The role of money

Money is any item or verifiable record that is generally accepted as payment for goods and services, as well as for the repayment of debt, within an economy.

Money is said to have four functions

  • Medium of Exchange:  used for buying and selling goods.
  • Store of Value: We value goods and wealth through money. Money makes it easy to compare goods
  • Standard of Deferred Payment: Money is used to pay back debt.
  • Unit of Account: prices and accounting records use money

Positive and normative economics

Positive Statements

Positive Economics – concerned with facts – value free. Positive statements are objective and can be tested as true or false. A positive statement is a statement about what is and contains no indication of approval or disapproval. A positive statement can be wrong; it can be tested by objective use of evidence. The tools of positive economics are reason, logic and empiricism.

Normative Statements

Normative Economics – concerned with opinions. Normative statements are subjective, i.e. they are opinions or value judgements. A normative statement expresses a value judgment about whether a situation is desirable or undesirable. Statements that include indicator words such as: should, ought, or prefer are likely to be normative rather than positive

Decide whether the following statements are positive or normative:

  1. The government can reduce obesity by offering a subsidy to low income families when they buy fresh vegetables in the supermarket
  2. Luxuries should be taxed more heavily than necessities
  3. A rise in the value of the exchange rate will reduce the number of overseas tourists visiting London
  4. The Minimum Wage needs to be replaced with a Living Wage of £8 per hour
  5. German taxpayers should not have to pay for bail outs to a failing Greek economy
  6. Drought in the United States should lead to a rise in the world price of grain
  7. Reducing the top rate of income tax to 45% will increase relative poverty in Britain
  8. It is right that the European Union has introduced a system of carbon trading as a way of cutting CO2 emissions
  9. A reduction in the standard rate of VAT ought to bring about a recovery in consumer spending on many goods and services
  10. A rise in the price of petrol will lead to an increase in the demand for rail transport
  11. An increase in the rate of inflation will lead inevitably to an increase in unemployment
  12. Unemployment is more harmful than inflation
  13. The Government might target unemployment rather than inflation in order to achieve an improvement in economic growth
  14. As a general rule, people are happier in more equal societies
  15. Despite a large increase in income per head, people are no happier today than they were 50 years ago
  16. The promotion of happiness is a more important goal than the maximisation of production

Free market and mixed economies

There are a number of approaches to organising an economy.

Free market economy: an economic system where all resources are allocated through the market forces of demand and supply, with no intervention by the government

  • Controlled by price mechanism.
  • Resources privately owned.
  • No government intervention.
  • None exist in the world.

 
Command, or centrally planned economy: an economic system where all resources are allocated by the government, with no markets (e.g. ex-Soviet bloc, North Korea)

  • Or ‘control’ economy.
  • Government has complete control – economic decision is centralised.
  • No price mechanism.

 
Mixed economy: an economic system where resources are partly allocated by the market and partly by the government (e.g. most economies today)

  • Controlled partly by the government, partly by the private sector.
  • Most developed economies are mixed.
  • Aim – advantages of the free market with all disadvantages prevented by the government

 
From the point of view of efficiency, most economists would argue that free markets are the most efficient, in terms of using their resources in the best possible way to meet the needs and wants of consumers.

However, when equity is considered, most economists would also argue that free markets lead to an unequal distribution of income and wealth, since owners of capital and entrepreneurs tend to accumulate the most income/wealth, and many people, such as the sick or elderly, are unable to work.

As a result, most  economies today are mixed economies, where markets allocate many resources, but governments intervene to different extents in order to ensure a minimum standard of living. They do this by raising revenue through taxes, and redistributing in the form of benefits and direct provision of services such as healthcare.

Specialisation and the division of labour

Specialisation is when production is concentrated on particular goods and services. It has led to increased standards of living. Countries which are specialised can trade their goods/services with those of other countries.

The Division of Labour is a type of specialisation in which the production of a good is broken up into tasks carried out by different workers.

 

Advantages:

  • Workers become highly skilled at their particular task – increased efficiency.
  • No time is wasted moving from one job to another.
  • Capital machinery can be used continuously throughout the production process (e.g. production line) – greater mechanisation.
  • Less time spent training workers for specific tasks.
  • More choice – workers can specialise in a job they are most suited to.
  • Higher output/increased quality – increased variety.
  • Saving of equipment – each worker doesn’t need a full set of tools.

 

Disadvantages:

  • Repetition creates monotony/boredom – decreased motivation and efficiency.
  • High turnover of staff – recruitment/selection costs.
  • Easier to replace workers with machines – increased structural unemployment.
  • Interdependence – if one sector collapses it could affect an entire industry.
  • Less flexibility – difficult for workers to switch to performing other tasks when there is a need to cover for other workers or when demand changes.
  • Loss of skills – tasks are simple and mechanised.
  • Increased risk of unemployment – workers have limited skills – change in demand could mean that their skills aren’t needed ® unemployment.

Production Posibility Frontier (Curve)

A production possibility frontier (PPF) shows the maximum potential level of output for two goods or services that an economy can achieve when all its resources are fully and efficiently employed, given the level of technology available.

Therefore, the assumptions when drawing a PPF are:

  • only two goods or services can be produced
  • all resources are fully and efficiently employed
  • at a given state of technology
  • Resources are interchangeable between the two goods/services
Production Possibility Curve
Production Possibility Curve

 

The diagram above shows the production possibility frontier of an economy with capital and consumer goods. It shows the different combinations of goods (consumer goods or capital goods) which can be produced if all resources are fully and efficiently utilized.

The economy therefore could be :

  • at point A, utilizing all its resources to the production of 100 units of capital goods and 0 units of consumer goods
  • at point B, producing 60 units of capital goods and 60 units of consumer goods
  • at point C, producing 30 units of capital goods and 75 units of consumer goods
  • at point D, utilizing all its resources to the production of 80 units of consumer goods, or at anywhere else along the PPF, when all available resources are fully and efficiently utilized.
  • Point F illustrates unemployment of resources.
  • Point G cannot be achieved with the available resources.

 

PPF AND THE CONCEPT OF EFFICIENCY

If the economy is at any point on the production possibility frontier, such as point A, B, C or D, there is full and efficient allocation of resources since all factors of production are being used to their maximum potential. However, if the economy is located within its production possibility frontier, such as at point F, then there is an inefficient allocation of resources as not all resources are being used.

Any point outside the PPF, such as point E, cannot be achieved with the given level of resources and technology, and can only be achieved through economic growth.

 

PPF DEMONSTRATES THE CONCEPT OF OPPORTUNITY COST

 

PPC and Opportunity Cost
PPC and Opportunity Cost

 

In the above diagram, when the economy moves from point B to point C, there is an increase in consumer goods from 60 to 75 units, and a fall in capital goods from 60 to 30. So it could be said that, to increase the production of consumer goods by 15 units, there is an opportunity cost of 30 units of capital goods, i.e. We have to give up capital goods to produce more consumer goods.

Shape of the PPC - concave
Shape of the PPC – concave

 

A typical PPF is concave to the origin (i.e. bowed outwards) and shows that, as more of one good is produced, the opportunity cost rises, because not all resources are as efficient as other resources in the production of both goods. i.e. as we move down the PPF, as more resources are allocated to produce consumer goods, the extra output gets small – and the more of capital goods have to be given up in order to produce the extra output of consumer goods.

PPC movement : unemployed resources to fully employed resources
PPC movement : unemployed resources to fully employed resources

 

However, if the economy moves from point F to point B, then there would be no opportunity cost as more is produced of each type of good. i.e. at point F resources were unemployed and by moving to point B the available resources will be utilized fully and efficiently.

PPF does not always have to be drawn as a curve. If the opportunity cost for producing two products are constant then we draw the PPF as a straight line. The gradient of that line is a way of measuring the opportunity cost between the two goods. 

Straight line PPC
Straight line PPC

 

ECONOMIC GROWTH

PPC and Economic Growth
PPC and Economic Growth

 

A point, such as point G, that is outside an economy’s current PPF (X1 Y1) is unattainable at a given moment. However, point E can be achieved through an outwards shift in the PPF to X2 Y2, i.e. economic growth.

 

SHIFTS OF THE PPF

An outward shift in the PPF shows that there has been either an improvement in productivity or an increase in the total stock of resources available to produce different goods and services. The outward shift represents an improvement in economic efficiency.

Outward shift of the PPC
Outward shift of the PPC

 

Therefore, the reasons for an outward shift in the PPF could be listed as:

  • an increase in factor resources
  • an increase in the efficiency (or productivity) of factor resources
  • an improvement in technology
Inward shift of the PPC
Inward shift of the PPC

Reasons for an inward shift in the PPF:

  • Investment spending is insufficient to replace worn out capital goods
  • Natural disaster (hurricanes, tsunami, floods etc.)
  • Civil war

 

CONSUMER GOODS AND CAPITAL GOODS : HOW CURRENT CONSUMPTIONS AFFECTS FUTURE STANDARD OF LIVING

  • Consumer Goods are goods that are used by consumers, and it adds to the standard of living in an economy.
  • Capital Goods are goods that are used to produce consumer goods

PPF9

If more consumer good and less of capital goods are produced today, the current standard of living would improve as there are more consumer goods available, however, in the long-run, there will be less capital goods available to produce consumer goods, therefore the standard of living in the future may decline

 

 

PPF99

If less consumer good and more of capital goods are produced today, the current standard of living would decline as there are less consumer goods available, however, in the long-run, there will be more consumer goods produced, therefore the standard of living in the future may improve.

 

Factors of Production

ECONOMIC RESOURCES

In economics we classify goods as “tangible” products and services are known as “intangible” products.

FACTORS OF PRODUCTION

Factors of Production refer to the resources we have available to produce goods and services.

 

Factor Description Reward
Land All natural resources (gifts of nature) including fields, mineral wealth, and fishing stock. The reward for landlords for allowing firms to use their property is rent
Labour  The physical and mental work of people whether by hand, by brain, skilled or unskilled The reward for workers giving uptime to create products is wages or salaries
Capital  Man made goods which are used to produce consumer goods. Examples include factories (plant), machines and roads. The reward for creditors lending money to firms to invest in buildings and capital equipment is interest
Enterprise  An entrepreneur risks financial capital and organizes land, labour and capital to produce output in the hope of profit The reward for individuals risking funds and offering products for sale is profit. Unsuccessful firms make losses.

 

 FINITE RESOURCES

There are only a finite (or limited) number of workers, machines, acres of land and reserves of oil and other natural resources on the earth. Because most of these resources (or factors of production) are finite, we cannot produce an unlimited amount of different goods and services. Finite resources cannot be renewed, they are exhaustible and irreplaceable. For example, plastic, crude oil and natural gas, no mechanism exists replenish them.

 

RENEWABLE RESOURCES

Renewable resources are commodities such as solar energy, oxygen, fish stocks or forestry that are inexhaustible or replaceable by new growth provided that the rate of extraction of the resource is less than the natural rate at which the resource renews itself.

 

THE ROLE OF SUSTAINABILITY

By producing more goods and services for an ever increasing consumer demand, we are in real danger of destroying the natural resources of the planet. This has important consequence on the long-term sustainability of economies throughout the world and potentially huge implications on living standards and the quality of life.

Environment pressure groups such as Friends of the Earth and Greenpeace seek to highlight the permanent damage to the stock of natural resources available throughout the world and the dangers from economic development and global warming. At the heart of improving resource sustainability is the idea of de-coupling – a process of trying to increase the efficiency with which resources are used in producing goods and services and breaking the link between ever-increasing output and resource depletion.

 

What is Economics?

“The study of the production, distribution and consumption of wealth in human society” – The Economist’s Dictionary of Economics

Another definition of the subject comes from the economist Lionel Robbins, who said in 1935 that:

“Economics is a social science that studies human behaviour as a relationship between ends and scarce means which have alternative uses. That is, economics is the trade-offs involved when choosing between alternate sets of decisions”

In simple, Economics can be defined as the allocation of scarce resources to provide for unlimited human wants.

It is often said that the central purpose of economic activity is the production of goods and services to satisfy consumer’s needs and wants i.e. to meet people’s need for consumption both as a means of survival but also to meet their ever-growing demand for an improved lifestyle or standard of living.

Examination Strategies for Economics Unit 4 Section A

After years of critical coaching, through observation and some analysis, I managed to arrive at a conclusion on why many students fail to perform at Unit 4: The Global Economy.  Unlike Unit 1 and 3 (the microeconomics units),  which you can perform very well on by memorising, Unit 2 and 4 required critical analysis and how things work/ transmission mechanisms.

My advice to students is that they practice on writing answers within the required time frame, rather than trying to study off a text or note book. But, as a start (definitely not closer to exams though) it’s definitely okay to go through the mark schemes and understand what is required by you in your answer. It’s always good to practice writing correct answers than practice writing incorrect ones.

So, you might find the list of past paper essay questions for Unit 4 useful as part of your revision. Select a question you’re comfortable with, try to plan out an answer plan, check  the answer guide and understand if your plan was accurate (or not) and use the answer guide to write the best answer that you can! Use your text/note book if you’d like. File each answer, and by the time of your exam you will have a collection of correct answers to go through and study with.

Alternatively, you can also use the list of most probable topics for Unit 4 essays I have listed below as part of your revision.

Try to brainstorm all the possible points as well as evaluations for the topics listed below. Some harder topics may require extra efforts e.g. consulting your teacher, lecturer, text/note books or even an internet research.

(A) World trade

  1. Reasons for globalisation
  2. Costs and benefits of globalisation
  3. Economic effects of the increase in numbers and size of trading blocs
  4. Reasons for protectionism
  5. Economic effects of protectionism
  6. Reasons for widening current account deficit
  7. Is large current account deficit a cause of concern?
  8. Measures to reduce current account deficit
  9. Factors that can affect the international competitiveness of UK goods and services
  10. Policies to increase the international competitiveness of UK goods and services
  11. Economic effects of an increase/ decrease in the price of non-renewable resources

(B) Growth and development and poverty

  1. Strategies to promote growth and development
  2. Reasons for the rise in absolute poverty in Sub Saharan African economies
  3. Reasons for widening income inequality in any country of your choice
  4. Problems with over dependency on primary sectors/ FDIs/ international aid

(C) Public finances and eurozone economies

  1. Costs and benefits of adopting the single currency
  2. Reasons for slower economic recovery: eurozone economies vs. non-eurozone economies (UK, Sweden etc)
  3. Reasons for the high budget deficit and national debt in a country of your choice
  4. Economic effects of high budget deficit/ national debt
  5. Economic effects if drastic measures are undertaken to reduce the budget deficit/ national debt

 

Time spent on Section A? Although the suggested time by Edexcel is 1 hour, most candidates take longer than that. Ideally, it shouldn’t be more than 1 hour 10 minutes. If yet to finish, move on. Section B is equally important too. They carry another 50% weightage for the entire paper

 

How many points and evaluations do we need to give?

  • question (a) 20 marks:  you are required to give 3 points and 2 evaluations
  • question (b) 30 marks: you have to provide 4 points with 3 evaluations

Do we provide an evaluative point soon after each analysis? This is a matter of preference. There is no right or wrong. You can provide an evaluation after each analysis or write out all the analysis followed by all evaluations towards the end. However, there is a good and bad for these two writing styles.

If you provide an evaluation soon after each analysis, chances are the flows of your essay will look so much better but it may take you quite a while to think of a proper evaluation. There is a possibility that you may use up too much time and hence unable to finish the essay.  On the other hand, candidates who write evaluations towards the end after all the analysis may not have written an essay with good flows but they stand a higher chance to score higher.  So, the choice is your’s. Try out and see what works for you.

Scarcity

THE BASIC ECONOMIC PROBLEM AND SCARCITY

The basic economic problem is about how best to allocate resources between alternative uses in order to meet the consumers’ needs and wants, since there are only a limited amount of resources available to produce the unlimited amount of goods and services we desire.

All societies face the problem of having to decide:

  • What goods and services to produce? Produce those goods that have a price and can make a profit? Or produce those that are essential for society?
  • How best to produce goods and services? Use labour-intensive methods or capital-intensive production methods?
  • Who is to receive goods and services? For the rich? The poor? Or should it be distributed equally?

Economic resources are finite, but human needs and wants are infinite. This is referred to as scarcity and means that there are insufficient resources to provide everyone’s wants and so people have to make a choice about how to use resources. Scarcity brings about opportunity cost as we are forced to make a choice about alternatives.

 

SCARCITY

This means that there are insufficient resources to produce all the goods and services which people want. This relative scarcity of resources means that a choice has to be made.

Scarcity brings about opportunity cost as we are forced to make a choice about alternatives. We cannot satisfy all our material wants with the limited means available.

 

OPPORTUNITY COST

Sometimes there are competing ends for which resources could be used. When a choice arises, an alternative has to be given up. The sacrifice of the next best alternative that is forgone is termed the opportunity cost.

 

Examples of opportunity cost:

  • a producer may have to forego expansion of a factory in order to conduct more research into a new product
  • a consumer may have to forego a visit to a cinema in order to have a fast food burger meal
  • a government may have to forego building a road in order to construct a hospital

 

 

Unit 2 Essay Question : May 2001 Q2

May 2001 Q2 :

Examine the impact of a decision to raise interest rates in an economy where there is both a high rate of inflation and a large current account deficit. Specific reference should be made to the exchange rate in your answer.

A rise in interest rates will reduce (candidates may use either the level, or the rate of growth of) aggregate demand. Consideration of likely transmission mechanisms: candidates should consider the impact on at least two elements of C+I+G+X-M.

  • An appropriate AD/AS diagram is also required.
  • Identifying income effects on inflation/current a/c
  • Identifying exchange rate effects on inflation/current a/c

Evaluation points might include:

  • More extended analysis of the impact of the changes already
  • The relative strengths of the various income and price effects identified
  • Other things may not be equal,
  • The shape of the AS curve (elasticities).