CIE IGCSE GEOGRAPHY (0455)

Contents
The Basic Economic Problem ............................................................................................................................................................................................ 2
Economic Systems ............................................................................................................................................................................................................ 2
How Markets Work........................................................................................................................................................................................................... 3
Social Costs and Benefits .................................................................................................................................................................................................. 4
Money and Finance .......................................................................................................................................................................................................... 5
Occupations and Earnings ................................................................................................................................................................................................ 5
The Role of Trade Unions ................................................................................................................................................................................................. 6
Spending, Saving and Borrowing ...................................................................................................................................................................................... 6
Types of Business Organization ........................................................................................................................................................................................ 7
Organization of Production .............................................................................................................................................................................................. 7
The Growth of Firms ......................................................................................................................................................................................................... 8
Integration and Economies of Scale ................................................................................................................................................................................. 8
Competition ...................................................................................................................................................................................................................... 9
Role of Government in an Economy ................................................................................................................................................................................. 9
Taxation .......................................................................................................................................................................................................................... 10
Price Inflation ................................................................................................................................................................................................................. 11
Employment and Unemployment .................................................................................................................................................................................. 12
Output and Growth ........................................................................................................................................................................................................ 12
Developed & Less Developed Economies ....................................................................................................................................................................... 12
Population ...................................................................................................................................................................................................................... 13
International Specialization and Trade ........................................................................................................................................................................... 13
Balancing International Payments .................................................................................................................................................................................. 14

June 2014

CIE IGCSE ECONMOICS (0455)

THE BASIC ECONOMIC PROBLEM
ECONOMIC SYSTEMS
NATURE OF THE ECONOMIC PROBLEM

There are too few productive resources to make all the goods and
services that consumers need and want.
Finite resources and unlimited wants
Scarcity of resources is the basic economic problem

FACTORS OF PRODUCTION
Consumers are people or firms who need and want goods and
services
Resources or factors of production are used to make goods and
services

LLCE
Land: all natural resources used in production (minerals from
ground, chemicals/gases from air, seas, forests etc.)
Labor: human effort used in the production of goods/services
(works, physical labor etc.)
Capital: the man-made resources that are used to produce
goods/services. (tractor to plough land
Enterprise: the skills and willingness to take the risks required to
organize productive activities
Entrepreneurs organize and combine resources in firms to produce
goods and services
Durable consumer goods last long while (e.g. furniture) nondurable consumer goods (e.g. food) do not
Capital goods and semi-finished goods or components are used up
in production

OPPORTUNITY COST
Opportunity cost is the cost of choosing between alternative uses
of resources
Choosing one use will always mean giving up the opportunity to
use resources in another way, and the loss of goods and services
they might have produced instead
The problem of resource allocation is choosing how best to use
limited resources to satisfy as many needs and wants as possible
and maximize economic welfare
The aim of economics is to find the most efficient allocation of
resources

PRODUCTION POSSIBILITY FRONTIER

Opportunity cost can be shown using a production possibility
frontier (PPF).
It shows the maximum combinations of goods and services that can
be produced by an economy in a given time period with its limited
resources.
A PPF shows all the combinations of possibilities, involving two
goods or options.
Society can use all its scarce resources to produce this combination.

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An economic system determines how scarce resources are

allocated
In a market economic system or market economy the decisions of
consumers and producers will determine what goods and services
are produced and who they are produced for
Producers in a market economy aim to maximize their profit from
producing and selling those goods and services that consumers
want
A market for a particular good or service consists of all those
producers willing and able to supply it and all those consumers
willing and able to buy it
The price mechanism allocates scarce resources to the most
profitable uses in a market economic system
Producers use market price to determine what is profitable. Rising
consumer demand for a product will tend to increase in price.
Producing more could earn producers more profit
A market economy will produce a wide variety of goods and
services if it is profitable to do so but only or those consumers that
are willing and able to pay for them.
Market failures can cause scarce resources to be allocated to uses
that are wasteful, inefficient or even harmful to people and the
environment.
A mixed economic system has a private sector and a public sector
A government can try to correct market failures in a mixed
economic system. It can allocate scarce resources to provide goods
and services that people need and introduce laws and regulations
to control harmful activities
Market economy
Mixed economy
Who decides
Producers and
Producers, consumers &
what & how
consumers
governments
to produce?
Who owns or
controls most
Private sector and
Private sector
scarce
public sector
resources?
How are
Market signals to
Same as market but
resource
identify what goods and government may also
allocation
services consumers
provide some goods and
decisions
want
services e.g. merit
made?
Same as market plus:
Who are
Consumers with
Government may
goods &
greatest ability to pay
provide goods and
services
for them
services to people in
produced for?
need
Wide variety of goods
Same as market plus:
and services.
Government can
Competition
Main
intervene to correct
encourages
advantages
serious market
development of new
failures
and more efficient
products & processes
Serious market failure
Same as market plus:
Worthwhile but
Main
Taxes can be high
unprofitable goods
disadvantages
not provided
Public sector provision
may be inefficient
Harmful goods may be
available to buy

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CIE IGCSE ECONMOICS (0455)

June 2014

HOW MARKETS WORK

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PRICE OF MECHANISM

Demand refers to how much of a product or service is desired by

buyers and supply represents how much the market can offer.
Demand Curve
Factors that Affect Demand
Price
Consumer
tastes/preferences
Income available to
consumer
Prices of substitute/
complementary goods
Interest rates (price of
borrowing money)
Consumer population
The higher the price of a good,
(population increase =
the less people will demand that
demand increase)
good
1

Supply Curve
Factors that Affect Supply
Cost of factors of production
Prices of other
goods/services
Global Factors
Technology Advance
Business Optimism/
Expectations

Forces of demand and supply establish the market price of a

product
Changes in demand and supply will cause changes in price
An increase in demand will raise market price. This will be the
signal to producers to use more resources to supply more. In this
way consumers get what they want.
Increase in supply of product lowers market price and enables
more people to share increased supply

PRICE ELASTICITY OF DEMAND

The responsiveness of demand to a change in price.
Inelastic Demand
Elastic Demand
It has a PEd lower than 1.
It has a PEd greater than 1.
The necessity of the product is
The necessity of the product
high it is either essential or
is relatively low.
habitual.
Demand would respond
A change in price has little
quickly and more drastically.
effect on the change in
demand.

%
%
Price elasticity and revenue
o When demand is price inelastic, an increase in price would
raise revenue.
o When demand is price elastic, a decrease in price would raise
revenue.
Factors that affect PEd:
o The number of substitutes
o The period of time
o The proportion of income spent on the commodity
o The necessity of the product
Special Demand Curves
Perfectly price inelastic:
demand remains
constant whatever the
price
=

The higher the price, the higher

the quantity supplied.

EQUILIBRIUM PRICE
When supply and demand
are equal the economy is
said to be at equilibrium.
At this point, the
allocation of goods is at its
most efficient because
amount of goods being
supplied is exactly the
same as amount of goods
being demanded.
Thus, everyone is satisfied with the current economic condition.

EXCESS SUPPLY

EXCESS DEMAND

If the price is set too high, excess

supply will be created within the
economy and there will be
allocative inefficiency.

Excess demand is created

when price is set below the
equilibrium price. Because the
price is so low, too many
consumers want the good
while producers are not
making enough of it.

Infinitely price inelastic:

there is unlimited
demand but at only one
price

Unitary elasticity:
revenue remains
constant at every
possible price

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CIE IGCSE ECONMOICS (0455)

June 2014

PRICE ELASTICITY OF SUPPLY

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MARKET FAILURE

The responsiveness of quantity supplied to a change in price.

Inelastic Supply
Elastic Supply
It has a PEs of less than 1.
It has a PEs of over 1.
A large price change will have
A large price change will
little effect on the amount
have a large effect on the
supplied.
amount supplied.

Market failure occurs when the market mechanism fails to allocate

scarce resources efficiently, so social costs are greater than social
benefits
How markets can fail
How a government intervenes
Only goods and services that
Produce merit goods such as
are profitable to make will be
education for the needy
produced
It can provide public goods
Services such as street lighting
such as street lighting
wont be provided as you are
Public sector can employ
unable to separate it
people and welfare benefits
can be given to the needy
Resources only employed if
profitable people may be left
Laws to make goods illegal or
unemployed without an income
high taxes to reduce
Harmful goods may be
consumption
produced and sold freely
Laws and regulations would
Producers may ignore
protect natural environment
environmental impacts
Monopolies can be broken up
Monopolies dominate supply of
or regulated to keep prices low
products and charge high prices

%
%
Factors that affect PEs:
o Time
o Availability of resources
o Supply available to meet demand
o Spare production capacity available
o Factor substitution available
Special Supply Curves
Perfectly price inelastic:
supply remains
constant whatever the
price
=

MERITS OF THE MARKET SYSTEM

Advantages
Gives producers incentive to
produce goods that consumers
want
Provides an incentive to
acquire useful skills
Encourages producers and
consumers to conserve scarce
resources
Competition pushes businesses
to be efficient
High degree of economic
freedom

Infinitely price inelastic:

there is unlimited
supply but at only one
price

Disadvantages
May be unstable
(unemployment, inflation)
Prices may give
false/inadequate signals to
producers
Markets do not work in some
areas (public and merit goods)
Monopolistic industries may
restrict output and raise prices
Large gap between rich and
poor

SOCIAL COSTS AND BENEFITS

Private Benefit/Cost: costs/benefits the business or consumer
receives from consuming/producing the good
External Benefit/Cost: advantages/disadvantages society receives
because of consumption of a certain good/service

Unitary elasticity: A
percentage change in
price will cause an
equal percentage
change in quantity
supplied

SOCIAL COST AND BENEFIT

USEFULNESS OF PRICE ELASTICITY

Tax:
Charge placed on production of good/service by the government.
A tax will increase the cost of production to the producer. It
makes it more expensive to produce. It is likely that the producer
will produce less; therefore the supply curve shifts to the left.
If people are really keen to buy the product (price inelastic)
demand will stay fairly high (e.g. cigarette). So if most people still
buy the taxed good, the government can make more revenue.
Subsidy:
A subsidy is a payment made to producers to help reduce their
costs of production.
It is made by the government to encourage producers to produce
or supply a certain good or service. It is likely that the producer
will be encouraged to produce more therefore the supply curve
will shift to the right.

Social costs = Private costs + External costs

Social benefits = Private benefits + External benefits
Social costs > Social benefits, producing product is uneconomic
Social costs < Social benefits, producing product is economic

CONFLICTS OF INTEREST
Conserving Resources
Conservationists argue that this
generation should pass on to
future generations at least as
many resources as our own
generation has inherited and
not exploit everything
Public Expenditure
Government can provide public
goods and merit goods that the
market would not produce.
Public sector workers may be
more likely to spend money in a
way that is fair to all

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Using Resources
Businesses and firms try to
maximize profits and therefore
want use as many resources
they can get their hands on to
do so
Private Expenditure
Government can only guess
how we would like to spend the
money
When the government spends
money, it can be wasteful.

CIE IGCSE ECONMOICS (0455)

June 2014

MONEY AND FINANCE

STOCK EXCHANGES

FUNCTION OF MONEY

Medium of exchange generally accepted as means of payment.

Unit of account - for placing a value on goods/services.
Store of value you can save money because it keeps its value.
Standard for deferred payment borrowers are able to borrow
money and pay back later

Ancestor relied on direct swapping of goods and services

Early form of exchange known as barter
Bartering is the most inconvenient way to carry out business
Main problems of bartering:
o Fixing a rate of exchange
o Finding someone to swap with
o Trying to save a good for long period of time

NEED FOR EXCHANGE

Institutions in which shares of stock are bought and sold.

A shareholder in a company is a part-owner of that company.
Shareholders will receive a payment known as a dividend, which
is their reward and share of company profits.
Shareholders are protected by limited liability
Stock exchanges also protect shareholders.
Functions:
o Helps companies sell their stocks or equities
o Helps them to raise finance
o Helps the public buy such stocks
o Produce a market price due to buying and selling of stocks
o Provides an indicator of how generally an economy is doing.

OCCUPATIONS AND EARNINGS

CHOICE OF OCCUPATION

CHARACTERISTICS OF GOOD MONEY

PADDS

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Portability - not too heavy

Acceptability
Divisibility - without loss of value
Scarcity
Stability it keeps its value

COMMERCIAL BANKS
Keeping money safe: banks vaults more secure than a safe box in
a private house. Individuals and businesses can open bank
accounts. Banks also keep documents and other valuables items
in safe deposit boxes.
Lending:
o Loans: borrowing fixed sum for set period of time but
borrower must pay back interest
o Overdraft: taking more than in account, but with interest
o Credit cards: offered for users to buy goods and pay for them
later. If they pay back the bill by a given date, no interest is set,
but if not, they are charged with a high rate of interest.
o Mortgages: banks lend firms and households big amounts of
money. Usually for long periods of time and must be paid back
over years.
Means of Making Payment cheques so bank then transfers
money to recipients that the person needs to pay.
Providing Foreign Currency

Non-wage Factors
Job satisfaction
Career prospects (promotion)
Fringe benefits; non-financial
incentives e.g.
o Payment of school fees
o Length of holidays
o Job security
o Location of the job

CHANGES IN EARNINGS
Entry: Young employee will receive low earnings due to lack of
work skills and experience, can become an apprentice or join a
management training scheme to become more skilled
Skilled workers: the more skilled a worker is, the more
opportunities he has for increasing his earnings. Bonuses will be
given and higher rate of overtime paid.
End-of-career employees: if workers keep updating skills, they
will continue to have opportunities to increase wages however
when they stop this, their demand would fall and income would
diminish, finally reaching a stop when retired.

RISE AND FALL

CENTRAL BANK
Printing notes and minting coins that are legal tender (accepted
as payment) as well as destroying torn notes and worn-out coins.
Setting interest rates
Lender of last resort: if a bank needs cash in a hurry, they can
borrow from central bank.
Supervising monetary policy: heads of the central bank holds
meetings with officials from other banks to determine interest
rate and quantity of money in economy. If there is too little
spending in economy, banks might be requested to lend more.
Banker for commercial banks and the government: Government
accounts and spending are carried out with central bank. It helps
Government to borrow money. Total amount government owes
to lenders is called national debt.
Helping to manage international financial system (governments
lending each other money)

Wage Factors
Basic pay
Earnings: total amount an
individual receives
Overtime pay
Bonuses
Commission: payment made
as a percentage of sales a
salesperson makes.

Rise in Demand for Labor

Increase in consumer demand
Increase in labor productivity
Increase in cost of employing
capital equipment
Rise in Supply of Labor
Improvement in net
advantages of occupation
Rise in working population
Improved education and
training

Fall in Demand for Labor

Fall in consumer demand
Fall in labor productivity
Fall in cost of employing
capital equipment
Fall in Supply of Labor
Decline in net advantages of
occupation
Fall in working population
Employees lack good
education and training

WAGE DIFFERENTIALS
Wage
differential
Public sector
or private
sector
employee?
Male or
female
employee?

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Who earns
more?

Why?

Private
sector
workers

Public sector workers enjoy more

job security and more holiday
entitlement

Male
employees
earn more

Women may take career break to

raise children
Most female workers work part
time or choose low-pay jobs e.g.
nursing, teaching

CIE IGCSE ECONMOICS (0455)

June 2014
Skilled or
unskilled
workers?

Employees
in different
industries

Skilled
workers
paid more

Agricultural
workers
paid less

Skilled workers are more

productive
Some specialist skills are in short
supply
Agricultural has become more
capital intensive so demand has
declined
Manufacturing and service
industry have expanded
Shortage of supply of labor with
specialist skills for many
manufacturing sectors

SPECIALIZATION
Division of labor: system whereby workers concentrate on
performing a few tasks and then exchange their production for
other goods and services.
Specialization: where individuals, firms and economies do this;
production process broken up into a series of different tasks
Advantages for Individual
Disadvantages for Individual
Employees can make best use
Doing same job or repetitive
of their particular talents/skills
tasks is boring and stressful
and can increase them by
Individuals must rely on
repeating tasks
others to produce goods and
Employees can produce more
services they want but cannot
output and reduce business
produce themselves
costs
Many repetitive tasks can now
More productive employees
be done by machines, leading
can earn higher wages
to unemployment of lowskilled workers

THE ROLE OF TRADE UNIONS

A trade union is an organization of workers formed to promote
and protect the interest of its members concerning wages,
benefits and working conditions.

FUNCTIONS
Negotiating wages and other non-wage benefits with employers
Defending employee rights and jobs
Improving working conditions, e.g. better hours of work and
health & safety
Improving pay and other benefits, including holiday entitlement,
sick pay and pensions
Encouraging firms to increase worker participation in business
decision-making
Developing skills of union members, by providing training and
education courses
Supporting members taking industrial action

TYPES OF TRADE UNIONS

General Unions: represent workers across many different
occupations
Industrial Unions: represent workers of the same industry
Craft Unions: represent workers with the same skill across
different industries
Non-manual unions/Professional Unions: represent workers in
non-industrial and professional occupations

UNION REPRESENTATION IN THE WORKPLACE

Closed shop: all workers in a place of work must belong to a trade
union
Open shop: firm can employ both unionized and non-unionized
labor

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Single union agreement: a firm agrees a single union can

represent all its workers

COLLECTIVE BARGAINING
Process of negotiating wages and other working conditions
between trade unions and employers
A trade unions will be in a strong bargaining position to
negotiate higher wages and better conditions if:
o It represents most or all of the workers in a firm or industry
o If union members provide goods and services that consumers
need and for which there are few alternatives, e.g. electricity

INDUSTRIAL ACTION
Industrial action is taken when collective bargaining fails to result
in an agreement
Taking industrial action can help a union increase its bargaining
strength to force employers to agree to their demands.
Industrial actions:
o Overtime ban: Workers refuse to work more than their normal
hours
o Work to rule: Workers deliberately slow down production by
complying with every rule and regulation
o Go slow: Workers deliberately work slowly
o Strike: Workers refuse to work and may protest outside their
workplace to stop deliveries or non-unionized workers from
entering
Consequences of industrial action:
o Firms suffer higher costs and lose output, and may lose big and
regular customers to rival firms.
o Union members may lose wages during a strike and even lose
their jobs if employers cut back demand for labor.
o Consumers may be unable to obtain the goods/services they
need and may have to pay higher prices if firms pass on their
increased costs.
o Reputation of an economy as a good place for business may be
damaged. Firms may decide to set up businesses elsewhere,
increasing unemployment and lower incomes.
Possible Advantages
Possible Disadvantages
Could help to bring about
Might cause lack of flexibility in
minimum working standards
working practices
Could help keep pay higher
Could be major problem as
fashions change very quickly
Could help maintain
Employment/enhanced job
Could lead to some firms going
security
out of business
Could lead to improvement in Workers made redundant
health and safety.
Workers will need to pay union
membership fees.

SPENDING, SAVING AND BORROWING

Disposable income: amount of income left to spend or save after
direct taxes have been deducted.
Spending: enables a person to buy goods and services to satisfy
their needs and wants.
Saving: involves delaying consumption. As interest rates rise,
people may save more and spend less.
Borrowing: allows a person to increase their current level of
spending; enabling them to buy goods they cannot afford now.
People with low disposable incomes may spend less in total than
people with high incomes but will tend to spend all or most of
their income meeting their basic needs.

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The amount of income we earn tends to rise as we get older, until

we retire, because:
o Employees earn more in wages as they learn more skills and
become more productive
o Tend to save more as they get older and earn interest in saving
o Entrepreneurs may become more experienced in business and
can earn more profit

SPENDING AND SAVING PATTERNS

Increase in
Spending
Saving
Borrowing
Real income

Direct tax

Wealth

Interest rates

Availability of

saving scheme
Availability of

credit
Consumer

confidence
Young single people tend to spend more on music and fashion.
People with families will spend more on their children & homes.
Elderly people may spend more on health care.

TYPES OF BUSINESS ORGANIZATION

SOLE TRADER
Owned and controlled by one person
Advantages
Disadvantages
A sole trader is his own boss.
Full responsibility - may lose
revenue if off sick or on
Can choose hours of work.
holiday.
Receives all profits.
Unlimited liability
Easy to set up
Lacks capital for business
growth.

PARTNERSHIP
Legal agreement between two or more people to own/finance
/run a business.
Unlimited liability unless its a silent/sleeping partner.
Advantages
Disadvantages
Easy to set up.
Disagreements
More capital.
Can lack capital to finance
growth.
Partners bring new skills,
ideas & share responsibility.

COOPERATIVES

Owned and controlled by its members

Each member has an equal share of ownership
Worker co-ops are owned and controlled by their workers.
Consumer co-ops are retail businesses owned by their consumers
Advantages
Disadvantages
Limited liability
Many consumer co-operatives
have been forced out of
Workers in worker cobusiness by larger companies.
operatives take business
decisions and share profits.
Worker co-operatives may be
badly run.
Members of consumer cooperatives enjoy profit
dividends or lower prices

MULTINATIONALS
Operates in more than one country and are some of the largest
companies in the world.
Governments often compete to attract multinationals because
they can provide jobs, incomes, business knowledge, skills and
technologies which can help other firms, as well as pay taxes on
their profits to boost government revenue.
Headquarters are based in one country.
Advantages
Disadvantages
Can reach many more
They can switch their profits to
consumers globally and sell
other countries to avoid
far more than other types
paying taxes on their profits.
It can minimize transport
Can force smaller firms out of
costs by locating plants in
business.
different countries to be near May exploit workers in low
the sources of raw materials
wage economies.
or big consumer markets.
May use their power to get
Minimize wage costs by
generous subsidies and tax
locating operations in
advantages from the
countries with low wages.
government.
Can enjoy low average
production costs

PUBLIC CORPORATION

JOINT STOCK COMPANIES

Private Limited Companies
Only sells shares to people
known to existing
shareholders.
Managed by Board of
Directors
Advantages
Shareholders have limited
liability & receive dividends.
Companies have a separate
legal identity.
Share sales can raise
significant capital.
Public Limited Companies can
sell shares to many more
investors on stock market.

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Public Limited Companies

Shares are advertised and sold
publicly on the stock market
through stock exchange to
many investors
Managed by a BoD
Disadvantages
Companies must publish
annual accounts.
Original business owners can
lose control.
Directors may run the business
in their own interests rather
than for shareholders.

Owned and controlled by the government.

Some aim to make a profit while others will deliver public services
A board of directors runs the corporation
Ownership
Committees may be set up to monitor and
and Control
investigate any irregularities or complaints
Has a legal identity separate from its directors
Legal status
and the government
From taxes and other government revenues
From profits re-invested in the organization
Finance
Any profits may be used by government to
finance other public services

FEATURES
Board of Directors: elected by the many thousands of
shareholders who manage business
Controlling Interest: a shareholder with more than 50% of shares
holds; they can out-vote all other shareholders.
Sleeping/silent partner: partner that provides money to be in
partnership in return for a share of profits, but will not be
involved in management of organization and has limited liability.

ORGANIZATION OF PRODUCTION
Primary industries: produces natural resources e.g. mining
Secondary industries: include all manufacturing industries and
construction.
Tertiary industries: produce and supply services.

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FACTORS FOR DEMAND OF FACTORS OF PRODUCTION

Small

Demand for goods and services by consumers: the higher the

demand, the more labor/capital firms will need
Price of labor and capital: the higher the cost, the less labor and
capital demanded. Firms may also decide to substitute labor for
more capital and vice versa depending on its productivity levels.
Productivity of labor and capital: more output/revenue labor and
capital help to produce, more profit they will generate over and
above cost of employing them.

=
= +

=

=
=

Markets cannot raise

enough capital to expand
their business

INTEGRATION AND ECONOMIES OF SCALE

COSTS, REVENUES AND PROFITS

Fixed costs: dont vary with level of output e.g. interest on loans
Variable cost: vary directly with level of output e.g. electricity
Breakeven: where total revenue = total cost

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Size of the market is

small and local
Consumers like tailored
goods/services
Owners may choose to
keep businesses small
Governments may
provide help

INTEGRATION
Growth by takeover or merger involves integration with other
firms.
A takeover occurs when a company acquires ownership and
control of another company by purchasing its shares.
A merger occurs when two or more firms agree to form a new
company and issues new shares.

TYPES OF INTEGRATION
Horizontal integration: occurs between firms at the same stage of
production producing similar products
Vertical integration: Occurs between firms at different stages of
production. Forward integration means taking over a firm at a
later stage of production. Backward integrations the opposite
Lateral integration or conglomerate merger: occurs between
firms at the same stage of production but producing very different
products

PRINCIPLE GOAL
The aim of production for most private sector firms is to make as
much profit as possible
Some productive organizations may have other motives:
o Public service: aim to provide services people need but cannot
pay for. Costs are funded from government revenues
o Charity: provide services to people or animals in need or to
help protect environment. Cover costs from donations
o Not for profit: aim to make enough revenue to cover their cost
and any surplus is re-invested; e.g. local clubs, cooperatives

THE GROWTH OF FIRMS

MEASURING FIRM SIZES
Number of employees: less than 50 are classed as small.
Amount of capital employed: large firms often invest millions of
dollars in fixed assets such as machinery and equipment
Market share: relative size of firms can be compared according to
their percentage share of total market supply/revenue.
Organization: large firms may be divided up into many different
departments and have offices, shops and/or factories spread over
many locations
Size
Advantages
Disadvantages
Large Can enjoy significant
If it gets too big, firm may
economies of scale
experience diseconomies
of scale
Can make it well known,
produce and sell on a
Going public may make
larger scale and have
the company become
wider range of markets
subject to a hostile
takeover (controlling
Can draw talented
interest)
people from around the
world to work for them

ECONOMIES AND DISECONOMIES OF SCALE

Economy of Scale
Cost savings due to increasing
scale of production, resulting
falling average costs
Financial economies: larger
firms often have access to
more and cheaper sources of
finance
Marketing economies: larger
firms buy materials in bulk at
discounted prices, employ
specialist buyers to secure
best quality materials at best
prices and spread advertising
costs over a large output
Technical economies: larger
firms afford to invest in
specialized methods of
production and equipment,
highly skilled workers, and
research and develop new
products and processes
Risk-bearing economies: the
ability to spread financial risks
over many investors and
reduce market risks by selling
a range of products in
different locations

Page 8 of 15

Diseconomy of Scale
Rising costs because a firm has
become too large
Management diseconomies:
Occurs when larger firms have
to manage so many different
departments in different
locations, making
communication and decisionmaking difficult
Labor diseconomies:
Demotivated workers lead to
decrease in productivity due to
boring, repetitive tasks.
Agglomeration diseconomies:
Occur if a company takes over
or merges with too many other
firms producing different
products, making it hard for
business owners and managers
to co-ordinate all the different
activities.

CIE IGCSE ECONMOICS (0455)

June 2014

COMPETITION

Price
Leadership

Competition between firms is good for consumer as profitseeking firms will compete to attract consumers
Price competition involves using pricing strategies to attract
consumers from rival producers
Non-price competition includes offering better quality products
than rival firms, improving customer services or by using
persuasive advertising

Predatory
Pricing

BARRIERS

COMPETITIVE MARKETS

Firms will compete with each other for consumer demand to:
Increase number of customers buying their products
Achieve product superiority over rival products (quality & sales)
Expand their share of total market sales
Increase their sales revenue
Maximize their profits

PERFECT COMPETITION
Businesses will charge the same price, a price that would be the
minimum they could charge without going out of business.
The price will be equivalent to the lowest average cost of
producing goods.
At the market price, the average cost of production would be the
same as the average revenue for selling.
No firm would risk charging more than the market price.
This is perfect competition. Under this, a business would be a
price taker; it would take its price from the market

MONOPOLIES
Firms with monopolistic powers control at least 25% of the
market share.
This makes them able to influence price; price makers.
They can restrict competition by making artificial barriers to entry
and other pricing strategies.
Oligopoly
Pure Monopoly
A handful of firms dominate
One firm controls the entire
the market supply.
market supply.
To avoid price wars, firms may A monopoly may use
act together to maximize their
predatory pricing and other
profits, setting market price
artificial barriers to entry to
high by restricting their
force competing firms out of
combined market supply.
the market.
A cartel is a formal agreement Other firms may be deterred
between firms to control
from competing because of its
market supply and price.
inability to match its size in
terms of its capital
They may create barriers to
employed/market share
entry together
Disadvantages of Monopolies and Oligopolies
They may supply less and charge higher prices.
They offer less consumer choice and lower quality products than
if they had to compete with other firms.
They may have higher production costs because they are poorly
managed. This is called X-Inefficiency.
They restrict competition using barriers to entry.

PRICING STRATEGY
Pricing
Strategy
Penetration
Pricing
Expansion
Pricing
Market
Skimming

About
Setting price low to encourage sales. Used to
attract demand for a new product.
Setting price low to expand demand for an
existing product.
Initially charging a high price for a new product
to maximize profit.

Zubair Junjunia
Smaller firms set their prices at a similar level to
a larger, more dominant firm; helps to avoid
aggressive price competition and price wars
Aggressive price cutting by a large dominant firm
intended to drive smaller firms out of business
because they have higher costs and wont be
able to match the price cuts.

Natural Barriers to Entry

Cost savings from large scale
production
Lots of capital equipment that
other firms cant afford.
Large customer base built up
over many years.
Developed advanced products
or processes that are
protected by patents

Artificial Barriers to Entry

Using predatory pricing
strategies to force smaller
firms out of business.
Preventing their suppliers
from selling materials and
components to other firms by
threatening to switch to rival
suppliers.
Forcing retailers to stock and
sell only their product

COMPETITION POLICY
Governments may introduce laws and regulations known as
competition policy and can involve:
Imposing fines on large firms who abuse their market power
Forcing oligopolies and monopolies to break up into smaller
competing firms
Setting maximum prices levels that firms are allowed to charge
their customers
Taking monopolies into public ownership to be run by a public
corporation

ROLE OF GOVERNMENT IN AN ECONOMY

As a Producer
Produce essential goods and
services such as healthcare
and education
Supply merit goods
To supply public goods such as
road repairs and traffic lights
Control natural monopolies;
they may take over companies
providing necessity goods e.g.
electricity or water

As an Employer
The government is also a
major employer.
Some people work directly for
the government as civil
servants, (e.g. tax collectors)
or provide public services (e.g.
education).
Employees in public sector:
o Secure employment
o May have state pension
Money earned by government
employees is mainly spent in
national economy

MACRO-ECONOMIC OBJECTIVES
Main objectives:
o Achieve low and stable rate of inflation in general levels of
price
o Achieve high and stable level of employment; therefore low
unemployment
o Encourage economic growth in national output and income
o Encourage trade and secure favorable balance of international
transactions
Additional objectives:
o Reduce poverty and inequalities in income and wealth
o Reduce pollution and waste; sustainable economic growth

Page 9 of 15

CIE IGCSE ECONMOICS (0455)

June 2014

DEMAND-SIDE POLICIES
Policy
Expansionary
Fiscal Policy
Contractionary
Fiscal Policy
Contractionary
Monetary Policy
Expansionary
Monetary Policy

Zubair Junjunia

TYPES OF TAXATION

About
Reducing taxes to boost demand, so
employment and output rises. May be used to
reduce recession.
Increasing taxes to reduce demand, so
employment and output rises. May be used to
reduce price inflation.
May be used to reduce price inflation by
increasing interest rates charged by the central
bank. This means commercial banks will also
raise interest to encourage more savings.
May be used during a recession to &
employment by cutting interest rates

SUPPLY-SIDE POLICY
Supply-side policies aim to increase economic growth by raising
the productive potential of the economy.
An increase in the total supply of goods and services will require
more labor and other resources to be employed.
It will reduce market prices & provide more goods and services to
export.
Instrument
Effect
Reducing taxes on profits and small firms can
Tax incentives
encourage enterprise. It can also encourage
investments in new equipment.
To reduce production costs and help firms fund
Subsidies/Grants
research and development of new technologies.
Education and
Teaching new/existing workers new skills to
Training
make them more productive.
Include minimum wage laws to encourage more
Labor Market
people into work, and legislation to restrict the
Regulations
power of trade unions.
Competition
Regulations that outlaw unfair trading practices
Policy
by monopolies and other large, powerful firms.
Removing barriers to international trade allow
Free trade
countries to trade their goods and services
agreements
more freely and cheaply
Removing old, unnecessary and costly rules and
Deregulation
regulations on business activities

CONFLICTING AIMS
Spending more money to stimulate growth can lead to rising
prices as a result of increased demand. If spending is reduced to
stop inflation, this will lead to a fall in growth.
If government tries to create full employment, labor becomes
increasingly scarce. Employers have to compete more strongly to
attract labor. They raise wages, which leads to wage inflation.
If the government tries to redistribute income, which may involve
taxing richer people at higher rates, the richer workers may feel
that they are unfairly penalized for working hard and may decide
to migrate. This in turn, may slow down economic growth.

TAXATION
REASONS TO TAX
To finance public expenditure; building schools and infrastructure
To discourage certain activities; e.g. taxes on cigarette
To discourage import of goods; tariffs are import taxes and can
be levied as a % of value of imports or a set tax on each item
To redistribute income from the rich to the poor.
To achieve other macro-economic objectives

Types of
Taxation
Progressive
Tax
Regressive
Tax
Proportional
Tax

Description
Tax rate rises with income.
The higher the income, the
higher the tax
Tax rate falls with higher
income. The higher the
income, the lower the tax
Everyone pays the same
effective tax rate

Examples
Income tax

Indirect taxes
Corporate income
tax (35%)

DIRECT TAXES
Levied on income or wealth of an individual/company including:
o Personal income tax: is levied on income including on interest
payments on saving
o Payroll taxes: including personal income taxes and social
security contributions
o Corporation tax: levied on company profits, smaller
companies have lower/zero tax to encourage enterprise
o Capital gains tax: tax on any gain in value from sale of assets
held by individuals/companies e.g. precious metals/property
o Transfer taxes: applied to transfer of assets from one person
to another
Advantages
Disadvantages
Major source of tax revenue
Income taxes can reduce work
incentive
Many are progressive and
help reduce inequalities
Taxes on profits reduce profit
available for reinvestment
Take account of peoples
ability to pay
High tax rates can cause tax
evasion

INDIRECT TAXES
Added to prices of goods and services
o Ad valorem taxes: levied as a percentage of selling price of
good/service however necessities (food) may be exempt
o Tariffs: custom duties applied to price of imported goods to
protect domestic firms from oversea competition
o Excise duties: applied to specific goods e.g. cigarette
o User charges: such as tolls for a bridge/motorway
Advantages
Disadvantages
They are cheap for a
Cost of collecting taxes falls to
government to collect
businesses
Wide tax base
They are regressive
Can be used to discourage
Tax revenues are less certain
consumption/production
They add to price inflation

REGULATIONS
Rules imposed by a government backed up by penalties.
Can be laws governing actions of private firms and individuals.
Inspections by qualified inspectors make sure that the businesses
are complying with regulations.
Failure to do so can mean fines or loss of the license.
Examples of Regulations:
Methods of
Management of waste/pollution. Rules
Production
protecting health/safety of workers.
Setting Up A New
Paperwork for filling in such as rules
Business
protecting shareholders and paying tax.
Quality of food products, labeling of
Product Standards
contents of a product.
Disclosure of
Companies must produce reports to
Information
shareholders.
Supply of Harmful
Health warnings on cigarettes.
Products

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CIE IGCSE ECONMOICS (0455)

PRICE INFLATION

June 2014

Advantages
Disadvantages
Improve efficiency and
Over-regulated: spend too
redistribute income.
much time and money
complying with regulations
Allows government to
and cannot concentrate on
regulate firms where there are
running business.
monopoly powers.
To limit effect of externalities. Loss of competitiveness
because of cost of complying
Possible to strike balance
with rules and regulations
between interest of private
firms and consumers

SUBSIDIES
Incentives provided by the government to individuals &
households in order to carry out desired activities.
Other reasons for subsidies include:
o To encourage the production of goods of natural importance
o To encourage development of new products and industries
o To provide support for industries that are in decline and that
are major employers of labor
o To protect domestic industries against foreign competition
When a supplier receives a subsidy, it will be encouraged to
produce more for the market. This leads to a shift to the right of
the supply curve

HOW TO MEASURE INFLATION

Consumer Price Index (CPI): an index of prices of goods and
services typically purchased by urban consumers. It is compiled
and published monthly by the government. It provides a
relatively accurate indication of the average price level of
consumer products in the economy, and thus inflation.
Weightings are based upon the importance of the item in
average expenditure. The greater the proportion spent on an
item, the higher the weighting.
Base year: first year with which the prices of subsequent years
are compared
The inflation rate is defined as percentage change in annual CPI

=
100

Main uses of CPI:
o A macro-economic indicator of price inflation in an economy
o A price deflator to deflate value of wages and incomes by
impact of price inflation
o To index-link income payments so their purchasing power
increases at the same rate as inflation

INFLATION

TAXATION

Zubair Junjunia

Taxes discourage certain activities as well as to raise revenue.

Seen as a cost to business and causes supply curve to shift left.
The incidence of tax refers to who pays the major part of the tax.
In an elastic good, the incidence of tax mainly falls on the seller.
In an inelastic good however, the incidence of tax mainly falls on
the buyer

PRIVATIZATION
In the past, governments nationalized industries:
o To control monopolies
o For safety (e.g. nuclear industry)
o To protect employment
o To maintain a public service
Privatization involves private sector firms taking over public
sector activities in the following ways:
o The sale of public sector assets
o Joint ventures with private firms
o Contracting out (giving private firms contracts)
o Removing barriers to competition (private & public compete)
For Privatization
Against Privatization
If industries are forced to
Private sector organizations
compete, prices will be lower
will not protect public services
& quality will improve.
and may cut services and raise
costs in the long run.
Wider variety of goods
Privatized industries still
Sale of shares raises
dominate markets they
government revenue and can
supply; able to raise prices
be used to lower taxes.
and cut services

General and persistent/sustained increase in the level of prices of

goods/services in an economy over a period of time.
Causes:
o Demand-pull Inflation: caused by total demand rising faster
than total output, causing market prices to rise
o Cost-push Inflation: caused by an increase in cost of
production (e.g. higher wages) so firms will try to pass these
costs onto consumers through higher prices.
o Imported Inflation: results from rising prices of goods and
services imported overseas. This can be due to an increase in
the costs of overseas producers and/or a fall in the exchange
rate of the currency of the importing country.
Hyperinflation: extremely high rates of inflation resulting in
money failing to be a good store of value or becoming virtually
worthless
Personal and economic consequences:
o Inflation reduces the purchasing power; especially difficult for
people on low and fixed incomes e.g. pensioners, unemployed
o Inflation reduces the real value of savings
o Inflation reduces the real value of loans
o Inflation may help boost tax revenues as they are a % of price
o Inflation increases government spending as it will also have to
pay more for goods/services it buys
o Inflation can reduce company profits; especially if it is caused
by rising costs or a reduction in demand.
o Inflation may cause unemployment; as prices rise, demand
will fall and firms sell less and make less profit. They will cut
production and size of their labor to reduce their costs.

DEFLATION
Deflation is a decrease in the general price level of goods and
services and occurs when the inflation rate falls below 0%.
As things become cheaper:
o People stop spending as they expect prices to fall further
o As such, firms start making less revenue.
o Firms start to produce less as less is demanded.
o Employers begin to hire fewer workers as they are no longer
needed anymore.
o This causes the economy to eventually go bust.

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CIE IGCSE ECONMOICS (0455)

OUTPUT AND GROWTH

June 2014

Consequences:
o Firms are able to sell fewer goods/services and so cut their
prices and lose profits
o Firms will reduce workforce due to lower production
o Household incomes fall as unemployment rises; demand falls
o Value of debts rise in real terms causing bankruptcy
o Economy goes into deep recession as demand, output and
demand for labor continue to fall.

EMPLOYMENT AND UNEMPLOYMENT

Indicator
Labor force
Participation Rate
Labor force as a
proportion of total
population of
working age
Employment by
Industry
Number of people
employed in different
industrial sectors
Employment Status
Number of fulltimers, part-timers or
with temporary
contracts
Unemployment
Number of people
registered as being
without work
Unemployment Rate
Unemployment as a
proportion of the
labor force

Recent Trends
Risen as world population has grown.
Risen in many countries especially
among females as it is now socially
acceptable. Poverty and rising living costs
in developing countries has forced many
women to work.
Employment in services has been
growing while employment in agriculture
and other primary sector industries has
fallen.
Most employees work full-time.
Part-time employees have grown rapidly,
especially among female employees.
Tends to rise during economic
recessions.
Almost half the unemployed are young
unskilled workers.
Relatively stable in the recent years but
did increase in 2008 during a global
financial crisis.

TYPES OF UNEMPLOYMENT
Cyclical Unemployment: occurs during an economic recession
due to falling consumer demand and falling incomes. Firms will
reduce their output and lay off workers.
Structural Unemployment: caused by changes in the industrial
structure of an economy. Entire industries may decline or close
due to a permanent fall in demand for their goods and services.
Frictional Unemployment: refers to short-lived unemployment
that occurs when people leave jobs they dislike, move to higher
paid jobs, move home or are made redundant.
Seasonal Unemployment: occurs because consumer demand for
goods and services changes with the seasons. For example, no
job for ski-instructor during summer (no ice)

COSTS OF UNEMPLOYMENT
Personal Costs
Loss of income and reduced
ability to buy goods & services
Unemployed people de-skill if
long out of work
Unemployed people may
become depressed and ill.
Strain on family relationships
and health services.

Costs to the Economy

Unemployment is a waste of
human resources: fewer
goods & services produced.
Total output and income in
the economy will be lower.
Government tax revenues will
also be lower. People in work
may have to pay more tax.
Government spending on
welfare payments to the
unemployed may have to rise.

Zubair Junjunia

Gross Domestic Product (GDP) is the main measure of total value

of all the goods and services produced in a given period of time.
An increase in prices will increase nominal GDP but this is
measured in current dollars thus it includes inflations

100

=

=

However, if an economy has an extremely rich person and

everyone else is poor, the rich person would bring up the level of
the Real GDP per capita.

ECONOMIC GROWTH
Economic growth is when there is an increase in real output over
time, i.e. there is in increase in real GDP and national income
Also an increase in productive potential/possibilities
Important as it can increase the standard of living in an economy.
Economic recession: a significant decline in economic activity
spread across the economy, lasting more than a few months,
normally visible in real GDP growth, real personal income,
employment, industrial production, and wholesale-retail sales

HUMAN DEVELOPMENT INDEX (HDI)

Used by the United Nations to make broader comparisons of
human and economic development in different countries
Combines three different measures for each country
o A decent standard of living, measured by average incomes
o Being educated, measured by adult literacy rate
o Living a long and healthy life, measured by life expectancy
Single index with a value between 0 and 1
Greater than 0.8 = high human development
Less than 0.5 = low human development

DEVELOPED & LESS DEVELOPED ECONOMIES

Developed Economy: advanced/industrialized economy; has a
relatively high average income per person, a well-developed road
and rail network, modern communications systems, produces a
wide variety of goods and services, has a stable government and
legal system; and a healthy and educated population. Examples
include Norway, England, France and Japan.
Less Developed/Developing Economy: low level of economic
development, low average income per person, under-developed
transport and communications systems, relies on agriculture for
many jobs and incomes, and has low levels of health care and
education provision. Examples include Africa, Central American
and the Caribbean.
Rapidly Developing/Emerging Economies: countries that are
quickly developing their industries, workforce skills and living
standards, but are not yet developed. Examples include China,
India and Brazil.

ECONOMIC INDICATORS
Main indicator used is GDP per capita.
Problems with using GDP:
o A country may have high GDP per capita but also high prices
o Distribution of income unequal; high elite class and the poor
Other Measures of Living Standards & Economic Development
Population living on less than
Prevalence of underweight
$1 per day
children
Life expectancy at birth
School and college enrolment
rates
Adult literacy rate
Population with HIV/AIDS
Population without access to
clean water
Share of women in paid
employment

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CIE IGCSE ECONMOICS (0455)

June 2014

POVERTY
Absolute
Number of people living
below a certain income
threshold or number of
households unable to afford
certain basic goods & services
Occurs when people do not
have access to basic food,
clothing and shelter

Zubair Junjunia

VARYING DEATH RATES

Relative
Measures extent to which a
households financial
resources falls below an
average income level.
Occurs when people are poor
relative to other people in the
country; unable to participate
fully in normal activities of the
society they live in

INTERVENTION TO ALLEVIATE POVERTY

Governments will use policies to help alleviate poverty in their
country, or in another country:
Policy
Why is it needed?
What are the problems?
Poor farming methods
Free supplies of food can
Food aid
produce insufficient food force farmers out of
supplies
business
LEDCs lack capital to
Financial
invest in an industrial
Loans have to be repaid.
aid
base, modern machinery
and infrastructure.
LEDCs lack access to
Most people lack skills to
modern machinery,
use modern technology.
Technolequipment and
Instead of using more
ogical aid
knowledge of modern
machinery, more jobs are
production methods.
needed to employ people.
Relieving LEDCs of their
May encourage LEDCs to
debt will allow them to
borrow more money or
Debt relief
use money for economic money may be misused by
development instead
corrupt governments.
Removing LEDCs may have natural
barriers to commodities, which can MEDCs will force down
overseas
be exported to earn
the price of them.
trade
money
Advice not enough; LEDCs
Governments in LEDCs
Economic
need more capital,
lack economic
Advice
stability and a trained and
knowledge
healthy workforce.

POPULATION
The natural rate of increase in population is the difference
between birth and death rates.
LEDCs
MEDCs
Birth rate
High
Low
Death rate
High but falling
Low
Natural rate
High and rising
Low or negative
of increases

MEDCs have better quality food, housing and sanitation which

can improve life expectancy
Eating fatty foods, smoking and lack of exercise has increased
rates of diabetes, cancer and heart disease in many MEDCs.
Improved medicine and healthcare has prevented or cured many
diseases and increased life expectancy.
HIV/AIDS prevalent in LEDCs have reduced life expectancy.
Natural disasters, famines, wars and escalating violence also have
a big impact on death rates especially in many LEDCs

DEPENDENCY
Dependency ratio: number of economically dependent people
relative to the economically active population in an economy
Dependent = people who are too young, too old or too ill to
work, school and college

=

Dependency Ratio
LEDCs
MEDCs
High and rising
Low but rising
High BR increased number of
Low BR and DR increasing no.
children and young people
of older and retired people
Low life expectancy, poor
Life expectancy is high and
skills & education, and lack of
rising.
an industrial base means less
Net inward migration boosted
growth in working population
working populations but also
Outward migration to MEDCs
increased pressure on
reduces working population
housing, education,
healthcare and welfare system
Net migration is the difference between immigration and
emigration. Many people from less developed and developing
countries have been migrating to more developed countries to
enjoy better living standards and jobs with higher incomes.
Structural Feature
LEDCs
MEDCs
Children under 15
High average age
account for 40-50%
Age Distribution
and up to 25% over
while people over 60
60
are less than 5%
Many live in rural
Most live in cities
Geographic
areas but now more increased pollution
Distribution
are moving to urban and congestion
Most work in
Occupational Most work in
tertiary, few in
Distribution primary, up to 90%
primary

INTERNATIONAL SPECIALIZATION AND TRADE

VARYING BIRTH RATES

In LEDCs, poor have large families to help them produce food and
work for money.
LEDCs have high infant mortality rate
LEDCs have lower supply of contraceptives or are forbidden to
use them due to religious beliefs.
In MEDCs, people are marrying later in life and so birth rates have
fallen.

Countries specialize in production of those goods and services in

which they have an absolute advantage or comparative
advantage over other regions or countries
A country has an absolute advantage if it can produce a given
amount of a good or service with far less resources and therefore
at an absolute cost advantage over any country
A country has a comparative advantage in the production of a
good or service if it can produce it at a lower opportunity cost
relative to other countries

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CIE IGCSE ECONMOICS (0455)

June 2014
For Consumers
Cheaper products
Better products
Workers more
productive
International
Trade
Increased
competition from
international
companies
Lower Prices
Better Qualities

Benefits of Trade
To Producers
To Governments
Larger markets
Exports increase
jobs, GDP,
Economies of scale
incomes
More produced,
lower average per But imports take
them away
unit cost
International trade
increases number
of products you
make

TRADE BARRIERS
Tariffs: tax on imports to raise its price and make them more
expensive than local goods to stop people buying them
Subsidies: grant given to an industry by government so industry
will lower its prices encouraging consumers to stop buying
foreign imports by making home-produced goods cheaper.
Quota: limit on number of imports allowed into country per year,
reducing quantity of imports without changing their prices.
Embargo: complete ban on imports of certain goods. An embargo
may be used to stop imports of dangerous drugs.

PROTECTIONISM

Arguments For
Protection of a young industry
To prevent unemployment
To prevent dumping
Because other countries use
barriers to trade
To prevent over-specialization

Arguments Against
Other countries will retaliate
with trade barriers
It protects inefficient domestic
firms
The loss of domestic jobs from
overseas competitions will
only be temporary
Trade barriers have increased
the gap between rich and
poor countries

BALANCING INTERNATIONAL PAYMENTS

VISIBLE AND INVISIBLE TRADE
Visible trade is the selling and buying of natural of natural
resources, parts and components of goods in production, and
finished products.

=
Invisible trade is the selling and buying of services.

=
Imports: money flows out of the country negative impact
Exports: money flows into the country positive impact
>
<

THE BALANCE OF PAYMENTS

The balance of payments of a country records all financial
transactions between the country and all others
It consists of three main accounts:

Current Account
Payment for visible
and invisible imports
and exports, plus
net income flows
and transfers

Capital Account
Payments involving
the sale for capital
goods or fixed assets
such as buildings
and machinery

Zubair Junjunia
Financial Account
Investments flows
including loans and
loan repayments,
and the sale of
shares

STRUCTURE OF THE CURRENT ACCOUNT

Visible trade account: the difference between the export
revenue and import spending on physical goods, e.g. cars,
washing machines
Invisible trade account: measures the difference between export
revenue from and import spending on services, e.g. banking,
insurance and tourism
Income flows: e.g. interest, profit and dividends flowing in and
out of the country
Current transfers: e.g. grants for overseas aid.
Balance of Payments Deficit
Balance of Payments Surplus
Money flowing out greater
Money flowing in greater than
than in.
out.
Current + Capital + Financial is Current + Capital + Financial is
negative.
positive.

PROBLEMS OF A TRADE DEFICIT

It means people are buying more imports and may be spending
less on products made by domestic firms
Deficit may be a symptom of a declining industrial base
The foreign exchange for the national currency is likely to fall.
This will increase prices of imports and cause imported inflation.

REDUCING TRADE DEFICIT

Contractionary fiscal policy, by reducing taxes and cutting
government expenditure can reduce total demand for imports
Raising interest rates can attract an inflow of savings from
overseas, and reduce borrowing by consumers which they might
otherwise spend on imports
Trade barriers can be used to restrict imported goods
Allow the exchange rate to depreciate. A large deficit will cause
foreign exchange rate of national currency to fall. Imports will
become more expensive but exports will be cheaper for overseas
consumers to buy. As consumer demand for imports falls and
overseas demand for export rise, the trade deficit will disappear

EXCHANGE RATE
Exchange rate is the price of a countrys currency in terms of
another countrys currency.
Most countries have a floating exchange rate, which means no
set value for their currency compared with any other currency
with a freely floating exchange rate, the government does not get
involved in the foreign exchange market.
Currency is a commodity thus the value of a currency is totally
dependent on demand and supply of that currency in the foreign
exchange market.
An appreciation in the value of currency means its exchange rate
against other countries has risen
A depreciation in the value of currency means its exchange rate
against other countries has fallen

DETERMINING VALUE OF MONEY

Demand for a currency comes from foreign money flowing into
the country. If demand rises, the currencys value will rise in
relation to the other currency.
Supply of the currency comes from domestic money flowing out
of the country. If supply rises, the currencys value will fall.

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A currency might depreciate
because:
There is a balance of
payments deficit
Demand for other currencies
rises as domestic consumers
buy more imports
Interest rates fall relative to
other countries. People move
their savings to bank accounts
overseas
Inflation rises relative to other
countries. This makes exports
more expensive and demand
for them, and the currency
needed to buy them, falls
People speculate that the
currency will fall in value and
they sell their holdings of the
currency.

CIE IGCSE ECONMOICS (0455)

A currency might appreciate

because:
There is a balance of
payments surplus
Demand for the currency rises
as overseas consumers buy
more exports
Interest rates rise relative to
other countries. This attracts
savings from overseas
residents
Inflation is lower than in other
countries so exports will be
cheaper and overseas demand
for them, and the currency
required to pay for them, will
rise
People speculate that the
currency will rise in value and
they buy more of the currency

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Zubair Junjunia