A2 Economics for OCR

Answers to activities
Chapter 1
ACTIVITY PAGE 5
The employment rate is lower than the economic activity rate. The economic activity rate measures the proportion of people aged 1665 who are employed or unemployed and seeking work; the employment rate, as its name suggests, includes only those who are employed.

ACTIVITY PAGE 8 (ToP)

a) There are a number of similarities between the Norwegian and the UK labour markets. In both countries, average male pay is higher than average female pay. Also, in both countries there are more female workers than male workers in the public sector and in part-time employment. The passage does, however, show that the unemployment rate was lower in Norway than in the UK in February 2008. b) The Nordic countries were facing a shortage of workers at the start of 2008. Such a shortage would probably have encouraged firms to offer higher wages to attract scarce labour and encouraged unions to press for pay rises. Both effects would have been likely to increase wage rates. c) The table supports the view that the Nordic countries were facing not a shortage of jobs, but a shortage of workers to a limited extent. Both Norway and Denmark had unemployment rates below what is usually regarded to be full employment. If unemployment falls below 3 per cent, firms wishing to expand may find it difficult to recruit extra workers. This will place a supply constraint on the economy. The unemployment rate in the other two countries, however, while being below the EU27 average, is not that low and does not really indicate a shortage of workers.

ACTIVITY PAGE 8 (boTTom)

a) There are a number of possible reasons, including differences in the labour turnover of industries, differences in attitudes to older workers, and differences in what is happening to the industries. An industry, such as hotels and restaurants, in which many workers stay for only a short time tends to have a relatively young labour force. This contrasts with the field of education. Most teachers join the profession in their early twenties and a relatively high proportion continue to work as teachers until retirement. Industries in which ageism is more prevalent are likely to employ fewer older workers than those that do not discriminate. Age discrimination legislation, however, may reduce this difference. An industry that is expanding, such as financial services, will be recruiting new workers, and this may tend to reduce the average age of workers. In contrast, older workers may stay with declining industries, but such industries are likely to find it difficult to recruit new workers. In a number of countries fishing, for instance, is a declining industry. b) A countrys firms are internationally competitive if they are producing what people at home and abroad want and are willing to buy at attractive prices. An ageing population may reduce the international competitiveness of a firm if, as workers get older, they become less productive. This may occur if older workers are less flexible, less mobile and less up-to-date with new developments. Some older workers may be reluctant to change the hours they work and the tasks they do. With family commitments and a house, some older workers may be reluctant to move to
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other parts of the country where there may be job opportunities with firms that are expanding. They may also be unwilling to learn jobs and to undertake training in, for instance, new technology. On the other hand, older workers may be more productive, given their experience. They may have been very well trained and may still be prepared to update their skills. Their greater tendency to stay with an employer may reduce firms costs and so help keep their prices competitive.

ACTIVITY PAGE 9
a) Occupational downgrading means moving from one job to a lower-paid and lower-skilled job. b) When a woman gives up managerial responsibilities for a time, the break may mean that she misses out on training, changes in working practices and advances in technology. This may make employers reluctant to place her in higher managerial positions in the future. There is a chance, however, that having a break may increase the ambition of some women, and their experience in lower positions may increase their understanding of how to motivate staff. If this is the case, employers may be more willing to promote them.

ACTIVITY PAGE 14
a) Groups who may have benefited are consumers of British Gas if the decision results in lower prices, shareholders of British Gas if it increases profits, and workers in other countries who will have more job opportunities. b) Offshoring has increased a number of companies profits, but there is no guarantee that it will always do so. Offshoring can raise a companys profits by lowering its costs of production. A number of costs abroad may be lower, including rent of premises, business taxes and, of course, wages. If productivity levels are reasonably high, unit costs may be lower. There is a risk, however, that profits may fall if moving work abroad either increases costs or reduces revenue. Productivity levels may not be as high as anticipated, and costs may start to rise, especially if other firms start to move into the same area, competing for resources. As well as output levels possibly being lower abroad, the quality produced may also be lower. If the goods or services produced are poor, the company may lose sales.

ACTIVITY PAGE 16
a) The success of a tourist attraction can be judged by the number of visitors, by revenue and by profits. b) The opening of other wheels, particularly within the UK, will increase competition for the London Eye. Someone in Southampton, for instance, who would have gone to the London Eye may not do so if a Southampton wheel is opened. If the increased competition does reduce visitors, revenue is likely to fall. The higher competition would also make it difficult for the London Eye to raise its price to offset the effect of a fall in sales demand will become more elastic. There is, nevertheless, a chance that having more wheels will develop a taste for this type of attraction. Someone who has enjoyed going on the Birmingham wheel may be encouraged to go on the London wheel when visiting the capital.

ACTIVITY PAGE 21
a) The passage mentions that revenue rose while the numbers of people going to the cinema fell. This means each person, on average, must have been paying more per ticket. b) The passage suggests that demand for a cinema ticket is relatively income-inelastic. It mentions that a spokesperson for the cinema industry was unconcerned that a fall in income would reduce demand. c) It is difficult to predict what will happen to the cross elasticity of demand between cinema going and the price of pay-TV in the future. There will be a number of influencing factors. One factor is changes in the relative quality of the films and programmes on pay-TV. Others include changes in the cost of transport to and from cinemas, the availability of parking spaces at cinemas, and how pay-TV can be received.
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ACTIVITY PAGE 23
a) ITV a 41.38 per cent fall. b) In April 2008, the BBCs share was higher than 28 per cent because figures for only two of the BBCs channels, albeit those with the largest audience share, are shown. c) The five-firm market concentration ratio, in terms of channels, fell from 84 per cent in 2000 to 57 per cent in 2008. This indicates a fall in market power and so an increase in competition. To analyse the share of the five largest TV companies, however, it would be necessary to have information on the share of the other channels run by the companies.

Chapter 2
ACTIVITY PAGE 25
a) Staff bonuses are a variable cost, as they are likely to be related to output and sales. A firm is likely to pay out more in bonuses when workers are producing a higher output. b) Business rates and insurance.

ACTIVITY PAGE 28
a) The changes in the relative cost of producing television programmes are likely to encourage television channels to produce fewer television dramas and more quizzes and reality shows. This suggests that the changes in costs are reducing the quality of programmes being made. b) The impact of foreign television programmes on the cost of producing UK programmes will depend on price. If foreign programmes are being sold at a low price, this will put downward pressure on the cost of producing television programmes in the UK. UK production firms will have to keep their costs down in order to remain competitive.

ACTIVITY PAGE 36
a) The need for a considerable amount of funding; and stars already being signed up by competitors. b) There are a number of factors that could cause an increase in attendance at cricket matches. One is a reduction in ticket prices. This will cause an extension in demand, with consumers being more willing and able to buy tickets. Another factor is increased advertising. The Twenty20 tournament in India, for instance, has been heavily advertised. A third factor is a rise in the ticket price of other sports events that are a substitute for cricket. The second and third factors will cause an increase in demand.

ACTIVITY PAGE 40
a) One argument is to ensure high-quality programmes. Not relying on subscriptions or advertising revenue means the BBC can produce programmes that are not guaranteed to draw large audiences. Thus they can cater for minority interests, and can develop programmes that might start with small audiences but then grow in popularity. It should also mean, given a reasonable level of funding, that the BBC does not have to rely on game shows and reality programmes. b) Viewers may not necessarily experience disutility from watching adverts. Some advertisements provide useful information about both new and existing products, and some advertisements are amusing. c) It is debatable whether the licence fee creates allocative inefficiency. Some economists say that it does so by switching resources from popular to unpopular programmes. For instance, if people want to watch more soaps, commercial channels may be more responsive to their demand. Other economists argue that the licence fee can contribute towards correcting market failure. Some people may suffer from information failure. They may be unaware of the pleasure that can be gained from watching opera. Coverage by BBC2 may bring this to their attention.
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The licence fee may also mean that the BBC produces more programmes that are merit goods and fewer that are demerit goods than the commercial channels produce. Watching documentaries, for example, may increase students educational performance and later their productivity, and so raise output for everyone. In contrast, some people argue that making violent films may encourage violent behaviour, and watching some reality shows can coarsen behaviour. This is a controversial area: results from studies on the connection between the two are inconclusive. There is also some debate about whether watching quizzes and reality shows can inform people and, by providing relaxation and amusement, raise their productivity.

ACTIVITY PAGE 44
a) The Australian cinema-operating industry is an oligopoly. The information in the passage indicates a high three-firm concentration ratio, particularly in terms of national box office takings. There are many small operators and a few medium-sized ones, but the industry is dominated by three large firms. There is less information on the Australian film-distribution industry, but what there is indicates that it is more competitive than the cinema-operating industry. There is reference to a higher number of film distributors. This may place the industry between oligopoly and monopolistic competition. b) Other information that would be useful includes the extent of barriers to entry and exit into the market, the amount of non-price competition, the degree of interdependency, and the type of profits earned in the long run. c) Film distributors vary their charges over time to take into account changes in demand for tickets. The charges are highest during the period when it is expected that demand will be highest. d) The merger activity among film distributors will result in fewer, larger distributors. This will increase their market power. Other things being equal, this will increase their bargaining power relative to cinema operators, and may enable them to charge the operators more. The distributors, however, may not be able to exploit their greater market power if demand for cinema tickets is falling. Their bargaining power relative to cinema operators may not increase if there is also merger activity among the operators.

ACTIVITY PAGE 45
a) Television programmes run phone-ins and quizzes to raise revenue, and because they are relatively cheap to make and can attract viewers. b) The fines and adverse publicity have reduced the number of phone-ins and viewer quizzes. Television companies are now more cautious in running phone-ins and quizzes because of their experience. They are also aware that these have become less popular because of the adverse publicity surrounding them. It remains to be seen whether, in the future, phone-ins and quizzes will regain their popularity among viewers and schedulers. c) Regulation of television phone-ins and quizzes is necessary because there is asymmetric information in their running. Viewers do not have the information or the time to check that they are being operated in a fair manner.

Chapter 3
ACTIVITY PAGE 49
a) The employment of plasterers and bricklayers would have been expected to fall. This is because their labour is used to produce new houses, and house-building was declining. Labour, being a derived demand, usually declines when demand for its product declines. b) The demand for plasterers and bricklayers may not have declined if it was thought that the downturn would not last. If plasterers and bricklayers productivity and flexibility increased, they may have been retained, while other building workers were sacked.
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ACTIVITY PAGE 52
a) Number of workers 1 2 3 4 5 6 Total output 8 20 40 55 65 72 MP 8 12 20 15 10 7 MR 15 15 15 15 15 15 = MRP = 120 = 180 = 300 = 225 = 150 = 105

The firm should employ three workers, since this where MRP equals the wage rate (300). b) If the wage rate were to halve to 150, the firm should employ five workers. This means the firm should recruit an additional two workers.

ACTIVITY PAGE 55
a) i) The private costs of overworking include marriage break-ups, heart attacks and health problems. ii) An external cost of overworking is lower potential living standards resulting from lower potential output. b) Workaholics Anonymous seeks to promote the income effect of a wage rate. It tries to encourage people who tend to overwork to take more leisure time.

ACTIVITY PAGE 59
a) The expansion of university education has reduced the value of some degrees, by increasing the supply of graduates in some subjects by more than the demand for graduate labour in that field. b) There are two main reasons why some students undertake degrees in geography despite the relatively low return. One is that students enjoy the subject and are prepared to seek a geography-related job even if it is not very well paid. Another is that they may be planning to seek employment in a career that recruits graduates, but is not concerned about what subject has been studied. c) There are arguments for and against setting tuition fees on the basis of the marketability of degrees. One is that this will encourage universities to respond to market forces by offering more of the degrees that are likely to be in high demand. Another is that the private benefit to those studying medicine will be higher than the private benefit to those studying geography, for instance, and so they should be paid more. The arguments against are based on grounds of equity and market failure. Poor people are more likely to be discouraged from studying by high tuition fees, in large part because the poor are more concerned about debt. If this is the case, charging differential tuition fees may increase inequality of income. There may also be information failure. Students and universities may incorrectly forecast which degrees will be in high demand in the future. In addition, all education can be regarded as a merit good, creating more benefits, not all of which are financial, for the students themselves, and benefits for third parties in the form of higher output and a more civilised society.

ACTIVITY PAGE 60
a) Turkish teachers may be relatively well paid because they are in short supply. This would mean that a relatively higher wage would have to be paid to attract their services. Turkish teachers may also have strong bargaining power, which their union or unions may be prepared to exercise in search of higher wages. In addition, Turkish teachers may be held in high esteem. This may influence the amount that the Turkish state and private sector schools are prepared to pay teachers.
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b) It is unlikely that many Norwegian teachers will seek to work in Turkey. Although the pay of Norwegian teachers is less than half the average Norwegian wage, it may still be higher than that paid in Turkey. Even if this is not the case, Norwegian teachers may not be able to migrate to Turkey because of Turkish controls on immigration, and because of an inability to speak the language. Norwegian teachers may also be reluctant to leave family and friends behind, and may not be aware of the high pay in Turkey. If, however, the pay is noticeably higher in Turkey, and working conditions and job prospects are better, some Norwegian teachers may seek to overcome the language and cultural barriers and move to Turkey.

ACTIVITY PAGE 61
a) The earning differential between lawyers and hairdressers in 2007 was 37,336 or 209.51 per cent. b) The occupations shown that have above-average earnings are in high demand and have relatively limited supply. The high demand arises from high MRP. For instance, the services of accountants can be sold for a high figure, and chief executives can add considerable value to a firm. The relatively long period of training and qualifications to be a medical consultant, for example, limit their supply. c) Lawyers are paid more than hairdressers because demand for their labour relative to its supply is higher; both its demand and supply are more inelastic; they have more bargaining power and are held in higher esteem. Lawyers are in high demand because a considerable amount can be charged for their services. This results in their MRP being high. This demand is also inelastic. It would not be possible to replace a lawyer in a court case with an unqualified person. The supply of lawyers is relatively low and inelastic, as they have to undertake a long period of training and be well qualified. The high, inelastic demand and low, inelastic supply results in lawyers being highly paid, as shown in Figure A3.1. In contrast, hairdressers have relatively low MRP and are in relatively high supply. Demand for and supply of their services is also relatively elastic. There are some celebrity hairdressers who can charge high prices for their services, but most cannot. It also does not have to take long for someone to be trained as a hairdresser, and any qualifications required are normally relatively easy to acquire. A small rise in the wage rate may attract significantly more workers into the industry. Figure A3.2 shows a low wage arising from the low demand and high supply of hairdressers.
Wages of lawyers D W S Wages of hairdressers

W D S S 0 Q Quantity of lawyers labour 0 D Q Quantity of hairdressers labour

Figure A3.1

Figure A3.2

Lawyers also belong to a strong professional body, while hairdressers, partly because they are widely dispersed throughout the country, are not highly unionised. In addition, most people believe that lawyers should be paid more than hairdressers, and this influences how much the two groups ask to be paid.
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ACTIVITY PAGE 64
a) The wage differential between GP partners and salaried GPs was 26,500 or 58.2 per cent in 2003. It rose to 67,000 or 142.55 per cent in 2006. b) The next best paid job for most GP partners is likely to be that of a salaried GP. This would mean the probable economic rent earned by the average GP partner was 67,000 in 2006. This is because, as noted above, this is the gap between what a GP is earning as a partner and what they can earn as a salaried GP. The transfer earnings were probably 47,000. If the pay to a GP partner fell below this level, s/he would probably have switched to being a salaried GP. c) i) The elasticity of supply of labour is the percentage change in quantity of labour supplied divided by the percentage change in wages. In this case, the number of GP partners rose from 18,000 to 22,000. This is a percentage change of 22.22 per cent. Their pay rose by 24, which was a 58.33 per cent increase. This means that the elasticity of supply of labour was 22.22%/58.33% = 0.38. ii) These figures indicate that the supply of GP partners is inelastic. This would be expected, as it takes a long time to train as a GP, and high qualifications have to be gained. The inelastic supply may have been the reason why the pay rise had to be high in order to attract the extra 4,000 GP partners. iii) It would have been more useful to have calculated the percentage change in the number of hours GP partners worked. Figures were not given on hours, but the passage indicates that the number of hours worked per GP partner fell, which suggests that overall, the number of hours worked may have changed by only a small percentage. The change in the number of hours worked is a more reliable source, as it gives a better indication of how the ability of a firm or organisation to alter the output of the product has altered.

Chapter 4
ACTIVITY PAGE 67
a) The BBCs purchasing power in the market for the labour of television presenters has been reduced. It used to be a monopsonist buyer, but now it is only one of a number of buyers. Its prestige and size, which offer a good and varied career path, nevertheless make it a popular choice for employees. b) The BBC would be overpaying Jonathan Ross if it could get his services for less and/or if the value he provides to the BBC in attracting viewers is less than his pay. If, on the other hand, there is high competition for the services of a presenter from other channels, it may be necessary to pay a high salary to recruit and keep him or her. Such a presenter may increase not only the audience figures, but also the reputation of the channel, and so may attract other staff. It could, however, be argued that such a large pay award takes up a noticeable amount of the BBCs licence fee revenue, that it could be better spent (has a high opportunity cost), and that it may cause discontent among other, less well paid BBC staff. It is interesting to note that an inquiry carried out by the BBCs regulator, the BBC Trust, concluded that Rosss pay deal was fair because ITV and Channel 4 compete regularly for top entertainers. It did, however, argue that radio is different, as the BBC dominates the commercial sector which is largely composed of local radio stations.

ACTIVITY PAGE 70 (lEFT)

a) Most nurses belong to the Royal College of Nurses and most are employed by the NHS, although a number work in the private sector. So in this case, a virtual monopsony bargains with a virtual monopoly. As well as the size of membership of the union and the importance of the NHS as an employer, the relative bargaining power of the two groups is influenced by a number of other factors. One of these is the high regard the public have for nurses. This increases their bargaining strength, but the reluctance of nurses to take industrial action weakens it. b) The marginal revenue productivity of Formula 1 mechanics has risen in recent years largely because their services can be sold for higher revenue. More and more money has gone into Formula 1 with extra sponsorship and more revenue from television deals.
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ACTIVITY PAGE 70 (rIGhT)

a) Chinas economic development is resulting in its output moving up the value added chain. The countrys output of medium-value manufacturing and services is increasing. This is causing a rise in demand for skilled workers. b) The existence of skill shortages may result in costpush inflation. Firms competing for the scarce labour may bid up wages. If wages rise by more than productivity, unit labour costs will rise. A lack of skilled workers may also result in Chinese firms not being able to meet domestic demand for a range of products. This shortage, in turn, may result in a rise in imports and a reduction in the countrys trade surplus. c) Whether China will experience skill shortages in the future will depend on whether the supply of skilled workers keeps pace with the demand for skilled workers. This, in turn, will be influenced by how much investment the government, firms and workers put into education and training, and whether it is in the right areas. Training tends to be under-consumed. This is partly because of information failure workers and firms often fail to appreciate the benefits that training can provide. It is also because training generates positive externalities other, rival firms can take advantage of training carried out, by poaching staff.

ACTIVITY PAGE 71
a) Among the barriers to work are an inability to speak English, limited numeracy and written skills, lack of qualifications, disability, a criminal record and a history of unemployment. b) One advantage to employers is that, while they have to support the workers, which is likely to involve some cost, they do not have to pay those on the LEP scheme. This means they are likely to obtain some work at a cheaper rate. Another advantage to employers is that they can assess peoples skills and reliability before deciding whether to offer them a job. c) It is possible that the LEP may lead to a permanent reduction in unemployment and an increase in economic activity. It may do this by developing the skills and work habits of people who have been unemployed for some time and, by providing support, may encourage some with disabilities and extreme shyness into the labour force. There is a risk, however, that the fall in unemployment and increase in economic activity may be only temporary. This may be the case if training and support are not of a sufficiently high standard, or if employers take advantage of the scheme to obtain cheap temporary labour.

ACTIVITY PAGE 73
a) An employment rate of 70 per cent would mean that 70 per cent of those of working age are in employment. b) The structural factors that could cause unemployment to fall include supply-side reforms that make labour markets more efficient by, for instance, increasing labour mobility, and the expansion of particular industries. In contrast, the cyclical factor is an increase in aggregate demand that has the potential to reduce unemployment in most areas of the economy. c) Sockelarbeitslosigkeit is equivalent to the non-accelerating inflation rate of unemployment (also called the equilibrium level of unemployment). It is the unemployment that exists even when the aggregate demand for labour equals the aggregate supply of labour.

ACTIVITY PAGE 76
a) The two key reasons are a further fall in membership and more merger activity. If membership falls to a low level, a union may cease to exist. Merger activity, similarly, may reduce the number of trade unions in existence. b) Members may gain a variety of benefits from the merger of Unite and the United Steelworkers Union. One is that they will have greater bargaining strength in negotiating with multinational companies that operate in both the UK and the USA. If, for example, a US-based pharmaceutical firm threatens to move to a UK branch if US workers refuse to accept new working conditions, members in both countries can join together to try and prevent this. As well as the greater number of members and greater spread of membership, international unions are also likely to have more funds than national unions. This may increase their bargaining power and may enable them to provide more facilities and training for their members.
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ACTIVITY PAGE 79
a) Low-quality jobs may not provide training and may not provide long holidays. b) Temporary work may reduce productivity if it fails to provide training. In this case, workers may not be brought up to date with the latest advances in technology and working practices, and may not be able to develop their skills. The uncertain nature of temporary work may also reduce effort and enterprise. Workers may wonder whether it is worth their while to work hard and to develop ideas and products if their employment will only be short term. c) Reducing the number of days pay to which a dismissed or redundant worker is entitled may increase employment. This is because it may encourage some employers to take on more workers, knowing that, should demand fall, it would be cheaper to dismiss them. There is a risk, however, that the cost of dismissing or making workers redundant, and so making employers more willing to shed workers, may increase unemployment. This is because some workers who lose their jobs may become discouraged, and those who are geographically and occupationally immobile may find it difficult to gain new jobs. In addition, making it cheaper to fire staff will not raise employment in the longer term if aggregate demand remains low.

ACTIVITY PAGE 80
a) Literacy and numeracy increase both the range of tasks workers can perform, and the efficiency with which they can perform those tasks. Being literate and numerate enables workers to follow written communications and interpret numerical data. It also enables them to communicate in writing, increases the benefits they gain from training, and generally develops their thinking skills. All these factors should lead to a higher output per worker hour. b) The diploma may initially reduce the UK labour force, as it will mean that some 1618-year-olds who would have joined the labour force will stay on at school. It should raise the quality of the labour force, as those who take the diploma should build up their skills before they enter employment. There is also a chance that the labour force may increase in the longer term. This is because undertaking the diplomas and so raising their employability may make it less likely that some teenagers will later become discouraged workers or recipients of employment and support allowance.

ACTIVITY PAGE 83
a) Leanne Wilkinson was dismissed on the grounds that she was too young and too inexperienced for the job. b) Young workers may be very up-to-date with advances in technology, may bring fresh ideas to a firm, and may be keen to work hard and undertake training in order to gain promotion. c) Anti-discrimination legislation may initially reduce the flexibility of labour markets. Firms may have to set in place procedures to ensure the recruitment and dismissal of workers are undertaken in a manner that does not conflict with the legislation. In the long run, however, such legislation may make employers aware of the skills of a greater range of workers. If this is the case, it will increase labour market flexibility.

ACTIVITY PAGE 85
a) The income share of 99 per cent of income recipients fell from 92 per cent to 84 per cent. b) i) Globalisation has increased competition for chief executives, top sportspeople and entertainers. Pearson Education, Manchester United and major concert venues will seek to recruit the best people, wherever they come from. Such high competition is pushing up the pay of the top earners. In contrast, the pay of unskilled workers is being squeezed by firms increasing willingness and ability to engage in outsourcing and offshoring. ii) Advances in technology are enabling top executives to control larger firms that are spread out across the world, and increasing the audiences top sportspeople and entertainers can reach. These effects are raising the MRP of these groups and so pushing up their pay. At the same time, some advances in technology are reducing demand for unskilled workers as machinery replaces workers. This lower demand is placing downward pressure on the pay of this group of workers.
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ACTIVITY PAGE 86
a) The percentage of women in the wealthiest 1,000 was 9.2 per cent in 2007. It is predicted that this will rise to 60 per cent by 2020. This is a percentage point rise of 50.8. b) Among the factors that will determine the proportion of wealth owned by women in the future are the patterns of womens employment; womens promotion success; and the pattern of ownership of shares and property, for example the pattern of inheritance and divorce settlements. The more women move into high-earning industries and the more successful they are in gaining promotion, the greater will be their ability to accumulate wealth. Wealth generates wealth, so the more assets women own, the more income they will earn from them, and the more assets they will be able to accumulate. If rich, aristocratic families move away from leaving their wealth largely to the oldest son, this is likely to increase womens share of wealth. Divorce settlements in recent years have tended to become more favourable to women, but it is uncertain whether this trend will continue.

ACTIVITY PAGE 91
a) Costs to the economy of a childs poverty include an increased burden on the NHS (as a number of these children will suffer poor health), and a loss of potential productivity. b) The poverty line is usually taken to be an income level that is 60 per cent of average disposable income. People living on an income below this are regarded as poor. c) One possible government policy measure to reduce poverty would be for the public sector to raise the wages of its low-paid staff. The passage mentions that schools, hospitals and local government are among the biggest employers of low-paid workers. d) It is impossible to eliminate relative poverty unless there is complete income and wealth equality. In every country of the world, some people are poorer than others. It should, however, be possible to reduce absolute poverty. As an economy grows and develops, a higher proportion of the population should be able to gain access to reasonably well-paid jobs, which would enable them to afford more than the basic necessities of life. A growing and developing economy should also increase a governments tax revenue, which would enable it to ensure that vulnerable groups can afford good nutrition, decent housing and other essentials. As, on average, people become richer and wealthier, however, the idea of what constitutes basic necessities and what is needed to participate fully in society changes. For example, is a washing machine now a necessity?

ACTIVITY PAGE 93
a) Italys population may be ageing because of a fall in its birth rate, a fall in its death rate, and net emigration of young people. In practice, it is the first two factors. b) One factor that would increase the power of a countrys trade unions is an increase in their membership. Having more members would make the trade unions more powerful when bargaining with employers and putting pressure on the government. Having a high proportion of workers as members gives unions credibility to speak on behalf of the workers. They would also know that their bargaining positions, and any actions they may pursue or threaten to pursue in support of their claims, will not be undermined by non-union labour. Having more members would also increase the funds of trade unions, which would increase their ability to take industrial action and to provide benefits for their members. Other factors include a rise in employment, the passing of legislation that increases the actions trade unions can legally take, and the removal of legislation that restricts their activities. c) Raising the retirement age is likely to reduce the amount the Italian government spends on pensions, at least for a while. With people working longer, the Italian government should raise more tax revenue. This may result in it spending more on the care of the elderly.

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d) One measure that the Italian government could take to reduce the costs of an ageing population is to encourage net immigration of young workers by advertising job vacancies to countries inside the EU, giving out more work permits to non-EU residents, and making it easier for people from outside the EU to settle in the country. If successful, this would increase the countrys labour force and reduce its dependency ratio there would be more workers per retired person. Net immigration, however may put pressure on the countrys housing stock and, if the immigrants are accompanied by their families, may also increase the costs faced by state schools. There is also the issue of how long the immigrants will stay in the country. They are generally mobile and may be tempted to move to another country if pay and conditions are found to be better elsewhere.

ACTIVITY PAGE 95
a) Net immigration into a country will increase both aggregate supply and aggregate demand. The increase in the labour force resulting from a rise in people of working age will increase the countrys productive capacity and so shift the AS curve to the right. The immigrants will also demand goods and services and this will shift the AD curve to the right. Figure A4.1 shows these two movements.
Price level AS AS1 AD AD1

P1

AD 0 Y

AD1 Real GDP

Figure A4.1

Y1

As indicated in the diagram, the effect of net immigration will be to increase the countrys output, real GDP. Whether real GDP per head rises will depend on whether the immigrants add more to AS than to AD. b) A fall in the value of the pound sterling against the Polish zloty will reduce the return that Polish workers gain in the UK in terms of their own currency. For instance, if initially 1 = 5 zloty, a Polish worker earning 300 a week in the UK who sends 100 home would be sending 500 zloty. If the pound then fell in value to 1 = 4 zloty, the person would then be sending back only 400 zloty to their relatives. It would also mean that the purchasing power of incomes in Poland would increase in terms of sterling. Some Poles may decide, in the light of this change, that the financial return from working in the UK is not high enough. c) There are a number of factors that may lead to a greater convergence of wage rates between EU countries than with wage rates outside the EU. These factors include greater mobility of labour and capital, the adoption of similar labour policies and economic convergence. Most of the restrictions on the movement of workers and firms between the member countries of the EU have been removed. Workers moving to high-wage countries increase the supply of labour there, which can put downward pressure on wages (for example, Polish workers moving to the UK). At the same time, firms move to low-wage countries, raising demand for labour there and so placing upward pressure on wages (for instance, German firms moving to Slovenia). The adoption of similar policies, including minimum wage legislation, as well as the tendency for poorer economies of the EU to catch up with the richer ones, is also causing wage rates to converge. d) Wage rates in the EU and in other parts of the world may move closer together in the future with globalisation, although wage differentials between skilled and unskilled workers in some countries may grow. There are, however, more barriers to the movement of labour between other countries and the EU and greater differences in labour policies.
11

QuICk-FIrE QuIz PAGE 98

1. The groups of people of working age who are economically inactive include the retired, adults in full-time education and those too disabled or sick to work. 2. Work covers time when people are applying mental and/or physical effort in a job, whereas leisure is time people can spend as they want. 3. The absence of barriers to entry and exit is likely to mean that only normal profits will be earned in the long run. This is because, should supernormal profits arise, new firms will be attracted into the market. This will increase supply, lower price and compete away the supernormal profits. If, on the other hand, losses are being experienced, some firms will leave the industry. This will reduce supply, raise price and restore normal profits. 4. A monopoly differs from monopolistic competition in a number of ways. In a pure monopoly there is only one seller, while in monopolistic competition there is a high number of sellers. This means that there is the highest degree of market concentration possible in a monopoly, while the market concentration ratio is relatively low in monopolistic competition. A monopoly has high barriers to entry and exit that enable the monopolist to earn supernormal profits in the long run. In contrast, there are no or only low barriers in a monopolistically competitive market and, as a result, the firms earn normal profits in the long run. The product produced by a monopoly is unique, while those made by monopolistically competitive firms are slightly differentiated. 5. There are a number of factors that influence the demand for television production crew. The key one is demand for television programmes. The more television programmes the television production companies can sell, and the higher the revenue they can get for them, the more television production workers they are likely to employ. The other key influencing factors are the productivity and wages of the crew, the cost of capital equipment, and whether such equipment acts as a substitute or a complement to the crew. If the wage rate paid to the crew grows at a more rapid rate than productivity, demand is likely to fall. If cameras, and other equipment that requires people to operate it, falls in price, demand for production crew is likely to increase. If, however, new equipment is developed that can be operated with fewer workers, demand for production crew will decrease. 6. The supply of teachers labour becoming more elastic would mean that it becomes more responsive to changes in the wage rate. A reduction in the qualifications and the skills needed to be a teacher would make supply more elastic. A small rise in the wage rate would attract more people into the profession, as more people would meet its entry requirements. A shorter period of training and rise in occupational and geographical mobility would also increase the pool of potential teachers. Time, itself, will also enable more people to train as teachers in response to a rise in the wage rate. 7. The immobility of labour leads to market failure, as it means that markets will not be able to respond fully to changes in demand and supply conditions. For instance, demand for skiing holidays in France may increase, but it may be difficult to recruit more skiing instructors because instructors from other countries are geographically immobile, and workers in France pursuing other occupations are occupationally immobile. In this case there would be under-production of skiing holidays the output would be below the allocatively efficient level. 8. If a countrys Gini coefficient increases, it means that its income has become more unevenly distributed. The closer the figure gets to 100%/1, the more uneven it is. So if, for example, it rises from 0.35 to 0.42, income has become more unevenly distributed.

ExAm PrACTICE PAPEr PAGE 102 SECTIon A

1 a) i) The four-firm market concentration ratio increased in 2007 compared with 2005. The four most listened-to stations had a 40.8 per cent share of the market in 2005. This share had risen to 41.6 per cent in 2007. ii) Magic experienced the greatest percentage increase in reach between 2005 and 2007: 0.5/2.9 100 = 17.24 per cent.
12

b) i) Three characteristics of monopolistic competition are a large number of small firms, product differentiation, and ease of entry and exit into the market. ii) A market moving from oligopoly towards monopolistic competition will be introducing more competition. Having more firms competing for the custom of consumers may result in them enjoying lower prices and higher quality. The ease of entry into and exit from the market will mean that only normal profits are earned in the long run, which should increase consumer surplus. There is a chance, however, that consumers may lose as a result of this change in the market structure. Larger firms can take greater advantage of economies of scale and so unit costs and prices may be higher under monopolistic competition, despite the greater level of competition. Some of any supernormal profits enjoyed by oligopolists may be spent on research and development, resulting in new and improved products. Consumers are likely to have a relatively wide range of different brands to choose from under oligopoly, and may enjoy some of the methods used by oligopolists to attract customers, including free gifts and competitions. c) A journalist may prefer to work for the BBC because the pay is better. The wage rate received is a key influence on the job selected by a worker. As well as the pecuniary reward, workers also take into account the non-pecuniary benefits of a job. The BBC may, for instance, offer better promotion chances. The BBC is a large organisation. Someone starting as a journalist on, for example, Radio Solent may work their way up to be a presenter on a BBC1 TV show. The relatively high prestige associated with working for the BBC may also make it easier to gain a good job with another media organisation. Indeed, someone might be prepared to work as a journalist on BBC radio for a lower wage than that available on commercial radio if they believe it will enhance their future earnings or generate extra work opportunities by raising their profile. In addition, the BBC may provide better holidays, more sociable working hours and/or better pension entitlements than commercial radio stations. d) An increase in trade union membership among radio journalists may increase their pay, but it will depend on a range of factors, including the extent of the rise in membership, the action they are prepared to take in support of any pay claims, the extent to which they can be substituted by nonunionised labour, profits earned by the radio stations, and the degree to which commercial radio stations act together. A small rise in trade union membership that means most journalists still do not belong to the trade union is unlikely to increase that unions bargaining power. There is also the possibility that trade union membership may increase, but may be fragmented among a number of unions, so that the commercial radio stations can play one union off against another one. Having more members may not be effective in raising pay if the members are not prepared to back up their pay claims with industrial action. The increase may, however, be more successful if it is difficult to replace unionised labour with non-unionised workers. This is because the commercial radio stations would find it hard to put out their news programmes if the unionised journalists went on strike and the stations could not recruit non-unionised journalists. If the commercial radio stations are experiencing losses or low profits, they will be unable to raise pay. In such circumstances, a union is unlikely to press for higher pay. A trade unions power to raise journalists pay would be weakened if commercial radio station bosses get together to bargain as one. Given their commercial rivalry, however, it is unlikely that they will join together. So an increase in trade union membership is likely to be more effective in raising commercial radio journalists pay if it results in most of the journalists belonging to the union, the members are prepared to support any action they are called upon to take, they cannot be replaced by non-unionised journalists, the commercial stations are earning high profits, and they negotiate separately with one trade union.
13

SECTIon b
2 a) Negative discrimination is one factor but other influences should be considered, using demand (MRP) and supply analysis. Female solicitors may work fewer hours, may have career breaks to have children, and a smaller proportion of them may belong to the careers professional body. The MRP of female solicitors may be lower than that of male solicitors if they have fewer qualifications, less training, and work in less lucrative areas of the law. b) There should be a discussion of the factors that will influence what will happen to the gap based on demand (MRP) and supply analysis. Demand for female solicitors relative to male solicitors may rise if negative discrimination falls, the qualifications and training gained by female solicitors improve, the hours worked by female solicitors may increase, and they may enter higher paid areas of the law. The reasons for, and the likelihood of, these changes should be examined. 3 a) The key factors that influence the number of hours a day an individual works include the number of hours on offer, the wage rate and the workers desire for leisure time. Use should be made of the income and substitution effects. It would be beneficial to include a diagram. b) There should be a discussion of the factors that influence the long-run supply of labour, that geographical and occupational mobility of labour may be limited, and a recognition that pecuniary and non-pecuniary advantages and disadvantages can change over time. Whether more people will move to France in the future will be influenced not only by the holidays and working hours, but also by the availability of work in the country, the pay on offer, promotion opportunities, job security, the qualifications needed, etc. Some UK workers may wish to work in France, but may be discouraged by the difference in language, cultural differences and family ties. They may, however, be encouraged by lower house prices in France and the relative ease of working in another EU country. UK people are also likely to consider whether the relative advantages and disadvantages of the jobs in the two countries will change over time. 4 a) The NMW should be explained (a diagram may be drawn). Then the arguments for maintaining it should be explained, including reducing poverty, countering the power of monopsonists and oligopsonists (and so correcting market failure),and raising labour productivity. b) There should be a discussion of arguments for and against paying the same NMW to all those aged 16 and over. The arguments for include avoiding age discrimination, reducing the costs of administrating and operating the law, and improving the morale, training and productivity of young workers. Arguments against include that it may discourage the employment of young workers and raise firms costs of production. These arguments are based largely on the assumption that the MRP of young workers is lower than that of older workers, and there will be more costs involved in employing young workers in the form of more training. The reasons why this may or may not be the case should be explored.

Chapter 5
ACTIVITY PAGE 108
a) There are no explicit answers to this activity. The following tables from Transport Statistics, Great Britain contain some relevant statistics on the determinants of demand for private car transport: 19.19 3.3 3.3 6.6 14.14 14.15 Retail Price Index: transport components Punctuality at UK airports Petrol and diesel prices and duties per litre National railways: passenger charter punctuality and reliability Local bus services: local authority support by area Local bus services: fare indices by area.

Most of the above tables cover a ten-year period.

14

Transport Trends tables contain similar information, usually with a statistical commentary: 1.4 2.6 3.2 3.3 4.111 b) Congestion Changes in relative costs of transport Local bus reliability Bus passenger satisfaction A range of data on travel by household income and car ownership, by age and gender, by trip purpose and accessibility.

Using some of the above data, the main determinants of demand for transport by local bus include: the cost of bus fares the cost of substitutes such as private car travel household income trip purpose age and gender reliability. These differ from the determinants of demand for private car transport insofar as car ownership/availability is usually the most important factor that determines whether a car is used for a particular journey.

ACTIVITY PAGE 110

There are no particular answers to part a). In part b), the relationship between journey purpose and derived demand should be understood. This should be followed by an evaluation of the extent to which household travel demand is determined by the qualitative assessment of the comparative advantages of, say, the private car and bus for particular types of journey.

ACTIVITY PAGE 113

a) The general determinants of demand are: the price/cost of a mode of transport the price of substitutes and complements household income taste, fashion.

b) Some points to note are: Increases in household income allow more families to purchase cars, hence greater use of private car transport. The increase in bus and rail fares relative to motoring costs might be used to explain the decline in bus transport over this period, and the decline in the use of rail transport up to 1995. Qualitative factors such as reliability, convenience and flexibility tend to favour the car over most forms of alternative transport.

ACTIVITY PAGE 115

a) The main problem is that there are many determinants of the demand for road passenger and freight transport services. These are often difficult to estimate. Particular problems arise with respect to behavioural factors that govern travel behaviour. b) The biggest benefit is a reduction in congestion. The volume of traffic falls just 7 per cent, but the intensity of congestion falls much more. In all cases, the benefits represent a very convincing case for the introduction of some form of road pricing. c) Road traffic forecasts provide a crude but essential estimate of future demand into the decision-making process for new roads. Historically, they have been the main reason why most new road schemes have been constructed. In recent years, though, the predict and provide approach that underpins new road development has been subject to increasing criticism. Consequently, some new roads have been built for other valid reasons, such as providing environmental relief or to reduce accidents at a particular black spot.

15

Chapter 6
ACTIVITY PAGE 120
a) Table 6.1 No. of planes 0 1 2 3 4 5 6 7 b) See Figure A6.1.
Cost () 1400 1200 1000 800 600 400 200 0 1 2 3 4 5 AC AVC AFC 6 7 Number of planes MC

Average fixed cost 1,000 1,500 1,333.3 1 250 1,200 1,166.7 1,142.9

Average variable cost 1, 400 1, 275 1, 216.7 1, 175 1, 200 1, 266.7 1, 342.8

Average cost 1,400 1,775 1,550 1 425 1 400 1,433.3 1,485.7

Marginal cost 400 150 100 50 300 600 800

Figure A6.1 c) In general, the four curves follow the same pattern as in Figure 6.1 (page 120 in the textbook). The shape of the AC and AVC curves is less pronounced than in this figure, due to the high fixed costs in relation to total costs. The MC curve cuts AC at its lowest point, although its shape is not as smooth as the MC curve in Figure 6.1.

ACTIVITY PAGE 129

a) The four-firm concentration ratio is 0.89 in 2002 and 0.86 in 2006. This represents a small decrease in the percentage of the total market of the four largest firms. British Airways market share has fallen significantly, while two of the low-cost carriers, Ryanair and easyJet, have increased market share. The overall size of the market has increased by around 45 per cent over the four-year period. b) There are various reasons for these changes. An increase in discretionary income has meant that more people are able to fly. Fares are likely to have fallen in real terms. New routes, particularly from low-cost carriers, have encouraged more people to fly. Domestic rail fare increases have led to more people flying in the UK.

c) This is a compound measure of supply. It takes into account the seat capacity of each aircraft in an airlines fleet and the total flights by distance made by that aircraft over a period of time, usually one year. It does not measure whether seats have been sold to passengers.
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ACTIVITY PAGE 142

a) i) The usual determinants of demand can be applied, namely: the price of the fare the discretionary income of consumers the price of substitutes (e.g. Channel Tunnel, other ferry routes, airlines) the price of complements such as fuel taste and fashion factors that might determine whether a family wishes to travel by sea. ii) P & O Ferries has about 30 per cent market share on the competitive short sea routes from Dover. Data from operators is not easy to obtain. On other longer routes, firms often have a route monopoly as far as that route is concerned. Evidence from websites indicates intense price competition this is not a feature of oligopolistic markets. There is also price variation depending on whether you look at the operators own website or that of a travel broker. The market today seems far removed from when it was investigated by the Competition Commission in 1996, the outcome of which was that conditions were made for the proposed joint venture between P & O and Stena. b) 0.72 c) Truronian has about 1.7 per cent of the buses owned by other bus operators. Its acquisition by First Group would lead to a small increase in the five-firm concentration ratio and First Groups share of the national market. Overall, there would be a marginal impact, although locally First Group may hold route monopolies.

ACTIVITY PAGE 146

There are no explicit answers to this activity.

ACTIVITY PAGE 147

a) The following data can be collected from national sources such as Transport Trends and Transport Statistics, Great Britain: trend in payments for unremunerative services number of passenger vehicle operators licences trend in real fare levels average age of the bus fleet bus miles operated. b) No explicit answer is available to this activity.

ACTIVITY PAGE 151

a) The following statistical information can be used to evaluate the impact of rail privatisation since 1995: growth in passenger kilometres and goods tonne kilometres private sector investment in rail vehicles public sector investment in Railtrack change in subsidy payments reliability and punctuality statistics increasing concentration of ownership new types of rail freight carried.

b) A short essay is required here. There is no correct answer. The important consideration is that the objective chosen is justified using appropriate evidence.

17

Chapter 7
ACTIVITY PAGE 154
Although total greenhouse gas emissions have been falling, the volume from the transport sector has actually been increasing in absolute and relative terms. From a modal standpoint, the largest increase has been from air transport. Rail and bus transport emissions are much lower in comparison and, given their passenger volumes, produce significantly lower carbon footprints per head. However, Figure 7.2 (page 153 in the textbook) shows that, over the past few years, mainly through more efficient vehicles, there is a widening gap between car use and CO2 emissions. A more environmentally acceptable transport policy would be one that encouraged the greater use of those modes of transport that produce low levels of CO2. It is also debatable whether there should be new constraints on the growth of air travel, particularly for non-essential reasons.

ACTIVITY PAGE 162

a) i) See Figure A7.1.
Costs and price MSC

MPC1
Y P1 P2 P Z X tax

MPC

MXC

D = MSB 0 Q1 Q2 Q Quantity

Figure A7.1 ii) The introduction of the flat rate tax has led to some improvement in efficiency the price paid has increased to P2 and the quantity demanded has fallen to Q2. The welfare loss has also been reduced the new triangle XYZ is smaller than that shown in Figure 7.7 (page 158 in the textbook). It should be stressed that this is still not an optimal outcome. b) Although there is no explicit answer to this question, it is likely that a search will come up with some of the following: the LCC is not popular with certain businesses, particularly those located within the charging zone; loss of trade is often referred to the LCC leads to congestion around the edge of the cordon there may be some change in direction of policy following the change of mayor in May 2008.

ACTIVITY PAGE 163

a) This is clearly a popular policy with the over-60s, and will generate some votes among this group. It may, in a modest way, encourage some over-60s to switch from using a car to the bus. If so, it would be a more sustainable outcome. The cost to the government is the opportunity cost involved the 2bn could have been allocated to other areas of government spending, such as health and social security, both of which would benefit older people. b) For the individual, if they use the bus, it means that their real income has increased. There is also the nonquantifiable benefit to be gained through increased travel opportunities. The costs seem negligible.

18

ACTIVITY PAGE 165

Some possibilities are: For: reduced CO2 emissions from air transport boost to domestic tourism enhances awareness of the negative externalities involved. Against: difficult to control what about business travel? direct intervention in working of the market mechanism fewer flights will mean less employment in aviation and related industries negative impact on recipient countries that rely on tourism why only control flights why not ban gas-guzzler cars?

ACTIVITY PAGE 166

The main trends are: a reduction in numbers using the private car, especially since 2000 a 20 per cent increase in those travelling by surface rail an 80 per cent increase in those travelling by bus. The main determinants are likely to be cost, and qualitative factors such as convenience, quality of service and so on. The congestion charge appears to have had a particular effect in reducing private car travel.

ACTIVITY PAGE 167

a) This information can be obtained from various statistical publications, including Transport Statistics. (i) In 2005/06, road users paid over 28bn in taxes (VED and fuel tax). Due to increased fuel prices, it will be considerably more in 2007/08. (ii) Capital and current road expenditure in 2006/07 was around 9bn. b) On the surface, road users are getting a poor deal they are paying at least three times more to the Exchequer than they are getting back in the form of road maintenance and new roads. This well-worn argument fails to acknowledge that the purpose of taxation is to fund all types of government spending, and that hypothecation has never been seriously suggested in this case.

ACTIVITY PAGE 171

a) All estimates for travel after 8 a.m. are inelastic. Travel between 8.30 and 9 a.m. is more inelastic and therefore likely to be more essential at this time. The estimate for travel between 9 a.m. and 9.30 is unusual it means that as price increases, more travel occurs. This is probably due to car users delaying the start of their trip to wait for a lower charge to be in place. The zero estimate indicates that there is perfect inelasticity those travelling between 7.30 and 8 a.m. have to do so. b) i) It seems logical to set the highest charges where the price elasticity estimates are most inelastic, namely between 7.30 and 8 a.m., and between 8.30 and 9 a.m. The positive estimate for 9 to 9.30 a.m. might result in congestion during this period. There may be a case for increasing the charge further during this period in an attempt to persuade some motorists to vary their journey time period. ii) Maximum revenue will be generated by increasing charges in time periods with the lowest inelastic price elasticity of demand, e.g. 8.30 to 9 a.m.

19

Chapter 8
ACTIVITY PAGE 176
Private costs: construction costs annual maintenance costs annual subsidy to operator. Private benefits: reduced journey times for users reduced costs for some users less congestion for those not using new facility. External costs: loss of buildings to make way for construction some blight and noise in city centre. External benefits: less traffic noise and air pollution improved work opportunities. Indirect costs: less spending available for other projects. Indirect benefits: wider benefits of new investment opportunities in the local economy. Some of the effects do not fit easily into the discrete categories above.

ACTIVITY PAGE 182

a) i) Time savings are invariably the biggest benefit in most cost-benefit studies time is money. As time does not command a market price, a value has to be imputed. ii) This is because any time savings can be put to an alternative use that will be more productive than idle time in congested traffic. b) The wider-impact effects of a huge project like Crossrail are very difficult to measure. This is because, from a scientific standpoint, it is difficult to establish which effects have come about just from, say, Crossrail and which would have come about in any case, irrespective of the project going ahead.

QuICk-FIrE QuIz PAGE 190

1 Billion passenger kilometres, billion tonne kilometres. 2 A few large firms; high barriers to entry; non-price competition; price rigidity; interdependence. 3 Removal of regulations, for example barriers to entry into a market. 4 Because it internalises the cost of the negative externality onto the road user. 5 Meeting present needs without compromising the ability of future generations to meet their own needs. It can apply to transport policies that encourage greater use of more sustainable modes of transport and promote a reduction in the demand for less sustainable modes. 6 A method for assessing whether a project should go ahead where the market mechanism cannot be used, for example in the case of public goods.

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ExAm PrACTICE PAPEr PAGE 194

Section A 1 a) i) Rail ii) Cars b) Various possibilities, including: an increase in car availability a fall in the real cost of car use an increase in the price of substitutes, e.g. bus, rail a deterioration in the reliability and punctuality of rail transport non-transport factors, such as an increase in out-of-town shopping centres, changing work locations. For full marks, the answers should explain why the particular determinant has actually resulted in an increase in passenger transport by car. c) i) Passenger transport is a derived demand because it fulfils some particular purpose, e.g. journey to work, school or shopping. ii) In theory, it is expected that there is a positive relationship between the annual change in real GDP and the annual change in demand for passenger transport. This is indicative of transport being a derived demand. When the economy is growing at a good rate, the demand for transport for work as well as non-work reasons is likely to increase. There may, though, be a short time lag. iii) There is no overwhelming evidence that this relationship applies to the data in Table 2 (page 195 in the textbook). There seems to be a time lag of one year at some stages of the series, but this is not consistent. A reason for the above is likely to be that the change in demand for passenger transport depends on a whole range of determinants, only one of which is the change in real GDP. d) There appears to be some evidence in the two tables to suggest that the demand for passenger transport is becoming more sustainable. In Table 1 (page 194 in the textbook), there has been a relatively small increase in demand for car transport compared with rail, which is a more sustainable mode. The demand for bus and coach transport has also increased. Table 2 seems to indicate a decoupling of the relationship between the change in real growth and the change in demand for passenger transport. However, the transport data are very crude, and not as accurate as those for real GDP growth. Also, a decline in the annual rate of increase in demand for private car transport could be due to growing congestion problems. The data for bus and coach transport are also misleading the increase in demand is mainly confined to London; elsewhere demand has continued to fall or, at best, has been stable. 2 a) Oligopolistic markets are characterised by having high barriers to entry for new firms. Additionally, there are typically a small number of large firms and differentiated products, with branding prevalent. In these circumstances, therefore, firms invariably compete through non-price competition; the brand image, customer service, fashion and other non-price factors are predominant. Reasons for this can be explained through price rigidity and the kinked demand curve. An explanation using simple game theory is equally relevant. b) Most transport markets do tend to be oligopolistic. This is particularly so when considering the total markets for local bus transport, rail passenger transport, rail freight, air transport in the EU and crosschannel ferries. Evidence of oligopoly can be shown through a three- or four-firm concentration ratio. An example of this will enhance the evidence base of the answer. The extent to which firms compete is variable. To some degree, it depends on how the market is defined. For example, a rail operating company may have a local monopoly, but may be an operating company of one of the main groups when looking at the whole market. Air transport is a good example of where alliances have been formed. It is these alliances, as well as individual operations, that actually compete with each other. In most markets, though, there is likely to be some limited competition.
21

3 a) A negative externality occurs when the marginal social cost of an activity is greater than the marginal private cost. This results in market failure, since the price that is paid by users does not reflect the true cost of that activity. (This can be shown on a diagram.) Various negative externalities arise from the increased use of air transport, including: an increase in CO2 emissions and contribution to global warming and climate change oise disturbance to people who live in the vicinity and on the flight paths of airports that have n experienced increased traffic levels various forms of environmental pollution and visual intrusion around airports possible health risks to air passengers and crew arising from increased air travel.

b) In theory, this type of negative externality could be resolved through a green tax that, if accurate, would be equal to the difference between marginal social cost and marginal private cost. Such a tax would be particularly efficient if it were hypothecated to offset the negative externalities referred to above. The Air Passenger Duty is a flat rate indirect tax on short- and long-haul air passengers. At present it is not related to the cost of externalities, although from 2010 it will be calculated per flight rather than per passenger. It is not hypothecated to provide for those affected by negative externalities revenue is collected by airlines and goes straight to the Exchequer. 4 a) Most major new transport projects are publicly funded or involve PPPs. As a consequence, the use of the market mechanism and raising investment funds on the open market is not appropriate. A second issue concerns the availability of public funding resources are invariably scarce in relation to demand, so some means has to be established in order to determine funding priorities. Cost-benefit analysis seeks to achieve these objectives by taking a long view and a wide view of all of the various costs and benefits involved. b) The underlying principles of the Crossrail cost-benefit study are in some respects well established. They involve projecting the volume of traffic that would use the extended facility, and the benefits in terms of travel time and cost savings to such users. Estimates are also made for the benefits that will apply to those travellers remaining on other modes of transport after some traffic transfers to Crossrail. This approach is not new, and the methodology that is used is relatively robust. What is new, though, is the estimation of the indirect costs and benefits of Crossrail, for example, the effects of its construction on employment in the City and the wider economic benefits on the community. Such costs and benefits are far from easy to calculate. They are, though, very important in the overall justification of the Crossrail project from a public funding standpoint.

Chapter 9
ACTIVITY PAGE 201 (lEFT)
a) Economic growth and the rate of inflation might be expected to be positively related. As the rate of economic growth falls, the rate of inflation might be expected to fall. Higher economic growth would be expected to generate higher rates of inflation. This relationship can be explained by increasing AD (to AD1 in the figure opposite). As the economy is operating closer to its full capacity output, the price level rises to P1. Increases in AS, on the other hand, would allow the economy to grow without any increase in the rate of inflation. However, rising inflation might coincide with falling economic growth if there is a leftward shift of AS1 (to AS2) caused by rising input prices. Real GDP in this case would fall to Y2 as the price level rises to P1.
Price level AS2 AS1

P1 P AD1 AD 0 Y2 Y Y1 Real GDP

Figure A9.1
22

b) A deterioration of the UKs current account of the balance of payments might be a cause for concern if: it results from a lack of international competitiveness it is not matched by a capital account surplus it constrains the rate of economic growth in the long run. However, a deterioration in the current account might not be a problem if: it results from imports of capital goods which raise the long-term rate of economic growth it is sustainable because of long-term capital flows into the economy.

Whether a deterioration of the UKs current account of the balance of payments is a cause for concern depends very much on the causes and consequences of the current account deficit.

ACTIVITY PAGE 201 (rIGhT)

a) Five indicators might include: GDP per capita doctors per 1,000 of the population televisions per 1,000 of the population life expectancy at birth adult literacy rate.

b, c) There is no one answer to these questions. d) The standard of living can be thought of as the quantity and quality of the goods and services available to the population. Where income is equally distributed, comparisons of GDP per capita will provide meaningful comparisons of the standard of living of the average person in two countries. However, income is not equally distributed and average GDP can give misleading comparisons. GDP per capita could be the same in two countries, but income inequality in one country might mean that the standard of living of the average person differs markedly. Comparisons of the standard of living are made more difficult and less meaningful because of the wide range of different indicators. These may give conflicting pictures of the standard of living in two countries. To some extent, comparisons are not meaningful because there is a degree of subjectivity in the interpretation of the different indicators.

ACTIVITY PAGE 202

a) Economic growth in China has led to an increase in average incomes in both urban and rural areas. As a result of higher average incomes, there will be higher standards of living because people in China will be able to consume more goods and services, as indicated by the increase in retail sales of consumer goods. Material living standards will have increased. b) Economic growth in China might have reduced the standard of living because some people in rural areas have been displaced from their homes by the building of reservoirs. For some, their ability to earn a living through farming, for example, has been reduced by the need to increase the production of energy for industry. c) Rapid economic growth in China has a positive impact on living standards in the UK through increasing the supply of goods and services and reducing the price of imported goods. It may also have provided a market for UK exporters, raising GDP and employment in the UK. On the other hand, increased competition from China may result in falling sales for UK firms, reducing output and employment. Chinese economic growth may also be responsible for increases in the world price of energy and oil, which has a negative impact on the standard of living in the UK.

ACTIVITY PAGE 203

a) Inflationary pressures might have been experienced in: 19731974 19851990 19992000. These are periods in which the output gap narrowed.
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b) Estimates of the output gap are useful because they indicate when inflationary pressures might be building up in the economy. They might, therefore, give advance warning that the rate of inflation is likely to rise, and guide policy makers in the setting of fiscal and monetary policy. The difficulty of measuring the output gap, however, provides problems for policy makers. For example, interest rates may be increased because the estimated output gap is narrowing and yet there are changes in the economy, such as immigration, that are increasing the economys potential output. Basing economic policy on only one indicator is likely to lead to inappropriate policy changes.

ACTIVITY PAGE 206 (ToP)

a) Reasons for the slowdown in consumer spending in late 2007 include: reduction in the availability of credit consumers may have found it more difficult to finance expenditure through borrowing, leading to a slowdown in spending expectations the Bank of Englands warning of a slowdown in economic growth might have caused some consumers to reduce their expenditure for fear of rising unemployment in the future. b) A reduction in interest rates reduces the cost of borrowing and the reward from saving. For those with mortgages, discretionary income is increased through a reduction in mortgage interest payments. As a result, it is likely to increase consumer spending. It is also likely to raise investment by reducing the cost of borrowing for firms. Increases in consumption and investment add to AD, creating short-run economic growth. There are some circumstances in which economic growth will not be stimulated, however. These include: market interest rates may not be reduced following a reduction in the interest rate by the Bank of England (as happened in the UK in 2008) a lack of confidence on the part of consumers and firms offsetting reductions in the other components of AD.

ACTIVITY PAGE 206 (boTTom)

a) A stronger euro will raise the price of euro zone exports and reduce the price of euro zone imports. This should lower the demand for euro zone exports and raise the euro zone demand for imports. Both of these will contribute to a lower level of AD, which will reduce economic growth in the short run. b) Two reasons why euro zone net exports have risen despite the euros appreciation against the dollar are as follows. Productivity gains increases in output per person will reduce euro zone unit costs. This will allow firms in the euro zone to lower prices to offset the impact of the appreciation of the euro on the price of goods produced. Growth in world demand an increase in world demand will increase the demand for euro zone exports, particularly those with a high income elasticity of demand. This will offset the reduction in demand caused by the appreciation of the euro. c) The case for a managed appreciation of the exchange rate includes: it reduces import prices, particularly important for an economy that is heavily dependent on imports for raw materials and components it helps to reduce inflationary pressures it forces domestic firms to be efficient and to strive to reduce costs in order to compete in international markets. A managed appreciation of the exchange rate, however, might reduce economic growth by raising the price of exports and reducing the price of imports, causing a reduction in AD. It may also lead to reductions in employment in industries unable to reduce unit labour costs by either raising productivity or reducing the growth of wages. Domestic monetary policy must be used to support the exchange rate policy such that interest rates cannot be used to manage domestic demand. The policy is more appropriate for an economy with a large exposure to international trade and capital flows, such that an independent monetary policy is difficult.

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ACTIVITY PAGE 216

a) Possible reasons for the projected decline in Bulgarias population of working age include: a falling birth rate emigration. b) An increase in investment will increase AD, but will also raise the productivity capacity of the economy, shifting the AS curve to the right. Increases in productivity improve the efficiency with which resources are used, also shifting AS to the right. Without either or both of these, Bulgarias long-term rate of economic growth will be constrained by the projected decline in the population of working age. This is because a smaller working-age population will shift AS to the left. c) Consequences might include: potential output expanded increased supply of labour impact on wages rates, labour costs and price of output reduction in labour shortages. Commentary might include: benefits reduced by restrictions on immigration benefits for whom? impact on wage rates dependent on who migrates i.e. skills profile consequences for social housing and benefits context of ageing population/population of working age extent to which there is an optimal population size distinction between the impact on GDP and GDP per capita e.g. making the economy larger as opposed to making it richer.

ACTIVITY PAGE 217

a) Generous unemployment benefits available in Germany and France are likely to shift the long-run aggregate supply curve to the left. This is because they may encourage workers to spend more time seeking work once unemployed, reducing labour mobility and flexibility. b) A lack of labour mobility and flexibility is likely to result in lower rates of economic growth for these economies, compared with those of the UK and the USA. This is because changes in economic activity are more likely to bring about prolonged periods of unemployment, which will limit the ability of firms to respond to rising demand.

ACTIVITY PAGE 219

a) According to the HarrodDomar model of economic growth: Y/Y = s/k Rearranging this equation for savings gives: s = Y/Y k The USA needs to devote 2.5 2.8 = 7 per cent of national income to savings to achieve a growth rate of 2.5 per cent. Kenya needs to devote 2.5 6.8 = 17 per cent of national income to savings to achieve a growth rate of 2.5 per cent. b) Low rates of savings due to low levels of income will constrain an economys long-run rate of economic growth according to the HarrodDomar model. However, Kenya is not doomed to low rates of economic growth if it can plug the savings gap. This might mean attracting investment from foreign multinational companies, aid from foreign governments or international institutions, or borrowing from abroad.

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ACTIVITY PAGE 220

a) Market failures that would justify government intervention to raise the UKs productivity might include: short-termism of banks and financial institutions positive externalities from investment, including investment in training information failures constraining access to finance for training/retraining.

b) Appropriate policies might include: investment grants to firms this would reduce the cost of investment for firms and make them less reliant on external sources of finance for investment projects training levies on firms all firms required to contribute to training costs or share costs of training within industries, preventing incentive to poach trained workers from other firms state provision of training loans individuals can access funds for training by using state credits.

ACTIVITY PAGE 222

a) An under-valuation of the Chinese currency will make Chinese exports more price competitive than they would be otherwise. This will increase the demand for exports. b) Rapid economic growth in China has created demandpull inflation, as the economy has increasingly moved towards full capacity. This has resulted in increases in the demand for labour and emerging labour shortages, which has increased wage rates. Since labour is probably a major input cost for Chinese firms, this has also created wagepush inflation. Inflationary pressures have been seen in construction due to the increased demand in this sector. c) Policies the Chinese government could use to reduce the inflationary impact of economic growth include: contractionary fiscal policy, reducing government expenditure and raising taxation contractionary monetary policy, raising interest rates revaluation of the currency, to raise export prices and reduce import prices incomes policy, to reduce the growth of wages. These policies would reduce inflationary pressure by reducing the growth in demand and limiting cost push pressures. Commentary on the policies could include: the impact on other macroeconomic objectives, particularly employment and unemployment the responsiveness of the components of AD to changes in the interest rate and exchange rate, including the interest elasticity of demand and the price elasticity of demand for exports and imports the time-scale over which the policies might be effective.

ACTIVITY PAGE 226

a) Since 1993, the US current account balance has deteriorated. b) Since 1993, the US capital account balance has improved. c) The gap between investment and savings in the USA first narrowed from 1993 to 2000, before widening to 2003. d) Whether the current account deficit of the USA is a cause for concern depends on its causes and consequences. On the one hand, a deficit caused by a lack of international competitiveness would be considered a cause for concern because, in the long run, it would be unsustainable. A growing deficit might not be a cause for concern if it is caused by imports of capital goods, which will enable the USA to generate higher levels of domestic output. In this sense, the deficit is simply a form of investment. A deficit caused by high level of US consumption, raising the demand for imports, might be thought of as a cause for concern, as it is an indication that the economy is living beyond its means. However, so long as the growing current account deficit is matched by a growing capital account surplus, there will not be adverse consequences on growth or the exchange rate the deficit is being financed by the sale of assets abroad.

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ACTIVITY PAGE 231

a) A rise in the interest rate should result in market rates of interest increasing. This is because of the way in which the financial system works, with the central bank providing funds to the banking system at the official base rate. If the central bank charges the banking system higher rates of interest, these should be reflected in higher market rates of interest. b) The rate of interest and asset prices should be negatively related. When interest rates come down, asset prices should rise, because it will be cheaper to borrow funds to buy assets, thereby increasing the demand for assets. c) Rising interest rates will tend to generate expectations of a slowdown in economic growth and therefore they will reduce confidence in the economy.

ACTIVITY PAGE 232

a) Government borrowing arises when the expenditure of the government is greater than its revenue. Government debt is the accumulation of unpaid borrowing over time. b) Advantages of Estonias fiscal policy rule include: no crowding out of the private sector the avoidance of fiscal deficits, meaning that interest rates do not have to be raised in order to attract funds to finance the deficit provides the conditions for economic stability by eliminating the possibility that fiscal policy contributes to the economic cycle. Disadvantages of Estonias fiscal policy rule include: automatic stabilisers are not allowed to function may make the economic cycle more pronounced as fiscal policy needs to be tightened in an economic slowdown or recession removes the ability of governments to employ counter-cyclical policy may limit public sector investments that could improve long-run economic growth the exception to the rule for pensions allows the government to borrow to finance current consumption but not capital investment may require short-term changes in government expenditure and taxation to balance the budget, which may be destablising.

c) Fiscal policy rules can contribute to economic stability by limiting the expansionary and contractionary impact of government spending and taxation. They provide a framework for the conduct of fiscal policy, which creates transparency in the way fiscal policy is conducted. This helps to create greater certainty and provides conditions that favour business investment. They limit the power of governments to make fiscal policy decisions based on short-term political considerations. The effectiveness of fiscal policy rules depends on the rules themselves, however. To be effective, they must take into account the impact of the economic cycle on the fiscal stance. For example, a rule that simply states that the governments budget must balance may create economic instability by requiring governments to tighten fiscal policy in a recession. Even more sophisticated rules that take account of the economic cycle may not promote economic stability because of the problems of measuring the underlying fiscal stance. While fiscal rules may, under certain circumstances, contribute to economic stability, they do not on their own guarantee it.

ACTIVITY PAGE 234

a) There are three key determinants of long-run economic growth: the size of the labour force the size of the capital stock the efficiency with which the labour force and the capital stock are used to produce output (productivity). By increasing the productive capacity of the economy, the factors above determine the rate at which aggregate demand can increase in a sustainable way.
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b) The output gap is the difference between actual and potential output. A negative output gap occurs when actual output is below the productive potential of the economy. In this situation, spare capacity is said to exist. Where the margin of spare capacity is limited, growth of aggregate demand is likely to put upward pressure on prices. The policy objective of the Bank of Englands Monetary Policy Committee (MPC) is to deliver price stability. It is set a target rate of inflation by the government of 2 per cent, and must ensure that inflation does not exceed 3 per cent or fall below 1 per cent. A limited margin of spare capacity is therefore significant for the MPC, as it indicates potential inflationary pressure in the economy. c) The UK inflation target is symmetrical the central target is 2 per cent, with an upper ceiling of 3 per cent and a floor of 1 per cent. As a result, built into the target is a belief that low inflation is as much a concern as high inflation. The costs of high inflation include: the impact on long-term planning; increased risks and borrowing costs; the misallocation of resources; and the impact on the distribution of inflation. Given the difficulties of measuring the rate of inflation, a low rate of inflation risks a low rate of economic growth. The advantage of a symmetrical inflation target, then, is that interest rate changes are likely to be less frequent and of a lower amount. In this way, a symmetrical inflation target is likely to promote economic stability. In addition, the objectives of this aspect of macroeconomic policy are clear and transparent. This has an impact on inflationary expectations, considered to be a key determinant of inflation in modern macroeconomics. Furthermore, the UK inflation target acts as a constraint on fiscal policy policy makers are aware that any fiscal expansion that is likely to compromise the inflation target is likely to be met by monetary policy tightening. In short, inflation targeting reduces macroeconomic instability created by manipulation of monetary and fiscal policy for short-term political objectives, and ensures that monetary policy decisions are not unduly influenced by current macroeconomic conditions. Implicitly, inflation targets recognise the time-lags inherent in monetary policy. Commentary on the extent to which an inflation target, such as that in the UK, promotes economic stability might seek to establish the problems in setting an appropriate target. There could be commentary on the extent to which inflation targeting could be compromised in situations where the inflation target is set by the government, as is the case in the UK. Alternatively, the composition of the body responsible for interest rate decisions (in the UK, the MPC) could be explored in terms of accountability, term of office and nature of appointment. There are difficulties in setting interest rates with a view to influencing future rates of inflation.

ACTIVITY PAGE 237

Three supply-side policies that might improve an economys international competitiveness are: ducation and training this is likely to increase labour productivity, reducing unit labour costs and so e improving price competitiveness of domestic firms rivatisation and deregulation provides incentives to increase efficiency, thereby lowering unit costs and p allowing firms to be more price-competitive in international markets overnment subsidy of research and development this increases investment, which could increase the g quality of goods and services produced, allowing domestic firms to compete better in international markets.

ACTIVITY PAGE 238

a) The price level is a measure of the average price of goods and services produced in an economy, whereas inflation measures the rate of change of prices. b) The Czech Republic because it has the lowest level of prices in the EU, even though prices are rising quickly. c) Increased labour force participation would improve the competitiveness of a high-cost, high-inflation economy such as Ireland. This is because an increase in labour force participation would increase the economys LRAS curve. This would have two effects. Continued growth of the economy would be possible without inflationary pressures, due to an increase in the productive capacity of the economy. In addition, an increase in the population willing and able to work would raise labour supply. This is likely to reduce the rate at which wages rise, and may even reduce unit labour costs. The reduction in inflationary pressures, both demandpull and costpush, would improve the economys price competitiveness in international markets. d) Effective supply-side policies allow an economys AD to increase without creating inflationary pressure. They do this by increasing labour productivity and the productive potential of the economy, and creating
28

more labour and product markets that are more responsive to changes in demand and supply. The consequences of effective supply-side policies create advantages for the conduct of monetary policy. First, by reducing inflationary pressures in the economy, monetary policy can be eased. Interest rates can be set lower without the danger of an inflationary stimulus to AD. This will encourage greater investment, which itself will create the conditions for more sustainable economic growth. Second, if labour and product markets adjust more quickly to changes in demand and supply, then this takes the pressure off monetary policy. This means that interest rate changes do not need to be so large to manage AD. However, supply-side policies take time to create the conditions under which these effects on monetary policy begin to be realised. It may also be the case that labour market flexibility has adverse effects on factors such as job security, levels of pay and welfare benefits. These consequences may give rise to social and regional problems that have to be offset against the benefits for the conduct of monetary policy.

Chapter 10
ACTIVITY PAGE 240 (ToP)
Three key findings might include the following. he WTO exists to promote free trade and encourages countries to abolish tariff and non-tariff barriers T to trade. he WTO also resolves trade disputes between countries it can place trade sanctions on countries that T do not abide by its rulings. The WTO runs global trade negotiations aimed at reducing trade barriers.

ACTIVITY PAGE 240 (boTTom)

a) Answers are dependent on students own research. b) Reasons students might give to explain the main exports and imports for a particular country might include: natural resource endowment for exports or lack for imports factor endowment for exports or lack for imports geography or climate (although this is part of resource endowment) labour cost advantages.

ACTIVITY PAGE 244

a) The PPC for each country should look this:
Clothes China (C) 5,000 Clothes Italy (C)

1,000

PPC 0 5,000 Motor vehicles (M) 0

PPC 4,000 Motor vehicles (M)

Figure A10.1

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b) China has the absolute advantage in the production of clothes, as its maximum output is higher than Italys. c) China should specialise in the production and export of clothes. This is because it has a lower opportunity cost in clothes production (1 unit of clothing: 1 motor vehicle) relative to Italy (1 unit of clothing: 4 motor vehicles). d) The terms of trade that would benefit both countries would lie between the relative opportunity cost ratios, 1C:1M to 1C:4M. For example, if the terms of trade were 1C:2M, then each unit of clothing traded by China would allow it to purchase two motor vehicles more than it could produce itself by transferring resources from the clothing to the car industry. Similarly, Italy could purchase one unit of clothing for two cars, less than the opportunity cost of domestic production of clothing. e) Based on terms of trade equal to 1C:2M, the trading possibility curves for each country would look like this:
Clothes China (C) 5,000 Clothes Italy (C)

2,000

TPC 0 10,000 Motor vehicles (M) 0

TPC 4,000 Motor vehicles (M)

Figure A10.2

ACTIVITY PAGE 248

a) The benefits of trade in textiles for Lesotho include: greater economic efficiency in terms of resource allocation employment tax revenue for the government from taxation of income and profit foreign exchange earnings addition to aggregate demand. Students might review their answers to this question when they have studied Chapter 11 of the textbook they will then be able to set these benefits in the context of a developing economy. b) Competition from China poses problems for Lesothos textile industry because of its much lower labour costs. One option might be to lower wage rates offered to workers, although this might result in workers moving to other occupations where they exist. Another option is to increase efficiency by raising labour productivity. This could be done by the use of more capital-intensive methods of production, although this would be inappropriate for a developing country such as Lesotho and may be prohibitively expensive for textiles firms themselves. A third option would be to diversify into production of fabric in order to reduce import and transportation costs. The only alternative to reducing production costs is to shift production into higher-value garments. This might be done through design, or the use of better quality or niche fabrics such as organic cotton. Such products would allow Lesotho to command higher prices for its garments in world markets, reducing the competition from low-price, low-value Chinese textiles.
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ACTIVITY PAGE 253

a) When a country imposes a tariff on imports, it raises its prices, lowering the demand for imports and allowing domestic firms to raise their supply and the level of imports fall. These effects are shown in Figure A10.3.
Price Sdomestic

Pw+t 1 Pw 2 3 4 tariff

Ddomestic 0 Q1 Q3 Q4 Q2 Quantity

Figure A10.3 Without tariffs, domestic production at the world price Pw is Q1 and domestic demand Q2, Q2 Q1 being imports. A tariff raises the price of imports to Pw + t. This allows an extension of supply from domestic firms to Q2. There is a contraction of domestic demand to Q4. Imports consequently fall to Q4 Q3. International trade is therefore reduced by tariffs. b) The winners from tariffs are: domestic suppliers price and output are higher, resulting in increased producer surplus of area 1 domestic workers there is likely to be higher employment as a result of tariffs the government imposing the tariff they earn tariff revenue on imports, equal to area. The losers from tariffs are: domestic consumers they pay higher prices and are unable to consume as much as before, resulting in a reduction of consumer surplus of area 1 + 2 + 3 + 4 exporters exports are reduced in volume and value, reducing export revenue and profits workers abroad they are likely to lose jobs governments abroad they will lose tax revenue.

ACTIVITY PAGE 258

a) The Hungarian forint has depreciated against the US$, since more forints are required to buy each US$. The forint has depreciated by 28 per cent against the dollar. b) A freely floating exchange rate is thought to benefit economies by allowing central banks to set domestic monetary policy to control the rate of inflation rather than the exchange rate. However, in the case of Hungary, the dramatic fall in the foreign exchange value of the currency is likely to have required central banks to raise interest rates to support the currency. This is because the large depreciation will have significantly raised import prices and put the control of inflation at risk. A second benefit of a freely floating exchange rate is the idea that the exchange rate will tend to reflect purchasing power parity and reduce speculation. Such a dramatic depreciation in the exchange rate of the forint against the dollar in such a short period suggests that this benefit was not being realised. It is likely that the forint was under speculative attack, with large capital outflows causing the currency to fall so far, so quickly there would appear to be a run on the currency. The impact on the cost of repaying borrowing in US$ would have been substantial. Unchecked, such a depreciation could have created deflationary effects on the economy. The benefits of a freely floating exchange rate for the Hungarian economy depend in large measure on the reasons for the rapid and significant depreciation experienced in October 2008. A loss of confidence in the forint is likely to bring more costs than benefits.
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ACTIVITY PAGE 262

Answers depend on students own research.

ACTIVITY PAGE 269

a,b) Other non-tariff barriers to trade and how they restrict trade: border controls add to costs of imports, making them less competitive against domestically produced goods quotas restrict the quantity of imports, thereby raising their price import bans obviously a complete restriction on trade public procurement policies the public sector may favour domestic firms in buying goods and services state monopolies create barriers to entry that restrict domestic and foreign competition import licences restrict imports to licensed buyers only and raise the price of imports minimum import prices raise the prices of imports, making them less competitive export subsidies reduce the price of exports making them more competitive rules of origin determine the nationality of goods and services in order to restrict imports from certain countries or give preferential access to goods from other countries rules on packaging and labelling increase the cost of production of imports above what would be necessary to supply the domestic market. c) Economic integration may seek to remove NTBs through removing them (negative integration) or creating common standards across the economically integrated area (positive integration). For example, the EU may create packaging and labelling rules that must be adhered to across the whole of the EU. This way, production for countries in the rest of the EU is not disadvantaged relative to production for the domestic market.

ACTIVITY PAGE 276

a) Two reasons why the retail price of cars differs between countries in the EU are as follows. Differences in GDP per capita these result in differences in effective demand. The price of cars is likely to be lower in countries with lower GDP per capita because effective demand is lower. If prices were the same across the EU, the affordability of cars would differ markedly, reducing the total volume of sales for manufacturers. This is related to the concept of purchasing power parity. Possibility of price discrimination car manufacturers may engage in price discrimination, charging high prices in countries where the price elasticity of demand is inelastic. This arises when manufacturers are able to prevent consumers buying in low priced markets.

b) Economic integration refers to the process of blurring the boundaries that separate economic activity in one nation state from activity in another. This involves the removal of tariffs and non-tariff barriers to trade, the free movement of goods, services and the factors of production, the harmonisation of product standards, fiscal harmonisation, and monetary union depending on the level of integration. Integration should result in the creation of a single market, raising the level of trade and competition. Price differences should be eroded by trade, competition, greater price transparency and the elimination of transaction costs. In an economically integrated area, prices should reflect demand and supply across the whole area as a result of consumers buying across borders and producers entering nations where prices are higher than average. The forces of demand and supply should lead, over time, to the convergence of prices the law of one price. The extent to which economic integration tends to lead to the convergence of prices of consumer goods depends on a range of factors. The level of economic integration determines the extent to which a single market exists. Where product standards are not harmonised, producers are able to engage in market segmentation across national borders, and will limit the extent to which consumers engage in cross-border shopping. A lack of fiscal harmonisation will result in price differences remaining as a result of differences in expenditure taxes. Different product specifications allow price discrimination to continue. There may be differences in regulation resulting in differences in costs in different parts of an economically integrated area. Prices will always reflect transport costs, and this will limit price convergence. Prices will also reflect the degree of competition within each national market, and may be higher in countries where there is less competition. Branding, product differentiation and consumer loyalty may all play a part in the extent to which prices converge.
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Chapter 11
ACTIVITY PAGE 282
a) Some of the targets for each of the Millennium Development Goals include the following. Goal 1 eradicate extreme poverty and hunger. Targets reduce the proportion of people living on less than a dollar and the proportion of people who suffer from hunger by a half, and create full employment. Link to development reduce poverty, increase GDP per capita and improve life expectancy. Goal 2 achieve universal primary education. Targets ensure all children complete primary education. Link to development improve literacy rates and human capital. Goal 3 promote gender equality and empower women. Targets get rid of differences in primary and secondary education for girls and boys. Link to development improve literacy rates and reduce inequalities in income distribution between the sexes. Goal 4 reduce child mortality. Targets reduce the death rate of those under five by two-thirds. Link to development improve life expectancy. Goal 5 improve maternal health. Targets universal access to contraceptives and family planning, and reduce maternal mortality rate by 75 per cent. Link to development improve life expectancy, human capital and earnings potential. Goal 6 combat HIV/AIDS, malaria and other diseases. Targets reverse the spread of AIDS/HIV and incidence of malaria. Link to development improve life expectancy, improve earnings potential and human capital. Goal 7 ensure environmental sustainability. Targets reduce biodiversity loss, reduce proportion without access to safe drinking water by 50 per cent, improve lives of at least 100 million people living in slums. Link to development create conditions for sustainable development, improve life expectancy, improve earnings potential and human capital. Goal 8 global partnership for development. Targets reduce debt problems by making debt sustainable, create tariff-free access to developed economy markets for developing countries. Link to development raise exports of developing countries, raise GDP per capita, reduce dependency and raise living standards. b) Answers dependent on students independent research. c) Answers dependent on students independent research.

ACTIVITY PAGE 284

a) Additions to each category include: economic objectives efficiency, stability, reduction of unemployment social objectives education, health, security environmental objectives clean air, reduced CO2 emissions, optimal use of non-renewable resources.

b) Reasons might include: economic objectives to raise GDP, GDP per capita and the rate of economic growth social objectives to ensure the benefits of economic growth are shared more equally and to raise standards of living environmental objectives to reduce negative externalities of economic growth, to ensure development is sustainable. c) Economic growth may conflict with economic development where growth creates negative externalities such as air pollution. In such cases, the benefits of economic growth for both current and future generations is reduced
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by the impact on health. The external costs of production reduce economic welfare. The marginal social cost of production exceeds the marginal private costs, such that resources are not allocated efficiently. The external costs of production, however, can be reduced by government intervention such as taxation, regulation or pollution permits. In the case of developing countries, however, the technology required to reduce air pollution may be prohibitively expensive.

ACTIVITY PAGE 286

a) The two countries that least support the relationship expected between HDI values and GDP per capita are Yemen and Chad. Yemen has the third highest HDI value in the table, but it has the second lowest GDP per capita. Chad, on the other hand, has the second lowest HDI value but has a GDP per capita higher than those of Benin, Yemen and Sierra Leone, and almost as high as that of Uganda, which has the third highest HDI. b) Despite a similar GDP per capita, Uganda may have a higher HDI because it may perform better on life expectancy, adult literacy or educational enrolment. These differences might reflect more effective resource allocation in Uganda, or the different priorities of the two governments. c) HDI and HPI measure the same components, but with different indicators. HDI measures the components positively and HPI measures them negatively. For example, HPI replaces life expectancy by the probability of survival, adult literacy and education enrolment by adult illiteracy and GDP per capita by measures of deprivation.

ACTIVITY PAGE 289

a) GDP per capita and life expectancy are positively related. Higher GDP per capita is associated with higher life expectancy. This is likely to be because of better nutrition arising from higher incomes, and because richer economies are able to provide better health care, either through the market or through government provision. GDP per capita and Internet users per 100 people are also positively related. This is likely to be because ownership of PCs increases with GDP per capita, due to PCs having a high income elasticity of demand. In addition, Internet usage is dependent on an advanced telecommunications infrastructure, which will tend to be undeveloped in countries with low GDP per capita, or totally absent in rural areas. b) Economic growth is necessary to achieve the three objectives of economic development set out by Todaro: an increase in the availability and distribution of basic life-sustaining goods; an increase in levels of living; and an expansion of the economic and social choices available to people. However, on its own economic growth does not guarantee development, so it is not a sufficient condition. For example, the benefits of economic growth may not be shared equally, and higher material living standards for some may coincide with continued poverty for others. This might arise where economic growth is achieved by capital-intensive production, raising the living standards of the owners of capital but providing little employment for the masses.

ACTIVITY PAGE 290 (lEFT)

Population problems of developing economies include rapid population growth, high dependency ratios, migration and rising death rates. In the short run, these problems arise because the need to provide for a greater number of dependents with a smaller workforce makes it difficult to raise living standards. Population problems create demands on productive resources, which begin to outstrip their supply, and levels of health and education consequently fall. In the longer run, there is increased pressure on governments to provide job opportunities to cope with greater urbanisation and to control the environmental impacts associated with some of these population problems.

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ACTIVITY PAGE 290 (rIGhT)

a) There are a number of different sectors of the economy, including the primary, secondary and tertiary sectors, the formal and informal sectors, the traditional and modern, and the urban and rural. Low levels of development often mean that there is a greater emphasis on primary, traditional, informal and rural sectors of the economy. Development leads to a move through the secondary to the tertiary sector, a reduced importance for informal activities, more modern systems and country-to-city migration. For example, the size of the primary sector of developing countries results from their low level of development. With a large proportion of the population living on low incomes (in Namibia, 35 per cent living on less than $1 a day and over 55 per cent on less than $2 a day), subsistence farming is the norm for many almost 50 per cent of the population in Namibia are engaged in agriculture. The result of low incomes is low levels and rates of saving. Low levels of savings constrain the ability of the secondary sector to grow, since it is essentially starved of funds for investment. Furthermore, the lack of developed financial markets and financial intermediaries mean that what savings exist are not efficiently channelled into the secondary sector. Rich elites in developing countries tend to invest savings outside the domestic economy (capital flight), further limiting the development of the secondary sector. The primary sector, therefore, remains large. b) Changes in the structure of production may involve the move out of primary into secondary or tertiary economic activity, a switch to export-oriented output, or even changes in the ownership of productive resources. This means the reallocation of resources between different uses and a change in the nature of output. Developing countries may face obstacles in attempting this change. For example, there may be inadequate expertise, factor immobility, a lack of technology, insufficient funds, trade barriers or a lack of comparative advantage. The change itself might create problems, such as the neglect of agriculture or too high a rate of urbanisation. Some of these problems may be overcome relatively easily, while others may be almost impossible to overcome. It may be possible to address some problems immediately, while others may be tackled only in the long run.

ACTIVITY PAGE 292

a) Primary commodities are likely to have price inelastic demand and supply. Changes in either demand or supply are therefore likely to bring about large changes in price. In Figure A11.1 a shift in supply from S1 to S2 causes a large change in price from P1 to P2. Primary commodities are subject to variations in supply, particularly in the case of agricultural commodities, where yields and harvests are subject to the forces of nature. Volatile prices can also be caused by a swing in demand because of price inelastic supply in the short run.
Price S1 S2

P1

P2

D 0 Quantity

Figure A11.1

35

b) A cartel of rice producers would involve a group of producers agreeing to regulate the supply of rice to the world market. c) By regulating the supply of rice, net exporters may stand to benefit from higher export revenue. Since the demand for rice is likely to be price inelastic, a reduction in supply will result in a proportionately greater increase in price than the decrease in consumption. As a result, revenue from sales will increase. Net importers stand to lose. However, the benefit to net exporters is dependent on the ability to regulate and police supply decisions in a cartel. Supply restrictions require quotas to be successful. Marginal producers have an incentive to produce more than their quota in order to increase revenue further. If significant numbers of producers act in this way, the cartel will break down. Although net importers may lose out from higher prices, it may be that the cartel regulates supply in order to stabilise rather than raise prices. This will be of benefit to net importers in the long run. The benefits therefore depend on the actions of the members of the cartel.

ACTIVITY PAGE 293

Answers depend on students independent research.

ACTIVITY PAGE 295

Industrialisation is the process of moving production from the primary to the secondary sector, so that manufacturing predominates over agriculture. It may also be interpreted as applying industrial methods to all forms of production. Manufacturing is seen as an engine for growth, bringing more employment, higher incomes, higher productivity, technical progress and greater value added. It has been the traditional method of achieving growth. The outcome would be faster growth, with the potential for higher living standards and greater development.

ACTIVITY PAGE 301

a) Structural adjustment programmes are promoted by the World Bank to restructure the economies of developing countries. They favour market solutions, and may involve deflationary policies, reduction of government intervention, devaluations, greater reliance on private enterprise and extensive use of markets. Loans and assistance may be conditional on their implementation. b) The poor economic performance of developing countries has been blamed on excessive state control, inflexibility, lack of competitiveness, budget deficits, trade deficits and resistance to change. These have been linked to the lack of market influences and a weak supply side of the economy. The outcome of the present structure has been poor living standards and low levels of development. A move from state control to the market is thought necessary to enable greater development. Structural adjustment is necessary to speed up change, improve efficiency and raise levels of development. c) Structural adjustment programmes are thought to promote economic development by enabling market forces to deliver greater economic efficiency and to promote sound management of the economy, which will deliver macroeconomic stability, creating the conditions for economic growth. In addition, they help to increase international competitiveness. Structural adjustment programmes are criticised for harming poorer citizens, reversing previous development, and concentrating on economic growth rather than human development. They are sometimes said to reflect the needs of the developed world at the expense of developing countries and they may increase dependency.

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a) Development raises the quality of life across an economy. Sustainable development involves meeting the needs of the present generation without compromising the ability of future generations to meet their own needs. It is concerned with intergenerational welfare/equity and the optimal use of resources over time. This involves maintaining the stock of man-made, human and natural capital. Economic growth may increase
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development in some ways, but harm future development, particularly in terms of the stock of natural resources and the environment. Failure to make development sustainable might mean falling quality of life for future generations. Damage to sustainability may be irreversible, so harming development permanently. b) MNCs invest in developing economies to make profits. As long as they act ethically, they may encourage sustainable development. Their policies may reveal awareness of the issues of sustainability. They may introduce efficient methods of production, co-operate with government policies, improve human capital and the capital stock, and raise the quality of life. Against this, however, they may exploit developing economies by paying low wages, may avoid paying taxes through transfer pricing, may encourage urban migration, may exhaust natural resources, may create external costs, may harm local cultures, and may create greater inequality. These effects would be anti-developmental and are linked to the concept of sustainability. The conflict arises from the contrasting aims of profit maximisation and sustaining levels of development.

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a) Possible environmental impacts of economic growth include: air pollution water pollution noise pollution global warming destruction of wildlife habits, species and biodiversity loss.

Possible social impacts of economic growth include: income inequality associated crime impact on the family health effects such as stress greater time spent commuting, resulting from increased traffic congestion. b) These impacts represent the negative externalities of economic growth. As a result, the social benefits of economic growth are less than the private benefits, and the social costs of production and consumption are greater than the private costs. Both result in over-production and over-consumption, and a misallocation of resources towards growth. While material living standards are increased by economic growth, true economic welfare is lower than GDP per capita would tend to suggest. c) The Index of Sustainable Economic Welfare (ISEW) adjusts national expenditure figures, such as GDP, by deducting the value of the negative impacts of economic growth and making additions to represent the value of the positive impacts of economic growth. The ISEW requires monetary values of the costs of negative externalities of economic growth, such as damage to the environment and monetary values of unrecorded economic activity, such as the value of work done in the home. d) By taking into account the negative and positive aspects of economic growth, indicators of sustainable economic development provide a better indication of progress than measures that simply value the total level of production and consumption taking place. This makes such measures useful in judging whether economic growth is delivering increases in not just the material standard of living, but also the quality of life. Judgements about the extent of progress in well-being can be made. The measures are also useful in forcing policy makers to address issues related to the environment and sustainability. They may allow better policy decisions to be made, and informed choices between different policies with different environmental and social impacts. The usefulness of such indicators is tempered by the difficulties of measurement inherent in quantifying impacts that do not have a market price. For example, it is difficult to put a monetary value on the loss of species, or on noise or ill-health caused by stress. Valuations can be made by calculating shadow prices, but there is no agreement on the reliability of such valuations. Combined with the problem of what environmental and social impacts to include in composite measures of sustainable development, the usefulness of the measures is undermined. Nevertheless, treating the environment as if it had no price is a recipe for continued environmental sacrifices at the altar of economic growth.
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ACTIVITY PAGE 308

a) Students own research. b) The EUs ETS sets a limit on CO2 emissions for the largest industrial polluters in the EU. Firms are then allocated permits by the governments of the EU member states. Firms not using their quota of pollution are allowed to sell permits to those firms that exceed their quota. This creates a market for pollution, and puts a price on CO2 emissions. Clean firms are rewarded with revenue from the sale of quotas and dirty firms are penalised. This creates incentives to reduce emissions of CO2 over time. A gradual reduction in the supply of permits over time raises their price. ETS therefore works with the market mechanism and internalises the negative externality by allowing the market to determine a price for pollution. c) The benefits to firms and the environment include: firms are rewarded through the market mechanism for reducing CO2 emissions firms are able to choose the most cost-effective way of reducing emissions a price is put on the environment, which means environmental impacts are internalised in firms costs structures the environment ceases to be treated as if it were a free resource.

d) The problems of carbon emissions trading schemes mainly relate to their effectiveness, which is dependent on a number of conditions being fulfilled. For a carbon emissions trading scheme to be effective: it must be possible to measure pollution and to monitor it it must be possible for authorities to enforce permits there must be a clear target set for emissions, and this should correspond to an output at which the MSB = MSC there should be a large number of firms involved in the scheme so that a correct market price can be determined by a large number of buyers and sellers there should be firms that find it easy and less costly to reduce pollution than others there should be few transactions costs in trading, and there should be perfect information and knowledge for the market to function well.

Chapter 12
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a) A possible disadvantage of the corporate tax rates being driven down to a low level is that governments may not raise enough tax revenue to finance an adequate social welfare system. This tendency for globalisation to drive down tax revenue, and so the standard of the social welfare system, is sometimes known as social dumping. b) Globalisation may keep inflation low by increasing the competitive pressures on firms. Knowing that consumers can now buy products more easily from foreign rivals means that firms have to keep their costs low. The increased ability to locate production processes in different parts of the world helps them to keep costs low. If globalisation and other factors keep inflation low, it means that central banks do not have to raise interest rates as a counter-inflationary measure. c) Globalisation may or may not reduce unemployment in a country. The outcome will be determined largely by how the economy responds to the challenges of globalisation. If firms and their workers can respond more quickly and fully to changes in comparative advantage and changes in demand, unemployment may fall. Freer trade, new production methods and new products are creating more products and more employment opportunities. If, however, firms do not pick up on market signals, and workers lack skills and mobility, unemployment may rise. If, for example, UK-based car producers do not innovate and reduce costs by means of greater mechanisation and improved training, they will lose out to producers in China, India and other countries.

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ACTIVITY PAGE 315

a) Two factors that have made it easier for firms to act transnationally are improved communications and a reduction in transport costs. Being able to contact a branch abroad easily makes it simpler to co-ordinate production, to deal with any difficulties quickly and to exchange information about new techniques. Falling transport costs make it cheaper to move items and staff around during the productive process. b) Firms acting transnationally has a number of implications for governments. These arise largely from production being more mobile. Governments may engage in tax competition, driving down tax rates in order to attract and keep firms in the country. The increase in firms acting transnationally also puts pressure on governments to increase the skills of the labour force by improving education and training, and to create a favourable business environment by, for instance, reducing regulations.

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a) Unilever may enjoy low production costs and a growing market by operating in South Africa. Given the high rate of unemployment in the country, it is relatively easy to recruit workers there. Wage rates are lower than in the EU and USA, and if the productivity of workers is reasonably high, labour unit costs are likely to be low. Other production costs, including rent and rates, are also likely to be relatively low. South Africa is a growing economy, with rising incomes. By having a presence in the country, Unilever may gain brand loyalty before other MNCs seek to locate and sell in the country. b) If Unilever pulled out of South Africa, the countrys aggregate supply is likely to fall, as the country is likely to remove some of its capital equipment and relocate some of its key staff. The effect on AS will be greater if the factories and offices that it closes down are not bought and re-opened by other firms in the country. As well as AS decreasing, AD will also fall. Unilever will no longer be demanding supplies and services from local producers, it will not have workers in the country, and it will stop contributing to South Africas exports. Figure A12.1 shows South Africa starting with a negative output gap, given its high level of unemployment. The decrease in AS and AD reduces the countrys real GDP.
Price level South Africa AS1 AS AD1 AD

P1

AD1 AD 0 South Africas real GDP

Figure A12.1

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ACTIVITY PAGE 318

a) It does not necessarily indicate that unskilled workers send more money back to developing countries than skilled workers. They send back a higher proportion, but this does not necessarily mean it is a higher amount. For instance, an unskilled worker may send back 60 per cent of his/her disposable income each week, while a skilled worker may send back only 20 per cent. If, however, an unskilled worker earns $50 a week, he/she will send back $30, whereas a skilled worker, earning $300 a week will be sending back $60. b) The emigration of skilled workers may benefit developing countries by bringing money back into the country. Remittances are a major source of finance for some developing countries. If workers return to the country after a number of years, they may also bring back new ideas, and they may have developed skills and qualifications while working abroad. The emigration of skilled workers, however, may harm developing countries. It may lead to a shortage of skilled workers, which in turn will reduce potential GDP and discourage MNCs setting up in the country. Income inequality may increase as the pay of skilled workers in the developing countries may rise due to their shortage, while the pay of unskilled workers may fall due to a reduction in economic activity. It will also mean that other countries will benefit from the training that the developing countries have given. The skilled workers may leave behind children and elderly relatives, thereby increasing the dependency ratio.

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a) US cotton subsidies will reduce the price of US cotton. Other countries cotton producers will be forced to reduce the price of the cotton they seek to sell in order to remain price competitive. b) The WTO seeks to promote free trade. Its actions do not, however, always lead to freer international trade. This is because it permits countries to improve tariffs on countries that engage in what are considered to be unfair trading practices, and do not stop them when instructed to do so by the WTO.

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a) i) Balance of payments difficulties usually refers to countries experiencing large current account deficits over a period of time. They may borrow to finance them and get into difficulty repaying the loans. ii) Improved economic management refers to better control of the economy through more efficient and appropriate fiscal, monetary and supply-side policies. The country will experience lower and more stable inflation, be closer to full employment, have a steadier and more sustainable economic growth, and be closer to a balance of payments equilibrium. b) One of the functions of the IMF is to promote international monetary stability and co-operation. It surveys and monitors economic and financial developments. Every year it publishes a report on individual countries, regions and the global economy. As well as providing information and advice to governments in pursuit of this aim, it also organises meetings of governments and central banks to discuss key developments and issues in international monetary markets.

QuICk-FIrE QuIz PAGE 323

1 Boom, slowdown, recession, recovery. 2 Economic growth in the long run is related to increases in LRAS, whereas economic growth in the short run assumes that the productive capacity of the economy is unchanged. 3 In a free trade area, there are no tariffs on trade between partners but each country retains an independent trade policy with other countries. In a single market, there is a common trade policy (and common external tariff) and further economic integration in terms of common policies in other areas. 4 Benefits include access to a larger market, economies of scale, greater competition, more trade (trade creation). 5 GDP per capita, life expectancy, educational attainment. 6 The primary sector shrinks as a proportion of total output as first the secondary sector grows and then the tertiary sector. In addition, informal sector activity declines and the urban sector grows.
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7 Benefits include greater trade and competition between economies, leading to lower prices, greater efficiency and higher economic growth. Costs include: developing countries may struggle to compete in international markets, and globalisation contributes to increased use of non-renewable resources. 8 The WTO seeks to encourage free trade. It settles trade disputes between countries and reduces the barriers to trade through international trade negotiations.

ExAm PrACTICE PAPEr PAGE 330

1 a) An economic slowdown occurs when there is a reduction in the rate of economic growth. It is normally used to describe the period of slower economic growth preceding a recession. b) An economic slowdown in the USA would lead to a reduction in aggregate demand in Brazil. This is because there would be a reduction in the demand for Brazilian goods and services in the USA, reducing Brazilian exports, and US companies would be less likely to invest during a slowdown, causing a fall in FDI in Brazil. The diagram below shows a leftward shift in AD as a result. The Brazilian economy suffers a reduction in real GDP (or a reduction in the rate of economic growth), a possible increase in unemployment, but a reduction in the price level (or more realistically a reduction in the rate of inflation). In addition, there might be a deterioration in the balance of payments on current account.
Price level AS

AD

AD1

Y1

Real GDP

Figure 1 c) Setting interest rates to promote economic stability involves a number of problems, including the length of time over which the monetary transmission mechanism operates, the information requirements to assess present and likely future performance of key economic indicators, the possibility of external shocks, and the responsiveness of economic agents to changes in interest rates. Reliable economic modelling will help to reduce the extent of these problems. However, these problems may be more severe at times of global economic uncertainty. 2 a) The World Bank exists to promote economic development by providing financial assistance and technical assistance for developing countries. The focus of its activities is on financial support for, among other things, internal investment projects such as building new roads, improving port infrastructure and constructing new health facilities. It does this by providing loans and grants to developing countries that would otherwise find it hard to raise capital on international markets. b) Developed countries have a different economic structure from developing countries. They tend to have a structure that is less dependent on the primary sector of the economy; economic activity tends to be much more concentrated in the secondary and tertiary sectors. The reasons for this relate to the special characteristics of developing economies. The size of the primary sector of developing countries results from their low level of development. Low incomes cause low levels and rates of saving. Low levels of savings constrain the ability of the secondary sector to grow, as it is essentially starved of funds for investment. Furthermore, the lack of developed financial markets and financial intermediaries means that what savings exist are not channelled efficiently into the secondary sector. The primary sector therefore remains large in developing economies and marks them out from more developed nations.
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c) Commodity prices tend to be volatile because of the interaction of changing demand and supply with low price elasticities of demand and supply. The result of the volatility in the price of primary commodities is largely negative for developing countries because of the impact on export revenues. In addition to volatile prices, it has been argued that commodity prices exhibit a long-term downward trend. This is caused by the low-income elasticity of demand for primary commodities, combined with increased supply. The PrebischSinger hypothesis suggests that developing countries that specialise in the production and export of primary commodities are trapped in a low level of development as a result of such changes. However, the extent to which developing countries are affected by such changes in commodity prices depends on their economic structure and their ability to change this. Countries that have changed their economic structure have avoided these problems successfully. The validity of the PrebischSinger hypothesis has also been challenged. Recently commodity prices have increased dramatically, and the impact of this change has been positive rather than negative. 3 Rapid economic growth results in an increase in GDP per capita. As a result, it raises material standards of living and contributes to economic development by raising average incomes, widening access to goods and services, and allowing resource allocation decisions that can increase life expectancy and educational attainment. However, even if economic growth is consistent with economic development, this does not guarantee that it is consistent with sustainable development. Sustainable development requires that the needs of the current generation are met without compromising the ability of future generations to meet their own needs. Rapid economic growth may involve a rate of depletion of natural resources that is less than optimal. Future generations can therefore be left with a stock of natural capital that reduces their ability to satisfy basic human needs. Slash-and-burn agriculture, for example, provides income for the current generation, but exhausts the land to the extent that future generations are unable to use it for productive economic activity. Rapid economic growth may also cause an increase in inequality, such that it is difficult to argue that genuine development has taken place. The extent to which economic growth is consistent with sustainable economic development depends in large part on the ability of developing countries to manage growth in a way that minimises its negative impact. This may take the form of government intervention to internalise the negative externalities of growth and to ensure that benefits of growth are shared widely among the population.

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