supports student understnding of recent economic events nd the 2008 Glol Finncil Crisis. The inclusion of some introductory ides in ehviourl economics ensures students develop n understnding of more recent economic thinking. A summry of these chnges compred with our 2008 specifiction re summrised in the tle on pge 10. Ides nd suggestions for teching pproches re detiled in Section 4 nd further support for the new res of the specifiction re ville on the Economics pges of the Edexcel wesite. Cler ssessments. There is cler nd consistent use of commnd words cross ssessments nd etween series. Our pproch to the ssessments, definitions for the commnd words nd detils of how the commnd words relte to the ssessments re explined in Section 5 on pge 87. Rel world focus. All of the ssessments re sed on rel dt nd rel issues. This helps provide stimulting ssessment mterils to cover wide rnge of economic issues for students to engge with. For more informtion out how stimulus mteril is utilised in the ssessments, see Section 5. Cler mrk schemes. The new mrk schemes provide consistent understnding of the skills nd connections etween these skills required for ech question type. Cler wording reflects how techers nd exminers descrie the qulities of student work, so the expecttions re cler for techers nd for mrkers. Our pproch to skills-sed mrk schemes is explined in Section 5.6 on pge 89. Skills for progression. Students will develop trnsferle skills to support study in wide rnge of sujects t university nd the trnsition to employment. These skills include numercy, communiction, criticl thinking, forming nd testing hypotheses nd commercil wreness. Our pproch to skills development is detiled in Section 5 (stimulus mteril), Section 6 (quntittive skills), Section 7 (trnsferle skills) nd Section 8 (economics nd the Extended Project Qulifiction). 1.2 Support for the new specifiction This Getting Strted guide provides n overview of the new AS nd A level specifictions to help you get to grips with the chnges to content nd ssessment, nd to help you understnd wht these chnges men for you nd your students. We will e providing pckge of support to help you pln nd implement the new specifictions: Plnning. In ddition to the relevnt section in this guide, we will e providing course plnner nd scheme of work tht you cn dpt to suit your deprtment. We will lso e providing mpping documents to highlight key differences etween the new nd 2008 specifictions. Teching nd lerning. To support you with delivering the new specifictions, we will e providing suggested resource lists, cse studies nd suggested ctivities, student guide nd mterils for options evening. Understnding the stndrd. Exemplr student work with exminer commentries for the smple ssessment mterils will e provided. Trcking lerner progress. Our ResultsPlus service provides the most detiled nlysis ville of your students exm performnce. It cn help you identify topics nd skills where students could enefit from further lerning. Extr ssessment mterils for A level will lso e ville (from spring 2015) to support formtive ssessment. 2 Person Eduction Ltd This mteril is not copyright free.

8 1. Introduction Support. Our suject dvisor service, led y Colin Leith, nd online community will ensure you receive help nd guidnce from us s well s shring ides nd informtion with ech other. You cn sign up to receive e-newsletters from Colin to keep up-to-dte with qulifiction updtes, nd product nd service news. These support documents will e ville on the Economics pges of the Edexcel wesite. Person Eduction Ltd This mteril is not copyright free. 3

9 2. Wht s chnged? 2. Wht s chnged? 2.1 How hve AS nd A level chnged? Chnges to AS nd A level qulifictions From Septemer 2015, A level Economics A will e liner qulifiction. This mens tht ll exmintions must e st t the end of the course. More informtion out the implictions of the move to liner ssessment is given in Section 3 on pge 13. From Septemer 2015, AS level Economics A will e stndlone qulifiction. This mens tht it cnnot e used to contriute towrds n A level grde. More informtion out the reltionship etween AS nd A level is given in Section 3 on pge 13. Chnges to suject criteri The suject content requirements for AS nd A level Economics hve een revised. All wrding orgnistions specifictions must meet these criteri. The full suject content document cn e found on the Deprtment for Eduction wesite, ut the oxes elow highlight the key requirements. The following requirements pply to oth AS nd A level Economics specifictions: AS nd A level specifictions must require students to: develop n understnding of economic concepts nd theories through criticl considertion of current economic issues, prolems nd institutions tht ffect everydy life develop nlyticl nd quntittive skills in selecting, interpreting nd using pproprite dt from rnge of sources, including those in the Annex explin, nlyse nd evlute the strengths nd weknesses of the mrket economy nd the role of government within it develop criticl pproch to economic models of enquiry, recognising the limittions of economic models understnd microeconomic nd mcroeconomic mrket models; use the models to explore current economic ehviour; mke cusl connections; nd develop n understnding of how the models shed light on the economy s whole e wre of the ssumptions of the model of supply nd demnd; explin the wy it works using rnge of techniques; nd use the model to descrie, predict nd nlyse economic ehviour develop n understnding of the enefits of mrkets nd the resons why they my fil; understnd the implictions of mrket filure for individuls, firms nd government, nd recognise the possiility of government filure use the ggregte demnd/ggregte supply (AD/AS) model nd dt to understnd why supply-side nd/or demnd-side policies my e seen s pproprite wys of mnging n economy consider the possile impct of mcroeconomic policies; recognise the issues government fces in mnging the mcroeconomy; rgue for different pproches; nd identify criteri for success nd evlute effectiveness develop the ility to pply nd evlute economic models s represented in written, numericl nd grphicl forms; interpret nd evlute different types of dt from multiple sources; nd propose nd justify possile responses to economic issues. 4 Person Eduction Ltd This mteril is not copyright free.

10 2. Wht s chnged? All AS nd A level specifictions must cover the following core knowledge, understnding nd skills: Economic choices nd mrkets Scrcity nd choice: the sic economic prolem, opportunity cost, specilistion nd trde. How competitive mrkets work: lloction of resources, the ojectives of economic gents, supply nd demnd, elsticity. Mrket filure nd government intervention: externlities, lterntive methods of government intervention, government filure. The ntionl nd glol economy The determintion of output, employment nd prices: circulr flow of income, expenditure nd output, ggregte demnd nd ggregte supply. Economic policy ojectives nd indictors of mcroeconomic performnce: for exmple, economic growth, employment, infltion, the lnce of pyments; potentil policy conflicts nd trde-offs. The glol context: interntionl trde, exchnge rte chnges. The ppliction of policy instruments: the nture nd impct of fiscl, monetry, exchnge rte nd supply-side policies. The following requirements lso pply to A level Economics specifictions: A level specifictions must require students to: develop n understnding of the role nd impct of the finncil sector recognise the ssumptions, reltionships nd linkges of the possile impcts of mcroeconomic policies pply nd evlute economic concepts, theories, methods nd models to wider rnge of contexts. A level specifictions must lso cover the following core knowledge, understnding nd skills: Economic choices nd mrkets Scrcity nd choice: the mrgin. How competitive mrkets work: productive nd lloctive efficiency, the interction of mrkets. Competition nd mrket power: usiness ojectives, mrket structures nd their implictions for the wy resources re llocted, interdependence of firms. Lour mrket: wge determintion, lour mrket issues, government intervention. Mrket filure nd government intervention: mrket power, informtion symmetries. The ntionl nd glol economy Finncil sector: the role of the finncil sector nd its impct on the rel economy, finncil regultion, role of centrl nks. Economic policy ojectives nd indictors of mcroeconomic performnce: income distriution nd welfre. The glol context: glolistion, trde policies nd negotitions. Person Eduction Ltd This mteril is not copyright free. 5

11 2. Wht s chnged? The min chnges in the revised suject content re: the core content requirements (outlined in the tles on pge 5) must constitute 60% of the AS nd A level specifiction content there is defined core content for AS level the inclusion of the finncil sector nd lour mrkets within the core content for A level there is greter emphsis on the ppliction of pproprite quntittive skills in rnge of economic contexts. The ssessment of these skills will include t lest level 2 mthemticl skills s minimum of 15% of the overll AS nd 20% of the overll A level mrks. Students re expected to ccomplish the following quntittive skills s prt of their AS nd A level study: clculte, use nd understnd rtios nd frctions clculte, use nd understnd percentges nd percentge chnges understnd nd use the terms men, medin nd relevnt quntiles construct nd interpret rnge of stndrd grphicl forms clculte nd interpret index numers clculte cost, revenue nd profit (mrginl, verge, totls) mke clcultions to convert from money to rel terms mke clcultions of elsticity nd interpret the result interpret, pply nd nlyse informtion in written, grphicl nd numericl forms * skills in old re not requirement in the AS level. More informtion out the ppliction of quntittive skills is given in Section 6. Chnges to Assessment Ojectives The AS nd A level Economics Assessment Ojectives hve een revised. The ojectives hve een mde more explicit to exemplify the skills developed through the AS nd A level specifictions. The Assessment Ojectives re the sme for oth AS nd A level ut the weightings re different. AO1 AS 25 35% A level 20 30% AO2 AS 25 35% A level 20 30% AO3 AS 15 25% A level 20 30% AO4 AS 15 25% A level 20 30% Demonstrte knowledge of terms/concepts nd theories/models to show n understnding of the ehviour of economic gents nd how they re ffected y nd respond to economic issues Apply knowledge nd understnding to vrious economic contexts to show how economic gents re ffected y nd respond to issues Anlyse issues within economics, showing n understnding of their impct on economic gents Evlute economic rguments nd use qulittive nd quntittive evidence to support informed judgements relting to economic issues 6 Person Eduction Ltd This mteril is not copyright free.

12 2. Wht s chnged? 2.2 Chnges to the Person Edexcel AS nd A level Economics A specifictions The A level specifiction is structured into four themes. In this structure students re introduced to core economic concepts nd principles nd develop n understnding of microeconomic nd mcroeconomic issues, efore uilding on this core knowledge nd understnding to consider more complex issues nd wider contexts. In this themtic pproch, progression is continuous s students develop their knowledge nd understnding throughout the course of study. Students use economic models to help them understnd the complexities of the world round them, nd use dt to help them nlyse mrkets nd economies, nd how governments try to influence oth. Students re introduced to different perspectives, spects of economic history nd develop n understnding of economic issues. In developing the 2015 specifictions we hve retined the strengths of the 2008 specifiction: Engging nd updted content Development economics Glol focus AS nd A level courses designed to llow co-techility The lyout of the specifiction content hs chnged to mke cler wht students need to lern. The guidnce column hs een removed nd the content requirements re detiled in the min content columns. Chnges hve een mde to the specifiction content nd the ssessments to ensure the revised suject content nd ssessment requirements for economics re met (s outlined in Section 2.1), nd to ring the specifiction up-to-dte (see pge 9). Specifiction overview The A level qulifiction is structured into four themes, with two microeconomic nd two mcroeconomic themes. The content is structured coherently nd logiclly, which enles students to uild on their knowledge nd understnding s they progress throughout the course students re introduced to economics through uilding knowledge nd ppliction of microeconomic nd mcroeconomic concepts in Theme 1 nd Theme 2, with redth nd depth of knowledge nd understnding, nd pplictions to more complex concepts nd models developed in Theme 3 nd Theme 4. This division etween microeconomic nd mcroeconomic themes lso supports techer specilism nd ensures the specifiction is deliverle for two teching specilists. The chrts on pge 8 provide n overview of the A level nd AS level specifictions, indicting the reltionship etween the two. (Further guidnce on the reltionship etween AS nd A level is provided in Section 3 on pge 13.) Person Eduction Ltd This mteril is not copyright free. 7

13 2. Wht s chnged? The A level is structured into four themes with three externlly ssessed exms: Theme 1 Introduction to mrkets nd mrket filure 1.1 The nture of economics 1.2 How mrkets work 1.3 Mrket filure 1.4 Government intervention Theme 3 Business ehviour nd the lour mrket 3.1 Business growth 3.2 Business ojectives 3.3 Revenues, costs nd profit 3.4 Mrket structures 3.5 The lour mrket 3.6 Government intervention Pper 1 Mrkets nd usiness ehviour Assessing Theme 1 nd Theme 3 Theme 2 The UK economy performnce nd policies 2.1 Mesures of economic performnce 2.2 Aggregte demnd 2.3 Aggregte supply 2.4 Ntionl income 2.5 Economic growth 2.6 Mcroeconomic ojectives nd policy Theme 4 A glol perspective 4.1 Interntionl economics 4.2 Poverty nd inequlity 4.3 Emerging nd developing economies 4.4 The finncil sector 4.5 Role of the stte in the mcroeconomy Pper 2 The ntionl nd glol economy Assessing Theme 2 nd Theme 4 Pper 3 Microeconomics nd mcroeconomics Assessing ll themes The AS level is emedded in the A level: Theme 1 nd Theme 2 comprise the sme content for oth the AS nd A level specifictions. There re two externlly ssessed exms: Theme 1 Introduction to mrkets nd mrket filure 1.1 The nture of economics 1.2 How mrkets work 1.3 Mrket filure 1.4 Government intervention Pper 1 Introduction to mrkets nd mrket filure Theme 2 The UK economy performnce nd policies 2.1 Mesures of economic performnce 2.2 Aggregte demnd 2.3 Aggregte supply 2.4 Ntionl income 2.5 Economic growth 2.6 Mcroeconomic ojectives nd policy Pper 2 The UK economy performnce nd policies 8 Person Eduction Ltd This mteril is not copyright free.

14 2. Wht s chnged? Chnges to specifiction content Chnges hve een mde to the specifiction content, oth to ensure the revised suject content requirements for economics re met nd to refresh the specifictions to ring them more up-to-dte in response to our reserch findings; for exmple, y incorporting current issues such s some introductory ides relting to ehviourl economics. The following content hs een included in ddition to the core content specified in the DfE suject criteri (outlined on pges 4-5). The content outlined in the tle elow hs een included to enle students to uild on the core content requirements to ensure sufficient depth, nd to include dditionl suject content to ensure sufficient redth. Specifiction content The nture of economics Rtionl decision mking nd lterntive views of consumer ehviour Economic history nd economic thinkers Emerging nd developing economies (in Theme 4) Rtionle for inclusion This introductory content ddresses the ims nd ojectives with regrds to ppreciting the contriution of economics, developing n ility to think s n economist nd understnding tht economic ehviour cn e covered through rnge of perspectives. This content ddresses the requirement from stkeholders to include n element of ehviourl economics nd ensure the specifiction includes up-to-dte nd contemporry issues in the suject re. Aspects of economic history hve een integrted throughout the course to support contextul wreness nd inform mcroeconomic dete. The content demonstrtes how economic events cn e interpreted in different wys nd how they impct on more recent economic events. The inclusion of reference to economic thinkers supports the understnding tht there re different perspectives in economics, with different wys of pproching economic issues. References to current economic policies nd issues, nd the requirement to develop n wreness of recent events re outlined in the specifiction. Theme 4 focuses on mcroeconomics in the glol context, with prticulr reference to emerging nd developing economies. This demonstrtes how economic concepts nd theories cn e pplied in different nd rel world contexts. Person Eduction Ltd This mteril is not copyright free. 9

15 2. Wht s chnged? The tle elow is n overview of the min chnges in content from our 2008 specifiction. More detiled mpping of individul topics from the 2015 specifiction to the 2008 specifiction cn e found on the Economics pges of the Edexcel wesite specifiction content Chnges from 2008 specifiction Theme 1 Introduction to mrkets nd mrket filure 1.1 The nture of economics 1.2 How mrkets work 1.3 Mrket filure 1.4 Government intervention Theme 2 The UK economy performnce nd policies 2.1 Mesures of economic performnce 2.2 Aggregte demnd 2.3 Aggregte supply 2.4 Ntionl income 2.5 Economic growth 2.6 Mcroeconomic ojectives nd policy Theme 3 Business ehviour nd the lour mrket 3.1 Business growth 3.2 Business ojectives 3.3 Revenues, costs nd profit 3.4 Mrket structures 3.5 The lour mrket 3.6 Government intervention Theme 4 A glol perspective 4.1 Interntionl economics 4.2 Poverty nd inequlity 4.3 Emerging nd developing economies 4.4 The finncil sector 4.5 Role of the stte in the mcroeconomy Inclusion of n wreness of economic thinkers with reference to Smith, Hyek nd Mrx. Inclusion of rtionl decision mking nd lterntive views of consumer ehviour n introduction to ehviourl economics. Selected spects of economic history for context, with the inclusion of Keynes nd references to nd wreness of different interprettions of nd policy responses to the Gret Depression nd the Glol Finncil Crisis. Inclusion of ntionl hppiness s mesure of welleing. Coverge of the lour mrket in this theme. Inclusion of topic on the finncil sector covering the role of finncil mrkets nd centrl nks, functions of money nd mrket filure in the finncil sector. 10 Person Eduction Ltd This mteril is not copyright free.

16 2. Wht s chnged? Chnges to ssessment The ssessment structures for the AS nd A level qulifictions re outlined elow nd on pge 12. More detil on the ssessment for ech component is given in Section 5 on pge 87. There re three A level ppers, ech comprising 100 mrks nd 2 hours in durtion. Pper 1 Mrkets nd usiness ehviour Totl mrks: 100 Weighting: 35% Exm time: 2hrs Questions drwn from Theme 1 nd Theme 3 content. Section A: Multiple-choice nd short-nswer questions. Students nswer ll questions. Section B: Bsed on stimulus mteril. One dt response question comprising numer of prts. Section C: One extended open-response question. Students select one from choice of two. Pper 2 The ntionl nd glol economy Totl mrks: 100 Weighting: 35% Exm time: 2hrs Questions drwn from Theme 2 nd Theme 4 content. Section A: Multiple-choice nd short-nswer questions. Students nswer ll questions. Section B: Bsed on stimulus mteril. One dt response question comprising numer of prts. Section C: One extended open-response question. Students select one from choice of two. Pper 3 Microeconomics nd mcroeconomics Totl mrks: 100 Weighting: 30% Exm time: 2hrs Questions drwn from ll themes. Section A: Bsed on stimulus mteril. One dt response question comprising numer of prts, including one extended open-response question (students select one extended open-response question from choice of two). Section B: Bsed on stimulus mteril. One dt response question comprising numer of prts, including one extended open-response question (students select one extended open-response question from choice of two). Person Eduction Ltd This mteril is not copyright free. 11

17 2. Wht s chnged? There re two AS level ppers, ech comprising 80 mrks nd 1.5 hours in durtion. Pper 1 Introduction to mrkets nd mrket filure Section A: Multiple-choice nd short-nswer questions. Students nswer ll questions. Totl mrks: 80 Weighting: 50% Exm time: 1hr 30 Questions re drwn from Theme 1 content Pper 2 The UK economy performnce nd policies Section B: Bsed on stimulus mteril. One dt response question comprising numer of prts, including one extended open-response question (students select one extended open-response question from choice of two). Section A: Multiple-choice nd short-nswer questions. Students nswer ll questions. Totl mrks: 80 Weighting: 50% Exm time: 1hr 30 Questions re drwn from Theme 2 content Section B: Bsed on stimulus mteril. One dt response question comprising numer of prts, including one extended open-response question (students select one extended open-response question from choice of two). Chnges hve een mde to the pproch of the AS level nd A level ppers to ensure the ssessments re cler nd consistent, enling students to understnd the skills they re required to demonstrte nd not overly focus on exm technique. The chnges summrised elow re explined in detil in Section 5: A reduction in the vriety of commnd words used, creful definition of the skills tht comprise ech commnd word nd consistent ppliction of the commnd words within nd cross ssessments. Skills sed mrk schemes tht focus on the qulities students re expected to demonstrte in their nswers rther thn the quntity of points within responses. Clrity of the skills required y ech commnd word reflects how techers nd exminers descrie the qulities of student work, so the expecttions re cler for techers nd for mrkers nd reduces sujectivity. The introduction of short-nswer questions comprising multiple choice nd short nswer elements. These questions focus on knowledge, understnding nd ppliction, ensuring questions re explicit nd cler in the knowledge nd understnding students re required to demonstrte. Choice is provided for the extended open-response questions, enling students to respond to n issue sed on context they re more engged or fmilir with. There is no choice of dt response question. This llows students to focus on one, roder dt response context, which supports comprility cross ppers nd reduces time spent in the exm on processing second dt response context nd question tht will not contriute to the overll mrks. 12 Person Eduction Ltd This mteril is not copyright free.

18 3. Plnning 3. Plnning 3.1 Plnning nd delivering liner AS nd A level courses Both the AS nd the A level qulifictions re liner, with ssessments tken t the end of the course. There will e no Jnury ssessment window. For AS level, therefore, centres cn decide whether to tech Theme 1 nd Theme 2 in prllel or sequentilly, sed on their timetling nd stffing sitution. For A level, centres will need to decide whether they re delivering the A level on its own or co-teching AS nd A level students together, s this my impct on the pproch to teching in the first yer. See Sections 3.2 nd 3.3 elow for further guidnce on this. With liner A level, considertion will need to e given to leving sufficient time for revision in the second yer, prticulrly to revisit topics studied in the first yer. The structure of the course supports continuous revision s students develop knowledge nd understnding from Theme 1 nd Theme 2 to Theme 3 nd Theme Delivery models One of the first decisions centres will need to mke is the pproch to offering AS nd A level. The enefits of liner A level course include more flexiility in structuring the course, more time for teching in the first yer, greter student mturity when completing ssessments nd more opportunity for students to mke links etween different elements of the course. On the other hnd, it mens tht ll students must emrk on the A level course; ny student who leves the course efore it is completed will leve with no qulifiction. Centres wishing to offer the AS longside the A level will need to decide whether they cn run seprte AS nd A level clsses, or whether AS nd A level students will need to e tught in the sme clss. Co-teching mens tht students my e le to dely their decision to tke the full A level once they hve experience of the suject content; mny students re lerning Economics for the first time t this level. Those who did go on to the full A level would still hve to e exmined on ll the A level content t the end of the second yer nd their AS grde will not count towrds their A level grde. Centres re dvised to check the funding implictions of students delying AS nd A level decisions. Centres co-teching the AS will follow themtic pproch, delivering Theme 1 nd Theme 2 in the first yer. The themes could e run in prllel or tught sequentilly, depending on wht is most pproprite for stffing nd timetling within ech centre. Centres offering only the A level my lso strt with Theme 1 nd 2 in the first yer, ut could decide to structure the course differently nd dopt n integrted pproch; for exmple, y teching ll microeconomic content together. Suggested different pproches to structuring the course re given in the seprte Course Plnner documents (on the Economics suject pges of the Edexcel wesite). The chrt on pge 14 illustrtes the different options descried ove. Person Eduction Ltd This mteril is not copyright free. 13

19 3. Plnning Sept 2015 Jn 2016 June 2016 Sept 2016 Jn 2017 June 2017 AS level only Theme 1 Theme 2 Enter for AS level qulifiction Co-teching AS nd A level Theme 1 Theme 2 Enter for AS level qulifiction Theme 3 Theme 4 Enter for A level qulifiction Themtic pproch to A level Theme 1 Theme 2 Mock for Themes 1 nd 2 Theme 3 Theme 4 Enter for A level qulifiction Integrted pproch to A level Theme 1, 2, 3 nd 4 (integrted pproch) Enter for A level qulifiction 3.3 Co-teching AS nd A level The AS level is emedded in the A level: Theme 1 nd Theme 2 is the sme content for the AS nd A level specifictions. This mens tht Theme 1 nd Theme 2 cn e co-tught for AS nd A level. The ssessments re differentited. The A level ppers require students to mke connections cross Themes. Content in Theme 1 nd Theme 2 my e ssessed t oth AS nd A level, ut the style of questions my e differentited. 3.4 Suggested resources To support in the teching nd lerning of the new specifictions, we will provide comprehensive suggested resources list to cpture rnge of sources you my find useful. The list will e regulrly updted nd cn e viewed on the Economics pges of the Edexcel wesite. 14 Person Eduction Ltd This mteril is not copyright free.

20 4. Content guidnce 4. Content guidnce Introduction This section provides ides nd suggestions for teching pproches nd is not intended to e prescriptive. The specifiction must e referred to s the uthorittive source of informtion. Theme 1: Introduction to mrkets nd mrket filure This section provides ides nd suggestions for teching pproches for Theme 1 nd is not intended to e prescriptive. The specifiction must e referred to s the uthorittive source of informtion. 1.1 Nture of economics This topic introduces students to the nture of economics through exploring some key underlying concepts, including the ide tht economics is socil science, positive nd normtive economic sttements, the economic prolem of scrcity nd production possiility frontiers. Students will lso consider the dvntges nd disdvntges of specilistion nd the division of lour in orgnising production nd in the production of goods nd services to trde. Specilistion mens there is need to exchnge nd this is why students will explore the functions of money. Students re lso introduced to the different wys economies cn orgnise themselves in terms of free mrket, commnd nd mixed economies. Students re required to distinguish etween the three nd consider the dvntges nd disdvntges of ech Economics s socil science c Economists try to understnd the economy through mking ssumptions to help them crete models. An understnding of why economists mke ssumptions in order to simplify their nlysis will e useful. The ility to question nd chllenge ssumptions cn e used s n evlutive tool in ech of the themes. It will e useful to introduce sic model nd consider how the ssumptions help simplify it. Students should lso consider how relistic the model is. The PPF could e considered t this stge (introduced in 1.1.4). Students could consider how PPF is helpful in simplifying two products to help illustrte the mximum productive potentil, opportunity costs nd efficiency, s well s chllenge whether these re relistic ssumptions. Students should explore wht ceteris prius mens ssuming other vriles remin constnt nd why this is n importnt ssumption for economists to mke when considering the reltionships etween different vriles. Often the impct of one vrile on nother is considered for exmple, how interest rtes ffect unemployment nd it is importnt to ssume ceteris prius to simplify the nlysis. A scientist cn prove the reltionships etween two vriles y conducting experiments. This is not possile for n economist n economist does not conduct n experiment to determine the impct of 10% increse in VAT. Insted, n economist cretes simplified model of the economy to look t the impct of such n increse. Person Eduction Ltd This mteril is not copyright free. 15

21 4. Content guidnce Positive nd normtive economic sttements Students re required to understnd the distinction etween positive nd normtive economic sttements nd they should e le to explin why sttements re either positive or normtive. Governments mke vlue judgements on economic issues nd how much they get involved in the economy will depend on these normtive issues. Economic nlysis tends to e more concerned with positive issues, i.e. sttements of fct tht cn e tested ginst rel world evidence. Some countries, such s the US, hve predominntly privte helthcre system, where people hve to py directly for their tretment. The UK hs predominntly pulicly provided helthcre system (the NHS) to sy tht the UK s pproch is firer is essentilly vlue judgement, i.e. normtive issue. To sy tht the mount spent per hed on helthcre in the UK is less thn tht in the US is positive sttement. Students should understnd tht the economic decisions mde y individuls nd the policy decisions mde y governments will e sed on their vlue judgements nd, s such, re normtive The economic prolem c The sic economic prolem is tht resources re scrce. For mny of these resources there re infinite wnts ut finite resources with which to stisfy them. Scrce resources men tht decisions need to e mde regrding wht, how, why, nd for whom goods nd services re produced. Economics cn e used s tool when choosing etween the competing demnds plced on the ville resources. Students should explore the difference etween renewle nd non-renewle resources nd e wre of exmples of ech. One interesting mrket to consider here is energy genertion nd students could distinguish etween renewle nd non-renewle energy resources. Scrce resources men tht choices hve to e mde nd, in doing so, there is n opportunity cost. Students should consider the opportunity costs tht consumers, producers nd governments experience; for exmple: should consumer spend his or her disposle income on new textook or mel out with friends; should producer increse the dividend to shreholders or invest in cpitl goods; should government llocte dditionl funding to eduction or invest in new medicl equipment for the NHS? Production possiility frontiers Production possiility frontiers (PPFs) help economists to nlyse trde-offs. They show the mximum possile comintion of goods/services tht cn e produced using ll ville resources. 16 Person Eduction Ltd This mteril is not copyright free.

22 4. Content guidnce c Students should e le to drw PPFs nd depict ech of the following: The mximum productive potentil of n economy, which is ny point long the PPF PP. The concept of opportunity cost the production of two more consumer goods incurs n opportunity cost of one cpitl good. Economic growth (n increse in the productive potentil of the country), which cn e shown y n outwrd shift in the PPF. Such shift cn e cused y n increse in the quntity or qulity of the fctors of production (such s etter educted lour, hi-tech cpitl or new oil field discovery). Very occsionlly, the PPF shifts inwrds nd would e seen s economic decline; for exmple, cused y civil wr or nturl disster such s hurricne or erthquke. The concept of efficiency ny point on the PPF is productively efficient point where the fctors of production (resources including lnd, lour, cpitl nd enterprise) re eing used to their mximum potentil. Any point on the PPF PP is efficient, ny point inside the PPF is inefficient some of the fctors of production re unemployed or under-employed. Possile production nything under or on the PPF. However, n exmple of unotinle production could e point Z ecuse it is eyond the PPF. Students re required to distinguish etween cpitl nd consumer goods. A considertion of how economic growth might e ffected y llocting more resources to the production of cpitl goods will e useful in developing deeper understnding of this re Specilistion nd the division of lour c d Students re not required to study the work of Adm Smith in detil the emphsis should e on understnding his key findings. One wy in which economic growth cn occur is vi specilistion, or the division of lour. Adm Smith wrote out the division of lour in The Welth of Ntions in the 18th century. In studying pin fctory in Glsgow he found tht when workers completed ll of the tsks involved in producing ech pin independently, output ws low. By splitting the production of good into numer of different tsks, nd llocting ech tsk to different worker, more could e produced s workers developed greter skill in performing their prticulr tsk with the use of specilist tools designed just for tht tsk, therefore leding to less wstge of mterils nd less time spent on their tsk. As well s incresed output, there were corresponding lower unit costs. However, when this method ws put into prctice in the erly 20th century for exmple, with Henry Ford s Model T production line workers ecme so ored tht they hd to e pid high wges s compenstion for the monotony of their work. Students need to consider the dvntges nd disdvntges of specilising in the production of goods nd services. Considertion should e given to the impct on productivity, unit costs, higher output nd oredom. As firms nd individuls specilise in the production of goods nd services they will need to sell their products to others. They will lso need to purchse other products. This trde cretes need for money to exchnge. Students will need to explore the functions of money s medium of exchnge, mesure of vlue, store of vlue nd method of deferred pyment. Person Eduction Ltd This mteril is not copyright free. 17

23 4. Content guidnce Free mrket economies, mixed economy nd commnd economy c There re numer of different economic systems with different pproches to orgnising the economy. Students re required to consider the distinction etween free mrket economy, mixed economy nd commnd economy. Students should hve n wreness of the perspectives of Adm Smith, Friedrich Hyek nd Krl Mrx; however, there is no requirement for detiled considertion of the work of ech economist. Smith rgued tht economies function most efficiently nd firly when individuls re llowed to pursue their own interests; the gret thret to economic growth is government intervention. Hyek ws criticl of commnd economies; he ws concerned out the informtion required to distriute resources effectively nd rgued it ws impossile for the government to process this informtion effectively. Mrx considered the flws of free mrket economies; he rgued tht the free mrket economy would rek down ecuse the owners of usiness mde huge profits t the expense of workers. Most economists would rgue tht free mrkets re the most efficient (in terms of using resources in the est possile wy to meet the needs nd wnts of consumers). However, when equity is considered, most economists would lso rgue tht free mrkets led to n unequl distriution of income nd welth, since owners of cpitl nd entrepreneurs tend to ccumulte the most income/welth nd mny people, such s the sick or elderly, re unle to work. As result, most economies tody re mixed economies, where mrkets llocte mny resources, ut governments intervene to different extents in order to ensure minimum stndrd of living nd to correct other mrket filures. Governments intervene y rising revenue through txes nd redistriuting income in the form of enefits nd direct provision of services such s helthcre. 1.2 How mrkets work This section introduces students to mrkets, exploring supply nd demnd. Students should use supply nd demnd to nlyse rel world situtions nd impcts on mrkets. Students will lso chllenge the ssumption tht consumers ehve rtionlly Rtionl decision mking When uilding supply nd demnd models we mke ssumptions out consumers nd producers s economic gents who seek to mximise their utility. Consumers im to mximise the utility they derive from purchsing goods or services nd firms im to mximise their utility y selling goods nd services for the mximum possile profit Demnd Demnd might e regrded s n strct concept so it should e relted to mrkets fmilir to students. It my e useful to conduct n uction. Demnd refers to the mount tht consumers re willing nd le to uy t ny given price in given period of time. A demnd curve shows this reltionship etween price nd quntity demnded. It slopes downwrds from left to right ecuse, s price flls, people re more willing to uy good. 18 Person Eduction Ltd This mteril is not copyright free.

24 4. Content guidnce c Students my find it difficult to rememer tht chnging the price leds to movements long the demnd curve nd not shift this point needs emphsising. In the exmple ove, the price hs fllen from 8 to 6 nd the quntity hs incresed from to shirts. Students should understnd tht this is n extension of demnd. When the price rises nd the quntity demnded flls it should e referred to s contrction in demnd. Fctors tht my cuse shift in the demnd curve include: chnges in rel incomes, chnges in tstes nd fshions, dvertising nd rnding, chnges in the prices of sustitutes nd complementry goods, nd chnges in size nd ge distriution of the popultion. Students should explore the concept of diminishing mrginl utility nd how this influences the shpe of the demnd curve. Mrginl utility is the dditionl utility, or mount of stisfction, gined from ech dditionl unit of consumption. Totl utility will normlly rise s dditionl units of product re consumed. Mrginl utility will usully decrese with ech dditionl increse in the consumption of good. This decrese in mrginl utility demonstrtes the lw of diminishing mrginl utility, which helps economists to understnd the negtive sloping demnd curve Price, income nd cross elsticities of demnd Price elsticity of demnd (PED) mesures the responsiveness of quntity demnded to chnge in price. Income elsticity of demnd (YED) mesures the responsiveness of quntity demnded to chnge in income. Cross (price) elsticity of demnd (XED) mesures the responsiveness of quntity demnded for one good to chnge in the price of nother good. Person Eduction Ltd This mteril is not copyright free. 19

25 4. Content guidnce Students will find it useful to hve lots of prctice clculting nd interpreting elsticities. Students should e confident using the formule elow: PED = % chnge in Quntity Demnded = % in QD % chnge in Price % in P YED = % chnge in Quntity Demnded = % in QD % chnge in Income % in Y XED = % chnge in Quntity Demnded of good x = % in QDx % chnge in Price of good y % in Py c YED nd XED my e positive or negtive. PED 0 Perfectly inelstic 0 to 1 Reltively inelstic 1 Unitry elstic 1 to Reltively elstic Perfectly elstic YED <0 (negtive) Inferior good s income rises the demnd for the product will fll 0 to +1 Norml good income inelstic demnd +1 to Norml good income elstic demnd XED <0 (negtive) Complements >0 (positive) Sustitutes 0 Unrelted goods d The fctors tht influence PED include: the vilility of sustitutes, the ddictiveness of the product, time nd the price of the product s proportion of income. 20 Person Eduction Ltd This mteril is not copyright free.

26 4. Content guidnce e f PED is importnt to firms in determining their pricing strtegy: if demnd is inelstic, then n increse in price leds to n increse in totl revenue nd fll in price reduces totl revenue; if PED is elstic, then rise in price reduces totl revenue nd fll in price increses totl revenue. PED is lso importnt to governments in terms of understnding the urden (or incidence) of txtion on producers nd consumers. The more price inelstic the good, greter proportion of the tx is pid y the consumer thn the producer. Similrly, for susidies ( government grnt given to producers in order to encourge production), the more price inelstic the good, the greter the price fll for consumers. Firms should consider the YED of products; if nlysis of YED shows demnd for their product is income elstic nd the economy experiences recession, demnd is likely to fll significntly. XED will tell firm how demnd for their own product will chnge following price chnge y their competitors or prtners. Students re required to understnd nd clculte the reltionship etween PED nd totl revenue Supply PED Price rises Price flls Inelstic Totl revenue rises Totl revenue flls Unitry elstic Totl revenue unchnged Totl revenue unchnged Elstic Totl revenue flls Totl revenue rises Supply refers to the mount tht producers re willing nd le to sell t ny given price in given period of time. The supply curve shows the reltionship etween price nd the quntity supplied. It slopes upwrds from left to right ecuse, s price rises, rtionl profit mximising producers will supply more ecuse profits should rise. A chnge in the price of the good leds to movement long the supply curve, not shift in the supply curve. Fctors tht my cuse shift in the supply curve include: chnges in the costs of production, the introduction of new technology, indirect txes (specific nd d vlorem), susidies nd chnges in the numer of firms in n industry. Person Eduction Ltd This mteril is not copyright free. 21

27 4. Content guidnce Elsticity of supply Price elsticity of supply (PES) mesures the responsiveness of quntity supplied to chnge in price. PES cn e clculted using the following formul: PES= % chnge in Quntity Supplied = % in Qs % chnge in Price % in P c A steep supply curve shows good where quntity supplied is not very responsive to chnges in price. It will hve inelstic supply. The percentge chnge in quntity supplied will e smller thn the percentge chnge in price. A shllow supply curve shows good where quntity supplied is more responsive to chnges in price. It will hve elstic supply. The percentge chnge in quntity supplied will e greter thn the chnge in price. PES is lwys positive numer. PES 0 Perfectly inelstic 0 to +1 Reltively inelstic +1 to Reltively elstic Perfectly elstic d e Supply is likely to e price inelstic if it is: complex to mke, rw mterils re scrce, the production process is lengthy nd if it is in the short run (the time period where the quntity of some fctors of production re fixed). Supply is price elstic when: the good is quick nd esy to mke nd if it is the long run (the time period where ll fctors of production re vrile). In the short run it is difficult to djust production, mking supply inelstic. This is ecuse some fctors of production re fixed. However, in the long run, ll fctors cn e djusted so firms cn increse production in response to price increses, mking supply more elstic Price determintion Students re required to know how equilirium price nd quntity re determined. Where demnd (D) nd supply (S) intersect is the mrket clering price (P). If the price is ove the equilirium price P, supply is greter thn demnd nd there is excess supply, surplus or glut. If the price is elow the equilirium price P, demnd is greter thn supply cusing excess demnd or shortge. Students re required to illustrte oth excess demnd nd excess supply digrmmticlly nd explin how the mrket will cler in terms of price djustment. 22 Person Eduction Ltd This mteril is not copyright free.

28 4. Content guidnce c d If there is excess supply, mrket forces will result in contrction in supply nd n extension in demnd, so cusing fll in price to its mrket clering level, P. If there is excess demnd, mrket forces will result in n extension in supply nd contrction in demnd, cusing rise in price to its mrket clering level, P. To support students in understnding excess supply nd excess demnd it is worth giving illustrtions; for exmple, flower seller who set prices too high resulting in unsold flowers t the end of the dy. Students re required to exmine rel world mrkets nd consider wht is cusing prices to chnge. Supply nd demnd digrms should e used to demonstrte how shifts in the demnd or supply curve cuse chnges in the equilirium price nd quntity. Price rises re cused y incresing demnd (shifting to the right) or decresed supply (shifting to the left). Price flls re cused y decresing demnd (shifting to the left) or incresed supply (shifting to the right). It is useful for students to consider commodity mrkets nd look t wht cuses such voltile price chnges. For exmple, demnd is highly price inelstic for oil nd supply is lso price inelstic s it tkes so long to discover new supply. Any chnges in the supply of oil or demnd for oil will hve lrge impct on its price Price mechnism Students re required to consider the functions of the price mechnism to llocte resources: Rtioning due to scrcity, not everyone is le to uy everything they wnt; when demnd is greter thn supply, prices will rise so tht the good/service is rtioned out only to those who cn fford to py for the items. Incentive when the price of product rises it cretes n incentive for firms to shift production towrds those products tht help generte higher profits. Likewise flling prices my crete n incentive for firms to move wy from the production of product. Signlling when the price of product rises it signls to producers tht the demnd for tht product is proly high nd firms should increse production. Prices re helping to determine where nd how resources should e llocted. The price mechnism should e considered in the context of different types of mrkets, including locl, ntionl nd glol. Person Eduction Ltd This mteril is not copyright free. 23

29 4. Content guidnce Consumer nd producer surplus Consumer surplus is the difference etween the mount consumers re willing to py nd the price they ctully py, wheres producer surplus is the difference etween the mount producers re willing to sell good for nd the price they ctully receive. Students re required to illustrte consumer nd producer surplus on digrm. Consumer surplus is illustrted y the difference etween the demnd curve (the mount they re willing to py) nd the mrket equilirium price (the mount they ctully py) the drker shded re on the digrm. Producer surplus is shown y the difference etween the supply curve (the mount they re willing to sell for) nd the mrket equilirium price (the mount they sell for) the lighter shded re on the digrm. c Students should consider how chnges in supply nd demnd will ffect the size of the consumer nd producer surplus, nd identify the originl, new nd chnge in oth the consumer nd producer surplus Indirect txes nd susidies In the digrm there is specific tx imposed which cuses supply to shift to the left from S to S+ Tx. This cuses the quntity to fll from Q to Q1 nd the price to rise from P to P1. The incidence of the tx pid y the consumer is in drk grey nd represents the fct consumers re now pying more. The incidence of the tx pid y the producer is given y the lighter grey nd represents the fct they ern less revenue per item. The sum of the two incidences represents the tx revenue erned y the government from this tx. 24 Person Eduction Ltd This mteril is not copyright free.

30 4. Content guidnce Students should consider how the elsticity will ffect the incidence of the tx. When demnd is more inelstic the incidence of the tx pid y the consumer will e igger nd the incidence of the tx on the producer will e smller. When demnd is elstic then the incidence will e greter for the producer thn the consumer. Txes should e linked to negtive externlities. Governments impose txes on goods such s cigrettes nd lcohol to reduce the consumption of the good nd to rise tx revenue in order to fund eduction nd helth. In the digrm there is susidy introduced which cuses supply to shift to the right from S to S+Susidy. This cuses the quntity to rise from Q to Q1 nd the price to fll from P to V. The enefit of the susidy to the consumer is in drk grey nd represents the fct consumers re now pying less. The enefit of the susidy to the producer is given y the lighter grey re nd represents the fct they ern more revenue per item. The totl cost of the susidy to the government will e the sum of the enefits to oth the consumer nd producer. Susidies should e linked to goods which exhiit positive externlities Alterntive views of consumer ehviour Some ehviourl economists hve used psychology nd conducted experiments to suggest tht consumers do not lwys mke rtionl choices nd tht economic theory should not ssume rtionlity. For exmple, ehviourl economists hve tried to demonstrte tht consumer decisions re often influenced y the opinions of others which might not led to utility mximistion. It is useful in this section to use rel mrkets such s nk ccounts nd energy suppliers to explore why consumers my not ct rtionlly. For exmple, consumers my e influenced y hit, inerti or the need to feel vlued. 1.3 Mrket filure This section considers how mrkets cn fil to deliver the socilly optiml level of output nd explores externlities, pulic goods nd informtion gps. Students should e le to pply the concepts to rel world mrkets. Person Eduction Ltd This mteril is not copyright free. 25

31 4. Content guidnce Types of mrket filure Mrket filure is where too much or too little of good is eing produced nd/or consumed compred with the socilly optiml level of output, or when the price mechnism leds to n inefficient lloction of resources. Students should e introduced to exmples of the different types of mrket filure, including externlities, pulic goods nd informtion gps Externlities c Externl costs (negtive externlities) exist when the socil costs of n economic ction re greter thn the privte costs. For exmple, chemicl mnufcturer locted on the nks of river will incur numer of privte costs of production (for exmple, rw mterils, lour nd running mchinery) ut my lso impose costs on third prties, such s noise from delivery lorries, n ugly fctory ffecting the qulity of life of locl residents nd pollution in the form of chemicls eing pumped into the river. Socil costs = privte costs + externl costs Externl enefits (positive externlities) exist when the socil enefits of n economic ction re greter thn the privte enefits. For exmple, the eduction received y child mens tht he or she cn get jo tht pys resonle income (i.e. there is privte enefit to eduction); however, tht child s eduction my lso enefit wider society if he or she ecomes doctor nd is le to tret people so tht they cn return to work (i.e. there is lso n externl enefit). Socil enefits = privte enefits + externl enefits (c nd d) Students should drw the relevnt digrms ccurtely nd it is importnt to py prticulr ttention to lelling the mrket equilirium, socil optimum nd welfre loss. e Mny students find this topic chllenging s it is strct. Use s mny prcticl exmples s possile nd get students to identify privte nd externl costs/enefits. Exmples could include: trnsport, extrction, mining nd forestry, energy genertion, chemicl mnufcturing, helth nd eduction. 26 Person Eduction Ltd This mteril is not copyright free.

32 4. Content guidnce Pulic goods Students cn usully identify tht pulic goods exhiit non-rivlry nd nonexcludility ut cn find it difficult to explin wht ech is. Giving exmples to support their understnding will e useful. Goods tht re oth non-rivl nd non-excludle re clled pulic goods. Non-rivl mens tht the consumption of product y one person does not prevent nother person from lso consuming tht product. For exmple, rdio or TV progrmme demonstrtes non-rivlry ecuse one person listening to the progrmme does not prevent others from listening to it. However, rdio or TV is rivl good. Non-excludle mens tht once good is provided it is impossile to stop people from using it. For exmple, once lighthouse is provided, ships t se cnnot e prevented from enefiting from it. However, cr mnufcturer cn exclude someone from purchsing its crs if tht person cnnot fford it, which is why crs re clssified s privte goods. Pulic goods hve to e provided y governments, ecuse people cnnot e prevented from using them nd firms hve no incentive to provide them s they cnnot mke profit. The prolem the privte sector fces is the free rider prolem, where consumers will enefit from the product without pying for it Informtion gps Perfect nd symmetric informtion held y uyers nd sellers mens tht consumers nd producers hve the sme level of knowledge out the products nd they know everything there is to know out them. In mny cses informtion is symmetric nd producers know more thn consumers or the informtion is incomplete or imperfect. Exmples of imperfect informtion include over-consumption of tocco or lcohol nd under-consumption of helthcre or eduction. Other exmples include the finncil sector, pensions, insurnce nd the used cr mrket. 1.4 Government intervention Mrket filure is justifiction for government role in creting more efficient socil optiml outcome. This topic considers wys in which governments cn intervene in mrkets nd the impct of these interventions. Students will lso consider how government intervention cn led to net welfre loss Government intervention in mrkets Txtion reduces supply, leding to n increse in price. This cts to discourge production/consumption of good with negtive externlities. An d vlorem tx is percentge, such s VAT. With n d vlorem tx the supply curve ecomes steeper in the digrm elow the supply curve hs pivoted from supply to supply + tx. The uyer pys proportion of the tx nd the supplier the rest. Person Eduction Ltd This mteril is not copyright free. 27

33 4. Content guidnce A specific tx is where the tx is specific mount; for exmple, 5p tx on chocolte tht is pid whtever the price of chocolte. The supply curve shifts left from supply to supply + tx. The uyer pys prt of the tx ecuse of the higher price nd the supplier pys prt ecuse they now mke less revenue. Susidies increse supply, leding to reduced price which encourges production/consumption of good with positive externlities. Governments could introduce minimum price, where goods cnnot e sold t price elow this. A minimum price my e set y government to discourge consumption of prticulr good. Pmin is the minimum price nd is set ove the mrket price. Qd is the quntity demnded y consumers nd Qs is the quntity supplied. Compred to the mrket equilirium, firms hve extended supply due to the higher prices ut the consumers contrcted demnd. Qs-Qd gives n excess supply/surplus/glut. Scotlnd s ttempts to introduce minimum price for lcohol might e n interesting cse study to use. 28 Person Eduction Ltd This mteril is not copyright free.

34 4. Content guidnce Governments could introduce mximum price, where goods cnnot e sold t price ove this. A mximum price my e set y government to encourge consumption of prticulr good. Pmx is the mximum price nd is set elow the mrket price, P. Qd is the quntity demnded y consumers nd Qs is the quntity supplied. Compred to the mrket equilirium firms hve contrcted supply due to the lower prices ut consumers hve extended demnd. Qd-Qs gives n excess demnd/shortge. An exmple of this is Cyprus introducing mximum price on milk. Other methods of government intervention re s follows: Trde pollution permits to tckle negtive externlities. The government decides the desired level of pollution nd releses numer of permits. These permits cn e trded y firms so tht low polluters cn sell to high polluters for profit. Stte provision of pulic goods the government provides good or service, using tx revenue to fund it. These goods re not provided y the privte sector due to the free rider prolem. Provision of informtion the government provides informtion to consumers to correct ny prolem of informtion gps. Person Eduction Ltd This mteril is not copyright free. 29

35 4. Content guidnce Regultion to tckle negtive externlities. The government imposes rules regrding the production or consumption of goods or services. This is usully cked up leglly y fines/prison sentences, etc Government filure c Government filure exists when the government intervenes to correct mrket filure, ut the result is more inefficient lloction of resources nd there is net welfre loss. Students need to e wre of cuses of government filure. These include how the government cn cuse the distortion of price signls, unintended consequences such s smuggling nd illicit production, excessive dministrtive costs nd informtion gps. Exmples of mrkets include: griculturl sector (Cyprus milk mximum price), trnsport policies (Mexico City nd cr emissions), housing policies (rent controls), nd tocco nd lcohol policies (txing tocco nd lcohol, leding to smuggling). 30 Person Eduction Ltd This mteril is not copyright free.

36 4. Content guidnce Theme 2: The UK economy performnce nd policies This section provides ides nd suggestions for teching pproches for Theme 2 nd is not intended to e prescriptive. The specifiction must e referred to s the uthorittive source of informtion. 2.1 Mesures of economic performnce This topic includes ides tht students nd techers will return to throughout the course. It introduces the min mesures of economic performnce used in ssessing the UK economy: economic growth, infltion, unemployment nd the lnce of pyments. Students should e fmilir with oth the theory covered here nd its ppliction to the UK economy over the lst ten yers Economic growth c d e Gross Domestic Product (GDP) is very importnt economic vrile. Students should understnd wht GDP is, oth so s to understnd the mening of economic growth figures, ut lso to e le to pprecite the differences etween GDP, Gross Ntionl Product (GNP) nd GNI (Gross Ntionl Income), nd the limittions of using GDP to compre living stndrds. GDP is the vlue of ll goods nd services produced in country in one yer nd cn e mesured y dding up ll of n economy's incomes (wges, interest, profits nd rents) or expenditures (consumption, investment, government spending nd net exports). Both results should e the sme ecuse one person's expenditure is lwys nother person's income. Students need to understnd the vrious djustments tht cn e mde to ntionl sttistics in order to mke them more meningful. At more sic level, this includes the distinction etween rel (djusted for infltion) nd nominl figures, totl nd per cpit figures, nd vlue versus volume. Economists refer to severl mesures of totl economic production for individul countries, including Gross Domestic Product (GDP) nd Gross Ntionl Product (GNP). Another mesure seen incresingly is Gross Ntionl Income (GNI), essentilly n ugmented version of GDP. Gross domestic product (GDP) is the totl mrket vlue of ll goods nd services produced in the country in given yer. GDP does not include ernings y its residents while outside of the country. Gross Ntionl Income (GNI) is GDP plus income pid into the country y other countries for such things s interest nd dividends. Gross Ntionl Product (GNP) is the totl mrket vlue of ll goods nd services produced y domestic residents (GDP) plus income tht residents hve received from rod, minus income climed y non-residents. Students should e comfortle using economic growth dt to compre nd contrst different countries' economic performnce, nd to drw conclusions out single country's economic performnce over time. Students should lso hve n pprecition of the ssumptions mde in such process, nd ny other weknesses. This my link to n understnding of the role of rel dt, Purchsing Power Prity (PPP) djustments nd per cpit djustments. It is importnt tht economic growth is mesured ccurtely, one reson eing tht growth is n indictor of the success of current economic policies nd guide to future ones. Students need to understnd PPPs nd hve sic understnding tht PPP figures re djusted for differences in the cost of living etween countries. Person Eduction Ltd This mteril is not copyright free. 31

37 4. Content guidnce f g The stndrd of living does not just refer to income ut lso to the qulity of life nd economic welfre. There re mny prolems with using GDP figures to compre living stndrds over time nd etween countries. For exmple: GDP does not tke into ccount the improving qulity of (in prticulr) technologicl goods. GDP does not include unofficil or unpid work. The vlue of goods nd services tht re consumed y the producers, rther thn trded, is lso not included. This is prticulr issue in developing countries with higher levels of susistence griculture. Increses in rel GDP my not e shred eqully mong n economy's popultion: GDP per cpit shows verge income per person, ut the verging process my msk huge inequlities. There my e increses in other prolems longside economic growth. There my e more pollution, congestion, numer of hours worked, stress levels ll these cn contriute to worsening living stndrds even for those whose incomes re rising. In response to these issues, there hs een move towrds mesuring Ntionl Hppiness, rther thn just focusing on economic vriles. In the UK, the ONS mesures Ntionl Well-eing. Within the re of hppiness economics there hs een much dete out the 'Esterlin prdox', the ide tht hppiness does rise with verge incomes, ut only up to point. Beyond this, the mrginl gins in hppiness fll, perhps ecuse people cre out reltive s well s solute incomes Infltion e Students re required to distinguish etween infltion, defltion nd disinfltion when presented with dt in written, grphicl, tulr nd numericl forms. ( to d) The use of indices is intended to mke comprisons esier over time nd etween countries, nd se yer is chosen to mke effective comprisons. Students should e confident working with indices. Students should understnd tht the UK clcultes oth the CPI nd the RPI on monthly sis. Both mesures use 'shopping sket' of pproximtely 700 goods nd services. The prices of most of these items re collected from round 150 different loctions ech month. The indices re weighted to reflect the importnce of the vrious items. The weights for the RPI re minly derived from the ONS's Living Costs nd Food Survey. Both the contents of the skets nd the weights re updted nnully. Infltionry pressures my come from different sources. Students should understnd tht increses in ggregte demnd (AD), or decreses in (short-run or long-run) ggregte supply (AS) in n economy my cuse the verge price level to rise. This cn e illustrted on n AD/AS digrm. Students should lso e wre tht growth of the money supply will cuse incresed infltionry pressures, s individuls nd firms my spend their excess money on goods nd services, rising ggregte demnd. In ddition, the increse in the demnd for lour resulting from higher demnds for goods nd services will cuse rise in wges nd costs of production. 32 Person Eduction Ltd This mteril is not copyright free.

38 4. Content guidnce f Students should e le to explin the effects of infltion on consumers, firms, the government nd workers. These my include effects on: UK interntionl competitiveness uncertinty nd usiness plnning nd investment the rel vlue of svings the purchsing power of those on fixed incomes economic growth nd unemployment (the short run Phillips curve). A rpid rte of infltion might cuse wge-price spirl nd n increse in menu costs nd shoe lether costs Employment nd unemployment In the UK, unemployment is mesured y oth the climnt count nd the Interntionl Lour Orgnistion (ILO) mesure. In times of economic prosperity the climnt count nd the ILO mesures tend to move prt, with the ILO mesure higher thn the climnt count, nd the opposite in n economic slowdown. The study of the resons for these chnges gives deeper understnding of how the mesures re mde. The ide of under-employment ecme prticulrly importnt in the ftermth of the 2008 Glol Finncil Crisis. The numer of under-employed workers ws firly stle over the period efore the onset of the economic downturn in 2008, ut etween 2008 nd 2012 it incresed y 47%. In the UK, the ONS defines n under-employed worker s someone who is currently in employment, ut wnts to work more hours. c Employment nd unemployment re not the opposite sides of the sme issue in fct the numer of people in work in the UK is often incresing t the sme time tht unemployment rises. This might e cused y incresed immigrtion, for exmple, so there re more people in the lour mrket, some of whom get jos nd some who do not or replce others lredy working. Alterntively, it could e ecuse the numer of people who re inctive is flling. Economiclly inctive people re those ged etween 16 nd 64 who re not ville for work, or not looking for work. This includes full-time students, homemkers, those who re too sick or disled to work long term, those who hve tken erly retirement nd 'discourged' workers. d There re vrious nmes for different types of unemployment. For exmple, cyclicl or demnd deficient the ide tht unemployment levels might e relted to the usiness cycle nd clssicl or rel-wge tht unemployment might e positively relted to wge pressures, especilly when wges re deliertely mintined ove equilirium level. The reltive importnce of some types might e considered, for exmple, tht structurl unemployment might hve long-term detrimentl effects, wheres frictionl unemployment might not. Other types should lso e considered: for exmple, sesonl. Ech type of unemployment hs different implictions for government policy. e Students should e wre tht lck (or undnce) of skills in n economy is likely to impct on the occuptionl moility of lour nd the rtes of employment nd unemployment. This is likely to e linked to the concept of structurl unemployment. Students should lso hve sic understnding of the effects of net inwrd or outwrd migrtion on n economy s employment nd unemployment rtes, nd how the skill levels of migrnts might ffect this. Person Eduction Ltd This mteril is not copyright free. 33

39 4. Content guidnce f Unemployment hs predominntly negtive effects on the individuls involved, firms, the government nd the whole of society, such s: lower stndrd of living for consumers; flling sles, revenues nd profits for firms; lower tx revenues for the government comined with higher expenditure on enefits; nd opportunity cost the goods nd services which could hve een produced y the unemployed Blnce of pyments c d The four elements of the current ccount of the lnce of pyments (trde in goods, trde in services, investment income nd interntionl trnsfers) should e understood, nd their reltive importnce to the UK economy pprecited, lthough the focus is on trde in goods nd services. Time series dt should e used to show the context of n imlnce. Students should understnd wht is ment y n economy hving either current ccount deficit or current ccount surplus, nd e le to nlyse some fctors which might led to either of these. See section for more detil here. Chnges in the lnce of pyments on the current ccount should lso e understood, from the viewpoint of their effect on n economy, prticulrly in reltion to chievement of the government's other mcroeconomic ojectives. It would e eneficil to consider whether the costs of trying to correct trde/current ccount imlnce re worthwhile in terms of the dmge they my cuse to other economic vriles. Students should understnd tht one country s exports re nother country s imports. In this wy, the sum of ll countries trde lnces will theoreticlly e zero. Economic conditions in one country might impct on economic conditions in nother country through their impct on demnd for imports; for exmple, through their impct on demnd for imports. 2.2 Aggregte demnd (AD) This topic introduces AD nd its components. Students need to understnd the min fctors which influence ech of the components nd how chnges in these fctors would ffect AD The chrcteristics of ggregte demnd (AD) c ( nd ) Students should hve n pprecition of the reltive importnce of the components of AD for the UK economy: household consumption (C) mkes up pproximtely 60% of AD, government spending (G) ccounts for pproximtely 25% of AD, investment (I) is round 15% of AD, nd net exports (X-M) round 1% of AD. Therefore 1% increse in consumption would hve much greter effect on the UK economy thn 1% increse in ny of the other components of AD. Aggregte demnd is drwn s downwrd sloping for severl resons. First, the rel lnce effect; for exmple, n increse in the verge price level reduces the purchsing power of households, usinesses, government nd the foreign sector, so reducing the quntity of rel output demnded. Another reson for drwing downwrd sloping AD re tht, t higher verge prices, n economy is less likely to export, more likely to import (decresing the X component nd incresing the M component of AD, nd therefore decresing AD overll) the interntionl competitiveness rgument. A third reson why the AD curve slopes downwrds is tht, t higher verge prices, the interest rte is likely to e higher, mening tht investment ( component of AD) is lower. Households nd firms might lso sve more. 34 Person Eduction Ltd This mteril is not copyright free.

40 4. Content guidnce d Students should e wre tht chnge in the verge price level in n economy will cuse movement long the AD curve, while chnge in the vlue of the components of AD will cuse shift of the curve Consumption (C) c Disposle income is the income tht n individul receives fter hving pid ny direct txes nd received ny trnsfer pyments/enefits. We expect there to e positive reltionship etween disposle income nd consumption. Generlly, s consumers sve more, they spend less, nd vice vers. The (household) svings rtio gives n ide of the verge extent of sving for ll households in the economy. It is clculted s the percentge of disposle income tht is sved. The interest rte is mjor influence on consumer spending. As interest rtes rise, consumers hve more incentive to sve, s the return on sving rises, so tend to sustitute sving for spending. In ddition, the cost of uying on credit rises nd interest pyments on ny vrile rte lons/mortgges lredy tken out will rise, reducing consumers' discretionry income. Rises in the interest rte my lso led to fll in verge house prices (s demnd for houses flls ecuse of the incresed cost of tking out mortgge), creting negtive welth effect in the economy. The mount tht consumers spend is lrgely influenced y the confidence of the consumer; for exmple, re they worried out losing jo, confident tht shres nd house prices re growing, or sving ecuse of worries out smll pension? Actul chnges in the economy (such s rises in the FTSE or in verge house prices) cn cuse rel spending increses if people decide to trde in their incresed welth or my simply increse confidence in spending. In contrst, flling shre prices or flling house prices might cuse people to reduce spending Investment (I) Students should understnd tht net investment ccounts for the deprecition of cpitl, while gross investment is efore deprecition is tken into ccount. Students should understnd the rnge of fctors which might influence the level of investment in the UK economy. The interest rte, s the cost of orrowing, is likely to hve n inverse reltionship with the mount of investment only few projects will e vile if the cost of credit is high. Incresingly, usiness confidence is regrded s prticulrly significnt influence on firm s decisions to invest. The use of the term niml spirits y Keynes referred to prticulr sort of confidence; nive optimism, where entrepreneurs, encourged y rising mrket, tended to tke too mny risks. In contrst, Keynes thought tht if there ws gret uncertinty, only mnic, strong-willed entrepreneur would put cpitl t risk. When niml spirits re strong, investment is sufficient to mintin ggregte demnd; when they re wek ggregte demnd flls, nd the economy lpses into depression. Exmples of these contrsting situtions could e explored. Following on from the credit crunch, students should lso hve n pprecition tht nks my not e willing to lend to firms even if firms do wish to orrow. Person Eduction Ltd This mteril is not copyright free. 35

41 4. Content guidnce Government expenditure (G) Government spending is y centrl nd locl government on goods nd services. See section for detils of wht students need to know out the trde cycle. Students should understnd how government spending on mens-tested enefits rises s the trde cycle enters the slowdown nd recession phses nd flls s economic growth picks up. In ddition, the government my choose to chnge the level of government expenditure s prt of its fiscl policy. It is useful to nlyse the nnul UK Budget nd Autumn Sttement in terms of students seeing wht fiscl policy chnges the government is mking, nd trcing through their likely effect on UK AD Net trde (X-M) Students should e le to nlyse some fctors which might ffect the UK's (net) trde lnce. Imports into the UK re usully norml goods. Therefore, n increse in rel incomes in the UK will led to n increse in demnd for imports, ceteris prius, worsening the UK's net trde lnce. If the exchnge rte strengthens (i.e. the pound gets stronger) then exports will ecome reltively expensive nd imports reltively chep. This would worsen the UK's trde lnce. However, if the competition is sed on qulity rther thn price, then the chnges in demnd might not e significnt nd the trde lnce might not suffer t ll. Students lso need to understnd how the economic performnce of other economies ffects the trde lnce of the UK; for exmple, how slow growth in the Eurozone in 2012 to 2014 ffected the UK's export sles. Students need to understnd tht protectionism (i.e. restrictions on free trde such s triffs) will hve n impct on the UK s net trde lnce. 2.3 Aggregte supply (AS) This topic introduces ggregte supply (AS) nd distinguishes etween the shortrun nd long-run AS curves. Students need to understnd the min fctors which influence ech of these. This topic lso introduces students to the dete etween the Keynesin nd clssicl schools of economic thought s to the shpe of the long-run AS curve The chrcteristics of AS ( to c) The short-run AS curve might e shown s either stright, upwrd sloping line or sttic ckwrd-ending L-shpe (Keynesin). The positive grdient might e explined either ecuse ll the industry supply curves tht re dded together to form the SRAS curve re upwrd sloping or ecuse, if rel output is to increse in the short run, firms will hve to py overtime or more money for the quick delivery of rw mterils, etc. As such, s rel output rises, costs per unit to the firms nd industries re likely to rise. These incresed costs will tend to e pssed on to the consumer through higher prices, so the increse in rel output hs resulted in rise in the verge price level. Movements long the AS curve occur when there is shift in AD, s new equilirium point is estlished. Shifts of the AS curve occur when there is chnge in the conditions of supply in the mcroeconomy. 36 Person Eduction Ltd This mteril is not copyright free.

42 4. Content guidnce Short-run AS Short-run AS will e influenced y firms' costs of production; for exmple, chnge in the price of oil or nother mjor commodity/rw mteril. If the UK imports rw mteril, then its cost will lso e ffected y the exchnge rte Long-run AS Students should understnd tht the clssicl LRAS curve is perfectly inelstic. Clssicl economists elieve tht in the long run ll mrkets will cler, mening tht there cn e no output gp in the long run, nd insted the economy will lwys return to producing t its mximum potentil level of output. Conversely, Keynesin economists elieve tht it is possile to hve long-run equilirium where mrkets do not cler nd so there cn e spre cpcity in n economy in the long run. The shpe of the Keynesin LRAS curve shows tht when there is lots of spre cpcity in the economy, it is possile to increse the level of rel output with no resulting increse in the verge price level. As spre cpcity egins to e used up, rise in rel ntionl output will cuse the costs of the fctors of production to rise, so the price level rises with output. Eventully, the economy will rech full employment, where output cnnot e incresed since ll the fctors of production re eing utilised. This finl section of the Keynesin LRAS curve is the sme s the clssicl LRAS curve. Long-run AS in n economy will e ffected y fctors tht chnge the quntity or qulity of the fctors of production; for exmple, improved eduction will (in time) increse the qulity of lour in the economy nd increse LRAS, while n increse in immigrtion would increse the quntity (ignoring ny effects on the verge qulity) of lour in the economy, lso leding to n increse in LRAS. 2.4 Ntionl income This topic introduces some importnt concepts: the circulr flow of income model nd the multiplier. Students need to understnd these ides in nd of themselves, ut lso their impct on other topics covered; for exmple, the significnce of the multiplier to shifts in AD nd hence to the use of AD/AS digrms to show how events in the economy cuse chnges in the equilirium price level nd rel ntionl output. Detil hs een included on clculting the vlue of the multiplier nd students need to e confident in nlysing the effects of the multiplier in quntittive, s well s qulittive, mnner. Person Eduction Ltd This mteril is not copyright free. 37

43 4. Content guidnce Ntionl income A simple digrm of the circulr flow of income could e used in this section: The purpose of the digrm is to stress the concept of money flows, which re chnged, with multiplied effects, when there is chnge in injections or withdrwls. Students should understnd the difference etween income s flow concept, nd welth s stock nd should e le to give some exmples of oth. They should lso pprecite tht if income increses re going to hve direct impct on welth then decision must e mde to forego current consumption in order to enjoy incresed welfre in the future tht is, the opportunity cost of the incresed future welfre is current consumption Injections nd withdrwls Students should understnd tht government spending (G), investment (I) nd exports (X) re injections into the circulr flow of income, nd txtion (T), svings (S) nd imports (M) re withdrwls (or lekges) out of the circulr flow. When injections re greter thn withdrwls the mount of money in the circulr flow increses, representing economic growth. When injections re less thn withdrwls the mount of money in the circulr flow decreses, representing fll in rel GDP. Students should e le to nlyse chnges in the economy in terms of their impct on the circulr flow; for exmple, rise in the interest rte would e expected to increse sving, withdrwl, nd decrese investment, n injection, reducing the mount of money in the circulr flow of income, ceteris prius. 38 Person Eduction Ltd This mteril is not copyright free.

44 4. Content guidnce Equilirium levels of rel ntionl output Equilirium income or equilirium rel ntionl output occurs where plnned AD equls plnned AS. Students re required to drw AD/AS digrms to show the effects of chnges in AD, SRAS nd LRAS (Keynesin nd clssicl) on the equilirium price level nd the equilirium rel ntionl output level The multiplier d The multiplier rtio is the rtio of chnge in equilirium rel income to the utonomous chnge (the injection) tht rought it out. For exmple, if 1m injection into the circulr flow results in 2m increse in ntionl income, the vlue of the multiplier is 2. (, c nd f) An injection into the circulr flow of income, such s the sle of exports, mens tht there is n immedite increse in AD. However, the extr income rised y selling goods nd services rod will increse the incomes of those mking the goods nd services nd t lest some of this income will e spent in the economy. Whtever is not withdrwn from the circulr flow will cuse second round increses in AD, which led to further rounds of income nd spending. These knock-on effects re the multiplier effects of injections. When injections decrese, the process works in reverse i.e. there will e downwrd multiplier effect. Students should understnd tht the most importnt fctor in determining the size of the multiplier is the size of the withdrwls from the circulr flow wht proportion of the dditionl income is sved y households, wht proportion is spent on imported goods nd wht proportion is pid to the government in the form of txtion. (d nd e) The multiplier is inversely proportionl to the mrginl propensity to withdrw (MPW) the proportion of one unit of dditionl ntionl income which is withdrwn from the circulr flow, or the sum of the mrginl propensities to sve, tx nd import (MPS + MPT + MPM). Students will e expected to know the stted formule nd to perform simple clcultions involving them. 2.5 Economic growth This topic rings together severl different spects of economic growth. Students re sked to consider the difference etween ctul nd potentil growth, the possile cuses of growth, nd its positive nd negtive consequences. Periods of growth re plced in context y looking t the trde cycle model, nd in prticulr the likely chrcteristics of periods of high growth (ooms) nd periods of negtive growth (recessions). The concept of the output gp is lso introduced nd linked to ides of recession nd oom Cuses of growth Economic growth cn e chieved y increses in the components of ggregte demnd; for exmple, n increse in investment. The size of this growth depends on the size of the multiplier nd lso on the shpe of the AS curve drwn. Growth cn lso e chieved y increses in the quntity or improvements in the qulity of ny of the fctors of production; for exmple, productivity growth or immigrtion. The effect is to shift the AS curve to the right. It is importnt to e le to compre nd contrst the cuses of growth nd to e le to illustrte them with n AD/AS digrm. Person Eduction Ltd This mteril is not copyright free. 39

45 4. Content guidnce c Actul growth is mesured s n increse in rel GDP nd potentil growth is n increse in the cpcity of the economy. Some countries (for exmple, Chin) hve generted economic growth through huge increses in the vlue of their exports export-led growth Output gps c Trends in the growth rte re shown y chnges in rel GDP over time; these my e compred with chnges in cpcity over time or compred with the trend or sustinle rte of growth. The difference etween ctul rel GDP nd mximum potentil rel GDP is the output gp. If ctul rel GDP is less thn potentil rel GDP, then there is negtive output gp. This signifies tht the economy is operting with spre cpcity nd unemployment is likely to e reltively high. In the short run, it my e possile for ctul rel GDP to e greter thn potentil rel GDP: positive output gp. In this cse, the economy is operting t over-cpcity nd infltionry pressures re likely to e incresing. It is very difficult to estimte the size of the output gp for n economy, s it involves estimting the economy s mximum potentil output level. An AD/AS digrm cn e used to show the size of the negtive output gp in n economy nd students should e le to nlyse how chnges in the economy tht ffect AD nd AS lso ffect the likely size of the output gp. Keynesin economists elieve tht negtive output gp cn exist in the long run s well s the short run: Clssicl economists elieve tht negtive nd positive output gps cn only exist in the short run: 40 Person Eduction Ltd This mteril is not copyright free.

46 4. Content guidnce Trde (usiness) cycle The trde or usiness cycle descries how the economy tends to exhiit recurring trends in economic growth rtes. Booms tend to e followed y economic slumps or slowdowns, which tend to e followed y recession, efore the economy moves into the recovery phse, nd then ck into oom. In oom period there tends to e: high rtes of economic growth low rtes of unemployment (low levels of spre cpcity or perhps even positive output gp) demnd-pull infltionry pressures high consumer nd usiness confidence improving government udget lnce (s tx revenue rises, nd government expenditure on enefits flls). Person Eduction Ltd This mteril is not copyright free. 41

47 4. Content guidnce c In the UK, recession is defined s period of two or more consecutive qurters of negtive economic growth. In recession there tends to e: negtive rtes of economic growth high rtes of unemployment prticulrly demnd-deficient unemployment (high levels of spre cpcity nd lrge negtive output gp) low rte of infltion low usiness nd consumer confidence worsening government udget lnce The impct of economic growth Students should explore the enefits of economic growth, such s: higher stndrds of living, s verge incomes rise nd more goods nd services re ville for consumption incresed revenues nd profits for firms incresed employment opportunities n improvement in the government udget lnce decrese in solute poverty rtes incresed consumer nd usiness confidence, leding to more investment improvement in the environment s more efficient, clener technology is developed. The costs of economic growth include fctors such s: negtive impct on the environment s non-renewle resources re used up nd negtive production externlities re creted the opportunity cost of growth in order to produce more cpitl goods tody, we hve to forego the production of consumer goods n increse in reltive poverty/income inequlity worsening of the trde lnce s consumers purchse more imports with their incresed verge incomes nd incresed infltionry pressures reduce the competitiveness of exports mcroeconomic instility s high infltion leds to oom nd ust cycles the socil effects of incresed production more stress, less leisure time. Students my crete links with y considering whether n increse in income necessrily increses living stndrds. Students could lso consider whether economic growth is eneficil nd wht fctors determine whether the enefits of economic growth outweigh the costs (or vice vers). 2.6 Mcroeconomic ojectives nd policies This topic introduces the different possile mcroeconomic ojectives of governments nd how they might conflict. This is n importnt topic s it lso includes the types, effects nd evlution of demnd-side (fiscl nd monetry) nd supply-side policies. In ddition to their generl knowledge of the UK economy over the pst ten yers, students should pply their knowledge of demnd-side policy to nlyse the likely effects nd effectiveness of US nd UK policy responses to oth the Gret Depression nd the Glol Finncil Crisis. 42 Person Eduction Ltd This mteril is not copyright free.

48 4. Content guidnce Possile mcroeconomic ojectives ( to g) Students should hve sense of the trends in mcroeconomic mesures over the pst ten yers nd the stge t which governments might ecome concerned out them. The side effects of mcroeconomic prolems could e considered nd the chnging importnce of ojectives might e used s wys of weighing up which ojectives re the most importnt to government; for exmple, the more recent focus on reducing the government udget deficit Demnd-side policies Students should understnd tht monetry policy involves using interest rtes nd the money supply to ffect AD, while fiscl policy involves government spending nd txtion. In the UK, monetry policy is currently conducted y the Bnk of Englnd, while fiscl policy is conducted y the Government. The digrm elow illustrtes the trnsmission mechnisms involved with chnges in the Bnk Rte in the UK: c d e f Students should lso hve sic knowledge of how quntittive esing hs een used in the UK nd how increses in the money supply would e expected to ffect ggregte demnd. The two instruments of fiscl policy re government spending nd txtion. The opertion of fiscl policy involves the government chnging the levels of these two vriles so s to ffect the economy. Students should e le to define, nd understnd wht is ment y, udget (fiscl) deficit nd udget (fiscl) surplus. A direct tx is tx on income, such s income tx, corportion tx or cpitl gins tx. An indirect tx is tx on expenditure on goods nd services, such s VAT, excise duty or stmp duty. Students should e le to use AD/AS nlysis to explin nd illustrte the effects of demnd-side policies. Person Eduction Ltd This mteril is not copyright free. 43

49 4. Content guidnce g h The Bnk of Englnd s Monetry Policy Committee (MPC) meet on t lest monthly sis to set the Bnk Rte nd, if pplicle, the level of the sset purchse fcility (quntittive esing). Students should explore the different fctors nd dt tht the MPC consider in coming to their decision. In My 2014, the UK infltion trget ws 2% CPI; in ssessments the dt chosen will mke use of the trget currently in use y the ody in chrge of monetry policy. These fctors my chnge nd it is importnt tht students hve good working knowledge of contemporry monetry instruments, opertions nd trgets. Students do not need to know out the likely cuses of the Gret Depression or the Glol Finncil Crisis of 2008; neither do they need to know out the gold stndrd, other thn tht it sets rte of conversion for currency into gold. Rther, these re two contexts in which students cn pply their knowledge of demnd-side policies n ility to nlyse the likely effects of the policies is more importnt thn recll of the precise detils of the policies. Demnd-side policies in the Gret Depression: Fiscl policy In the US, Roosevelt's New Del involved huge fiscl stimulus pckge, s the US government incresed its spending mssively. The money ws spent on uilding pulic infrstructure, nd employing people in oth conservtion nd construction. There is dete surrounding the extent to which the New Del helped to end the Gret Depression or whether it ws relly the huge government spending on fighting the Second World Wr tht did so. In ddition, the US government introduced protectionist policies like the Smoot Hwley Triff Act in (Knowledge of the detils of the Act is not required.) In the UK, focus ws more on efforts to lnce the government udget. In 1931, n Emergency Budget cut pulic sector wges nd unemployment py y 10% nd rised income tx from 22.5% to 25%. These mesures were defltionry nd reduced purchsing power in the economy, worsening the sitution. In 1932, the UK government introduced triffs t rte of 10% on ll imports except those from the countries of the British Empire. Monetry policy Economists disgree s to the effect of monetry policy on the course of the Gret Depression in the US. Some lme tight monetry policies for the strt nd the length of the Depression, while others disgree even tht monetry policy ws tight. In Ferury 1930, the Federl Reserve cut the interest rte from 6% to 4%, lthough in lte 1930 it rised it gin to help to preserve the vlue of the dollr fter sustntil mounts of dollrs were converted into gold, wekening the currency. Critics rgue tht these increses in the interest rte further restricted the vilility of credit for usinesses, cusing more nkruptcies. The US government cted to increse the money supply from April to June 1930, ut economists re divided over the effectiveness of this. In the UK, in Septemer 1931 the government ws finlly forced to ndon the gold stndrd. Immeditely the exchnge rte of the pound fell y 25%, which improved the interntionl competitiveness of the UK. Following this, interest rtes were lso reduced from 6% to 2%, dding to the economic recovery. 44 Person Eduction Ltd This mteril is not copyright free.

50 4. Content guidnce i Demnd-side policies in the Glol Finncil Crisis: Fiscl policy In 2008, the US government instituted the Economic Stimulus Act of 2008, $152 illion fiscl stimulus pckge. This ws followed y the Americn Recovery nd Reinvestment Act of 2009, $787 illion ill which involved government spending over period of severl yers. In the UK, numer of fiscl mesures were introduced throughout 2008, including tx cut for sic rte tx pyers, temporry 2.5 percentge point cut in the VAT rte, 3 illion worth of investment spending rought forwrd from 2010 nd vriety of other mesures such s 20 illion Smll Enterprise Lon Gurntee Scheme. Further mesures were unveiled in the 2009 Budget, including trining help for the young unemployed nd cr scrppge scheme. However, from 2010 focus moved to mesures to reduce the udget deficit. Monetry policy In the US, the Federl Reserve cut the interest rte from 5.25% to 4.25% over the finl three months of 2007, nd then cut it further seven times over the course of 2008, to go to rte of %. In ddition, the US used three rounds of quntittive esing (QE) in order to oost the money supply QE1 in , QE2 in 2010 nd QE3 in These led to the Federl Reserve incresing the vlue of the ssets it held from less thn $1 trillion in 2007 to more thn $4 trillion in Jnury Despite the size of this increse, economists re still deting how effective QE hs een. In the UK, the MPC cut the Bnk Rte from 5.75% to 5.5% in Decemer Over the course of 2008 it ws cut further five times, to tke it to 2.0% y the end of the yer. Three further cuts in the first three months of 2009 took it to historic low of 0.5% in Mrch Between Mrch nd Novemer 2009, the MPC uthorised the purchse of 200 illion worth of ssets, mostly UK government det or gilts. The MPC voted to egin further purchses of 75 illion in Octoer 2011 nd, susequently, t its meeting in Ferury 2012 the Committee decided to uy n dditionl 50 illion. In July the MPC nnounced the purchse of further 50 illion to ring totl ssets purchses to 375 illion. Students should e le to use AD/AS nlysis to explin nd illustrte the effects of demnd-side policies nd to discuss their likely strengths nd weknesses. When doing so, they should e creful to relte their nlysis to the chievement of the stted im of the policy Supply-side policies A supply-side policy is government scheme to promote mrket forces, cut costs nd to rise the full employment level of output. Students should e le to distinguish etween mrket-sed nd interventionist supply-side policies. Mrket-sed policies focus on the power of the free mrket, or llowing the forces of supply nd demnd to eliminte equiliri imlnces. The role of the government in mrket-sed policies is limited since it tends to interfere with the mrket mechnism. Conversely, interventionist policies focus on the need for the government to intervene in mrkets to chieve gol. Person Eduction Ltd This mteril is not copyright free. 45

51 4. Content guidnce c Mrket-sed supply-side policies include: reducing income nd/or corportion tx rtes deregulting nd/or privtising the pulic sector reducing or olishing the ntionl minimum wge nd trde union power reforming the enefits system to encourge workers to tke ville jos encourging free trde. Interventionist supply-side policies include: incresed government spending on eduction nd trining incresed government spending on helthcre incresed government spending on infrstructure stricter government competition policy policies to reduce the geogrphicl immoility of lour, such s improving informtion on jo vcncies nd susidising worker reloction. Now tht mny UK firms hve een privtised, the stndrd rgument tht government cn sell off stte-owned usinesses is losing its potency. It is stronger to rgue tht competition etween firms cn e improved, with descriptions nd exmples of how this might e chieved. Similrly, in reltion to reducing trde union power in the UK, students should focus on dditionl mesures tht might e undertken, rther thn wht hs lredy een done. Students re required to show the likely impct of successful supply-side policies using either Keynesin or clssicl long-run ggregte supply curve on n AD/AS digrm: d Students should e le to discuss the likely strengths nd weknesses of supply-side policies. When doing so, they should e creful to relte their nlysis to the chievement of the stted im of the policy Conflicts nd trde-offs etween ojectives nd policies ( to c) The Phillips curve, n empiricl oservtion in 1958, comments tht shortge of lour might set off n increse in wges. The impliction is tht there might e trde-off etween reductions in unemployment nd increses in infltion. This is set ginst the clssicl view tht there is only unemployment if wges re too high tht is, if the supply of lour is greter thn the demnd for lour in which cse if more people re llowed to ecome unemployed the pressure on wges will fll. Knowledge of the shortrun Phillips curve only is required. 46 Person Eduction Ltd This mteril is not copyright free.

52 4. Content guidnce Another trde-off tht my e considered is etween economic growth nd the current ccount of the lnce of pyments. If n economy is growing quickly, s in Indi, it is likely to suck in mny imports nd exporters hve reduced incentive to export if the output cn e sold t home. However, if the growth is export-led, s in Chin, economic growth my improve the current ccount. (Note tht country-specific dt is not required.) Growth my dmge the environment if it involves incresed mnufcturing ut if service sed it my not. Indeed, the incresed incomes from growth might enle country to convert to clener or renewle fuels or tighten environmentl legisltion. There is some overlp with here, s students my lso consider the possile conflicts etween chieving economic growth nd reducing income inequlity, nd etween chieving economic growth nd controlling infltion. There re mny more potentil conflicts etween ojectives nd in prticulr students should e confident in using AD/AS nlysis to explin, illustrte nd evlute these. Students should lso hve n wreness of possile policy conflicts nd trdeoffs tht my rise. For exmple, n increse in government spending (prt of fiscl policy) is likely to hve direct, positive impct on the supply-side of the economy through improved stndrds of helthcre or eduction, or through the impct of chnges in txes nd enefits. However, the incresed spending might cuse prolems in supply in the short run, leding to incresed demndpull infltionry pressures in the economy. Alterntively, incresing interest rtes (monetry policy) in order to control infltion is often seen s eing dmging to the supply-side of the economy. If higher interest rtes reduce investment in the economy, then this my led to incresed cost-push infltionry pressures, while reducing demnd-pull infltionry pressures. Other policy conflicts lso exist, nd students should e le to nlyse these nd use them to evlute the effectiveness of suggested mcroeconomic policy. Person Eduction Ltd This mteril is not copyright free. 47

53 4. Content guidnce Theme 3: Business ehviour nd the lour mrket This section provides ides nd suggestions for teching pproches for Theme 3 nd is not intended to e prescriptive. The specifiction must e referred to s the uthorittive source of informtion. 3.1 Business growth In this topic students will explore usiness size, why some remin smll nd why others might grow, nd how they do this. When looking t how usinesses grow students will consider the dvntges nd disdvntges of ech method. Students will lso explore resons for, nd the impct of, demergers Sizes nd types of firm c d A strting point could e to explore why firms grow nd how the following might mke firm seek growth: Profits to generte more profits to give shreholders etter return. Costs to enefit from economies of scle, resulting in lower unit costs of production. Mrket power to ecome more dominnt force in their mrket; if firm domintes the mrket it cn increse its prices. Reducing risk firms might wnt to diversify so tht if sles drop in one mrket they hve nother mrket to generte sles. Mngeril motives senior mngers my wish to grow in order to control lrger usiness. This cn e contrsted with why some firms remin smll. Possile resons include: lck of finnce for expnsion; voiding diseconomies of scle; providing niche products which hve low PED or high YED; offering more personl service s they get to know customers nd their needs; cting s suppliers; nd cting s locl monopolies t specific times. Students need to consider the significnce of the divorce of ownership from control. Shreholders own the usiness nd ppoint directors nd mngers to run it on their ehlf. Shreholders wnt to mximise profits to mximise their dividends, wheres mngers might hve different motives, such s wnting to increse sles nd revenue t the expense of profits. This divorce of ownership cretes the principl-gent prolem. The principl is the shreholder nd the gent is the mnger nd their divergent ims. This my led to the usiness growing lrger thn firm iming to mximise profit. Students re required to know nd understnd the difference etween pulic nd privte sector orgnistions. Students re required to know nd understnd the difference etween profit nd not-for-profit orgnistions Business growth Exmples should e used to support understnding of how usinesses grow: Orgnic growth is where usiness grows internlly y reinvesting profits or orrowing from nks. Resons for internl growth include: to increse mrket shre; the development of new innovtive products, finding new mrkets to sell its existing products, getting existing customers to uy more products through dvertising or investing in new cpitl or technologies to expnd production. Exmples include Suwy, Wsi, Poundlnd nd Hotel Chocolt. 48 Person Eduction Ltd This mteril is not copyright free.

54 4. Content guidnce c Forwrd nd ckwrd verticl integrtion is where two usinesses t different stges of production, ut in the sme industry, join together. Forwrd verticl is where one firm integrtes with firm in stge of production closer to the customer, such s rewer uying pu chin. Bckwrds verticl is where firm integrtes with nother in the stge of production further wy from the customer, such s cr mnufcturer uying tyre mnufcturer. Horizontl integrtion is where two usinesses t the sme stge of production in the sme industry join together, such s merger etween two nks or two chocolte mnufcturers. Exmples include Virgin Money nd Northern Rock, nd Amzon nd LoveFilm. Conglomerte integrtion is where two usinesses in different industries merge. For exmple, Tt s cquisitions in different sectors including Jgur Lnd Rover, Corus, Ritz-Crlton hotels, British Slt, Citigroup nd Tetley. Students should consider the dvntges nd disdvntges of ech. Exmples include the following: Verticl integrtion dvntges include greter control over the supply chin resulting in reducing costs nd improving qulity, nd etter ccess to rw mterils; disdvntges include different cultures in usinesses nd diseconomies of scle. Horizontl integrtion dvntges include economies of scle, spreding risk, llowing rtionlistion nd reducing competition; disdvntges include different cultures in usinesses nd diseconomies of scle. Conglomerte integrtion dvntges include reducing risk y operting in different mrkets nd enefiting from knowledge from the other mrket; disdvntges include the requirement for different skills, not necessrily enefiting from economies of scle nd culturl difference. Students need to consider constrints on usiness growth, including the size of the mrket, limited ccess to finnce, owner ojectives nd regultion Demergers A demerger is when usiness sells off one or more of the usinesses tht it owns into seprte compny. Resons for demergers include: culturl differences, creting more focused firms, protecting the vlue of the firm, reducing the risk of diseconomies of scle, rising money from sset sles nd return to shreholders to meet requirements of competition uthority regultors. Exmples include the Foster s Group demerging its wine nd eer divisions nd Lloyds TSB Bnking Group demerging to crete two seprte nks TSB nd Lloyds Bnk. Students should e le to consider the impct of demergers on usinesses, workers nd consumers, such s: usinesses llowing focus on the core usiness, rising funds from selling prt of the usiness, removing loss-mking prts of the usiness workers incresed jo security if loss-mking prts of the usiness re demerged, reduced conflict etween cultures, incresed focus on the usiness to enle it to e more profitle consumers greter competition leds to lower prices, more focused usinesses re le to etter meet consumer needs. Person Eduction Ltd This mteril is not copyright free. 49

55 4. Content guidnce 3.2 Business ojectives This section introduces students to the key gols of usinesses. Profit mximistion cn e connected with rtionl decision mking nd the ssumption of profit mximising should e chllenged. Students should consider tht people running usinesses re likely to hve different gols nd therefore my revenue nd sles mximise. Understnding wht stisficing is nd why it is likely to occur is useful here. This topic requires digrms nd students should e le to produce digrms nd use formule to illustrte different usiness ojectives Business ojectives Students should consider wht motivtes firm nd the min prticipnts nd influencers of firms, including owners, directors nd mngers, workers nd consumers. The ssumption of rtionlity mens tht shreholders will seek to mximise their utility y mximising profits. Profit mximistion occurs where Mrginl Revenue is equl to Mrginl Costs (MR=MC). As shreholders will e motivted y mximising their dividend to mximise their profits from the compny, it is ssumed tht the firm will wnt to mximise its profits. However, when pricing ccording to MR=MC firms my find they re loss-mking. Keynesin economists elieve tht firms will try to mximise their long-run rther thn short-run profits. This is sed on firms using cost-plus pricing where firms clculte the verge cost nd dd mrk-up. Firms will djust price nd output in response to chnges in mrket conditions. However, rpid price chnges my ffect firm s position in the mrket. Consumers dislike rpid price chnges, nd my see price reductions s signs of firm s despertion nd distress. So rther thn djusting prices rpidly they will continue to chrge the current price nd my mke loss in the short term ut will djust the price to the profit mximising point in the long term. Like shreholders, mngers will lso seek to mximise their utility. Mngers re often pid slry tht is linked to the mount of sles they chieve. So to mximise their own utility they will seek to mximise sles so they chieve higher slry. Sles mximistion is where the usiness mkes the mximum sles possile while still reking even. This occurs where Averge Revenue = Averge Cost (AR=AC). Similrly, some mngers will wnt to mximise their utility y mking s much revenue s possile. Revenue mximistion is where the usiness mkes the mximum revenue nd occurs where Mrginl Revenue = 0 (zero). Mngers my e motivted y high slries, the numer of people under their control nd the vilility of fringe enefits. They my, therefore, pursue policies other thn profit mximistion. However, if they ignore profit shreholders cn revolt, nd my vote out the mngers. So often mngers will profit stisfice where they stisfy the demnds of shreholders. Once those demnds hve een met, mngers would e free to mximise their own rewrds from the compny they will do just enough to stisfy the shreholders nd void eing dismissed. This mens they re likely to give n outcome somewhere etween profit mximistion nd sles mximistion. Students re required to show digrmmticlly the positions of profit, revenue nd sles mximistion. The monopoly digrm elow illustrtes the three positions. Students re required to identify the condition for ech; for exmple, MR=MC, MR=0 nd AR=AC. 50 Person Eduction Ltd This mteril is not copyright free.

56 4. Content guidnce 3.3 Revenues, costs nd profits This section will support students in exploring theories of the firm. Students re required to understnd the reltionships etween totl, verge nd mrginl revenue. They should understnd how PED reltes to revenues. Similrly students will need to clculte nd understnd the reltionships etween different costs. An pprecition of the short nd long run is essentil here. Economies nd diseconomies of scle should e covered. When looking t profit, students should explore supernorml nd norml profit, nd understnd the short- nd long-run shut-down points Revenue Students re required to know the formule for ech of the following: Totl revenue = price x quntity Averge revenue = totl revenue quntity Mrginl revenue = chnge in revenue chnge in quntity Students will need to understnd the reltionship etween the revenues. It would e useful for them to see the reltionships numericlly nd digrmmticlly. Students could lso consider wht hppens if usiness cnnot djust the price nd the reltionship etween the different revenues. This will support the study of perfect competition. Students should consider PED long demnd/verge revenue curve nd how this reltes to totl revenue. Students might find it useful to show the reltionship digrmmticlly nd should rememer tht: when demnd is elstic, incresing price will reduce totl revenue nd decresing price will increse totl revenue when demnd is inelstic, incresing price will increse totl revenue nd decresing price will decrese totl revenue. Person Eduction Ltd This mteril is not copyright free. 51

57 4. Content guidnce Costs c Students re required to know the formule for ech of the following: Totl cost = totl fixed cost x totl vrile cost Totl vrile costs = vrile cost x quntity Averge (totl) cost = totl cost quntity Averge fixed cost = totl fixed cost quntity Averge vrile cost = totl vrile cost quntity Mrginl cost = chnge in cost chnge in quntity Students should understnd the reltionship etween the different costs. It would e useful for them to see the reltionships numericlly nd digrmmticlly. You could provide students with price nd quntity dt nd sk them to clculte the revenue curves. Students could construct grphs sed on the informtion provided. Students should understnd tht, in the short run, some fctors of production re fixed. From this, they need to understnd the ssumption of diminishing mrginl productivity. Cost curves re needed here. Students should lso pprecite the reltionship etween short-run nd longrun verge cost curves Economies nd diseconomies of scle c Students re required to understnd types of economies nd diseconomies of scle for exmple, finncil, technicl, mngeril, mrketing, purchsing nd risk-ering nd e le to explin these using exmples. Students should e le to understnd these s long-run concept. An understnding of the minimum efficient scle is lso required. Students should drw long-run verge cost curves to show economies nd diseconomies of scle s well s eing le to identify the minimum efficient scle. Students should consider the distinction etween internl nd externl economies of scle. Students could consider exmples of where usinesses enefit from economies of scle; for exmple, explining the possile externl economies of scle AstrZenec would enefit from in its move to Cmridge Norml profits, supernorml profits nd losses c Profit mximistion occurs where MR=MC. Students need to know wht is ment y norml profits. Fundmentl here is the ide of opportunity costs. It is useful to explin tht this forms prt of the costs. Students should lso mke the distinction etween norml nd supernorml profits. Being le to identify profits nd losses will e useful when considering mrket structures in 3.4. The short-run shut-down point occurs when verge vrile costs equl verge revenue (AVC=AR). If AR>AVC then ech dditionl unit sold will reduce the size of ny losses nd go towrds covering fixed costs. The firm will e etter off continuing to operte s they will e reducing the size of their losses. Firms will shut down when AVC>AR ecuse every dditionl unit sold will dd to losses. The long-run shut-down point occurs when verge (totl) costs equl verge revenue (ATC=AR). If AR>ATC then ech dditionl unit sold will dd to profits. The firm will e etter off continuing to operte. Firms will shut down when ATC>AR ecuse every dditionl unit sold will dd to losses. In this digrm the firm will profit mximise where MR=MC nd the price chrged is P nd quntity Q. In the short run they will continue to operte s AR>AVC. In the long run ATC>AR so this firm will shut down. 52 Person Eduction Ltd This mteril is not copyright free.

58 4. Content guidnce When profit mximising the price chrged is P nd quntity Q. In the short run AR=AVC, so the firm is t the shut-down point. In the long run ATC>AR so this firm will shut down. 3.4 Mrket structures This topic ws introduced in 3.3. Students will consider efficiency nd the following mrket structures: perfect competition, monopoly, monopolistic competition nd oligopoly. Students will lso explore monopsonists nd contestility. It is useful to look t rel world exmples to support understnding of mrket structures Efficiency c Students need to understnd tht lloctive efficiency is where price equls mrginl costs. Productive efficiency is where verge costs re t their lowest point. Alloctive nd productive efficiencies re sttic in the short term. Dynmic efficiency looks t how, over the long term, new technology nd productive techniques cn increse the productive potentil of firms. Person Eduction Ltd This mteril is not copyright free. 53

59 4. Content guidnce d e X-inefficiency is where firms find themselves with verge costs tht re higher thn they could e. Students should e le to identify cuses of such efficiencies. Students should consider the efficiencies nd inefficiencies in the different mrket structures they explore in this section Perfect competition Perfect competition exists in mrket where there is high degree of competition. A perfectly competitive mrket must possess four chrcteristics: there re mny uyers nd sellers, none of whom is lrge enough to influence price; there re no rriers to entry nd exit from the industry; uyers nd sellers possess perfect knowledge of prices; the products re homogenous. There re few industries tht meet ll of these chrcteristics n exmple is the foreign exchnge mrket. ( nd c) Perfect competition hs lrge numer of suppliers in the mrket. A firm cn expnd or reduce output without influencing price. The price is determined y the mrket ecuse the individul firm is too smll to influence price nd is price-tker. Students need to explin nd show digrmmticlly the reltionship etween the mrket nd the firm. The horizontl demnd curve is lso the firm s verge nd mrginl revenue curves. If firm sells ll its output t the mrket price, then this price must e the verge price or revenue. In ddition, ech extr item sold will receive the sme price for ech dditionl unit nd, therefore, mrginl revenue will e the sme s verge revenue. The perfectly competitive firm s demnd curve: In perfectly competitive mrket, the supply curve for firm is the mrginl cost curve ove the verge vrile cost in the short run, nd the verge totl cost in the long run. The mrginl cost of production the chnge in totl cost resulting from the sle of one more unit represents the dditionl cost of supplying one more unit of output. In perfect competition, we ssume firms re profit mximisers nd produce where mrginl cost is equl to mrginl revenue (MC=MR). Perfectly competitive firms cn mke supernorml profits in the short run. In this digrm the horizontl demnd/verge revenue curve is shown to e ove the verge totl cost t the point where MC=MR (point A). At Q1 the firm chrges P1, ut fces only verge costs of P2. The firm will mke supernorml profits shown y the shded re (P1P2AB). 54 Person Eduction Ltd This mteril is not copyright free.

60 4. Content guidnce The digrm elow shows short-run firm-mking losses. The firm is profit mximising where MR=MC. The price chrged is P2 nd verge costs P1. This rings out losses equl to P1P2CD. If firm mkes supernorml profits in the short run, other firms would hve the incentive to enter the mrket (nd could do so owing to lck of rriers to entry in perfect competition). The entry of new firms stimultes n increse in supply from S1 to S2, with the demnd curve for the firm shifting down nd the price shifting down to PE. The firm is now mking norml (not supernorml) profit. Person Eduction Ltd This mteril is not copyright free. 55

61 4. Content guidnce If firm is mking losses in the long run, some firms would leve the industry s there re no rriers to exit. As result, totl supply flls from S1 to S2. At S1, the firm mkes loss. At S2, the demnd shifts upwrds s firms leve the mrkets leding to norml profits. In the long run, competition ensures tht equilirium occurs where firms mke neither supernorml profits nor losses. Averge costs will equl verge revenue nd the firms mke norml profit Monopolistic competition The ssumptions for monopolistic competition re tht: there re lrge numer of smll firms; there re low rriers to entry nd exit; nd firms produce similr ut differentited products. ( nd c) Product differentition mens there is downwrd sloping curve ecuse firms hve some mrket power. They cn chnge price nd will not lose ll customers. The firm will profit mximise nd produce where MC=MR so will produce t n output level of Q1 nd chrge price P1. 56 Person Eduction Ltd This mteril is not copyright free.

62 4. Content guidnce In the long run, supernorml profits will e eroded ecuse new firms will enter the mrket owing to lck of rriers to entry. The entry of new firms will increse supply, shifting the verge revenue curve downwrds to the point where AR=AC, s in the digrm. If the firm ws mking loss, it would leve the industry, reducing supply nd shifting the AR curve upwrds gin to point where AR=AC. Therefore, in the long run, monopolisticlly competitive firm cn mke neither supernorml profits nor losses Oligopoly c d e f g Firms operting in oligopolistic mrkets tend to keep prices stle. The ctions of one firm will impct on other firms in the industry they re interdependent. Students should e le to clculte concentrtion rtios nd e le to identify the likely mrket structure nd the significnce. Oligopoly firms hve n incentive to work together through collusive greements. Students should consider why firms might collude tcitly or overtly, or engge in non-price competition. Gme theory cn e used to predict how firms might ehve. It is used to explin why firms my collude nd why collusive greements my rek down. The prisoner s dilemm cn explin the wy tht gme theory cn e used y firms. Students should explore types of price competition. If one firm increses its price, competitors will not follow s they cn ttrct the firm s customers y hving lower price. If firm lowered their prices, then other firms would follow suit, resulting in price wr with lower prices no firm would gin from this. Other types of price competition should e considered; for exmple, predtory pricing nd limit pricing. Non-price competition cn tke the form of dvertising, issuing of loylty crds, rnding, pckging nd other mesures to reduce the closeness of sustitutes Monopoly A monopoly is ssumed to: e the only firm in the industry; hve high rriers to entry, preventing new firms from entering the mrket; nd e short-run profit mximiser. ( nd c) A monopoly firm is the sme s the industry s it is the only firm in the mrket. Monopolies hve downwrd sloping demnd curve nd cn set the level of price or output. Person Eduction Ltd This mteril is not copyright free. 57

63 4. Content guidnce A monopolist profit mximises where MC=MR. The digrm shows the equilirium profit mximising level of output t Q1, with price of P1. Supernorml profits re equl to P1C1BA. d Third degree price discrimintion is when usiness chrges different groups of customer different prices for the sme product. For exmple, discounted ril fres for students. For price discrimintion to e possile 3 conditions pply: mrket power price discrimintion cn only tke plce when the firm hs the ility to vry the price (such s monopoly) informtion it must e possile to distinguish etween different customers willingness to py limited ility to resell consumers cnnot resell the product The ssumption is tht there re two mrkets one with inelstic demnd nd the other with elstic demnd. The totl firm digrm on pge 59 shows tht profit mximising firm will hve price Pt nd ern supernorml profit equl to the re old profit. Where MR=MC in the inelstic demnd mrket this is profit mximising nd gives price P nd profit mrked y the lue shded re. The elstic demnd mrket sees price P nd profit mrked y the lue re. 58 Person Eduction Ltd This mteril is not copyright free.

64 4. Content guidnce Comining these two profits should generte more profit for the firm thn profit mximising without price discriminting. P t e Students should explore the costs nd enefits of monopoly to firms, consumers, employees nd suppliers. For exmple: Advntges of monopoly power Anorml profit mens: finnce for investment to mintin competitive edge reserves to overcome shortterm difficulties nd provide funds for reserch nd development. Monopoly power mens powers to mtch glol compnies. Cross-susidistion my led to n incresed rnge of goods or services ville to the consumer. Price discrimintion my rise totl revenue to point tht llows survivl of product or service. It is often sid tht economy-clss flights re funded y those flying usiness nd first clss. Disdvntges of monopoly power Anorml profit mens: less incentive to e efficient nd to develop new products efforts re directed to protect mrket dominnce. Monopoly power mens higher prices nd lower output for domestic consumers. Monopolies my wste resources y undertking cross-susidistion, using profits from one sector to finnce losses in nother sector. Monopolists my undertke price discrimintion to rise producer surplus nd reduce consumer surplus. Monopolists do not produce t the most efficient point of output (i.e. t the lowest point of the verge cost curve). Person Eduction Ltd This mteril is not copyright free. 59

65 4. Content guidnce Monopolists cn tke dvntge of economies of scle, which mens tht verge costs my still e lower thn the most efficient verge of smll competitive firm. Monopolists void undesirle dupliction of services nd therefore mislloction of resources. There re few permnent monopolies. Supernorml profits ct s n incentive to rek down the monopoly through process of cretive destruction, i.e. undermining the monopoly through product development nd innovtion. Monopolists cn e complcent nd develop inefficiencies. Monopolies led to mislloction of resources y setting prices ove mrginl cost, so tht price is ove the opportunity cost of providing the good. f In the UK, wter supply nd the rilwy trck re ll monopolies. These industries re often referred to s nturl monopolies ecuse economies of scle re so lrge, new entrnts would find it impossile to mtch the costs nd prices of the estlished firm. Some monopolies, such s the wter compnies, hve considerle monopoly power ecuse there re no good sustitutes for their product. A locl monopoly descries the only supplier in n re; for exmple, the only villge shop or petrol sttion. A monopoly mintins its position s the sole supplier ecuse of rriers to entry, including: legl rriers such s ptents; mrketing rriers such s dvertising; restrictive prctices; nd ccess to specific technology or rw mterils Monopsony A monopsony exists when there is one uyer in the mrket. There re few pure monopsonists; for exmple, the government domintes the mrket for hiring techers. Monopsonists re profit mximisers they im to minimise costs y pying suppliers the lowest possile price. Monopsonists will py lower prices to suppliers thn if the mrket ws competitive ut suppliers will lso supply less to the mrket. 60 Person Eduction Ltd This mteril is not copyright free.

66 4. Content guidnce Students should consider costs nd enefits of monopsony to firms, consumers, employees nd suppliers. For exmple: Firms Consumers Employees Suppliers Benefits Lower costs cost minimistion supports firms in mking more profits. Lower prices the monopsonist pys the minimum it cn. In minimising costs of rw mterils it leves more funds to py its stff. When the supplier hs mrket power s monopolist it cn counterct the monopsonist. Costs The reltionship with the supplier my worsen, the monopsonist my drive their supplier out of usiness. The supplier my hve to cut corners or lower qulity to lower its costs to remin profitle. My question the ethics of the wy their firm is cting. The uyer minimises costs leding to reduced price pid to the supplier. The monopsonist my exploit its mrket power y pying less or lter. Suppliers my e driven out of the mrket due to lower profitility Contestility c Contestle mrkets: must hve no rriers to entry or exit hve no sunk costs firm s strt-up costs tht they cnnot recover if they exit the mrket new firms must hve no competitive disdvntge compred to the incument must hve ccess to the sme technology. Incuments cnnot set price ove AC if they do nd ern supernorml profits others will enter nd compete the profits wy. If usinesses mke supernorml profits: this would mke them vulnerle to hit nd run entry y new firm they would come into the mrket, tke some profits nd then exit gin. To void this, the incument firm my chrge where P=AC where there re no supernorml profits nd no incentive for entry to the mrket. Alterntively the incument firm(s) my chrge limit price, i.e. one elow the profit mximising price nd low enough to deter new entrnts. Brriers to entry re ostcles tht limit firm s ility to enter, set up or extend into new mrkets. Brriers to exit re fctors tht prevent firms leving mrket or, when firm is mking loss, mke it more unprofitle to leve. Exmples of this include sunk costs costs tht re irretrievle such s dvertising. Person Eduction Ltd This mteril is not copyright free. 61

67 4. Content guidnce d Brriers include: illegl nti-competitive prctices y incuments, including predtory nd limit pricing the nture of the usiness cusing rriers to exist, such s economies of scle leglly imposed rriers ptents, stte-owned frnchises such s trin operting compnies nd legisltion tht llows firms to operte such s postl services nd 4G licenses. Sunk costs re costs tht re irretrievle; for exmple, dvertising costs. When sunk costs re high in mrket it will mke entry to nd exist from tht mrket less ttrctive nd therefore mke the mrket less contestle. 3.5 Lour mrket This topic gives students the opportunity to explore specific type of mrket in detil y focusing on the lour mrket. It is importnt to emphsise tht when looking t the lour mrket, students re exploring specific mrkets: for exmple, the lour mrket for Mths techers or unskilled griculturl workers. Students should explore lour demnd nd lour supply, ppreciting fctors influencing ech of these. Students should lso consider occuptionl nd geogrphicl immoility nd how they ffect the lour mrket, nd policies tht cn e used to reduce immoility. Minimum nd mximum wges should lso e explored Demnd for lour ( nd ) In prticulr lour mrket, the supply of lour comes from people in households nd the demnd for lour comes from usinesses. The demnd for lour is known s derived demnd, which mens the demnd for lour is dependent on demnd for the finl goods nd services tht they produce. If there is high demnd for the finl goods nd services they produce usinesses will demnd more lour; for exmple, in times of economic oom. When demnd for finl good flls the demnd for lour will fll. Demnd for lour lso increses when workers ecome more productive; for exmple, ecuse they hve etter skills. Firms cn choose to use cpitl or lour so if cpitl ecomes more expensive then firms will demnd more lour Supply of lour The supply of lour is dependent on numer of fctors, including: chnges in migrtion, income tx, enefits, presence of trde unions, socil trends, nd required skills nd qulifictions. Mrket filure cn result from the inility of workers to esily move etween jos. There re numer of resons for this: Geogrphicl immoility refers to workers eing unle to move to different plces to seek nd find work. This my e due to socil resons, such s not wnting to move wy from fmily. It my lso e due to the cost of trvel or cost of ccommodtion. Occuptionl immoility refers to workers eing unle to move etween jos s they lck the pproprite skills or trining. As n economy shifts from hving mnufcturing se to service-sector se, mny mnufcturing workers find it difficult to trnsfer to jos in the service sector s they lck the required skills. 62 Person Eduction Ltd This mteril is not copyright free.

68 4. Content guidnce Wge determintion in competitive nd non-competitive mrkets The price of lour is the wge rte. If wges re too high, lour supply will e high ut lour demnd will e low there is excess supply leding to unemployment. In competitive mrket, workers will hve to ccept lower wges or go without jo, mening the wge rte will tend to fll to the mrket clering wge rte. If wges re too low, lour demnd will e high ut supply will e low there is excess demnd nd therefore there will e lour shortge. Workers will not work if they re not pid enough to do so. Firms will hve to py workers more to convince them to work, nd so the wge rte will rise towrds the mrket clering wge. Students re required to drw, nnotte nd interpret lour mrket digrms. c Students should lso consider the importnce of the prticiption rte in the lour force, nd recognise the concepts of unemployment nd underemployment. Students should hve n understnding of current lour mrket issues. These might include: skills shortges; young people in the lour mrket such s prolems ccessing the lour mrket nd youth unemployment; chnges to retirement ges; schooling ges; nd temporry, flexile nd zero-hour contrcts/working. The minimum wge is the minimum firms re leglly llowed to py their workers. Students should consider the impct of n introduction or chnge in minimum wges. The minimum wge, set t W1, will result in wge ove the mrket equilirium wge, We. The higher wge will result in n extension of the supply of lour to Q ut firms will contrct demnd to Q1. This leds to excess supply nd Q-Q1 will e unemployed. Person Eduction Ltd This mteril is not copyright free. 63

69 4. Content guidnce d Students should consider the impct (enefits nd drwcks) of the introduction or increse in oth minimum nd mximum wge. Students should lso explore how, through pulic sector wge setting, the government cn impct the lour mrket, s well s the policies to tckle lour mrket immoility. These include trining progrmmes nd reloction susidies. Elsticity of demnd for lour refers to how responsive the demnd for lour will e to chnges in wges. If demnd for lour is elstic, usinesses cut ck ggressively on employment if wge rtes increse nd will expnd rpidly when lour ecomes cheper reltive to other fctor inputs. When the elsticity of demnd for lour is inelstic the response to chnges in wges will e smller. The wge elsticity of demnd for lour depends on numer of fctors: the proportion of lour costs in the totl costs of usiness, the ese nd cost of fctor sustitution, the price elsticity of demnd for the finl output produced y usiness nd the time period under considertion. The elsticity of lour supply to n occuption mesures the responsiveness of lour supply to chnge in the wge rte. In low-skilled occuptions, lour supply is elstic ecuse pool of lour is ville to tke the jo. Where jos require specific skills, trining or qulifictions, the lour supply will e more inelstic ecuse it is hrd to expnd the workforce in short period of time when demnd for workers hs incresed. 3.6 Government intervention Throughout this theme, res hve een identified where there is role for the government to ring out etter outcomes; for exmple, in limiting mergers tht would crete firms with mrket power, limiting exploittion y monopolies nd promoting competition, nd protecting suppliers ginst monopsonists. In this topic students will explore the impct nd limits of government intervention. 64 Person Eduction Ltd This mteril is not copyright free.

70 4. Content guidnce Government intervention ( to d) Students should consider competition uthorities nd the ctions the government tkes to control mergers nd monopolies, promote competition nd protect suppliers nd employees. In ech cse it is importnt to consider why the ction is needed. It could e useful to look t the Europen Competition Commission nd the Competition nd Mrkets Authority (CMA) in the UK (which took over the powers of the Competition Commission nd certin functions of the OFT in April 2014). Another exmple is the Antitrust Commission in the US The impct of government intervention When exploring government intervention it is importnt to consider wht the government ims to chieve in terms of: prices, profit, efficiency, qulity nd choice. Government intervention my fil to ring out the socil optiml position; for exmple, through regultory cpture. It is lso importnt to consider how symmetric informtion could mke it difficult for the uthorities to investigte nd discover nti-competitive prctices. Person Eduction Ltd This mteril is not copyright free. 65

71 4. Content guidnce Theme 4: A glol perspective This section provides ides nd suggestions for teching pproches for Theme 4 nd is not intended to e prescriptive. The specifiction must e referred to s the uthorittive source of informtion. 4.1 Interntionl economics This section introduces economics in glol context y considering glolistion: its cuses nd consequences; the sis of free trde; protectionism; the lnce of pyments; exchnge rtes; nd interntionl competitiveness Glolistion c According to Peter Jy, glolistion is defined s: The ility to produce ny goods (or service) nywhere in the world, using rw mterils, components, cpitl nd technology from nywhere, sell the resulting output nywhere, nd plce the profits nywhere. Glolistion refers to the incresing interntionl interdependence of economic gents (producers, consumers, governments, entrepreneurs). Key phrses include glol rnding nd glol sourcing, lthough it is not just out the ctivity of glol (trnsntionl) compnies (TNCs). Glolistion is chrcterised y incresing foreign ownership of compnies, increses in trde in oth goods nd services, de-industrilistion in developed countries nd incresing glol medi presence. Fctors contriuting to glolistion in the lst 50 yers include: improvements in trnsport infrstructure nd opertions improvements in communictions technology nd IT (especilly the internet, llowing glol medi presence) trde lierlistion resulting from greements reched y the World Trde Orgnistion (WTO) incresing numer nd influence of glol (trnsntionl) compnies the end of the Cold Wr, which led to the opening up of formerly closed economies in communist countries nd susequent increse in glol lour supply the development of interntionl finncil mrkets. The impcts of glolistion nd glol compnies on individul countries, governments, producers nd consumers, workers nd the environment include: incresing living stndrds resulting from incresed specilistion nd trde (through the lw of comprtive dvntge see section 4.2.1) incresed interdependence of economies de-industrilistion in developed countries, comined with glol serch for new sources of energy (especilly oil/gs reserves) nd the growth of economies such s Chin nd Indi hs left mny Western countries concerned out their future nd their power in the glol economy increse in the numer of footloose compnies which cn cuse unemployment s they move from country to country; glol sourcing should e considered in the light of ctivity y TNCs greter consumer choice lower prices, through specilistion ccording to comprtive dvntge workers my e exploited y lrge glol (trnsntionl) compnies 66 Person Eduction Ltd This mteril is not copyright free.

72 4. Content guidnce incresing environmentl destruction nd other negtive externlities students should e wre of environmentl prolems cused y glolistion; for exmple, rising greenhouse gses from incresed trnsporttion of goods ssocited with the increse in interntionl trde. Students should lso e introduced to the ide tht glolistion is not new phenomenon nd tht there hs een continul process of glolistion since the time of the first humns Specilistion nd trde The primry reson for trde is tht countries re not le to produce everything they wnt in tody s society. This is ssocited with economic development nd increses in income. Trde llows countries to specilise in producing the goods/ services tht cn e produced efficiently. Goods re imported ecuse of their vilility, price nd product differentition. Students re required to use numericl nd digrmmtic exmples to illustrte solute nd comprtive dvntge. Assume world with two countries (A nd B) nd two products (ornges nd smrtphones). Country A hs n solute dvntge ecuse it cn produce more of oth goods. To produce one smrtphone, Country A must give up production of 2 ornges, wheres Country B must give up production of 1 ornge. Becuse Country B gives up fewer ornges to mke more smrtphones, it hs comprtive dvntge in smrtphones (similrly Country A for ornges). Country A s PPF is shown in lue. Country B s PPF is shown in red. The opportunity cost of producing smrtphone in Country A is 2 ornges; the opportunity cost of producing smrtphone in Country B is 1 ornge. The opportunity cost of producing n ornge in Country A is 0.5 of smrtphone wheres the opportunity cost of producing n ornge in Country B is 1 smrtphone Country A should specilise in producing ornges. Country B should specilise in producing smrtphones. The theory of comprtive dvntge ssumes: constnt costs of production (ignoring economies of scle); tht trnsport cost re zero; there is perfect knowledge; nd tht fctors of production cn esily e switched from producing one good to producing nother. Limittions include tht the externl costs of production (such s environmentl degrdtion) re ignored. The dvntges of specilistion nd trde include: lower prices nd more choice for consumers lrger mrkets nd economies of scle for firms Person Eduction Ltd This mteril is not copyright free. 67

73 4. Content guidnce higher economic growth nd living stndrds (sed on the lw of comprtive dvntge). Disdvntges of specilistion nd trde include: deficit on the trde in goods nd services lnce could rise if country s goods nd services re uncompetitive dnger of dumping y foreign firms, i.e. selling t elow verge cost incresed unemployment resulting from the ove incresed economic integrtion might result in incresed exposure to externl shocks unlnced development interntionl specilistion sed on free trde mens tht only those industries in which the country hs comprtive dvntge will e developed while others remin undeveloped; in other words there will e sectorl imlnce which my restrict the overll rte of economic growth glol monopolies s glol (trnsntionl) compnies ecome lrger developing nd emerging economies my fce prticulr prolems; for exmple, infnt industries my e unle to compete nd go out of usiness; the monopsony power of glol compnies my men tht low prices re pid for commodities from developing countries Ptterns of trde The G7 shre of world trde in mnufcturing hs fllen significntly over the pst century. In glol terms, trde flows with emerging economies hve incresed significntly. Trde within trding locs, such s the EU, hs lso significntly incresed (trde cretion), ut t the expense of trde with more trditionl trding prtners, such s etween the UK nd the Commonwelth countries (trde diversion). Students should e encourged to look t how ptterns of trde hve chnged nd the resons for these chnging ptterns, prticulrly with reference to the growing importnce of trding locs nd the growth of emerging economies Terms of trde The reltive prices of imports nd exports my hve n importnt impct on competitiveness nd on country s living stndrds. These re cptured in country s terms of trde. Students re required to clculte terms of trde: Terms of trde = Index of export prices x 100 Index of import prices Fctors influencing country s terms of trde include: reltive infltion rtes, reltive productivity rtes nd chnges in exchnge rtes. c Chnges in country s terms of trde impct on living stndrds nd on the competitiveness of country s goods nd services, with implictions for the lnce of pyments on current ccount, output nd employment. For exmple, n improvement (increse in) country s terms of trde implies n increse in its living stndrds ecuse less hs to e exported to uy given quntity of imports. However, it could men tht the country s goods nd services re less competitive nd so result in deteriortion in the current ccount, lower output nd higher unemployment. 68 Person Eduction Ltd This mteril is not copyright free.

74 4. Content guidnce Trding locs nd the World Trde Orgnistion (WTO) c d Students should consider the chrcteristics of the vrious types of trding loc nd understnd the ide of trde cretion nd trde diversion (which links to the conflict etween locs nd the WTO). Free trde res these re locs in which groups of countries gree to olish trde restrictions etween themselves ut mintin their own restrictions with other countries. Customs unions these hve free trde internlly nd common set of protectionist mesures. Exmples include the EU, the North Americn Free Trde Agreement (NAFTA) nd the Assocition of Southest Asin Ntions (ASEAN). Common mrkets these hve the sme chrcteristics s customs unions ut lso llow the free movement of fctors of production. Monetry unions these re customs unions which dopt single currency. The costs of regionl trde greements, which re monetry unions, include: trnsition costs (costs of chnging price lists, slot mchines, etc.), loss of independent monetry policy nd loss of exchnge rte flexiility. Benefits include: elimintion of trnsction costs, price trnsprency, reduction in exchnge rte uncertinty nd incresed ttrctiveness for foreign direct investment (FDI). The WTO promotes free trde etween memer countries through series of trde negotitions. It is lso responsile for resolving trde disputes etween memer countries. Trde within regionl trde greements hs lso significntly incresed (trde cretion) s result of their emphsis on free trde. However, this is t the expense of trde with non-memers (trde diversion) who my e suject to trde rriers. This is in conflict with the primry im of the WTO Restrictions on free trde Students should consider the resons for, nd types of, restrictions on free trde s well s their impct on n economy. A country my restrict trde to: protect infnt industries nd sunset industries protect employment retin self-sufficiency correct imlnces on the current ccount of the lnce of pyments retlite ginst restrictions imposed y nother country prevent dumping reduce competition from countries with chep lour nd poor lour/environmentl lws protect strtegic industries, such s defence, essentil foodstuffs nd energy. Students should e wre of current exmples of protectionist mesures nd consequent retlition. Ale students could e introduced to the ides of Dvid Ricrdo regrding the enefits of free trde versus protectionism, s well s criticisms of these ides from economists such s H-Joon Chng. Person Eduction Ltd This mteril is not copyright free. 69

75 4. Content guidnce Students should explore types of trde rrier. Triffs re txes on imported goods. They re lso known s import or customs duties. Txes rise prices to consumers with the im of restricting imports. The following digrm illustrtes the impct of triff: c Before triff domestic suppliers supply 0A, totl demnd is 0B, so imports re AB. After triff domestic suppliers supply 0E, totl demnd is 0F, so imports re EF. Triff revenue rised y government is LMWV. Additionl domestic producer surplus is P 1 P 2 LR. The dedweight welfre loss res re RLV nd WMT. Quots re physicl limit on the quntity of imports. They hve similr effect to triffs ut no tx revenue is rised nd shortges re creted. Susidies to domestic producers re grnts given to domestic producers to enle them to lower production costs, therefore lowering prices, which should mke the country s products more competitive interntionlly. Unlike triffs nd quots, susidies incur cost to the pulic finnces. Non-triff rriers re protectionist mesures which might include: product specifictions, helth nd sfety regultions, environmentl regultions nd lelling of products. Students should consider the impct of protectionist policies on consumers, producers, governments, living stndrds nd equlity. 70 Person Eduction Ltd This mteril is not copyright free.

76 4. Content guidnce Blnce of pyments The lnce of pyments is record of ll country s finncil delings with the rest of the world over the course of yer. It hs four prts: the current ccount, the cpitl ccount, finncil ccount nd the interntionl investment position. Students should hve cler understnding of these elements nd exmine fctors which cuse current ccount imlnces nd mesures which cn reduce such imlnces. The current ccount comprises the following: Blnce of trde this refers to the difference etween the vlue of goods nd services exported nd the vlue of goods nd services imported. Exports pper s positive entry into the lnce of pyments ecuse they ring money into the country. Imports pper s negtive entry into the lnce of pyments ecuse money leves the country. The lnce of trde itself comprises two elements: the trde in goods lnce nd the trde in services lnce. Income this comprises income erned y domestic citizens who own ssets overses minus income erned y foreign citizens who own ssets in this country. It includes profits, dividends on investments rod nd interest. Current trnsfers these re usully money trnsfers etween centrl governments (who lend nd orrow money from ech other) or grnts, such s those tht the UK receives s prt of the CAP from the EU. If country hs current ccount deficit, the vlue of money leving the country exceeds the vlue of money entering the country. If country hs current ccount surplus, then the vlue of money entering the country exceeds the vlue of money leving the country. The cpitl ccount refers to trnsctions in fixed ssets nd is reltively smll. The finncil ccount comprises trnsctions ssocited with chnges of ownership of the UK s foreign finncil ssets nd liilities. It includes the following: Direct investment this reltes to cpitl provided to or received from n enterprise, y n investor in nother country. Portfolio investment this reltes to investments in equities nd det securities. Finncil derivtives these include ny finncil instrument the price of which is sed upon the vlue of n underlying sset (typiclly nother finncil sset). Finncil derivtives include options (on currencies, interest rtes, commodities, indices), trded finncil futures, wrrnts nd currency nd interest swps. Reserve ssets these refer to those foreign finncil ssets tht re ville to, nd controlled y, the monetry uthorities such s the Bnk of Englnd for finncing or regulting pyments imlnces. Reserve ssets comprise: monetry gold, Specil Drwing Rights, reserve position in the IMF nd foreign exchnge held y the Bnk. Students should focus especilly on flows of FDI etween countries. The interntionl investment position is in the lnce sheet of the stock of externl ssets nd liilities. Person Eduction Ltd This mteril is not copyright free. 71

77 4. Content guidnce c d The lnce of pyments must lwys lnce. If country hs current ccount deficit, it must hve surplus on the other elements of the lnce of pyments. This is ecuse it hs to py for everything it consumes nd funds in some wy to fund current ccount deficit, country must e selling ssets to foreign investors. It is detle whether this is sustinle in the long run since, if people invest in country, t some point they will require return on their investment, nd this will cuse deficit on the finncil ccount. In ddition, ecuse the dt is never completely ccurte, the ccounts lso incorporte net errors nd omissions item, which mkes sure tht everything will lnce. Students should understnd the components within the current ccount, nd should e wre of which components record deficits or surpluses. Students should consider the size of deficits or surpluses on the current ccount in glol context, nd exmine the implictions of lrge imlnces etween countries. Cuses of current ccount deficits include: reltively low productivity reltively high vlue of the country s currency reltively high rte of infltion rpid economic growth resulting in incresed imports non-price fctors such s poor qulity nd design. Current ccount surpluses my rise from the reverse of these points. Mesures to correct deficit on the current ccount include expenditure reducing, expenditure switching nd supply-side policies; ech of these should e evluted, nd students should e encourged to rech their own conclusions s to the most pproprite mesure. Students should consider the option of doing nothing, in light of theory on floting exchnge rtes. Expenditure-reducing policies relte to mesures designed to reduce ggregte demnd, such s defltionry fiscl policy. As result people spend less on imports. However, side-effect of this is tht spending on domestic goods lso decreses, cusing unemployment nd fll in the rte of economic growth. Expenditure-switching policies involve the use of protectionist mesures such s triffs or quots, or devlution of the currency under fixed exchnge rte regime. Such mesures encourge people to uy domestic goods rther thn imports. However, they my led to retlition, cusing exports to lso fll so tht the current ccount deficit my not e corrected. Supply-side policies, such s spending on eduction nd trining in order to improve the qulity nd therefore competitiveness of exports, im to oost export demnd. While they cn incur n opportunity cost, they contriute positively to economic growth nd cn e nti-infltionry in the long run. Some rgue tht, since country s lnce of pyments must lwys lnce, ny glol imlnces re insignificnt. However, the Glol Finncil Crisis of 2008 suggests tht persistently lrge current ccount deficits my e unsustinle in the long run. Lrge nd persistent deficits cn e prolem ecuse there is need to finnce the incresing expenditure on imports, usully through lons from rod. In contrst, lrge nd persistent surpluses cn e prolem ecuse resources re focused on producing to meet export demnd rther thn domestic demnd, so consumer choice nd resulting living stndrds could ctully e low. Further, such imlnces my led to lrge currency fluctutions which cn hve destilising impct of world trde. 72 Person Eduction Ltd This mteril is not copyright free.

78 4. Content guidnce Exchnge rtes Students should understnd the different exchnge rte systems, the fctors influencing exchnge rtes nd the impct of chnges in exchnge rtes. d e Exchnge rtes re the price of one currency in terms of nother. Under system of floting exchnge rtes, demnd nd supply determine the rte t which one currency exchnges for nother. In system of fixed exchnge rtes, the country s exchnge rte is fixed in reltion to, sy the US dollr. It cn only e chnged y the centrl nk in greement with other countries usully medited through the IMF. Mnged exchnge rtes imply tht the monetry uthorities control the exchnge rte through the uying nd selling of the country s currency on the foreign exchnge mrket nd through chnges in interest rtes. ( nd c) Apprecition nd deprecition re the terms used under system floting exchnge rtes to descrie increses nd decreses in the vlue of country s currency in reltion to other currencies. Revlution nd devlution re the terms used under system fixed exchnge rtes to descrie increses nd decreses in the vlue of country s currency in reltion to other currencies determined y the country s centrl nk. Apprecition/revlution mens tht the vlue of the pound, in terms of other currencies, hs incresed. For exmple, if the vlue chnges from 1 = $1.50 to 1 = $1.70 then more dollrs re required to uy 1. With n pprecition/revlution, even though good my still e priced t 10, it now costs Americns $17 insted of $15, therefore reducing demnd for UK exports. Deprecition/devlution mens tht the vlue of the pound, in terms of other currencies, hs decresed. For exmple, if the vlue chnges from 1 = $1.50 to 1 = $1.40 then fewer dollrs re required to uy 1. With deprecition/devlution, even though good my still e priced t 10, it now costs Americns only $14 insted of $15, therefore incresing demnd for UK exports. Essentilly, the exchnge rte will e determined y the supply of, nd demnd for, the currency. In turn, these will depend on fctors such s: reltive interest rtes reltive infltion rtes (purchsing power prity theory) the current ccount of the lnce of pyments UK exports crete demnd for sterling wheres imports into the UK crete supply of sterling on the foreign exchnge mrket; therefore, n incresing trde surplus would cuse n increse in the vlue of sterling net investment into the UK FDI into the UK cretes demnd for sterling wheres UK investment rod cretes supply of sterling; therefore, n increse in FDI from rod would cuse the vlue of sterling to rise specultion quntittive esing since QE hs the effect of incresing money supply, it is likely tht this will cuse deprecition in the country s exchnge rte. Attempts to mnge the exchnge rte my e chieved y: chnging interest rtes if the centrl nk wishes to increse the vlue of the country s currency, it would rise interest rtes, so mking it more ttrctive for foreigners to plce csh lnces in the country s nks intervention on the foreign exchnge mrket if the centrl nk wishes to increse the vlue of the country s currency then it would uy its own currency. Person Eduction Ltd This mteril is not copyright free. 73

79 4. Content guidnce f g Some countries try to gin competitive dvntge y tking mesures to lower the vlue of their currencies. However, if severl countries do this then ny dvntge would dispper quickly. Consequently, there might e decline in world trde if countries pursued such policy s hppened in the 1930s. Impct of chnges in exchnge rtes include: The current ccount of the lnce of pyments: deprecition or devlution will increse the competitiveness of country s goods nd services y cusing fll in the foreign currency price of its exports nd n increse in the domestic price of its imports. However, there will only e n improvement in the current ccount of the lnce of pyments if the sum of the PEDs for exports nd imports is greter thn 1. This is clled the Mrshll-Lerner condition. Further, the impct on the current ccount my e different in the short run thn in the long run. In the short run there might e deteriortion in the current ccount of the lnce of pyments ecuse the demnd for imports might e price inelstic if firms hve stocks or if they re tied into contrcts; nd the demnd for exports might e price inelstic ecuse consumers tke time to djust to the new, lower, prices. However, in the long run demnd for exports nd imports is likely to ecome more price elstic so the significnce of the ove fctors disppers. This difference in short-run nd long-run effects is often referred to s the J curve effect. Economic growth nd employment/unemployment: n increse in the competitiveness of country s goods nd services following deprecition/devlution should result in decrese in unemployment s demnd for the country s goods nd services increses. Rte of infltion: the price of imported rw mterils nd mnufctured goods will increse following deprecition/devlution. This could hve infltionry consequences ecuse firms costs would increse nd wgeprice spirl could ensue. FDI flows: following deprecition/devlution it would e cheper for glol compnies to invest in the country so FDI might increse. An pprecition/revlution of country s currency would hve the reverse of the ove effects Interntionl competitiveness c Competitiveness refers to the ility of country to sell its goods/services rod. Competitiveness is usully determined y the price nd/or qulity of the good or service. Fctors influencing interntionl competitiveness include: reltive unit lour costs which re hevily dependent on productivity wges nd non-wge costs reltive to those of competitors rte of infltion reltive to competitors regultion reltive to tht of competitors. A country which is interntionlly competitive is likely to e le to enjoy export-led growth with positive implictions for employment nd its lnce of pyments on the current ccount. The reverse would e true for country which is interntionlly uncompetitive. Countries often try to improve their interntionl competitiveness y dopting supply-side policies. 74 Person Eduction Ltd This mteril is not copyright free.

80 4. Content guidnce 4.2 Poverty nd inequlity The different cuses nd consequences of poverty nd inequlity in oth developed nd developing countries should e considered in this section. It should e noted tht, while solute poverty is decresing glolly, some countries hve experienced increses in inequlity over the lst 25 yers. The possile resons for these chnges should e explored Asolute nd reltive poverty c Asolute poverty exists when person s continued dily existence is thretened ecuse they hve insufficient resources to meet their sic needs. Reltive poverty exists when person is poor compred with others in their society. Most poverty in developed countries tends to e reltive poverty. Asolute poverty in 2008, the World Bnk set the poverty line t $1.25 dy t 2005 GDP mesured t purchsing power prity. Some economists mesure the poverty line t $2 dy. Reltive poverty this is mesured in comprison with other people in the country nd will vry etween countries. People re considered to e in reltive poverty if they re living elow certin income threshold in prticulr country. For exmple, in the EU, people flling elow 60% of medin income re sid to e t-risk-of poverty nd re sid to e reltively poor. Cuses of chnges in solute poverty nd reltive poverty include: chnges in the rte of economic growth, economic development, FDI, policies which result in incresed trde, government tx nd enefits policies, nd chnges in sset prices Inequlity Students re required to understnd the distinction etween welth nd income inequlity. Welth reltes to differences in people s stock of ssets. Income is flow concept; therefore, income inequlity reltes to differences in people s income flows from wges, dividends, rents, etc. Mesures of inequlity include the Lorenz curve nd the Gini coefficient. Lorenz curves plot cumultive shre of income (or welth) ginst the cumultive shre of the popultion with tht income (or welth). To determine the degree of inequlity, the Gini coefficient my e clculted: G = A x A + B A represents the re etween the digonl line nd the Lorenz curve nd B represents the re under the Lorenz curve. The Gini coefficient will hve vlue etween 0 nd 1, with 0 representing solute equlity (the 45º line) nd 1 representing solute inequlity (i.e. the Lorenz curve would lie long the horizontl nd verticl xes). Person Eduction Ltd This mteril is not copyright free. 75

81 4. Content guidnce c d e Cuses of income nd welth inequlity within nd etween countries include: eduction, trining nd skills wge rte including minimum wge rtes strength of trde unions degree of employment protection socil enefits the tx system (e.g. how progressive it is) pension entitlements ownership of ssets (e.g. houses nd shres) nd inheritnce. It is often oserved tht, s country develops nd its GDP grows from susistence economy, inequlity initilly increses nd then decreses. This oservtion could e nlysed y reference to the Kuznet s curve (lthough this is not requirement). Industrilistion results in incresed inequlity s workers move from the lower productivity nd lower pid griculturl sector into the higher productivity mnufcturing sector. However, t some point, inequlity strts to decrese. This my e ecuse governments hve more resources to redistriute income through the tx nd enefit system. Inequlity in free mrket economy is inevitle, since people with higher skills nd ilities will ttrct higher wges, wheres those with poor skill levels will ern nothing. Further, privte ownership of resources mens tht some people will cquire considerly more ssets thn others which, in turn, my generte n income. Some rgue tht inequlity is essentil in cpitlist system to provide n incentive for individuls to tke risks in the knowledge tht they, personlly, will enefit from ny profits mde. 76 Person Eduction Ltd This mteril is not copyright free.