Scarcity and Unlimited Wants.

Borja Hormaeche

Business Studies Research

Scarcity

Unlimited Wants

Humans have many different types of wants and needs. Economics looks only at man's material wants and needs. These are satisfied by consuming (using) either goods (physical items such as food) or services (non-physical items such as heating).

There are three reasons why wants and needs are virtually unlimited:

Goods eventually wear out and need to be replaced.
New or improved products become available.
People get fed up with what they already own.

Limited Resources

Commodities (goods and services) are produced by using resources. The resources shown in Table 1.1 are sometimes called factors of production.

Table 1.1 Different types of resource

Types of Commodity

A free good is available without the use of resources. There is zero opportunity cost, for example air. An economic good is a commodity in limited supply.

Expenditure on producer or capital goods is called investment.

The Economic Problem

The economic problem refers to the scarcity of commodities. There is only a limited amount of resources available to produce the unlimited amount of goods and services we desire.

Society has to decide which commodities to make. For example, do we make missiles or hospitals? We have to decide how to make those commodities. Do we employ robot arms or workers? Who is going to use the goods that are eventually made? Do we build a sports hall in Wigan or Woking?

Opportunity Cost

The opportunity cost principle states the cost of one good in terms of the next best alternative. For example, a gardener decides to grow carrots on his allotment. The opportunity cost of his carrot harvest is the alternative crop that might have been grown instead (eg potatoes). Further examples are given in Table 1.2.

Table 1.2 Examples of opportunity cost decisions

Economic Systems

An economic system is the way a society sets about allocating (deciding) which goods to produce and in which quantities. Different countries have different methods of tackling the economic problem. There are three main types of economy.

Market Economies

A market or capitalist economy is where resources are allocated by prices without government intervention. The USA and Hong Kong are new examples of market economies where firms decide the type and quantity of goods to be made in response to consumers. An increase in the price of one good encourages producers to switch resources into the production of that commodity. Consumers decide the type and quantity of goods to be bought. A decrease in the price of one good encourages consumers to switch to buying that commodity. People on high incomes are able to buy more goods and services than are the less well off.

Command Economies

In a command-planned or socialist economy the government owns most resources and decides on the type and quantity of a good to be made. The USSR and North Korea are examples of command economies. The government sets output targets for each district and factory and allocates the necessary resources. Incomes are often more evenly spread out than in other types of economy.

Mixed Economies

In a mixed economy privately owned firms generally produce goods while the government organises the manufacture of essential goods and services such as education and health care. The United Kingdom is an example of a mixed economy.

Population Size

Method of Calculation

The study of population statistics is called demography. Since 1801 a population census (survey) of the UK has been held every ten years to count the number of people in the country.

A census is carried out because the government needs to plan ahead. The figures can be used to estimate the number of roads, schools, hospitals etc likely to be needed in the future.

Birth Rate

The crude birth rate is the number of births per thousand of the population in a year. The birth rate has fallen from 28.6 in 1900 to 12.8 in 1988. This dramatic fall has been caused by:

Improved birth control. Contraceptives are now more available and socially accepted.
Women choosing to continue working, or waiting before raising smaller families.

Death Rate

The death rate is the number of deaths per thousand of the population in a year. The death rate has fallen from 18.4 in 1900 to 11.7 in 1988. This fall has been caused by:

Improved housing, diet and sanitation.
Improved health care through medical discoveries and introduction of the National Health Service.

Migration

Migration happens when people either permanently leave a country (emigration) or enter it (immigration). Net migration is the difference between the number of people emigrating and immigrating.

People usually want to leave countries (voluntary emigration) for two reasons:

Push factors which include high unemployment, low living standards or poor climate in their own country.
Pull factors which include good job prospects and high living standards in a new country.

Population Structure

Population Structure by Sex and Age

Population pyramids can be used to show the sex and age structure of a particular country. Developed countries tend to have an even sex and age structure while less developed ones have over half their population aged under 16.

An ageing population occurs when the average age per person is rising.

Population Structure by Area

There is an uneven spread of population about the country because:

Some areas are remote, hilly or uninhabitable.
Farming areas employ few people.
Industry is concentrated in towns.

80 per cent of the UK population live in England, largely in the south-east and midlands. 80 percent of people live in urban (built-up) areas. 20 cities have a population of more than 250 000. The seven UK conurbations (several towns joined together) house a third of the population but they occupy only 3 per cent of the land area. Move away from living in the inner cities.

Optimum Population

T R Malthus

Writing at the end of the eighteenth century, Malthus argued that:

Population rises in a geometric way, ie 1,2,4,8,16.
The food supply rises arithmetically, ie 1,2,3,4,5.

Only way, famine and plague would prevent absolute poverty.

Malthus did not take into account the spread of birth-control techniques which reduced the rate of population growth. Malthus also overlooked the effects of future farming inventions, and the development of foreign trade which dramatically increased the food supply.

Optimum Population

Optimum (best) population occurs when productivity (output per person) is highest.
An under-populated country can increase productivity by increasing its population.
An over-populated country can increase productivity by reducing its population.

Specialisation

Specialisation happens when one individual, region or country concentrates in making one good.

Division of Labour

The division of labour is a particular type of specialisation where the production of a good is broken up into many separate tasks each performed by one person. An early economist, Adam Smith, suggested that without any help one worker could produce only ten pins in one day. However, in a pin factory where each worker performs only one task, ten workers using the division of labour principle, could produce a daily total of 48 000 pins. Output per person (productivity) rose from 10 to 4800 when the division of labour principle was used.

Advantages of the Division of Labour

The division of labour raises output, thereby reducing costs per unit, for the following reasons:

Workers become more practised at the task
Workers are able to be trained more precisely for the task
Specialisation enables more efficient organisation of production with a series of distinct tasks

Disadvantages of the Division of Labour

Eventually the division of labour may reduce productivity and increase unit costs for the following reasons:

Continually repeating a task may become boring.
Workers begin to take less pride in their work.
If one machine breaks down then the entire factory stops.
Some workers receive a very narrow training and may not be able to find alternative jobs.
Mass-produced goods lack variety.

Limits to the Division of Labour

Mass production requires mass demand.
The transport system must be good enough to reach a large number of consumers (mass market)
Barter is the direct exchange of goods for other goods. Each worker creates only part of the finished goods, therefore the division of labour cannot be used in a barter society.

Automation

The introduction of conveyor belts at the turn of the century allowed mass production (very large output). Automation refers to intensive use of machinery in production.

Costs of Production and Revenue

Total Costs

A firm organises the manufacture of a good or service. An industry is made up of all those firms producing the same commodity. The amount spent on producing a given amount of a good is called total cost, TC, and is found by adding together variable and fixed costs.

Variable Costs

Variable costs, VC, depend on how many goods are being made (output). If just one more unit is made then total variable costs rise. Variable costs include the following:

Weekly wages paid to the shop floor workers.
The cost of buying raw materials and components.
The cost of electricity and gas.

Fixed Costs

Fixed costs, FC, are totally independent of output. Fixed costs have to be paid out even if the factory stops production. Fix costs include the following:

monthly salaries paid to managers;
rent paid for the use of premises;
rates paid to the council;
any interest paid on loans;
insurance payments in case of accidents
money put aside to replace work-out machines and vehicles sometime in the future (depreciation).

Average Cost

Average cost, AC or unit is the cost of producing one item and is calculated by dividing total costs by total output.

Marginal Cost

Marginal cost, MC is the cost of producing one extra unit and is calculated by dividing the change, , in total costs by the change in output.

Revenue

Total revenue, TR, is the money the firm gets back from selling goods and is found by multiplying the number sold, Q, by the selling price, P.
Average revenue, AR, is the amount received from selling one item and equals the selling price of the good.
Marginal Revenue, MR.

Equations

TC = VC + FC

VC = TC - FC

FC = TC - VC

AC = TC/Q

TR = P x Q

AR = TR/Q

MC = TC/Q

MR = DTR/DQ

Social Cost

The private cost to a motorist of driving from Cornwall to Scotland is the cost of petrol and oil and the wear and tear on his car. However, other people have to put up with the externalities of the journey, for instance the noise, smell, pollution and traffic congestion the motorise helps to cause along the way.

If we add on to private cost an amount of money to compensate for the inconvenience caused, the overall figure will be the social cost of the journey:

Private costs + Externalities = Social cost

(Cost to individual) + (Cost to other people) = (Cost to everyone)

Economies of Scale

These occur when mass producing a good results in lower average cost. Economies of scale occur within an firm (internal) or within an industry (external).

Internal Economies of Scale

These are economies made within a firm as a result of mass production. As the firm produces more and more goods, so average cost begin to fall because of:

Technical economies made in the actual production of the good. For example, large firms can use expensive machinery, intensively.
Managerial economies made in the administration of a large firm by splitting up management jobs and employing specialist accountants, salesmen, etc.
Financial economies made by borrowing money at lower rates of interest than smaller firms.
Marketing economies made by spreading the high cost of advertising on television and in national newspapers, across a large level of output.
Commercial economies made when buying supplies in bulk and therefore gaining a larger discount.
Research and development economies made when developing new and better products.

External Economies of Scale

These are economies made outside the firm as a result of its location and occur when:

A local skilled labour force is available.
Specialist local back-up forms can supply parts or services.
An area has a good transport network.
An area has an excellent reputation for producing a particular good. For example, Sheffield is associated with steel.

Internal Diseconomies of Scale

These occur when the firm has become too large and inefficient. As the firm increases production, eventually average costs begin to rise because:

The disadvantages of the division of labour take effect
Management becomes out of touch with the shop floor and some machinery becomes over-manned.
Decisions are not taken quickly and there is too much form filling.
Lack of communication in a large firm means than management tasks sometimes get done twice.
Poor labour relations may develop in large companies.

External Diseconomies of Scale

These occur when too many firms have located in one area. Unit costs begin to rise because:

Local labour becomes scarce and firms now have to offer higher wages to attract new workers.
Land and factories become scarce and rents begin to rise.
Local roads become congested and so transport costs begin to rise.

Integration

This occurs when two firms join together to form one new company. Integration can be voluntary (a merger) or forced (a takeover). The figure below shows the three main types of integration.

Motives for Integration

Integration increases the size of the firm. Larger firms can achieve more internal economies of sale.
One firm may need fewer workers, managers and premises (rationalisation).
Large domestic firms are then more able to compete against large foreign multinationals.
Integration allows firms to increase the range of products they manufacture (diversification. Diversified firms no longer have 'all their eggs in one basket'.
Reduce competition by removing rivals.

Survival of the Small Firm

Small firms are able to compete with large firms because:

Some products cannot be mass produced, eg contact lenses.
Some products have only a limited demand, eg horse shows.
Some products require little capital, eg window cleaning.
Small firms receive grants and subsidies from the government.

Market Structure

Market structure refers to the number of firms in an industry. In perfect competition there are a large number of small firms in the industry, each producing identical products. Very few markets are perfectly competitive but one example is wheat.

In a monopoly one firm supplies 25 per cent or more of a market. The Ford Motor Company is an example of a monopoly firm. A pure monopoly is a special type of monopoly where one firm supplies the entire market. British Rail is an example of a UK pure monopolist.

Private- and Public-sector Firm

The Private Sector

The economy can be divided into the private and public sectors. The private sector is made up of members of the general public and firms owned by the general public. These firms include sole traders, partnerships, limited companies (owned by private shareholders) and Public Limited Companies (Plcs) (also owned by private shareholders).

The Public Sector

The Public Sector is made up of the central government in London, various local councils, and firms owned by the government (nationalised industries) such as the Post Office.

Private-sector Firms

Types of Private-sector Firm

Table 5.1 summarises the main types of firm owned by members of the general public.

Table 5.1 Private-sector firms

Liability

The owners are liable or responsible for the debts of a company.

Unlimited liability means the owner may have to sell some or all of his personal possessions to help pay off the company's debts.
Limited liability means that the owner loses only the money he has put into the company and no more. He does not have to sell personal belongings.

Establishing a Limited Company

Limited companies have their own legal identity. They can sue people and other companies and be sued themselves. Anyone wanting to establish a limited company must issue:

A memorandum of association stating the name, aims and address of the company and the amount of capital to be raised.
Articles of association stating the internal organisation of the company.

The Registrar of Companies then issues a certificate of incorporation which permits the company to trade.

The limited company then prepares a prospectus describing the history and prospects of the firm and inviting individuals to buy their shares. Only a public limited company can advertise its prospectus.

Each share allows one vote and pays one dividend (profit payment). Each year the shareholders elect a chairman and a board of directors who control the everyday running of the firm.

Public-sector Firms

Types of Public-sector Firm

Each nationalised industry (or public corporation) has its own Act of Parliament and its own government minister. Firms owned by the government aim to operate in the public interest and do not necessarily try to make maximum profits.

Public Limited Companies and Public Corporations

These are compared in Table 5.2

Table 5.2 Differences between public limited companies and public corporations

Privatisation

The Thatcher administration followed a course of selling state-owned firms such as British Telecom back to the private sector. This is called privatisation.

Arguments for Privatisation

Firms operate more efficiently in the private sector because they are trying to maximise profits.
Money can be raised to increase government services or to pay for tax cuts.
Ordinary people become shareholders and take a greater interest in economic matters ('peoples's capitalism').

Arguments Against Privatisation

Public monopolies simply become private monopolies.
Socially necessary but unprofitable services may not now be provided.
Nationalised industries are already owned indirectly by the general public.

Multinationals

A multinational corporation is a very large firm with a head office in one country ...

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Arguments for Privatisation

Firms operate more efficiently in the private sector because they are trying to maximise profits.
Money can be raised to increase government services or to pay for tax cuts.
Ordinary people become shareholders and take a greater interest in economic matters ('peoples's capitalism').

Arguments Against Privatisation

Public monopolies simply become private monopolies.
Socially necessary but unprofitable services may not now be provided.
Nationalised industries are already owned indirectly by the general public.

Multinationals

A multinational corporation is a very large firm with a head office in one country and several branches operating overseas.

Advantages of Multinationals

Investment by multinationals creates jobs for the host country.
The multinational will introduce new production techniques and managerial skills.
New or better goods may now become available in the host country.

Disadvantages of Multinationals

Profits are returned to the overseas head office.
The multinational may operate against the interest of the host country.
The multinational may force its overseas branches to buy supplies from the head office.

Factors Influencing Location

Sometimes firms have to decide where to build a new factory. It is important to consider the different costs of different locations. Businessmen take into account the natural and acquired advantages of a particular area.

Natural Advantages

An area may have a water source for waste disposal or cooling.
An area may be flat or isolated and attract dangerous or unpleasant industries.
An area may have the right climate for the production of a good.
Weight-losing industries use bulky raw materials to produce a compact finished product and tend to locate near the source of raw materials.

Acquired Advantages

An area may have developed a number of advantages as the result of firms locating in the region. These are called external economies of scale.

Weight-gaining industries use compact raw materials to produce a bulky finished product and tend to locate near the major market for the good.

Footloose Industries

A footloose industry gains no particular advantage from any one location usually because transport costs are the same for each site.

Industrial inertia occurs when a firm continues to expand on its existing site even though there are cheaper alternatives.

Structure of UK Industry

Regional Structure of UK Industry

The localisation of industry occurs when there is a concentration of producers of a particular product in one area. See Table 6.1

Table 6.1 Structure of UK industry by region

Recent Changes in the Structure of UK Industry

Declining industries. Since 1973 manufacturing output has been falling by 2 per cent each year. The shipbuilding, textile and motor vehicle industries have suffered particularly.
Expanding industries. The energy crisis and discovery of North Sea oil has increased the output of the mining industry, dramatically. However, the collapse of oil prices in 1986 may see a reversal of this trend. Service industries including banking, communications and insurance have expanded rapidly.

Regional Policy

Regional Problem

The regional problem refers to the uneven spread of living standards between different regions of the UK. Areas with below-average income per person and high unemployment are depressed regions. They usually have a large concentration of declining industries and are remote from the major markets. New firms prefer to locate in the expanding South East.

The gap between the prosperous South East and the rest of the country is growing. New firms are attracted to the South East by the extensive motorway and air links and the availability of workers familiar with the new technologies. For example, computer-based, high-technology firms have located along the M4 motorway corridor west of London.

Government Regional Policy

Footloose firms can be attracted to depressed regions by government grants. The government offers:

Urban development loan.
Regional selective assistance. Firms locating in intermediate development areas may receive a grant towards machinery and training costs.
Enterprise Zones. These are small areas situated mainly in inner-city areas where rate and rent allowances are provided by the government.

Demand

Definition

Desire refers to people's willingness to own a good. Demand is the amount of a good that consumers are willing and able to buy at a given price.

Utility

Utility is the satisfaction people get from consuming (using) a good or a service. Utility varies from person to person. Some people get more satisfaction from eating chips than others. Even the same person can gain greater satisfaction by eating chips when hungry than when he has lost his appetite.

Factors Influencing Demand

The amount of a good demanded depends on:

the price of the good;
the income of consumers;
the demand for alternative goods which could be used (substitutes);
the demand for goods used at the same time (complements);
whether people like the good (consumer taste).

The demand curve labelled DD in the figure below shows the amount of a good one or more consumers are willing and able to buy at different prices.

Movements Along and Shifts in Demand Curves

A change in price never shifts the demand curve for that good. In the figure below an increase in price results in a movement up the demand curve. The fall in the quantity demanded from Q1 to Q2 is sometimes called a contraction in demand.

A demand curve shifts only if there is a change in income, in taste or in the demand for substitutes or complements. In the diagram below a decrease in demand has shifted the demand curve to the left. The new demand curve is D1 D1.

Supply

Factors Influencing Supply

Supply is the amount of a good producers are willing and able to sell at a given price. Supply depends on:

the price of the good;
the cost of making the good;
the supply of alternative goods the producer could make with the same resources (competitive supply);
the supply of goods actually produced at the same time (joint supply);
unexpected events that affect supply.

The supply curve labelled SS in the figure below shows the amount of a good one or more producers are prepared to sell at different prices.

Movements Along and Shifts in Supply Curves

A change in price never shifts the supply curve for that good. In the diagram below an increase in price results in a movement up the supply curve. The increase in quantity supplied from Q1 to Q2 is sometimes called an expansion in supply.

A supply curve shifts only if there is:

a change in costs;
a change in the number of goods in competitive or joint supply; or
some unforeseen event which affects production.

In the diagram below an increase in supply shifts the supply curve to the right.

Market Price

At prices above the equilibrium (P*) there is excess supply while at prices below the equilibrium (P*) there is excess demand. The effect of excess supply is to force the price down, while excess demand creates shortages and forces the price up. The price where the amount consumers want to buy equals the amount producers are prepared to sell is the equilibrium market price. All these situations are shown in the diagram below:

Indirect Taxes and Subsidies

In the figure below an indirect tax has been added to SS. This has the effect of shifting the supply curve up vertically by the amount of the tax. Note in the diagram below that price does not increase by the full amount of the tax. This suggests that part of the tax is paid by the firm.

In this figure a subsidy has been given to the firm. This has the effect of making firms willing to supply more at each price and so shifts the supply curve downwards. The shift is equivalent to the value of the subsidy. Note that price falls by less than the full amount of the subsidy. This suggests that the firm keeps part of the subsidy.

Elasticity

Price Elasticity of Demand

Price elasticity of demand measures the responsiveness of demand to a given change in price and is found using the equation:

PED = Percentage change in quantity demanded/Percentage change in price

PED = P/Q x Q/P

where P = the original price

Q = the original quantity

and = 'the change in'

See Table 7.1

Table 7.1 Features of price elasticity of demand

Price Elasticity of Supply

Price elasticity of supply (PES) measures the responsiveness of supply to a given change in price.

PES = Percentage change in quantity supplied/Percentage change in price

or PES = P/Q x Q/P

See Table 7.2

Table 7.2 Features of elasticity of supply

Income Elasticity of Demand

Income elasticity of demand (YED) measures the responsiveness of demand to a given change in income:

YED = Percentage change in quantity demanded/Percentage change in income

If YED is negative then the good is inferior. People use an increase in income to buy less of this good and more of a superior substitute.

If YED is positive then the good is normal. Consumers use an increase in income to buy more of the good.

Cross Elasticity of Demand

Cross elasticity of demand (XED) measures the responsiveness of demand for one good (z) to a given change in the price of a second good (w):

XED = Percentage change in quantity demanded of good z/Percentage change in the price of good w

If XED is positive then the two goods are substitutes. If XED is negative then the two goods are complements.

Income

Types of Income

Income is the amount of money received by a household over a period of time. This income may come from employment, self-employment, dividends, rent or a variety of other sources.

Distribution of Income

Income distribution is the way in which total income is shared out between households. Not everyone receives the same amount of money each year because of wage differences and the uneven ownership of wealth.

Wages

Methods of Payment

Workers sell their labour to employers in return for:

Salaries. Usually salaries are paid monthly to non-manual workers such as managers irrespective of the number of hours worked.
Wages. Wages are weekly payments for work done and are paid by:

Piece rate or piece work: an amount for every item made.
Time rate: an amount for every hour worked.

Deductions

The gross wage is made up of basic wages plus overtime and bonus payments. Deducting income tax and national insurance contributions leaves net wages or take-home pay.

Money and Real Wages

Money wages refers to pay without any adjustment for inflation. Real Wages are the amount of goods and services money wages can buy; this is given by the equation:

Real wages = Money wages/Retail price index x 100

Wage Differences

The wage for a job is determined by the supply and demand for labour in that particular occupation. A job where labour is in high demand but in short supply will pay higher wages.

Demand for Workers

The demand for labour is found (derived) from the demand for the finished good. There will be an increased demand for workers if:

There is an increased demand for the finished good.
Workers increase their productivity.

Supply of Workers

There will be a limited supply of workers if the job:

Requires special qualifications, skills, training or ability/
Is unpleasant, dirty or boring.
Is stressful or carries great responsibility.
Involves antisocial hours.

Wage Drift

Wage drift occurs when the earnings of some workers rise above the average for the industry. Workers doing the same job within the same industry may be paid differently because:

Workers in cities are sometimes paid more to meet the higher cost of living.
In spite of equal-opportunities legislation women tend to earn less because their careers are interrupted by family commitments, or they suffer from sex discrimination.
Older workers tend to earn more because they are paid a bonus to reward their experience.
Some workers are paid more for working harder.
Some workers receive overtime, bonuses, etc.

Wealth

Types of Wealth

Wealth is the value of all the assets (items) owned by a household at a particular moment in time.

Wealth Distribution

Wealth Distribution means the way the ownership of assets is shared out between households. Wealth is much more unevenly distributed in the UK than incomes.

Table 8.1 suggests that while the top 1 per cent and 10 per cent now own a smaller share of total wealth than in 1971, half the population still own only 4 per cent of all assets.

Table 8.1 Wealth trends

Features of Trade Unions

Types of Trade Union

A trade union is an organisation which represents workers. There are four main types:

Craft unions representing skilled workers from one occupation. For example, SOGAT 82 (printers) and the AUEW (engineering).
General unions representing mainly unskilled workers from many occupations. For example the TGWU (Transport and General Workers' Union).
Industrial unions representing mainly workers in one industry. For example, the NUM (miners' union)
Professional or white-collar unions representing skilled workers in mainly service industries. For example, the NUT (teachers' union).

Functions of Trade Unions

Trade unions aim to:

Improve the pay of workers.
Improve working conditions and secure longer holidays.
Protect members' jobs.
Provide local, social and welfare facilities.
Influence government policy by sponsoring Members of Parliament and contributing money to political parties.

Organisation of Trade Unions

Each trade union has its own internal organisation. Generally:

Small groups of workers elect a local spokesman (shop steward).
Every area has a branch which sends delegates (representatives) to a yearly national conference.
Conference passes resolutions (policies) and elects a national executive. Only the national executive can call an official strike.
The entire membership elects a general secretary. The general secretary acts as the union's spokesman and manages everyday affairs, usually until he reaches retirement age.

The Trades Union Congress

The Trades Union Congress (TUC) is made up of over 90 unions representing more than 9 million members. An annual conference decides overall union policy and elects the General Council. The General Secretary of the TUC is the trades union spokesman in any negotiations with the government or employers' organisations. The TUC has no power to initiate or halt an individual union's industrial action.

Employers Associations

Collective Bargaining

In the nineteenth century workers used to negotiate their own pay and conditions with their employers. Collective bargaining occurs when workers allow the union to negotiate on their behalf. Negotiations can be with an individual employer or an employers' association.

Types of Dispute

Disputes can arise over pay, working conditions, redundancies or restrictive practices which include:

A closed shop when a union insists that all workers in a place or work are members.
Demarcation when a union insists that only their members do certain jobs.
Blacking goods when the union refuses to handle goods produced by a firm in dispute with a union.
Over-manning when the union insists on a large number of workers for one job.

Industrial Action

If negotiations break down employers may lose output while workers may lose some pay. More often than not a compromise is found. However, sometimes one party resorts to industrial action. Unions can:

Work to rule and do the bare minimum of work.
Impose an overtime ban and refuse extra work.
Strike and refuse to work altogether.
Mount a picket line outside their place of work and ask other trade unionists not to enter.

Employers can operate a lockout and refuse workers entry or they can dismiss striking workers to breach of contract.

Recent Legislation

Recent legislation has severely weakened trade union power as follows:

An employer can now sue a union for lost profits if industrial action is taken without an initial secret ballot of workers.
Industrial action can be taken only against the original employer and not against his suppliers or buyers.
Mass picketing is unlawful. Only a handful of strikers are allowed to man a picket line, peacefully.

Arbitration

Arbitration is when employers and the unions agree to an independent referee to try to find common ground.

Since 1974 an independent Advisory Conciliation and Arbitration Service (ACAS) has been available to help solve disputes.
In the 1980s and 1990s there have been an increasing number of single-union agreements where employers negotiate with only one union. Pendulum arbitration is used to settle a dispute where an independent referee chooses one side or the other.

Circular Flow of Income

Real and Money Flows

The figure below divides the economy into two sections or sectors made up of households and firms.

There are two types of flow (an amount per time period) between these groups:

A real flow. Households own factor services which they hire out to firms. Factor services are then used to manufacture goods and services.
A money flow. Households receive payments for their services (income) and use this money to buy the output of firms (consumption).

Leakages or Withdrawals From the Circular Flow

Not all income will flow from households to firms directly. The circular flow below shows that some part of household income will be:

Put aside for future spending, ie saved.
Paid to the government in taxes.
Spent on foreign made goods imported into the country.

Injections Into the Circular Flow

These flows out of the circular flow of income will be counterbalanced by flows back in. These flows are known as injections. These may take the form of:

Other firms, ie investment expenditure.
The government, ie government expenditure.
Foreigners, ie export expenditure.

The diagram shows the impact of these injections on the circular flow:

The Multiplier Effect

When there is an increase in the level of injections a part of it will be received by a household as extra income. The households will probably act so that part of this extra income is then spent and part is saved.

This extra consumer spending then gives rise to a series of further incomes and expenditures. The overall increase in spending is much higher than the initial injection. This effect is known as the multiplier effect. The greater the proportion of the extra income that is spent (the Marginal Propensity to Consume), the bigger the multiplier effect will be.

National Income Accounts

The relationships explained in the sections above form the basis of national income accounting. The aim of national income accounting is to place a money value on this year's output. There are three methods of calculation.

Income Method

The income method adds together the total value of all incomes that have been earned in the relevant time period. These may include income from employment, income from self employment, profits, surpluses of public (government) corporations and rent. Note that only incomes earned from supplying a factor service are counted. Transfer payments are ignored.

Expenditure Method

The government adds up all the money spent in buying this year's output. This will be the total of Consumption, investment, government expenditure and net exports (exports - imports). This ignores:

Indirect taxes and subsidies included in the selling price.
Spending on second-hand goods.

Output Method

The economy is broken up into twelve different sectors (eg manufacturing). The money spent on making the goods (inputs) is taken away from the money received from the sale of the goods (outputs) to give each sector's value added. Taking final output or adding up each sector's value added gives national income.

Unpaid output such as the work of housewives is not recorded.

Standard of Living

Measurement of the Standard of Living

The value of this year's national income is a useful measure of how well-off a country is in material terms. However, inflation increases the money value of national income but does not provide us with any more goods to consume. Real national income is found by applying the equation:

Real national income = Money national income/Retail price index x 100.

The standard of living refers to the amount of goods and services consumed by households in one year and is found by applying the equation:

Standard of living = Real national income/Population

A high standard of living means households consume a large number of goods and services.

A second method of calculating living standards is to count the percentage of people owning consumer durables such as cars, televisions, etc. An increase in ownership indicates an improved standard of living.

A third method of calculating living standards is by noting how long an average person has to work to earn enough money to buy certain goods. If people have to work less time to buy goods, then there has been an increase in the standard of living.

Interpretation of the Standard of Living

An increase in the standard of living may not mean a better life-style for the majority if:

Only a small minority of wealthy people consume the extra goods.
Increased output of certain goods results in more noise, congestion and pollution.
Leisure time is reduced to achieve the production increase.
There is an increase in the amount of stress and anxiety in society.

Features of Money

Functions of Money

Money is something which people generally accept in exchange for a good or a service. Money performs four main functions:

a medium of exchange for buying goods and services;
a unit of account for placing a value on goods and services;
a store of value when saving;
a standard for deferred payment when calculating loans.

Properties or Characteristics of Money

Any item which is going to serve as money must be:

acceptable to people as payment;
scarce and in controlled supply
stable and able to keep its value
divisible without any loss of value
portable and not too heavy to carry.

Origins of Money

The earliest method of exchange was barter in which goods were exchanged directly for other goods. Problems arose when either someone did not want what was being offered in exchange for the other good, or if no agreement

could be reached over how much one good was worth in terms of the other.

Valuable metals such as gold and silver began acting as a medium of exchange. Governments then decided to melt down these metals into coins.

By the seventeenth century people were leaving gold with the local goldsmith for safe keeping. Receipts of £1 and £5 were issued which could then be converted back into gold at any time. Soon these receipts were recognised as being 'as good as gold' and were readily taken in exchange for goods. Goldsmiths became the first specialist bankers and their receipts began to circulate as banknotes.

Only the Bank of England can now issue banknotes in England and Wales. However, notes are not usually used to buy expensive items such as cars. The buyer is more likely to write out a cheque, which instructs his bank to transfer money from his account into the account of the seller. Hence bank deposits act as money.

Commercial Banks

Banks are authorised institutions and perform four functions. They accept deposits, make loans, arrange payment of bills and provide a number of customer services. The four main high street or clearing banks in the UK are Barclays, Lloyds, Midland and National Westminster.

Types of Bank Account

Banks provide different types of account for different needs. Customers can open:

A current account which provides a cheque book but usually pays no interest. Current accounts are mainly used to pay bills.
A deposit account which does pay interest but money can only be taken out by visiting the bank. Deposit accounts are mainly used for short term saving.
An investment or savings account which pays a higher rate of interest but written notice of withdrawal must be given. Accounts of this type are used mainly for long-term saving.

Types of Bank Loan

An overdraft is when the bank allows a customer to take out more money than is in his account. Overdrafts are up to an agreed limit, and must be paid off whenever the bank asks. Interest is charged daily on any outstanding balance.
A loan account is when a customer borrows a fixed sum of money to be repaid in monthly instalments over a number of years. A fixed rate of interest is charged.

Methods of Payment

These include:

Cheques when the bank is ordered to pay money to someone else. The people involved in writing a cheque are:

The person writing out the cheque (drawer).
The bank ordered to pay the money (drawee)
The person receiving the money (payee).

A cheque card is issued to trusted customers which guarantees payment by the bank of any cheque up to the sum of £50, though some will now go up to £100.

Standing orders when a fixed sum is paid out on set dates.
Direct debits when a variable sum is paid out on set dates.
Credit cards when customers have a special card (eg Visa or Access) which can be used to buy goods. Cardholders receive a statement every month and no interest is charged if the account is settled in full. Interest is changed monthly on any outstanding balance.
EFTPOS.

Other Services

Banks have cash points; exchange foreign currency and issue travellers' cheques; provide night safes and store valuables; execute (carry out) wills and trusts; and factor (collect) debts.

Commercial Bank Balance Sheet

A balance sheet shows the present position of a company. One for a commercial bank is shown here.

The balance sheet of a commercial bank

In the balance sheet the liabilities column shows the origin of the money held by the bank. Items (a) to (c) show the amount of money held in each type of account. Item (d) states the total value of the deposits held by the bank.

The assets column shows what the bank has done with the money. Note that only a small percentage of total liabilities is kept as cash in tills (item (e)). Item (f) is the bank's own current account for settling debts. Item (g) is money lent out to discount houses for a few days. Items (i) and (j) are IOUs issued mainly by the government. Items (e) to (I) are the bank's liquid or reserve assets and can easily be turned into cash.

Items (j) and (k) are illiquid (not easily turned into cash) but highly profitable. By definition, the amount of total assets (item (l) must equal total liabilities.

Credit Creation

Some customers leave money in the bank earning interest. A bank can use these idle deposits to make loans to people who then buy goods. Shopkeepers receive extra money which they redeposit with the bank. Some of this redeposited money is left to earn interest and can be re-lent. The bank has therefore created money. If all customers were to try to cash their deposits at once, their would not be sufficient cash. The amount of money the bank can create therefore depends on the ratio of cash to liabilities that they hold. The higher this cash ratio the less money the bank can re-lend or create.

Money Supply

Definition

The money supply is the total amount of assets in circulation which are acceptable in exchange for goods. In modern economies people accept either notes and coins or an increase in their current account as payment. Hence the money supply is made up of cash and bank deposits. There are five main measures of the money supply known as M0 to M5.

Control of the Money supply

The Bank of England is responsible for controlling the money supply and this involves limiting the amount of cash, and bank deposits in circulation.

As the Bank of England actually issues notes and coins, it can easily control the amount of cash in the money supply.

However, the major part of the money supply is not created by the Bank of England. Commercial banks decide the amount of bank deposits in circulation using the equation:

D = 1x A

where D = total deposits

A = liquid assets

and = the percentage of deposits held in liquid form.

The Bank of England can:

Place a limit on the amount of deposits a bank can have.
Force up interest rates to discourage customers from taking out loans.
Reduce the amount of liquid assets held by a bank selling bills to the public. The public then write out cheques to the government and money leaves the bank.

The Bank of England

The Bank of England is the central bank of the United Kingdom. It was established in 1694 and nationalised in 1946.

Functions of the Bank of England

The Bank of England is the sole issuer of notes and coins through the Royal Mint.
The Bank of England is the government's banker.
The Bank of England is the banker for commercial banks.
The Bank of England has close links with foreign central banks and the IMF.
The Bank of England holds the UK gold and foreign currency reserves in the exchange equalisation account which it uses to help stabilise sterling.
Since the election of the Labour government in 1997, the Bank of England has been given operational independence. This means that they set interest rates through a Monetary Policy Committee that meets monthly. This takes the setting of interest rates out of the hands of politicians. The Bank of England set them at a level appropriate to meet the governments inflation targets.

The Money Market

The money market arranges large-scale short-term loans (up to three months) and is mainly used by commercial banks and discount houses.

The Stock Exchange

The London stock exchange is the centre of the capital market and provides large-scale long-term loans for companies and the government.

New Share Issues

Firms can raise money for expansion by reinvesting profits or arranging a loan through a bank. However, a company wanting to raise millions of pounds' worth of capital may consider going public, ie becoming a public limited company. The firm prepares a prospectus stating the history and aims of the company and inviting the public to buy shares.

A public limited company can raise further capital through a rights issue when shareholders are invited to buy new shares at a discount on the current stock market price.

An alternative method of raising money is to issue debentures. A debenture is a loan to a company paying a fixed rate of interest. Second-hand debentures can be bought and sold on the stock exchange.

Table 12.1 Types of share

Organisation of the Stock Exchange

In 1986 the stock exchange underwent a radical change in organisation (the 'big bang'):

Market makers buy and sell shares.
Brokers or dealers represent the client but may be part of the same firm as the market maker.
Market makers and brokers are linked by a new computer system, SEAQS (Stock Exchange Automated Quotation System).
The stock exchange has been enlarged to include a number of high street banks and foreign financial institutions.
The Stock Exchange Council (a committee of elected dealers) is directly responsible for policing the market. The council itself is under the supervision of the Securities and Investment Board.

Changes in Share Prices

An increase in the demand for a share will raise its price. This may be the result of a possible takeover bid, increased profits or because the economy is booming.

A speculator buys or sells shares hoping to make a quick profit. There are three sorts:

A bull buys shares now expecting share prices to rise.
A bear sells shares now expecting share prices to fall.
A stag buys new share issues expecting their price to rise.

Functions of the Stock Exchange

An organised market for the purchase and sale of second-hand shares.
The stock exchange gives people confidence to buy new shares issued by companies since they know there is an organised market for their resale.
The stock exchange allows institutions collecting money for small investors such as trade unions, insurance and pension funds to make large purchases of shares in UK companies.

Other Financial Institutions

A number of specialist institutions lend for special purposes:

Building societies assist house buyers by collecting money from many small savers and lending large long-term loans.
Merchant banks specialise in lending directly to firms, and in giving advice to companies involved in takeover deals.
Finance houses specialise in leasing and hire purchase agreements.
Pension funds collect contributions which are then used to buy stocks and shares.
Unit trusts allow small investors to buy a spread of shares in different companies. The money raised from selling units is used to buy stocks and shares in a large number of companies. Units can only be bought and sold from the trust.
Insurance companies collect premiums from policy holders. Some of this money is used to buy stocks and shares.

There is an increasing trend for financial institutions to extend the scope of their business. As a result of the Building Societies Act (1986) they are now able to offer a wide range of financial services. However, many Building Societies have converted to Plcs as they feel that they are unable to compete fully if they retain their mutual status. This process was started with the conversion of the Abbey National to a Plc. These conversions have resulted in substantial windfall payments during the 1990s and helped contribute to the recovery in retail sales in the middle of the 1990s.

Sources of Government Income

The government needs money to pay for public expenditure . Revenue can be raised through taxation, national insurance contributions, borrowing, charging for services or by selling off state-owned assets.

Taxation

Aims of Taxation

To raise money to pay for government spending.
To discourage people from buying harmful goods such as cigarettes.
To influence the level of total demand in the economy.
To redistribute income from the rich to the poor.

Principles of Taxation

A tax should be certain so that everyone knows the amount, method and time of tax payment.
A tax should be convenient so that tax collection is at a time and in a form suitable to the payer.
A tax should be economical with the cost of collection representing only a small part of the revenue raised.
A tax should be equitable (fair) so that wealthy people pay more than poor people.
A tax should not act as a disincentive and stop people from working.
A tax should be flexible so that the government can use tax changes to help control the level of demand in the economy.

Main Types of Taxation

Income tax. Everyone is given a tax-free personal allowance (amount) above which additional earnings are taxed at an increasing rate.
Value added tax (VAT) is a tax on spending. 17.5 per cent is added onto the selling price of most non-essential goods and services.
Duties are taxes on the sale of luxury goods. A fixed amount is added to the selling price.
Council Tax is a local tax on property. All properties are valued and the amount of council tax paid depends on the value band which the property falls into.
Corporation tax is a tax on company profits.
Petroleum revenue tax is a tax on oil taken from the North Sea.
Inheritance tax is a tax on the transfer of money and property.

Method of Collection

Direct taxes are paid straight to the Inland Revenue.They are therefore taxes on income.
Indirect taxes are first collected by the seller and then passes on to Customs and Excise. These taxes are therefore taxes on expenditure.

Tax Burden

Some taxes are fairer than others. A tax can be:

Progressive, where the percentage of income taken in tax rises as income rises. Income tax in an example of progressive taxation.
Regressive, where the percentage of income taken in tax falls as income rises. Rates are an example of regressive taxation.
Proportional, where the percentage of income taken in tax stays the same as income rises. VAT is an example of proportional taxation.

Budgets

Calculation of the Budget

The Chancellor of the Exchequer is the minister of finance in charge of the Treasury. The Chancellor announces how much the government is going to spend over the next twelve months, sometime in November.

The government states how it is going to raise the money to pay for its expenditure at the same time in the Budget.

Table 13.1 Advantages and disadvantages of various taxes.

Types of Budget

A reflationary or deficit budget where government spending is greater than government income. Reflationary budgets increase total demand within the economy.
A deflationary or surplus budget where government income exceeds expenditure and total demand is falling within the economy.
A neutral budget where government income and spending are the same and total demand in the economy remains constant.

Government Borrowing

Public Sector Net Cash Requirement

If the government spends more than its received income it will have to borrow the difference. The amount the government needs to borrow in a given time period is called the public sector net cash requirement (PSNCR). The PSBR is met by:

Selling National Savings certificates and Premium Bonds.
Selling Treasury bills which are IOUs which will be bought back in ninety-one days; time.
Selling securities, which are IOUs paying interest yearly which will be bought back sometime in the future. Securities are sometimes called gilts, stocks or bonds.

National Debt

The total amount owed by the government to UK citizens and foreigners at a particular moment in time is called the national debt. The money raised may have been spent on capital goods which increase our ability to produce goods. Interest has to be paid on the debt. A large national debt is a problem if:

Interest has to be paid to overseas citizens, so that the balance of payments suffers.
Taxes have to be increased to meet interest payments

Public Expenditure

Structure of Public Expenditure

Public expenditure is spending by central government, local government, and nationalised industries. For every pound of public spending in 1996:

Central government spends 74p
Local authorities spend 25p
Public Corporations spend 1p

Table 14.1 The main government spending departments

Public and Merit Goods

A public good is an item which cannot be withheld from one consumer without withholding the good from all customers. Non payers cannot be excluded. Since public goods, such as street lighting, can be used free of charge, they will not be supplied by private-sector firms. Public goods are therefore supplied by central and local government.

A merit good is a useful item, such as education, which some people are unwilling to buy. Merit goods are supplied by the public authorities either free or for a minimal charge so as to enlarge consumption.

Aims of Government Spending

To provide public goods and services.
To encourage the consumption of merit goods.
To relieve poverty.
To influence the level of total demand in the economy.

Macroeconomics

Macroeconomic Problems

Macroeconomics is concerned with the study of the whole economy. Problems arise when the economy suffers from high unemployment, inflation, or a balance of payments deficit. Therefore the government sets itself certain macroeconomic objectives:

Low unemployment
Low inflation
A balance of payments surplus
Economic growth

Booms in the Economy

A boom is when output and employment in the economy are rising. This is the peak of the trade cycle.

However:

A boom increases spending on imports, causing balance of payments problems.
Once high levels of employment have been reached, output cannot be increased any further and the boom causes inflation.

Slumps in the Economy

A slump is when output and employment in the economy are falling. This is the bottom of the trade cycle. However:

A slump reduces spending on imports, thus improving the balance of payments.
Reduced total spending lowers inflationary pressure.

Trade Cycles

The trade or business cycle refers to regular movements in the economy between booms and slumps.

Government Macroeconomic Policies

Table 14.2 shows some of the policies the government can use to try to get full employment, stable prices etc.

Table 14.2 Macroeconomic policies

Working Population

Structure of the Working Population

The UK population divides into two sections:

The working population is made up of people who are of working age and available to work. It does not include people in full-time education. All those people actually employed or self-employed make up the labour force.
Dependants make up the rest of the population.

Employment Trends

There has been a radical change in the structure of occupational employment. Before the industrial revolution over 80 per cent of the labour force were employed in agricultural production. Now the figure is less than 3 per cent. As recently as 1951, over half the labour force were employed in manufacturing. Since then there has been a period of rapid decline, particularly in the heavy-engineering sector. The complexity of modern society has increased the number of administrators. This trend has been accelerated by the spread of information technology.

Measurement of Unemployment

When calculating the level of unemployment the government only counts those people who register as unemployed and claim benefit. A large number of people seeking work either do not register or do not claim benefit and are now excluded from official figures. The benefit count that was used for the headline figure for unemployment was superceded in 1998 by a figure based on the Labour Force Survey.

The unemployment rate is the percentage of the labour force officially jobless. Full employment occurs when the number of notified job vacancies exceeds the number of registered unemployed.

Costs of Unemployment

Lost Output

The opportunity cost of each unemployed person is their foregone output. Since average annual output per worker is £12,000, unemployment of 3.3 million costs the UK £40 billion a year in lost goods.

Increased Benefit Payments

Each extra person who becomes unemployed stops paying tax ( perhaps £4000) and starts receiving benefit (upwards of £5000). The government therefore has to raise a minimum of £27 billion to finance unemployment benefits for 3 million unemployed. As the figure falls the government pays out less unemployment benefits and receives more in tax. The savings to the exchequer from this will be considerable.

Lost Tax Revenue

Growing unemployment means less direct and indirect tax revenue. When people lose their jobs they will stop paying income tax, and their spending will fall considerably reducing government receipts from VAT and other indirect taxes.

Human Costs of Unemployment

The long-term and youth unemployed feel increasingly isolated and removed (alienated) from society. There will also be increased NHS costs as people's health often suffers when they are unemployed, and there will be increased costs to society in terms of crime.

Types, Causes, and Remedies for Unemployment

Table 15.1 summarises the main causes and remedies for different types of unemployment.

The Thatcher and Major administrations (1979 - 1997) believed that the current high level of unemployment cannot be reduced by more government spending. The government argues that extra spending only increases inflation and UK imports. The government does offer a number of employment and training schemes summarised in table 15.2. The Labour government elected in 1997 has introduced the New Deal for the unemployed to try to get people back to work by giving them the skills and experience they require. This is targeted particularly at the young and long-term unemployed.

Unemployment Trends

Unemployment is a flow and not a stock. There are always inflows onto the unemployment register, and there are outflows off the register as people get jobs or join training schemes.

If all inflows rise and all outflows except training fall then overall unemployment will rise. Young people, women, the over-fifties and ethnic minorities tend to be the hardest hit. Inner cities and manufacturing areas also tend to have above-average unemployment. The average length of time workers remain unemploymed is a critical measure of the seriousness of the unemployment figures. If the average length of unemployment is short then the economy will be healthier and people will not lose their skills from long periods without work.

Unemployment rose sharply from 1979 - 1983 and reached a peak of over 3 million. From then on it fell very slowly, until the late 1980s when the impact of the Lawson Boom was to create large numbers of jobs. The impact of the subsequent recession (1989-1992) was to increase unemployment once more, but recovery in the 1990s has reduced the figure once again. For more detail see the of Biz/ed.

Table 15.1 Causes and remedies of unemployment

Table 15.2 Employment and training schemes that have been used in the 1980s and 1990s

Measurement of Inflation

Definition of Inflation

Inflation refers to the continual increase in prices. The value or purchasing power of money refers to the amount of goods or services one pound can buy. Inflation means the value of money is falling because prices keep rising.

Calculating the Retail Price Index

The retail price index (RPI) is a monthly survey carried out by the government which measures price changes. The following procedure is used:

A basket of goods and services consumed by the average family is listed. For example, food, clothing and transport are included in the basket.
The price of items in the basket in the base (first) year is noted.
Each item in the basket is given a number value (weighted) to reflect its importance to the average family. For example, food has a higher weighting than transport.
The price of goods in the basket is recorded every month compared with base year as a percentage (price relative) using the equation:

Price relative = Current price/Base price x 100
The price relative of each item is then multiplied by its weighting.
The new RPI is found using the equation:

RPI = Total weightings x Price relative/Total weightings

The value of the RPI in the base year is always 100. After twelve months the price of good items in the basket may have risen by 25 per cent and that of housing by 20 per cent while the cost of transport is unchanged. Table 16.1 shows how the RPI for year two might then be calculated.

The RPI = Total weightings x Price relative/Total weightings = 12 100/100 = 121

Table 16.1 Calculation of the retail price index

The rate of inflation is the percentage change in the RPI over the last twelve months and is calculated using the equation:

Rate of inflation = (Current RPI - Last RPI)/Last RPI x 100

At the beginning of year two the rate of inflation is:

(121 - 100)/100 x 100 = 21 per cent

See the of Biz/ed for a worksheet on calculating and interpreting index numbers.

Problems in Using the Retail Price Index

Which items should be included in or excluded from the basket of goods?
Different families have different tastes hence different weightings. How is an average family found?
Not all regions in the country experience identical price changes.
For a while new products ( eg mobile phones) may not be included in the index.

Effects of Inflation

Advantages of Inflation

Not everyone suffers from inflation. Some parts of society actually benefit:

The government finds that people earn more and so pay more income tax.
Firms are able to increase prices and profits before they pay out higher wages.
Debtors (borrowers) gain because they have use of money now, when its purchasing power is greater.

Disadvantages of Inflation

People on fixed incomes are unable to buy so many goods.
Creditors (savers) lose because the loan will have reduced purchasing power when it is repaid.
UK goods may become more expensive than foreign-made products so the balance of payments suffers.
Industrial disputes may occur if workers are unable to secure wage increases to restore their standard of living.

Causes of Inflation

Cost-push Inflation

Cost-push Inflation occurs when a firm passes on an increase in production costs to the consumer. The inflationary effect of increased costs can be the result of:

Increased wages, leading to

a wage-price spiral, which occurs when price increases spark off a series of wage demands which lead to further price increases and so on;
a wage-wage spiral, which occurs when one group of workers receive a wage increase which sparks off a series of wage demands from other workers.

Increased import prices which can be the result of:

a rise in world prices for imported raw materials;
a depreciation of sterling

Increased indirect taxation

Demand-pull Inflation

Demand-pull inflation occurs when there is 'too much money chasing too few goods' because the demand for current output exceeds supply.

The figure below shows increased demand and increased prices as consumers compete to buy up goods still available.

A major source of inflationary pressure is the government which can print money to buy goods. The monetarist view of inflation can be stated in the equation:

MV = PT

where M = the money supply,

V = the number of times each pound changes hands (the velocity of circulation),

P - the average price of goods, and

T = the number of goods bought (transactions).

Monetarists believe that the values of V and T are fixed so that any increase in M, the money supply, must raise P, the level of prices, ie be inflationary.

Remedies of Inflation

Cost-push Remedies

Introduce a prices and incomes policy to free price and wage increases.
Encourage an appreciation of sterling.
Reduce indirect taxation.

Demand-pull Remedies

Reduce government spending.
Increase income tax to reduce consumer spending.
Reduce peoples's ability to borrow money by increasing interest rates and tightening credit regulations.
Control the supply of money.

Reasons for Trade

Domestic Non-availability

International trade is the exchange of goods and services between countries. An import is the UK purchase of a good or service made overseas. An export is the sale of a UK-made good or service overseas.

A nation trades because it lacks the raw materials, climate, specialist labour, capital or technology needed to manufacture a particular good. Trade allows a greater variety of goods and services.

Principle of Comparative Advantage

The principle of comparative advantage states that countries will benefit by concentrating on the production of those goods in which they have a relative advantage.

For instance, France has the climate and the expertise to produce better wine than Brazil. Brazil is better able to produce coffee than France. Each country benefits by specialising in the good it is most suited to making.

France then creates a surplus of wine which it can trade for surplus Brazilian coffee.

Protectionism

Advantages of Protectionism

Protectionism occurs when one country reduces the level of its imports because of:

Infant industries. If sunrise firms producing new-technology goods (eg computers) are to survive against established foreign producers then temporary tariffs or quotas may be needed.
Unfair competition. Foreign firms may receive subsidies or other government benefits. They may be dumping (selling goods abroad at below cost price to capture a market).
Balance of payments. Reducing imports improves the balance of trade.
Strategic industries. To protect the manufacture of essential goods.
Declining industries. To protect declining industries from creating further structural unemployment.

Disadvantages of Protectionism

Prevents countries enjoying the full benefits of international specialisation and trade.
Invites retaliation from foreign governments.
Protects inefficient home industries from foreign competition. Consumers pay more for inferior produce.

Protection Methods

Tariffs

Tariffs (import duties) are surcharges on the price of imports. The diagram below uses a supply-and-demand graph to illustrate the effect of a tariff.

Note that the tariff

raises the price of the import;
reduces the demand for imports;
encourages demand for home-produced substitutes;
raises revenue for the government.

Quotas

Quotas restrict the actual quantity of an import allowed into a country. Note that a quota:

raises the price of imports;
reduces the volume of imports;
encourages demand for domestically made substitutes.

Other Protection Techniques

Administrative practices can discriminate against imports through customs delays or setting specifications met by domestic, but not foreign, producers.
Exchange controls (currency restrictions) prevent domestic residents from acquiring sufficient foreign currency to pay for imports.

International Institutions

The European Community (EU)

The European Community was established by the Treaty of Rome (1957) and is also called the European Union (EU). The fifteen members of the EU (Belgium, Denmark, France, Greece, Irish Republic, Italy, Luxembourg, Netherlands, Portugal, Spain, West Germany and the United Kingdom ........) form a customs union which aims for eventual economic and political unity. The EU has:

free movement of capital and labour within member countries;
free trade between member countries;
common tariffs against non-members;
a Common Agricultural Policy (CAP) which guarantees minimum prices for farmers' output;
standardised trade and customs procedures, eg metric measurements;
some members who are part of the European Monetary System (EMS) which aims to maintain exchange rate stability by concerted government intervention. In January 1999 many of the members will adopt a single european currency - the EURO. Britain has elected to stay outside this until at least after the next election - 2002.

The International Monetary Fund (IMF)

Established in 1944 at Bretton Woods, the main aim of the IMF is to stabilise exchange rates and to lend money to countries needing foreign currency. Over 140 member countries pay a sum of their own currency into a pool. The amount paid in depends on the size of their economy. Each country can then borrow foreign currency from the pool according to their contribution to settle temporary balance-of-payments problems. Countries can draw up to 25 per cent of their quota before the IMF begins to set conditions on the loan. In 1967 the IMF created a new international currency called special drawing rights (SDRs) which governments use to settle debts with other countries.

The International Bank for Reconstruction and Development (IBRD)

Known as the World Bank. IBRD lends money to developing countries for capital projects such as power stations or roads. Loans are for about thirty years and carry a low rate of interest.

The World Trade Organisation (WTO)

The World Trade Organisation was set up in 1995 and succeeded the General Agreement on Tariffs and Trade (GATT). The aim of the WTO is to help trade flow smoothly, freely, fairly and predictably. It;

administrates trade agreements
acts as a forum for trade negotiations
settles trade disputes
reviews national trade policies
assists developing countries in trade policy issues

The Organisation for Economic Co-operation and Development (OECD)

The OECD is made up of member countries who send a representative to a council. This offers an opportunity to discuss common policies to help stabilise exchange rates and encourage growth. The OECD also publishes surveys of individual economies.

The Organisation of Petroleum Exporting Countries (OPEC)

This is an international group of many of the largest oil-producing nations which tries to limit world production and so maintain the price of oil. In 1985 the price of a barrel of oil stood at over $30. By mid-1986 members had exceeded set production levels and the price of oil had fallen below $10 for the first time in a decade. Since then it has recovered, but never to the previous levels.

Components of the Balance of Payments

Definition of the Balance of Payments

The balance of payments is a record of one country's trade dealings with the rest of the world. Any transaction involving UK and foreign citizens is calculated in sterling (UK pounds).

Dealings which result in money entering the country are credit (plus) items while transactions which lead to money leaving the country are debit (minus) items.

The balance of payments can be split up into two sections:

the current account which deal with international trade in goods and services;
transactions in assets and liabilities which deals with overseas flows of money from international investments and loans;

Current Account

The current account consists of international dealings in goods (visible trade) and services (invisible trade).

Invisible trade includes payments for overseas embassies and military bases: interest, profit and dividends from overseas investment; earnings from tourism and transportation.

Table 18.1 The UK current account 1985

By referring to Table 18.1 you can see that in 1985:

The UK bought £80 140 million worth of goods made overseas.
The UK sold £78 072 million worth of goods overseas.
The difference between visible exports and imports is knows and the balance of trade or visible balance. The amounted to -£2 068 million.
The UK bought £75 007 million worth of foreign-produced services.
The UK sold £80 027 million worth of services overseas.
The difference between invisible exports and imports is called the invisible balance. This amounted to £5 020 million.

Adding the balance of trade and balance on invisibles together gives the balance on the current account. A deficit on the current account means that more goods and services have been imported into the UK than have been sold abroad. A surplus on the current account means more goods and services have been exported than imported.

Transactions in Assets and Liabilities

The transactions in assets and liabilities section of the balance of payments shows all movements of money in and out of the country for investment. This may be direct investment - investment in productive capacity, or portfolio investment - investment in shares or other assets. Changes in assets will be outflows from the UK, as UK investors invest money overseas. These flows will be debits to the UK Balance of Payments. Changes in liabilities will be credits to the UK Balance of Payments as overseas investors invest money into the UK

Balance of Payments Problems

Correcting a Balance of Payments Deficit

Strictly speaking, the balance of payments always balances because of official financing. However, a balance of payments deficit means a persistent and large negative balance for official financing. This can be the result of excessive purchases of foreign goods and services or excessive UK investment overseas. In the short term, a balance of payments deficit can be corrected by:

continued borrowing of foreign currency;
increasing interest rates to attract overseas investors;
imposing exchange controls;
imposing tariffs and import quotas.

In the long run, the government can correct a balance of payments deficit by reducing demand in the economy for all goods including imports. Reducing UK inflation rates or encouraging a sterling depreciation will also help.

Correcting a Balance of Payments Surplus

An unwanted balance of payments surplus can be the result of excessive foreign investment in the UK. This will place a future strain on the invisible balance. A reduction in interest rates or restrictive exchange controls will correct the surplus.

Exchange Rates

An exchange rate is the price of one currency in terms of another. For the UK, the dollar exchange rate means the number of dollars ($) one pound (£) can buy. The exchange rate is determined by the supply and demand for sterling (pounds) and is $2 per pound in the diagram below:

Demand for Sterling

Americans want to exchange dollars for pounds for two reasons:

to buy British goods and services;
to lend or invest in the UK.

The diagram above shows the number of pounds demanded at each and every exchange rate. This is the D curve.

Supply of Sterling

Britons want to exchange pounds for dollars for two reasons:

to buy American goods and services;
to lend or invest in the USA.

In the diagram above S shows the number of pounds supplied by Britons at each exchange rate.

Changes in the Exchange Rate

A fall in the value of sterling (depreciation) means one pound now buys fewer dollars. Sterling depreciates if Americans
demand fewer pounds (shown in the diagram below) or if UK citizens offer more pounds. UK exports become cheaper and UK imports become dearer. Hence, a sterling depreciation improves the balance of payments.

A rise in the value of sterling (appreciation) means one pound now buys more dollars. UK exports become dearer and UK imports become cheaper. Hence a sterling appreciation worsens the balance of payments.

Features of Economic Growth

Definition

Economic growth refers to an increase in a country's ability to produce goods and services. The advantage of economic growth is that an increase in real national income allows more goods for consumption.

Developing Countries

A developing country or less developed country (LDC) is one which is not yet fully industrialised and tends to have the following features:

Agriculture is more important than manufacturing.
There is limited specialisation and exchange.
There are not enough savings to finance investment.
Population is expanding too rapidly for available resources.
A low standard of living.

A developed country is more fully industrialised and has a high standard of living.

Barriers to Economic Growth

A country can increase production if it increases the amount of resources used or makes better use of existing factors. Economic growth is more difficult if:

A country lacks the infastructure (underlying capital) to produce goods more efficiently. There are three types of infastructure:

basic including electricity, road and telephone networks;
social including schools, hospitals and housing;
industrial including factories and offices.

A country lacks the machines or skilled labour needed to manufacture modern goods or services.
A country lacks the technical knowledge.
Workers are not prepared to accept specialisation and the division of labour.
Population growth is too rapid.
A country has too large a foreign debt.

Disadvantages of Economic Growth

Increased noise, congestion and pollution.
Towns and cities may become overcrowded.
Extra machines can be produced only by using resources currently involved in making consumer goods.
A traditional way of life may be lost.
People may experience increased anxiety and stress.

North v. South

The Brandt Commission

The Brandt Report divided the world into rich (North) and poor (South) sectors and found that in developing countries more than 800 million are destitute and 17 million die needlessly before they are five years old. We in the North have 25 per cent of the world's population but consume 80 per cent of all the goods made.

Recommendations of the Brandt Commission

Brandt suggested that the North should help the South by transferring resources and starting a global famine relief programme. The development role of the World Bank should be strengthened. Nations should pay an income tax, and a tax should be put on the sale of military equipment.

Housing

Renting

Many people cannot afford to buy their own homes. Renting is when a tenant pays money to a landlord (owner) for the use of a house.

The landlord is responsible for repairs to the building. The tenant is not allowed to make alterations to the building without the landlord's permission.

A tenant has security of tenure, ie he cannot be forced out of the house by a landlord. If a tenant thinks his rent is too high then he can go to a rent tribunal where a government rent officer will decide a fair rent. The tenant and the landlord have to accept the decision of the rent officer.

Houses can be rented from private landlords but there is a great shortage of rented accommodation. Local authorities provide council housing but there is still not enough to go round. People wanting a council house are put on a waiting list. Priority is given to families in need. Tenants now have the right to buy their council houses from the local authority.

Buying

Houses cost thousands of pounds. Most people buying a house take out a special loan (mortgage) from a bank or a building society which they repay usually over twenty-five years. There are two main types of mortgage:

An ordinary (repayment) mortgage is where the loan is repaid with interest in monthly instalments over twenty-five years.
An endowment mortgage is more expensive than an ordinary mortgage. Every month a premium is paid to an insurance company, and interest is paid on the loan to a building society. After twenty-five years the insurance company pays out enough money to pay for the house and the owner keeps any money left over.

Home ownership is encouraged by the government which reduces the cost of monthly repayments by giving tax relief (a reduced tax bill).

People buying their own home have a good choice of property. If house prices go up, they may be able to sell at a profit.

Moving House

The shortage of rented property makes if difficult for tenants to move house. Home owners are faced with various 'hidden' costs when moving. They have to pay for:

An estate agent who keeps a list of houses for sale in an area and arranges for potential buyers to see them. The seller pays commission if the agent finds a buyer.
A surveyor who checks the house to see if it is well built and in good repair.
A solicitor who checks the seller actually owns the house and draws up a contract between the buyer and the seller.
A removal firm which transports belongings to the new house.
Stamp duty which is a tax on the purchase of a house.

The cost of moving can add up to several thousand pounds.

Transport

Private Transport

There are two types of cost involved in running a car:

Fixed or standing costs which must be paid even if the car is not used. These include the interest lost by not having the money used to buy the car in the bank, depreciation, insurance and car tax.
Variable or running costs for petrol and servicing.

Public Transport

A car is convenient but costs hundreds of pounds a year to run and maintain. Public transport by bus, rail or underground offers a cheaper alternative. An increase in the number of private motorists using public transport would reduce pollution because there would be fewer cars on the road.

Insurance

Pooling Risks

Insurance is a system where in return for a previous payment a company will give money to repair accidental damage. Insurance is based on the pooling of risks. Thousands of policyholders pay a small sum of money (premium) into a central pool. The pool is then large enough to meet the expenses of the small number of people who actually suffer an accident. Insurance companies use the principle of indemnity which means that the insured is returned to the same financial position as before the accident. The policyholder is given enough money to repair the damage and no more.

Companies use data (information) to calculate a particular risk and the premium to charge.

Main Types of Insurance

Liability insurance.
Household insurance covers damage to the building and the contents.
Motor insurance covers damage to your car, to other people and their property. There are three main types of car insurance:

Third party. You are the first party; the insurance company is the second party; anyone else is a third party. You are covered for damage to other people and their property, only.
Third party, fire and theft. As for (1) plus you are covered for damage to your own car through fire or theft, only.
Comprehensive. You are covered for any damage to your own car, other people and their property.

Life assurance which covers dependants and provides for retirement. There are three main types of life assurance:

Term. Money is paid to dependants if death occurs within a stated period, eg twenty-five years.
Whole life. Money is paid to dependants upon your death.
Endowment. Money is paid at death or after a stated period. Whichever is the sooner.

National insurance. Workers pay 5 per cent or more of their wages into a pool. If they are ill or unemployed they receive benefits (money). Once they are over 65 they receive a pension.

Leisure

Leisure is free time when someone is not doing paid work, or at school or looking after the house. The average worker spends 45 hours each week on employment and travel. The average worker has 2.6 hours of free time each weekday and 10.2 hours of free time per weekend day.

The principle of opportunity cost is used to value leisure time. For example, the cost of going to the cinema is the cost of the ticket plus any lost overtime payments that could have been earned from working.

Retailing and Advertising

Types of Retail Outlet

A retail outlet is a shop. There are several types:

A unit or corner shop is local, convenient, friendly, open long hours and offers credit to known customers but is also expensive and has little choice.
A multiple or chain store is several shops using the same name. Chain stores are cheap and offer a large choice but they are not always local or friendly places to shop.
A department store is several shops under one roof. They are luxurious, stock all types of goods and offer personal service but they are found only in city centres and can be expensive.
Supermarkets have goods on shelves (open display) and customers help themselves (self service). Payment is made at tills.
Hypermarkets are huge supermarkets found on the outskirts of large towns. They have their own car parks.

Advertising

Advertising is the publicising of goods and services. Advertising creates a brand image whereby consumers buy more of a good because they believe it is better than substitutes.

There are two types of advertising:

Informative which gives details about the use, price quality, etc. of a product.
Persuasive which gives opinions about a product.

Consumer Protection

Legislative Protection

Many laws have been passed to protect the consumer when he buys a good. Here are a few:

Trades Descriptions Act. Goods must be marked with their country of origin. A good on special offer must have been on sale at a higher price for at least twenty-eight days in the last six months.
Weights and Measures Act. The weight of a good must be shown on a packet. It is an offence to sell under weight goods.
Sale of Goods Act. Goods sold must match their description. Goods sold must be undamaged. Goods sold must live up to their description. For example, a waterproof coat must be waterproof.
Goods Act. If you are sold faulty goods you are allowed your money back or a replacement. Proof of purchase must be given.

Voluntary Protection

The Consumers' Association is an independent watchdog which investigates products and applies pressure on the government on behalf of the ordinary shopper. The Association publishes a monthly magazine called Which? Giving impartial information about products.

Personal Budgeting

Making a Budget

Budgeting means making your expenditure less than your income. You draw up a budget plan by:

Making a list of all the money you receive each month (income).
Making a list of all the money you spend each month (expenditure).

If your expenditure is greater than your income you will have to buy fewer things.

Credit

Credit involves buying a good now and paying for it later. The annual rate of interest for borrowing money on credit can be as high as 18 per cent. This means that for every pound borrowed you must pay back 18 pence in interest each year.

With hire purchase the customer pays a deposit and then makes monthly repayments including interest. The customer does not get a discount (money off) when using hire purchase but the good can be returned with nothing more to pay once half the repayments have been made. The customer does not own the good until the last payment has been made.