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Micro Economics

The Economic Problem

Opportunity Cost

Factors of Production

Our wants are unlimited but our resources are limited. This
gives rise to scarcity. Therefore, we have to make decisions.
Every time a decision is made, an opportunity cost is involved.
The next best alternative forgone when an economic decision
is made
The things we need in order to make goods and services to
satisfy our wants. There are 4 factors of production:
Land: Natural, non-human resources
Payment: Rent
Labour: all human effort whether skilled or unskilled,
manual or mental
Payment: Wages/Salary
Capital: The human-made resources which help
future production
Payment: Interest
Entrepreneur: The risk-taker, decision-maker,
organiser of production
Payment: Interest

Sectors of Production + Demand

+ Supply + Price

(exercise book)

Production Possibility Curve

A curve which shows all possible combinations of two

measured outputs, which maximises output. (exercise book)

Price Elasticity Of Demand

The responsiveness of quantity demanded to changes in price

of a good or service.
Measure PED:


If PED > 1 i.e price is elastic

If PED < 1 i.e price is inelastic

Compulsory payment to the government. Only the

government can impose tax
Types of taxes:
Direct tax: Based on income or wealth (Eg Income tax)
Indirect Tax: Based on expenditure (excise duties)
Specific (tax per unit)
Ad Valorem: Percentage of price
Effects of Tax on the Market
Tax imposed on producers would cause them to increase,
hence increase market prices (Supply curve shifts upwards).
Reduce disposable income. Consumer demand contracts,
especially if the demand is price elastic


Money: Function

Money: Characteristics of a
good money

Banks: Commercial Banks

The exchange of one good or service for another. The barter

system. The barter system was introduced as in ancient
society, not all individuals are self-sufficient. They decided that
each person should specialize and that there should be
division of labour, and exchanges could be made afterwards. It
was introduced before money was invented and had many
Finding someone to swap with: Double coincidence
where you can find someone who needs your good
and sells what you want was very hard, nearly
Fixing a rate of exchange: It was hard to express the
value of one good in terms of all other goods
Saving: Many goods were non-durable and saving was
not possible. Others were hard to store.
Money was invented to solve the problems of the barter
system. The functions of money are:
Medium of exchange: this solves the problem of
finding someone to swap goods with
Measure of value: This solves the problem of fixing a
rate of exchange
Store of value: This solves the problem of saving
Means of deferred payment: as money remains the
same throughout, deferred payment is made possible
Acceptability: a good money has to be recognize and accepted
widely in order to carry out its function properly
Durability: As money is used in trade after trade, it should
remain durable or else the value would be lost
Portability: Money should be portable so that it is convenient
to bring to trades at all time
Divisibility: As goods have different values, money should be
divisible to acquire the desired sum.
A bank is a financial intermediary that brings together people
who want to save money and people who want to borrow
How banks work:
1. People deposit money they make in banks
2. Banks use this money to lend people desiring to
3. People and firms buy goods and services with their
Back to first step
Role of commercial banks:
Safe-keeping of money
Lending of money through loans and overdrafts
Allowing transfers of money through means of
debit/credit cards and cheques

Banks: Central banks

Stock exchange

Considered the bank of all banks. All commercial banks have

an account at the central bank
Functions of a central bank:
Issues coins and notes for the national currency
Manages payments to and from the government
Manages national debts on behalf of the government
Supervises the banking system, regulating the conduct
of banks, holding their deposits and transferring
between them
Lender the last resort (as interest rate is very high) to
prevent banks from running out of money which may
lead to bankruptcy
Manages the nations gold and foreign currency
reserves. When necessary, it can stabilize the national
Manages monetary policies: adjust interest rates to
handle inflation
Stock exchange is a business organisation that enables
individuals, companies and governments to buy and sell
shares on the global stock market.
Roles of the stock market:
Brings together buyers and sellers of new and secondhand shares
Provides up to the minute information on the market
prices of different stocks and quantities traded
Supervises the conduct of firms of brokers that buy
and sell shares on behalf of investors

Labour market

The labour market is where employers and workers interact. It

brings together the supply of labour (employees) and demand
for labour (employers) to determine employer and wage level.

Division of labour

Dividing up a job into a number of individual operations


Where workers concentrate on one task and become expert at

that task
Differences in wages between different occupations and
employees in the same occupations
(Exercise book)

Wage differential
Circular flow of income

Macro Economics
Aggregate demand

Total demand of all goods and services in an economy

Aggregate Supply

Total supply of all goods and services in an economy


Effects of Low inflation

Definition: Inflation is an increase in the general price level of

goods and services
Types of Inflation
Demand-pull inflation: Increase in aggregate demand
due to increase in government/household or firm
spending. Banks may issue more notes and coins,
hence increase inflation even more as the money supply increases, reducing the purchasing power of
money (money is more abundant)
Cost-push inflation: when costs of production rises
causing producers to increase prices in order to
maintain their profit.
Wage-price spiral: Workers demand higher wages
because they do not feel their current wage level is
not compatible with their effort. This leads to price
increase. However, they continue to demand higher
wages to keep pace with inflation. This keeps going,
pushing the cost of production hence the prices higher
and higher
Imported inflation: Inflation due to an increase in the
price of imports. As the price of imports increase,
prices of domestic goods using imports as raw
materials also increase, causing an increase in the
general prices of all goods and services. Imported
inflation may be caused by foreign price increases or
depreciation of a country's exchange rate

Effects of High inflation

Low and stable inflation in the economy will keep

workers and their representatives from
demanding higher wages. It will also make it more
appealing to borrow money, as interest rate tend
to be low as well hence increase investments and
economic growth
Exports in a country with lower rate of inflation
will be more competitive than other overseas
producers. Demand for these exports will rise and
create additional income and job opportunities
Inflation decreases the value of money, hence
reduce the real income of every person in the
economy. This tends to affect workers with little
bargaining power.
Savers and investors suffer: the real value is
reduced. If interest rates are lower than inflation
there will be negative interest rate
Firms and producers of luxury goods suffer as the
prices of their products are very elastic: the
quantity demanded fall more than

Price Index: Measuring Inflation

proportionately -> Firms may lose business and

workers lose their jobs
Reduces the competitiveness of exports against
rival producers from other countries on the
international market as price rises i.e demand for
these exports reduce affecting economic growth
and job opportunities/payments of these
Imposes additional costs on firms
- Demand-pull: increase firms profits as
aggregate demand increases
- Cost-push: decrease firms profits
Economic uncertainty: people will not know what
the value of their money will be and firms will be
reluctant to invest, individual consumers will be
reluctant to spend
WHAT? The price of a typical selection of goods and
services purchased by a typical family/household in an
economy. CPI/RPI is the main measure of price inflation
WHY? It is difficult to acquire up-to-date price of all
goods and services exchanged in an economy, therefore
making it difficult to measure inflation.


HOW? The price of this typical selection of goods is

monitored at a number of different retail outlets across
the economy -> Compile CPI/RPI
WHAT? People who are members of the labor force who
are able and willing to work but cannot get a job
Labor force: the economically active (aged 16-65)
excluded of full time students
HOW? (Measure of unemployment)
Unemployment level = Total number of people
Unemployment rate =

x 100%

WHY? (See Types of Unemployment Sheet)

Employment terms

The conditions that an employer and employee agree upon for

a job. Terms of employment include an employee's job
responsibilities, work days, hours, breaks, dress code, vacation
and sick days and pay. They also include benefits such as
health insurance, life insurance and retirement plans.
Employees whose skills are in higher demand will have an
advantage when negotiating terms of employment.

Economic Growth

Government Policy: Monetary

Government Policy: Fiscal

GDP (Gross Domestic Product): The total value of

all output produced in a country
Economic growth (nominal): An increase in GDP
Only in nominal terms as the real value might
not increase apparently due to inflation,
which means in fact there has been no
economic growth. If nominal GDP increases
only because price increases (inflation) then
the real GDP stays the same. The economy is
no better off
Real economic growth: an increase in REAL GDP
(Real GDP measures changes in total output
assuming prices are unchanged overtime)
Involves changes in the money supply and/or interest
rates to influence the level of aggregate demand and
economic activity
Reduced interest rates encourage borrowing of
money and investments and make saving less
attractive -> raise consumer expenditure
Quantitative easing: government buy bonds from
the bank to increase the money banks have to
lend to the people.
Raising interest rates
Cut the money supply
Involves varying the overall level of public expenditure
and/or taxation in an economy to manage aggregate
demand and influence the level of economic activity
Increase public expenditure
Cut taxation: -> increase investments in new
productive capacity
Boost employment + Output
Decrease public expenditure
Increase taxation -> reduce disposable income
Reduce pressure on prices by cutting
aggregate demand

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