Economics1MicroandMacroTheoryandApplication (SV2)

Economics 1: Micro and Macro Theory and Application Unit Student Guide
Scottish Qualifications Authority
Contents
1 2 Introduction to the Scottish Qualifications Authority Introduction to the Unit 2.1 2.2 2. 2.$ 2.' 2.What is the Purpose of this Unit? What are the Outcomes of this Unit? What do I !eed to "e A"le to do in Order to Achie#e this Unit? Appro%imate Study &ime for &his Unit ()uipment*+aterial ,e)uired for this Unit Sym"ols Used in this Unit 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
Assessment Information for this Unit .1 $ ' What .o I /a#e to .o to Achie#e &his Unit?
Su00ested 1esson Plan 1earnin0 +aterial '.1 '.2 '. '.$ Section 1 2 (%plain Costs and +ar3et Structure Within Which a 4irm Operates Section 2 5 (#aluate the Impact of Unemployment and Inflation Section 5 (#aluate 6o#ernment Use of ,e#enue and (%penditure
Section $ 5 &he Scottish (conomy
Additional ,eadin0 +aterial Solutions to Self5Assessed Questions and Acti#ities
8 9
Copyri0ht ,eferences Ac3no:led0ements
2 2
1 Introduction to the Scottish Qualifications Authority

This Unit, .( 6 ' (conomics 1; +icro and +acro &heory and Application, has been devised and developed by the Scottish Qualifications Authority SQA!" The SQA is the national body in Scotland responsible for the development, accreditation, assessment and certification of #ualifications other than de$rees" %ts &ebsite can be vie&ed on: &&&"s#a"or$"u'" The SQA(s function: to devise, develop and validate #ualifications, and to 'eep them under revie& to accredit #ualifications to approve education and trainin$ establishments as bein$ suitable for enterin$ people for these #ualifications to arran$e for, assist in, and carry out the assessment of people ta'in$ SQA #ualifications to assure the #uality of education and those trainin$ establishments that offer SQA #ualifications to issue certificates to candidates"
%n order to pass SQA units, students must complete prescribed assessments" These assessments must meet certain standards" The Unit Specification outlines the three )utcomes that students must complete in order to achieve this Unit" The Specification also details the 'no&led$e and*or s'ills needed to achieve the )utcome or )utcomes" The Evidence +e#uirements prescribe the type, standard and amount of evidence re#uired for each )utcome or )utcomes"
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2
Introduction to the Unit

2.1 What is the Purpose of this Unit?
This Unit is desi$ned to build on the candidate,s introduction to economics and e-pose them to microeconomic and macroeconomic applications of theory" The Unit allo&s the introduction of current issues in economics and provides an opportunity for candidates to analyse and evaluate them"
2.2
1" ." /"
What are the Outcomes of this Unit?

E-plain costs and the mar'et structure &ithin &hich a firm operates" Evaluate the impact of unemployment and inflation" Evaluate $overnment use of revenue and e-penditure"
2.
What do I !eed to "e A"le to do in Order to Achie#e this Unit?
This Unit is a one credit Unit and is part of the 01 2usiness frame&or'" %t is the second economics unit of three" The first Unit is (conomic Issues; An Introduction, &hile the third is (conomics 2; &he World (conomy. This Unit introduces you, in )utcome 1, to microeconomic theory, &here you &ill be loo'in$ at the behaviour of $roups &ithin the economy" )utcomes . and / then introduce macroeconomic theory, studyin$ the economy as a &hole" The Unit has / )utcomes, introducin$ you to: costs, the structure of mar'ets and the role of profit unemployment and inflation the $overnment,s use of revenue and e-penditure
3or Outcome 1, you &ill need to be able to: demonstrate an understandin$ of cost in either the short or lon$ term assess the characteristics, price and output behaviour of t:o mar'et structures e-plain t:o roles of profit ma-imisation analyse t:o alternatives to profit ma-imisation
A different sample of costs short or lon$ run! and mar'et structures is re#uired on each assessment occasion"
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3or Outcome 2, you &ill need to be able to: outline one type of unemployment or inflation e-plain a policy desi$ned to deal &ith unemployment or inflation e-plain t:o effects of unemployment or inflation on individuals and businesses analyse U4 trends in unemployment or inflation over the last .5 years
3or Outcome , you &ill need to be able to: e-plain the aims of fiscal policy e-plain fiscal policy methods &ithin the U4 evaluate $overnment spendin$ and its effects e-plain monetary policy &ithin the U4
2.$
Appro%imate Study &ime for &his Unit
The nominal study time for this Unit is 65 hours"
2.'
()uipment*+aterial ,e)uired for this Unit
There is not a definitive list of resources or materials for this Unit" At the end of this Unit you &ill find a list of sources from &hich you &ill be able to select information or material" 7ou &ill also be e-pected to be conversant &ith and able to use personal computers, the %nternet, fa- machines, telephones, mobile phones, etc" The latest mobile phones are capable of very sophisticated research"! 7ou may of course use the library" Thou$h some people re$ard libraries as bein$ out of date, most modern libraries are very &ell e#uipped and the facilities are usually cheap to use" Many centres of learnin$ also have e-cellent e#uipment that is as modern as it is currently possible to be" 7ou &ill be e-pected to be able to demonstrate your understandin$ of any particular topic by providin$ current e-amples of &hat is happenin$ in your o&n local economy, the lar$er economy and indeed the $lobal economy" Sources that can provide such information include local ne&spapers, and radio or television discussions of economic topics" They could be $ivin$ information on the $ro&th of the local economy, unemployment and house prices" 3or the lar$er economy or the &orld economy, the business pa$es of national ne&spapers often contain very useful economic information and*or national and international trends"
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7ou &ill also find specialist ne&spapers such as the Financial Times or ma$a8ines li'e The Economist to be comprehensive sources of up9to9date material" All the activities and self assessed #uestions SAQs! are desi$ned to help you to understand that you already 'no& a $reat deal about economics : althou$h you may currently find it hard to believe; Economics is not an e-otic science meant only for the fe&" %t is about ho& you and % spend our money, &hat choices &e ma'e and &hy and ho& that affects the &ider economy" 7ou &ill certainly be a&are that if as a nation &e purchase a lar$e proportion of our $oods from abroad &e &ill create a <balance of payments, problem" This means that money &ill be flo&in$ out of the U4 faster than it comes in" This balance &ill need to be reduced or financed" =urchasin$ cars from other countries could be a factor in creatin$ such a problem" The solution to such problems, as you are probably only too a&are, can sometimes be painful" >hen thin$s are $oin$ &ell, ho&ever, and an economy is sho&in$ stron$ $ro&th, then in areas such as unemployment or inflation the levels are $enerally lo& and people feel able to afford $oods and services" 7ou should also be a&are that the different elements that are said to ma'e up the science of economics are not separate but are intimately lin'ed" %f you loo' throu$h the topics in the ?esson =lan, you &ill no doubt notice that each topic has been treated as a distinct entity for the purpose of study" %n real life, ho&ever, they cannot be separated" Each little snippet of economic information you pic' up, therefore, may have many uses" 7ou are very much encoura$ed to create a file in &hich you can place these pieces of information and continually refer to them"
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Sym"ols Used in this Unit
The various learnin$ materials sections see Section @! are desi$ned so that you can &or' at your o&n pace, &ith tutor support" As you &or' throu$h them, you &ill encounter symbols" These symbols indicate that you are e-pected to do a tas'" These tas's are not )utcome Assessments" They are e-ercises desi$ned to consolidate learnin$ or encoura$e thou$ht in preparation for the )utcome Assessment see Section / 9 Assessment %nformation for this Unit!" Acti#ity
This symbol indicates an Activity" Activities are usually used to improve or consolidate your understandin$ either of the subAect in $eneral or a particular feature of it" %n this Unit, you are as'ed to underta'e activities based on topics you have Aust studied and to use e-amples from your o&n e-perience to demonstrate 'no&led$e and understandin$" +emember that the Activities &ill not serve this purpose if you refer to the responses $iven to them at the bac' of the Student Guide before attemptin$ the Activities; Self Assessed Question 1
This symbol indicates a Self Assessed Question SAQ!" SAQs help chec' your understandin$ of content already covered" Ans&ers to the SAQs can be found at the bac' of the Unit Student Guide" This &ill allo& you to assess your o&n responses" 7ou should not loo' at these responses before attemptin$ SAQs" The SAQs found in the Unit Student Guide help prepare you for the formative assessments and help identify topic areas &here you may re#uire clarification and additional tutor support" They &ill not serve this purpose if you loo' at the ans&ers before tryin$ SAQs; SAQs and Activities are desi$ned to be chec'ed by you" 1o tutor input is necessary at this sta$e unless special help is re#uested" 7our tutor may, ho&ever, &ish to ta'e a loo' at your responses to SAQs to see ho& you are pro$ressin$"
Assessment Information for this Unit

.1 What .o I /a#e to .o to Achie#e &his Unit?
To achieve a pass in this Unit you &ill be as'ed to complete t:o assessments" Assessment one is an open9boo' essay or report that you &ill complete &ithout supervision" %t is e-pected that your response &ill be of no more than 1<=== :ords" Assessment t:o is a closed boo' assessment that you &ill be able to prepare for throu$h your o&n research" This research &ill ta'e the form of &ritten notes containin$ $raphs, tables and other material relevant to the topic" The topic &ill be $iven to you one &ee' in advance" 7ou &ill be as'ed to submit your research material &ith your assessment ans&er" 7ou &ill not be permitted te-tboo's and class handouts" 7ou &ill, ho&ever, be allo&ed to brin$ &ith you t&o sides of an A6 sheet &ith relevant &ritten notes" The assessment may be completed in one sittin$ &ith a ma-imum total duration of t:o hours" Supervision of the assessment and any relevant reassessment &ill ta'e place" The assessment may be dra&n from relevant ne&spaper pieces, Aournals or %nternet sources"
Su00ested 1esson Plan

The learnin$ materials see Section @! are desi$ned to lead you throu$h a series of activities that &ill consolidate your learnin$ and allo& you to chec' on your o&n pro$ress" &opic
Appropriat e Study &ime
Bosts of the firm : short run and lon$ run Bharacteristics of mar'et structures 9 perfect competition, monopoly and oli$opoly =rice output and behaviour in perfect competition, monopoly and oli$opoly The role of profit ma-imisation Alternatives to profit ma-imisation Types of unemployment : frictional, cyclical, seasonal and structural Solutions employed to combat unemployment Types of inflation : Keynesian and Monetarist vie&s Solutions employed to combat inflation The impact of unemployment and inflation on individuals and businesses +ecent trends in unemployment and inflation in the U4 The aims of fiscal policy 3iscal policy methods in the U4 Government spendin$ and its effects The aims of monetary policy
. hours / hours / hours . hours . hours / hours . hours / hours . hours / hours . hours . hours . hours . hours . hours
Monetary policy in the U4 Government use of fiscal and monetary policy in the U4 over the last .5 years +e$ional development and policies
. hours . hours 1 hour
' 1earnin0 +aterial

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1.1
Section 1 2 (%plain Costs and +ar3et Structure Within Which a 4irm Operates
O">ecti#e
To demonstrate an understandin$ of cost in either the short or lon$ term" %t is assumed, for the purpose of this Unit that candidates &ill have previously studied an introductory Economics Unit or have other&ise obtained some 'no&led$e of Economic issues" 0o&ever it may be pertinent to loo' at one or t&o basic areas a$ain" %n economic theory &e loo' at the behaviour of three $roups" They are:9 /ouseholds Bomposed of individuals livin$ under one roof &ho ma'e individual or Aoint decisions to purchase $oods or services Economic units &hich use factors of production to produce $oods or services for sale to other firms, households or central authorities ?ocal and Bentral Government authorities &hich e-ert le$al and political po&er" They can e-ert po&er and control over mar'ets and individuals ma'in$ decisions" %t is &orthy of note that the lar$est purchaser of $oods and services in the U"4" is the Bentral Government"
4irms
Central Authorities
1.2
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+ar3ets
These are the entities that allo& buyers and sellers to come to$ether to buy and sell $oods" +emember the basic premise, <The ?a& of Supply and Cemand,; %f there are more $oods supplied than there is demand for, the price of the $oods &ill fall" %f the supply is restricted and demand is heavy the price &ill rise"
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The latest information is that <0ouse =rice %nflation, in the U"4" is runnin$ at .5D" >hat do you thin' this meansE
Chec3 your ans:ers in Section 7 2 Solutions to Self Assessed Questions and Acti#ities
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1.
4actors of Production
These are the economic resources &e use to supply $oods or services" There are four, ie ?and, ?abour, Bapital and Enterprise" Characteristics 1and All natural resources used for productive purposes" ?ocation cannot be chan$ed" +e&ard is rent" 1a"our
Avera$e Bost Ciseconomies of Scale Bost Economies Technically Efficient Avera$e Total Bost )utput of Scale )utput
+e&ard is called &a$es" %nvolves all physical and mental effort" Supply is made up of un9s'illed, semi9s'illed, s'illed" %s hired to produce $oods and services"
Capital 0as several different meanin$s but as a factor of production it is said to consist of buildin$s, plant and machinery &hich can be used in the production process" >ith the other factors, land and labour it can be combined to produce $oods and services &hich can be sold" The re&ard to capital can be interest, profits or rent" (nterprise %s the process by &hich the other factors of production are or$anised to produce $oods and services" These resources mi$ht other&ise be idle" Those &ho actually or$anise the factors are 'no&n as <Entrepreneurs, and are seen as ris' ta'ers, ris'in$ their o&n money and time as &ell as the financial capital of others" The re&ard they hope to achieve is termed <=rofit,"
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1.$
Costs of Production 2 Classification of Costs
4i%ed Costs Co not vary &ith output e$ Bost rent of factory Avera$e Bost Burve &ill not alter as )utput output rises and falls" That is to say the costs remain the same ho&ever many articles are produced" A firm may build a factory and then e#uip it &ith machinery" The costs of doin$ so &ill remain the same &hether the firm is producin$ to full capacity or almost nothin$" +ent and rates &ill also remain the same &hatever happens to output" This is li'ely to be true for administrative salaries as &ell" ?aria"le Costs Co vary &ith output ie they are directly related" 3or e-ample costs of ra& materials, fuel, po&er and labour" >hen more $oods are produced, $reater #uantities of materials, fuel, po&er and labour &ill be re#uired" %f fe&er $oods are produced less of these factors &ill be re#uired" &otal Cost This is the sum of 3i-ed and Fariable costs" %f nothin$ is bein$ produced then 3i-ed Bosts &ill be Total Bost" As production commences and Fariable Bosts rise so &ill Total Bost" A#era0e Cost %s obtained by dividin$ Total Bost by 1umber of Units =roduced" 3or e-ample if a firm
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produces .55 units and Total Bosts are G.5,555 then avera$e cost is: G.5,555 .55 H G155 per unit
Avera$e Bost &ill vary &ith output because as production increases 3i-ed Bost &ill assume a smaller proportion of the cost of producin$ each unit" >hen output is small Avera$e Bosts &ill be hi$h because 3i-ed Bost &ill be spread over a small number of units" As output increases Avera$e Bost &ill fall because 3i-ed Bost &ill no& be a smaller element of each unit" This means that every firm &ill &ant to reduce its Avera$e Bost to the minimum point at &hich it is still ma'in$ a profit"
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A#era0e Cost
Avera$e cost may fall because not only &ill 3i-ed Bosts fall but as firms $ro& they may be able to purchase materials at lo&er cost because they can order lar$er #uantities" The most Technically Efficient =oint is the lo&est point of the Avera$e Bost curve" %n practice ho&ever there may be a ran$e of outputs at &hich Avera$e Bosts are almost constant $ivin$ the lon$ run Avera$e Bost a lon$ish, flattish bottom"
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?on$ run Avera$e Bost curve over a ran$e of almost constant outputs"
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(%ample A firm has 3i-ed Bosts of G15,555 and Fariable Bosts of G15,555 &hen it produces 655 units" >hat &ill the fall in 3i-ed Bosts be per unit if the firm no& produces 1,555 unitsE 3i-ed Bost G15,555 : units produced 655 3i-ed Bosts per unit H G15,555 655 H G.@ per unit" 3i-ed Bost G15,555 : units produced 1,555 3i-ed Bost per unit G15,555 1,555 H G15 per unit"
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3rom the follo&in$ list e-plain &hich are 3i-ed Bosts and &hich are Fariable Bosts" >a$es Salaries +ent =o&er +a& Materials %nterest Machinery
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Bosts )utput MB Economics ATB 1: Micro and Macro Theory and Application
Unit Student Guide
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>a$e Quantity of ?abour >a$e +ate %ncrease E-tra sales revenue over and above e-tra labour costs
1.'
+ar0inal Cost
This is the addition to Total Bost resultin$ from increasin$ total output by one more unit : <At the Mar$in;, 3or e-ample: A firm produces .55 units at a Total Bost of G.,555" %t produces one further unit and Total Bost is no& G.,515" >hat is Mar$inal BostE )utput .55 .51 Mar$inal Bost Total Bost G.,555 G.,515 .515 : .555 H 15 .51 : .55 1
Therefore Mar$inal Bost H G15
!ote The mar0in is important because economists are concerned &ith the effects of chan0es in factors: costs, production, revenues"
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(%ample sho:in0 different classifications of cost Units of )utpu t 5 1 . / 6 @ J L I K 15 3i-ed Bosts G 1I 1I 1I 1I 1I 1I 1I 1I 1I 1I 1I Fariable Bosts G Total Bosts G Avera$e Bosts G Mar$in al Bosts G 5"55 1@".5 1/".5 11"J5 15"65 K"J5 15"55 11".5 1/"J5 1L"J5 .."55
5"55 1@".5 .I"65 65"55 @5"65 J5"55 L5"55 I1".5 K6"I5 11."65 1/6"65
1I"55 //".5 6J"65 @I"55 JI"65 LI"55 II"55 KK".5 11."I5 1/5"65 1@."65
%nfinity //".5 ./".5 1K"/5 1L"15 1@"J5 16"L5 16".5 16"15 16"@5 1@".5
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The dia$ram belo& sho&s the effect of Mar$inal Bost on Avera$e Total Bost" The Mar$inal Bost curve al&ays cuts the Avera$e Bost curve at its lo&est point" %f MB is lo&er than ATB then ATB &ill be fallin$" >hen MB is $reater than ATB it &ill dra$ it up"
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1.-
+ar0inal ,e#enue
%s the increase in revenue brou$ht about by the sale of e-tra units" As lon0 as +ar0inal ,e#enue is 0reater than +ar0inal Cost profits :ill "e increasin0 "ecause the re#enue< :hich comes from sellin0 each unit is still 0reater than the cost of producin0 it. Profit ma%imisation :ill occur :hen +ar0inal Cost and +ar0inal ,e#enue are e%actly e)ual "ecause there is no 0ain in producin0 further units. >e can calculate that revenue &ill be derived from: =rice - Quantity (%ample %f &e use the previous e-ample &ith .55 units bein$ produced at a total cost of G.,555 &e 'no& the Mar$inal Bost per unit is G15"55" %f the units are sold for G/,555 then the sellin$ price per unit is G1@"55" At the ne& level of production that is .51 units, the Mar$inal Bost is still G15"55" Mar$inal +venue could fall to G15"55 per unit before the firm &as no lon$er ma'in$ a profit"
This dia$ram sho&s the cost of introducin$ one e-tra unit of labour at $oin$ &a$e rate &hich increases output" M=S is Mar$inal +evenue =roduct &hich is the e-tra sales revenue $enerated by the
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input of one more factor of production in this case labour!"
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E-plain ho& Total Bost is calculated and &hat &e mean by Mar$inal Bost and Mar$inal +evenue"
Chec3 your ans:ers in section 7 2 Solutions to Self Assessed Questions and

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Acti#ities
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>hat effect &ill a rise in output have on Total Avera$e and Mar$inal BostE
Chec3 your ans:ers in section 7 2 Solutions to Self Assessed Questions and

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Acti#ities
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1.7
Costs of the 4irm 2 Short ,un and 1on0 ,un
Short ,un Economists define this as that period of time durin$ &hich at least one of the factors of production is fi-ed in supply" %n other &ords there is a limit to &hat can be achieved in this time scale" 1on0 ,un
Mar'et =roducers 3actor =rices Bonsumers
=rices
This is defined as that period of time &hen all the factors of production can be varied" %f for e-ample, a firm had been restricted because of space and no& finds it can e-pand or move to a bi$$er production unit it could also perhaps purchase more e#uipment, employ more labour etc" 2ecause the factors of production can be varied so can costs" 6ro:th of 4irms in the Short ,un As lon$ as one of the production factors remains fi-ed in supply a firm &ill only be able to increase output &ith a fallin$ cost over a limited ran$e of outputs" This is the ?a& of Ciminishin$ +eturns" This occurs because the factor, &hich is fi-ed, &ill reach a ma-imum output and cannot be increased" Addin$ to the other factors &ill not increase output but &ill reduce productivity because effectively more resources &ill be used to
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produce either the same #uantity or a very small increase" 6ro:th in the 1on0 ,un 2ecause all the 3actors of =roduction can be varied a firm should be able to e-pand the scale of its operations to continue obtainin$ fallin$ costs as output level increases" This &ill allo& the firm to obtain economies of scale" As a firm $ro&s it should be able to persuade suppliers to reduce prices or Aoin &ith other lar$e firms to $et bul' discounts from suppliers" %t may also be able to share operations &ith other similar firms" These activities should allo& reductions in costs, comin$ about because of si8e and 'no&n as economies of scale" %ncreasin$ si8e may also ho&ever brin$ disadvanta$es, &hich are termed diseconomies of scale and are classified as E-ternal of %nternal" E-ternal diseconomies could occur for e-ample, by a restriction in the supply of labour forcin$ firms to compete for this factor by increasin$ &a$es, pushin$ up Avera$e Bosts" The same could be true if demand for ra& materials rose, land for e-pansion become scarce and transport costs rose because of con$estion"
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%nternal diseconomies of scale could occur because mana$ement of lar$er firms becomes very much more comple-" %t becomes more difficult to coordinate and control the activities underta'en in a lar$e firm" Bommunications and industrial relations are other areas &here the comple-ity of the lar$er firm demands mana$ement s'ills of the hi$hest order" Optimum Si@e The optimum si8e of a firm in any industry is said to be &hen Avera$e Bost reaches a minimum" Summary >hether firms &ant to $ro& in the short or lon$ run there are $enerally thou$ht to be three motives &hich drive them" The desire to achieve economies of scale" The desire to obtain a $reater share of the mar'et and hence $reater mar'et po&er" The &ish to achieve $reater security by e-tendin$ the ran$e of products and mar'ets"
3irms &ill use one or t&o methods to $ro&" Internally by increasin$ si8e by ma'in$ more of e-istin$ product or e-tendin$ the ran$e of products" (%ternally and much more common, is to $ro& by means of Mer$ers, Amal$amations or Ta'eovers" Mer$er : combinin$ t&o business concerns by a$reement! Amal$amation : a smaller business may a$ree to be absorbed by a lar$er company! Ta'eover : one company buys another company either by a$reement or by a hostile bid! Cost Cur#es in the Short ,un and the 1on0 ,un The follo&in$ dia$ram helps to e-plain the chan$in$ cost structure of a firm as it chan$es its scale of production"
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SAB is Short +un Avera$e Bost" ?AB is ?on$ +un Avera$e Bost"
SAB @!
SAB 6! SAB 1! A A C Cost SAB .! SAB /! ?AB
Q1
Q2
(conomies of Scale
Q Output .iseconomies of Scale
The firm &ill initially have SAB 1 as its short run cost curve" %t &ill produce an output of 5Q1 at an Avera$e Bost of AQ1" Cemand increases and the firm responds by increasin$ those factors of production needed to meet the demand" )utput increases to 5Q. and 2Q. is Avera$e Bost" 0o&ever, if the firm increases in S%ME, the same output can be produced, but the Avera$e Bost is reduced to BQ." Until point Q, because of economies of scale, &hich are obtainable by $ro&in$ the firm, the Avera$e Bost &ill fall" 3rom that point on Ciseconomies of Scale &ill apply" This simply means that there is an optimal si8e for a business or plant" This varies from industry to industry" 7ou should note that the ?on$ +un Avera$e Bost curve is created by smoothin$ out the Short +un cost curves" ?AB in dia$ram is a smoothin$ out of SAB,s 19@" Summarisin$ then, as a firm $ro&s it &ill move from one Short +un Bost curve to another one as it reduces costs by obtainin$ economies of scale" Then it reaches a
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point &here this no lon$er applies and costs be$in to rise"
E-plain &hy a limited supply of any one factor of production &ill restrict a firm,s $ro&th in the Short +un"
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Chec3 your ans:ers in section 7 2 Solutions to Self Assessed Questions and Acti#ities
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E-plain &hat is meant by internal and e-ternal $ro&th of firms" %llustrate your ans&er &ith current e-amples if possible"
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1.8
Characteristics of +ar3et Structures
O">ecti#e To be able to assess the characteristics, price and output behaviour of mar'et structures" >hy Study the Mar'etE 2ecause the Micro9Economic vie& of an economy, sometimes entitled the <=rice System,, ans&ers some of the fundamental #uestions raised &hen &e try to understand the functions of economic society" Bonsider the follo&in$ dia$ram"
Cemand for Goods and services
Supply of Goods and Services
Supply of 3actor Services
Cemand for 3actor Services
The dia$ram sho&s that consumers demand $oods and services &hich producers supply and the la&s of supply and demand $enerally determine mar'et prices" The three fundamental #uestions are <>hat is to be producedE, <0o& is it to be producedE, <3or &hom is it to be producedE, The mar'et system therefore offers an
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e-planation for consumer behaviour and that of business as &ell" Price .etermination in Competiti#e +ar3ets >hen economists classify types of firms it is usually &ith respect to the type of competition under =erfectly Elastic Cemand Burve &hich they e-ist" I L J @ 6 / . 1 A+ H M+ H =rice At one end of the spectrum &e have =erfect Bompetition, at the other =ure Monopoly" %n bet&een &e have %mperfect Bompetition" Types of %mperfect Bompetition =erfect Bompetition =ure Monopoly
N
Monopolistic
N
)li$opoly
N
Cuopoly
Monopolistic : a lar$e number of firms ma'in$ similar products" Bommon in the service sector e$ 0airdressers and +etailers!" )li$opoly : mar'ets dominated by a fe& lar$e producers e$ oil and deter$ents! Cuopoly : there are only t&o suppliers in the mar'et! These are models, &hich may have no e-act match in the real &orld, but they &ill help us to predict ho& firms &ill try to operate" This &ill of course depend upon the type of mar'et they are in" >hatever the structure e-amined the assumption is al&ays that a firm &ill &ant to ma-imise profits" A$ain it is necessary to e-plain that this is to allo& us to predict behaviour" 3irms indeed, &ill not al&ays see' to ma'e as much profit as possible but &e &ill loo' at that later"
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Ban you thin' of reasons &hy some firms mi$ht not simply seem to ma'e as much profit as possibleE
39
Characteristics of Perfect Competition A lar$e number of buyers and sellers of the commodity, so that no one firm can affect the mar'et price throu$h its o&n action" 3reedom of entry and e-it to the mar'et for buyers and sellers" This is probably the most important condition for the theory of =erfect Bompetition" All products sold are identical ie they are homo$enous" =erfect 'no&led$e of the mar'et on the part both of the buyers and sellers" %t must be possible to buy or sell any amount of the commodity at the mar'et price" 1o seller or buyer has control over price"
There are no real e-amples of perfect competition althou$h a number of economists su$$est that the Banadian &heat mar'et comes closer than most" There are thousands of sellers and ultimately millions of buyers" The product once $raded is homo$enous, all those &ho are in the mar'et are specialists &ith $ood 'no&led$e and individual farmers can usually sell all they &ant to at the mar'et price" 3la&s appear ho&ever in that farmers band to$ether in co9operatives to try and control supply, the $overnment may intervene, and some very lar$e buyers may also try to drive the price do&n"
40
Characteristics of +onopoly This is the other end of the spectrum from perfect competition" ?iterally, it means there is only one seller and commodity" A"solute +onopoly =roduction is in the hands of one supplier and there is no substitute for the commodity" Coes not occur in real life" There is al&ays a substitute" !ote Some nationalised industries in the past &ere seen as monopolies, e$ 2ritish +ail and 2ritish Boal, but they &ere al&ays subAect to $overnment intervention and non9mar'et control" They &ere not profit ma'in$ or$anisations" Some firms can be seen to be close to monopoly positions &here they control lar$e proportions of total supply" 3or e-ample most of the &orld,s nic'el supply comes from Banada and is mined by the %nternational 1ic'el Borporation" Microsoft supplies much of the soft&are used in personal computers" 0o&ever, remember its troubles &ith the US Government; 2arriers to entry into the monopolistic competitive area are usually those of advertisin$, brandin$ or patentin$" >here others do try to brea' in, le$al means may be used by monopolies to 'eep them out"
41
Characteristics of .uopoly and Oli0opoly Cuopoly
C G ) C = Q
Cuopoly is a situation &here there are only t&o suppliers of a commodity" %n practice they are usually classed as behavin$ in the same manner as oli$opolists" )li$opoly
This means that there are only a fe& sellers of a particular commodity" There are #uite a number of oli$opolies in the United 4in$dom e$ 2an'in$, Supermar'ets, Ceter$ent =roduction etc" Bharacteristics 0i$h de$ree of industrial concentrations" Goods or services may be very similar" 2arriers to entry e-ist e$ lar$e scale of production and e-istin$ economies of scale" Ban earn super normal profits in the lon$ run" =rices are unli'ely to chan$e very often" Cominance by a fe& lar$e firms" Cifficult to predict behaviour : considerable non9price competition ie loyalty cards, brandin$ and re&ard schemes"
42
?ist some other oli$opolies that you are a&are of"
43
%n oli$opoly there are very fe& players in the mar'et place" This means they are constantly &atchin$ one another to prevent loss of mar'et share" Thin' of Tesco, Asda, Sainsbury, Safe&ay" Thin' Ta'eovers; Entry can be restricted but it is difficult because there are nearly al&ays substitutes that are acceptable"
44
Summarise the main characteristics of =erfect Bompetition, Monopoly and )li$opoly"
Chec3 your ans:ers in Section 7 2 Solutions to Self Assessed Questions and

45
Acti#ities
46
Price Perfect
Perfect The depicts &hich and note that
Ma- T+ TB Ma- =rofit Q. T+ Q1
and Output Aeha#iour Under Competition< +onopoly and Oli0opoly Competition
dia$ram belo& the situation, relates to price output" 7ou &ill the premise is that A+HM+H=rice" M+ means Mar$inal revenue and &e have already used it" A+ means Avera$e +evenue and is obtained by dividin$ the value of all the sales by the #uantity sold" Thus &e have: A+ H Falue of Sales Quantity sold
2ut &e also 'no& that &e $et the value of sales from multiplyin$ the #uantity sold by the price obtained" Therefore A+ and price must be the same" E-ample A firm sells .5 items at G.55 each" Falue of sales G6,555 A+ H Falue of Sales Quantity Sold G6,555 .5 H G.55
Price
47
MB ATB A+ Q. Q1 M+ =1 ) =.
48
2ecause of the characteristics of this form of mar'et no one can $ain an advanta$e and firms can sell their $oods up to the point at &hich they have ma-imised their profit" %n this mar'et firms are <=rice Ta'ers, because any chan$e in output of one firm is too insi$nificant to affect the price" +onopoly A monopoly may &ell have almost complete control over the supply of a commodity" %t cannot ho&ever control the demand for the commodity" This means that if the monopolist &ishes to supply more this is only li'ely to be achieved by lo:erin0 the price" The monopolist can also, if they &ish, fi- the price then allo& the consumer to determine the #uantity bou$ht" %n any other form of competition than =erfect Bompetition, the demand curve shapes do:n:ards" %f a firm raises its prices it may lose some sales" 0o&ever it can also try to increase demand by lo&erin$ prices" The po&er a monopoly has to influence price &ill depend upon: The availability of close substitutes" The po&er to restrict the entry of ne& firms"
7ou may remember that &e have sho&n Mar$inal +evenue to be e#ual to =rice" >here monopoly is faced &ith a fallin$ demand curve then Mar$inal +evenue &ill be less than Avera$e +evenue" The follo&in$ table sho&s this" )utput 1 . / 6 A+ price! 15 K I L T+ 15 1I .6 .I M+ I J 6
This sho&s that as output increases so Mar$inal +evenue falls belo& Avera$e +evenue" This is because Mar$inal +evenue becomes ne$ative and demand becomes inelastic"
49
This is illustrated in the follo&in$ $raph
=rice A+ M+ Quantity Sold Oli0opoly There are many more e-amples of this form of mar'et than almost any other" E-amples mi$ht be in industries, &hich produce oil, deter$ents, tyres, motorcars, synthetic fibres and ci$arettes"
50
7ou should $ive e-amples of recent amal$amations, mer$ers and ta'eovers that you are a&are of"
51
52
A problem, &hich is uni#ue to oli$opolies, is, that a firm,s demand curve may not follo& the assumptions upon &hich they have so far been structured" There are very lar$e firms, &hich &e have already identified as very carefully monitorin$ one another" Therefore if one firm cuts prices another mi$ht cut prices more" 7ou may &ish to thin' about the Tesco and Asda price campai$ns for e-ample" Each firm is claimin$ to be the cheapest in the mar'et for their $oods and &ill constantly offer price cuts" )r Esso,s <=rice >atch, promise &here in any locality it constantly monitors its competitors, prices and &ill ta'e action to match competitor prices" This then can cause some uncertainty in the mar'et place" %t can also have absolutely <unintended, effects" Some time a$o the German >ine %ndustry set out to dominate the European &ine mar'et by cuttin$ the price of its &ines fairly substantially" %t &as initially very successful in that the volume of sales rose #uic'ly and dramatically" Many suppliers moved in but the industry lost its reputation for #uality, sales collapsed and many producers &ere forced out" A conse#uence of oli$opoly may therefore be that a business may appear to face a 'in' in the demand curve for its product" This may occur because the moment a firm introduces price reductions competitors &ill respond by doin$ the same" This means that the elasticity of demand is $reater above the rulin$ mar'et price than belo& it as the follo&in$ fi$ure sho&s" =rice
Quantity =rice is )= and output is )Q" At prices hi$her than = demand is elastic : raisin$ prices &ill li'ely cause loss of mar'et share" At prices lo&er than = ho&ever the fear is that cuttin$ prices &ill force rivals to follo& suit and there &ill be little $ain in the &ay of additional sales"
53
)li$opolies therefore are not 'een to indul$e in severe price competition because they fear they &ill reduce prices but their mar'et share &ill remain much the same as before" They may, therefore rely upon other types of non9price competition, such as advertisin$, loyalty schemes, free $ifts, special offers, sales etc" 7ou should also be a&are of some of the more recent developments amon$st lar$e or$anisations" %n the car industry there have been <Bo9operative Fentures," 3or e-ample 3ord and =eu$eot have combined to desi$n and build a ne& diesel en$ine, Fau-hall buys diesel en$ines from 2M>" A number of firms use the same basic chassis and components for their vehicles, chan$in$ only bodies and interiors" Another form of non9price competition is <2randin$," %f &e return to the deter$ent industry &e 'no& that there is a lar$e ran$e of brands" 7et there are only t&o main firms, =roctor and Gamble and ?ever 3aber$e" Each firm produces competin$ brands and uses advertisin$ and promotion to ma'e them attractive to consumers" A feature of brandin$ is the loyalty it may induce in consumers" This is particularly true of areas such as 2rea'fast Bereals, Bonfectionary, Tobacco etc"
54
E-plain &hy perfect competition is not a really practical possibility and list three characteristic features each for monopoly and oli$opoly"
55
1.9
Profit +a%imisation
O">ecti#es a" b" to be able to e-plain the roles of profit ma-imisation" to be able to analyse alternatives to profit ma-imisation"
So far in this unit &e have su$$ested that firms &ill see' to sell products up to the point &here Mar$inal Bost e#uals Mar$inal +evenue" 3rom this point e-tra production &ill result in costs becomin$ $reater than the e-tra revenue to be earned" The point at &hich Mar$inal Bosts and Mar$inal +evenue are e#ual is the point at &hich profits are ma%imised" >hat ho&ever do &e mean by the term =rofitE 3or the economist profits are the difference bet&een Total Bost and Total +evenue" 0o&ever for an entrepreneur profit is an incentive to underta'e a ris3 in the belief that a 0ain can be made" Profit is the ,e:ard to (ntrepreneurs and the Incenti#e that (ncoura0es them to ta3e ,is3s. =rofit is also a re:ard" %t must be earned, as &e have seen, $enerally in an imperfect competitive situation" Many businesses fail and for many different reasons" ?ar$e firms can survive even if not efficient because they have a very lar$e share of their mar'et" This may allo& them to e-ploit customers to continue ma'in$ profits" 3irms can of course also ma'e <losses," This is sometimes termed <1e$ative =rofit," !ote; Bin the lon0 run all firms must ma3e positi#e profits to stay in "usinessC " =rofits can also be termed B!ormalC or BSupernormalC <,Abnormal,!" sometimes defined as
1ormal profit is the minimum amount of profit, &hich is necessary to 'eep a firm in an industry" Supernormal or Abnormal profit is anythin$ above that minimum amount of profit" 1ormal profit is the avera$e rate of re&ard per unit of output prevailin$ for the avera$e entrepreneur over an economy as a &hole" Avera$e +evenue A+! &e have already sho&n to be e#ual to price" Therefore Avera$e +evenue must include an element of profit" %f Avera$e +evenue is $reater than Avera$e Bost in an industry firms are ma'in$ abnormal profits" E#uilibrium &ill occur &hen Avera$e Bost and Avera$e +evenue are e#ual"
56
The follo&in$ dia$ram sho&s the normal relationship bet&een revenue cost and profit and output"
+evenue Bost O =rofit
)utput Ma-imum profit occurs at point Q. &here $ap bet&een total cost and total revenue is $reatest" Total revenue hi$hest point occurs at Q1 and after this point declines because the total cost starts to rise #uic'ly as output increases"
57
An alternative &ay of sho&in$ &hat effect mi$ht be of ma-imisin$ profits or revenue &ould be to use the mar$inal and revenue dia$ram already sho&n" This &ould loo' li'e this:
+evenue
Euro8one USA
1KK6 1KK@ 1KKJ 1KKL 1KKI 1KKK .555 .551 .55. .55/ =ercenta$e
The profit
15
11
ma-imisin$ output is Q1" This is &here mar$inal cost e#uals mar$inal revenue MBHM+!" This means a price of =1" 0o&ever the revenue ma-imisin$ output is Q. &here MBH8ero" This ho&ever means a lo&er mar'et price of =."
58
E-plain &hy &hen Avera$e +evenue e#uals Avera$e Bost a firm is ma'in$ profit"
59
A$$re$ate Cemand AC! A$$re$ate Supply AS! )utput Economics 1: Micro and Macro Theory and Application Scottish Qualifications Authority Unit Student Guide 3ull Bapacity
Chec3 ans:ers 72 to Self Questions and Acti#ities
your in section Solutions Assessed
60
Summary of Profit +a%imisation %t is a unifyin$ principle in that all firms are li'ely to be tryin$ to ma%imise profits, certainly in the lon$ run =rofit ma-imisation occurs &hen Mar$inal Bost e#uals Mar$inal +evenue Even if many business people have not the sli$htest idea of Mar$inal Bost or Mar$inal +evenue they &ill try to increase profit by reducin$ costs or increasin$ prices" They &ill be <tendin$, to&ards M+HMB" 2y this &e mean that the firm &ill be attemptin$ to ensure that +evenue is al&ays $reater than Bost and is in a profit ma'in$ situation" 3irms may find that ma'in$ constant chan$es to prices and costs creates instability and therefore &ill try to adopt a <Strate$ic, or <?on$ +un, vie&, ma-imisin$ profits in that time scale"
61
Bomplete the follo&in$ table" Ceman d output! L5 I5 K5 155 115 1.5 1/5 165 1@5 1J5 =rice A+! Total +evenu e Mar$in al +evenu e Total Bosts Avera$ e Bosts Mar$in al Bosts =rofit
G11"@ 5 G11"5 5 G15"@ 5 G15"5 5 G K"@5 G K"55 G I"@5 G I"55 G L"@5 G L"55
G JLI G L// G LI/ G I.I G IJI G K5/ G K6I G1,51 /
=. =rice =1
Q1
Q.
Q/ S1/
G1,15 G1,.6 5
Quantity S.
62
63
!ote" At the time of &ritin$ 2ritish Air&ays has Aust announced that after a number of years of cost9cuttin$ it has moved bac' into profit" %t has embar'ed on a price9cuttin$ e-ercise in an attempt to re$ain lon$ haul 2usiness and 3irst Blass customers &hom it had lost to other carriers" Alternati#es to Profit +a%imisation To some e-tent &e have already touched on this premise in su$$estin$ that profit ma-imisation is not al&ays the main 0oal of a firm" %n the summary of profit ma-imisation &e su$$ested that many business people may 'no& very little &ith re$ard to Mar$inal Bost and Mar$inal +evenue" There is a problem for many mana$ers or directors in that they may never 'no& &hether or not profits have been ma-imised" %ndeed in many firms tar$ets may be set for profits su$$estin$ that they should be a particular percenta$e of Total Turnover" Turnover is e#ual to Total Sales multiplied by #uantity of product sold" This is of course also Total +evenue" The mana$ers and directors &ould then try to ensure that &ith a predicted level of sales they can control costs to meet the profit tar$ets" 0o&ever mana$ers operate in a constant state of flu- and this ma'es it difficult to establish the hard information, &hich &ould allo& profit ma-imisation to occur in practice" Many business decisions have to be carried out in too short a time frame to allo& considered Aud$ement of the economic issues" A second area that is allied to the first is <separation of o:nership from control," Most lar$e public companies, e$ Shell, and Mar's and Spencer, are o&ned by shareholders, but decisions are made by mana$ers and directors" These $roups may have conflictin$ re#uirements, the shareholders loo'in$ for increased profits to improve the value of their shareholdin$, the mana$ers to have improvin$ salaries and re&ards and retain control over decision9ma'in$" %n practice as lon$ as profits offer a reasonable return on their investment shareholders &ill probably not complain overmuch;
Satisficin0 Aeha#iour
This particular theory &as e-pounded by 0 A Simon and his collea$ue A Byert" %t is based on the fact that achievin$ specific tar$ets &ith re$ard to sale, profit and mar'et share &ill result in <satisficed behaviour, by those &ho o&n and those &ho run firms" They 'no& that it may be possible to do better but in the lon$ run to press for further profit may result in unintended dama$e"
64
U4 Euro8one
1KK@ 1KKI .551
Social ,esponsi"ility Economics is re$arded as a Social Science because it attempts to predict human behaviour in a &orld &here &ants are many but resources to meet these &ants are limited and have varyin$ use"
This means that &e cannot separate or divorce economics from society" 3irms are e-pected to behave in a socially responsible &ay" 3irms are therefore tas'ed, by society, often in the form of le$islation to loo' after: Bonsumers >or'ers The broader environment ?ocal residents Shareholders
A$ain all of these $roups or areas may have desires or needs &hich conflict &ith profit ma-imisation" Indi#idual +oti#es 0uman bein$s are comple- and may have conflictin$ motives, both as individuals, and in combination as formal or informal $roups" )ne $ro&in$ area in most countries is the environmental or <$reen, aspect" 2oardroom battles are fre#uently identified in 3inancial =apers or Ma$a8ines" They may end up in sac'in$s, resi$nations or votes on issues, &hich may have considerable effect on ho& a firm operates" Other &heories The follo&in$ theories represent the &or' of individuals &ho are not Economists but have attempted to place economic theories &ithin a social settin$"
=ercenta$e %nflation 1 . / 6 @
1KKJ 1KKK 1KKL .555
65
Sales ,e#enue +a%imisation &heory =ropounded by =rofessor > P 2oumal based on the follo&in$: Mana$ers $et better per's and salaries from sales than profit" Bhec' to see if this is verified by TF and 1e&spaper reportin$!" Mar'et share is considered a better si$n of pro$ress of a firm e$ Tesco versus other supermar'ets" 2ecause of the above, heavy advertisin$ &ill ta'e place to ma-imise sales" =rofit may be reduced to pay for advertisin$" 3irms &ill still ma'e profits : to 'eep shareholders happy : and salaries and per's up : but it &ill not be a =rofit Ma-imisation =hilosophy" 3irms &hich operate on this philosophy &ill attempt to sell more but at a lo:er price than a firm loo'in$ for ma-imum profit"
6ro:th +a%imisation &heory =ropounded by +obin Marris Mana$ers loo' for per's, status, salaries etc but &ant to $ro& their o&n firm" %f firms &ant to sell more they must produce more" =roductive capacity assets! must also $ro& e$ plant, e#uipment etc" Gro&th is therefore more balanced" %f mar'et or product is <mature, and has little $ro&th potential firms mi$ht have to diversify into ne& areas" Gro&th can occur because of amal$amation, mer$er, ta'eover" E$ +oyal 2an' of Scotland ta'eover of 1ational >estminster 2an' &hich &as a lar$er ban'!" Mana$ers can never i$nore their shareholdersQ they must 'eep them on board" This &ill only occur if shareholders believe there is increasin$ value for them in this $ro&th"
2y no& you should perhaps be notin$ that in fact Satisficin$ 2ehaviour is implicit in most of these theories in the sense no one identified $roup can achieve all they see' but must compromise to 'eep each $roupin$ satisfied &ith its share of the benefits or re&ards"
66
'
Summarise the $oals a firm mi$ht pursue as an alternative to ma-imisin$ profits"
'.2
67
Section 2 5 (#aluate the Impact of Unemployment and Inflation

2.1 O">ecti#e
To be able to outline types of unemployment : 4rictional< Cyclical< Seasonal and Structural" >hat do &e mean by unemploymentE There is a very simple ans&er to this #uestion" %t is of course <all those &ho are see'in$ &or', but cannot find it," Unfortunately this is no lon$er a truism" 3or one thin$ &e are not sure if everyone &ho is on an unemployment re$ister is actually see'in$ employment" Many economies, such as the U4, run a Social Security system for those &ho are unemployed" This is because past e-perience has tau$ht the hardship and accompanyin$ conse#uences of lar$e9scale unemployment" %t is also true that the statistics are used to purportedly sho& the true e-tent of unemployment in an economy and it is usually e-pressed as a percenta$e of the total &or'force available" )ne problem is that it is very often not possible to measure one economy,s fi$ures &ith others because different measurin$ devices may be used or one factor, &hich may be e-cluded in one economy, is included in others" 1evertheless all advanced economies tend to see unemployment above a certain fi$ure as <bad, and efforts &ill be made to try and brin$ the fi$ure do&n to that considered acceptable" )ne of the reasons for doin$ so is that Social Security Bosts are met from Ta-ation" Therefore if there is hi$h unemployment there &ill be t&o effects" 3irstly the ta- bill &ill rise" Secondly there &ill be a loss to the E-che#uer because those &ho are no& unemployed &ill no lon$er be earnin$ and therefore not contributin$ throu$h ta-" They &ill also li'ely be on %ncome Support from the E-che#uer" Unemployment is also seen as a &aste of resources in that s'ills, &hich could have been used to increase output, are idle" 3urther the unemployed may find it difficult to $ain the ne& s'ills, &hich mi$ht be re#uired as technolo$y in an economy chan$es"
68
&ypes of Unemployment Usually defined as: 3rictional Byclical Seasonal Structural
Unemployment ,ates (uro@one and USA 199$ 2 2==
1"2" Burves have been smoothed out to elimate short sharp chan$es and sho& lon$ term trends"
69
4rictional Unemployment ?abour is not perfectly mobile and cannot simply $ive up one Aob and #uic'ly move to ta'e up another" =eriods of notice or even the re#uirement to train or learn a ne& s'ill may have an impact on &hen a person can actually ta'e up a ne& Aob" Some people may $ive up a Aob to see' a ne& s'ill before even applyin$ for the 'ind of Aobs the ne& s'ill attained &ould su$$est" There is therefore not a lac' of demand for labour but immobility in the labour force &hich forces up unemployment" This is termed 3rictional unemployment" Cyclical Unemployment This is $enerally considered to be the most serious form" %t is usually the result of a $eneral depression of the &hole economy" The 1K/5s and 1KI5s represent t&o such periods in the fairly recent history of the U4 althou$h you must be&are that the e-periences of the t&o periods may not be relative" This form of unemployment usually occurs &ith &hat is 'no&n as the <Trade Bycle," This is the e-planation of ho& a country,s economy $ro&s, not usually in a strai$ht line but up and do&n in a series of curves" The $raph belo& sho&s an idealised e-ample"
May be /9@ years =ositive Gro&th =ercenta$e 6 / . 1 5 91 1e$ative Gro&th 9. =ercenta$e 9/ 96 boom trade cycle time
depression Blearly employment &ould $ro& as the economy e-panded and decrease as it shran'" )ne interestin$ aspect is that the U4 &as said to suffer and not achieve &hat it should because it be$an to train people too late to catch the <boom, years" Bompetitor economies had learned to train their &or'force &ith the ne& s'ills needed as the economy started to shrin'" This meant they &ere available &ith appropriate s'ills as the economy started to $ro&" The U4, on the other hand, seemed to &ait for the first real si$ns of positive $ro&th and &ould train people on the upslope period : too late to be available for the boom"
70
=rice ?evel
The dia$ram sho&s that a$$re$ate demand &ill only buy a level of output &hich &ill leave many people unemployed" Seasonal Unemployment This is much less serious than it used to be" Generally considered to be vulnerable to this particular form &ere those &ho &ere &or'in$ in farmin$, construction and tourism" All of those industries have learned ho& to adapt to chan$in$ environments &hilst chan$in$ technolo$y in each area has meant the possibility that &or' can continue all year round" )ne e-ample mi$ht be the tourist industry learnin$ ho& to attract people from around the &orld to events at times that &ould be thou$ht to be seasonally non9 effective" The 1e& 7ear =arty in Edinbur$hE; Structural Unemployment This is said to occur &hen old style industries decline and are not immediately replaced by ne& industries, &hich can absorb the labour made redundant" This may be because the ne& industries are in a different area $eo$raphically or re#uire an entirely ne& set of s'ills" This form of unemployment pla$ued the U4 throu$hout most of the .5th century, probably because the U4 led the &orld into the %ndustrial +evolution" E-amples of the industries, &hich &ere part of this problem &ere, 0eavy En$ineerin$, Shipbuildin$, %ron and Steel %ndustries and Boal Minin$" 2ecause most of these industries &ere effectively re$ionalised so &as the Structural Unemployment" Another e-ample mi$ht be the demise of the 2ritish Motor Bycle %ndustry lar$ely because of forei$n competition, mainly from Papan, but also from %taly"
71
1=
Ma'e a list of the main features of 3rictional, Byclical, Seasonal and Structural unemployment"
72
2.2
Solutions to Unemployment
O">ecti#e To be able to e-plain measures desi$ned to reduce unemployment" There have been t&o broad approaches to the attempts to control unemployment" They are sometimes referred to as the <Cemand9side, or <Supply9side, approaches" The <Cemand9side, approach is based on the &or' of Pohn Maynard 4eynes and associates" They ar$ued that unemployment $enerally &as caused by a fall in a$$re$ate demand" <This is total planned spendin$ at a $iven price level" %f demand could not be stimulated by consumers buyin$ $oods and services then the Government re#uired to intervene by runnin$ <bud$et deficits, and usin$ fiscal policy to fine tune or mana$e a$$re$ate demand bac' to a level &hich &ould provide economic $ro&th and full employment" 2y <bud$et deficit, &e mean the overall balance achieved bet&een the +evenue a $overnment receive and the E-penditure it carried out" A <deficit, is &hen the Government spends more than it receives in income" 3iscal policies include the use of $overnment e-penditure, benefit payments and ta-ation to increase the level of demand" A $overnment may also use monetary policy to try and influence demand" This means, lo&erin$ interest rates, easin$ control on lendin$ and easin$ 0ire =urchase restrictions" <Supply9side, approach emphasises the natural competitive forces in the economy" These economists believe economies in practice should be self re$ulatin$, that mar'ets &ill brin$ economies bac' into balance and the reason unemployment rises is that the re&ard for labour ie &a$es, is too hi$h" 3irms &ill therefore try to reduce labour costs by sheddin$ labour" They recommend action, &hich &ill lead to reduction in the costs of production, &hich &ill in the lon$ run reduce unemployment, by freein$ other resources, &hich can ma'e the economy &or' more effectively"
73
Burve S. sho&s the effect of bein$ able to move the supply curve to the ri$ht because of fiscal policy chan$es or economies of scale" This allo&s $reater supply at the same price" Their policy prescriptions are: +educe &elfare payments : cuts $overnment e-penditure" ?o&er direct ta-ation : puts more money in peoples poc'ets" +educe employee and trade union ri$hts : reduces restrictive practices" Abolition of minimum &a$e rates : ma'es labour more mobile" The promotion of trainin$ and retrainin$ schemes : increases s'ills of labour force"
%n practice in the U4 &hich is $enerally run as a mi-ed economy, Governments &ill use policies &hich could be seen to be both <Cemand9side, and <Supply9side," 0ere are some e-amples of Government Actions to deal &ith unemployment, often headed under the banner of Trainin$ and ?earnin$ to develop s'ills, &hich &ill ma'e individuals more employable and mobile" Community Pro0rammes 2 Pu"lic Sector 4undin0 for 1ocal Community Schemes !e: .eal 2 6o#ernment 1ed 4undin0 Schemes (nterprise Schemes !e: 4orms of Qualification D:or3 "asedE Su"sidies to (mployers< to ta3e on !e: Foun0 Staff Increase !um"er of 6raduates ,e0ional Policy
74
>hat measures can $overnments ta'e to deal &ith persistent levels of unemploymentE >hat can 3iscal or Monetary =olicies contribute to combatin$ unemploymentE
75
2.
Inflation
O">ecti#e To be able to e-plain types of inflation : 4eynesian and Monetarist Fie&s %nflation is defined as the annual rate of chan0e of the 0eneral price le#el in an economy or a sustained increase in the a#era0e price le#el.
1"2" Smoothed out to avoid short sharp fluctuations !ote This is for a &hole economy" Some mar'ets may be risin$ #uite #uic'ly and others fallin$ but it is the overall effect &hich matters" 3or e-ample in the U4 at the present time <0ouse, price inflation is risin$ rapidly but overall inflation is at a historically fairly lo& level" 1ote : house prices are no lon$er included in the inflation inde- used by the Government" This brin$s the U4 into line &ith Bontinental Economies" 0o&ever for most people this is still a very important area in that it is probably the $reatest sin$le e-penditure they &ill underta'e" Some economists ar$ue that there are t&o main types of inflation : <Bost =ush, and <Cemand =ull," Bost =ush inflation occurs &hen the costs of production increase" This could be due to &a$e or ta-ation rises or increased material costs" %n the 1KL5s sharp increases in oil prices caused prices to rise #uic'ly in the &orld,s maAor producin$ countries" 3unnily enou$h at the time of &ritin$ this unit oil prices have risen sharply a$ain;
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Three factors are su$$ested to be at &or' here" The decision of the )il E-portin$ Bountries )=EB! to limit supply Stoc'9pilin$ of oil reserves by the United States the >orld,s lar$est economy! The bur$eonin$ economic $ro&th of Bhina, lar$ely in manufacturin$, &hich means it has $reatly increased its need for oil as fuel for rapidly e-pandin$ industry"
The seven lar$est economies : the GL $roup : have approached )=EB to e-pand supply of oil to reduce prices" Cemand9=ull inflation happens &hen there is an increase in a$$re$ate demand and it is not possible to increase supply of the $oods and services demanded" 2ecause there are more buyers than sellers the buyers &ill compete for the limited $oods and services forcin$ prices up" Pro"lems of Inflation %t hits those on fi-ed incomes very hard because they &ill be unable to purchase the same #uantity of $oods and services" %t also hits those &ho have no po&er of any 'ind to ne$otiate on &a$es" %t assists the borro&er reduces the value of the debt! and penalises the saver return is reduced in value! 3irms may initially receive hi$her prices and become complacent and not strive for efficiency" Bonsumers may decide to spend rather than save ma'in$ the problem &orse Some firms may not be able to survive" %t may lead to a <balance of payments, deficit for an economy because if other economies are not inflatin$ to the same e-tent then the $oods or services of the economy &ith hi$h inflation &ill be less competitive hi$her prices!"
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)utline the characteristics of Cemand9=ull and Bost9=ush inflation"
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2.$
Geynesian and +onetarist ?ie:s on Inflation
O">ecti#e To be able to e-plain solutions employed to combat inflation" Blassical economists broadly follo& the vie&s of Adam Smith a Scot, &ho is re$arded as the 3ather of Economics" 0is maAor &or', <A >ealth of 1ations, &as printed in 1LLJ" Stran$ely, Smith never sa& himself as an economist" 0e occupied the Bhair of Moral =hilosophy at Glas$o& University" Smith and those &ho follo& and support him, believe that the mar'et and the la&s of supply and demand should be left alone to re$ulate an economy" 4eynes, &hom &e have already mentioned, challen$ed the assumptions of Smith,s follo&ers &ho had become 'no&n as the Blassical School of Economists" 4eynes is seen as the 3ather of Macro Economics the study of economics as a &hole : the overall picture!, &hich su$$ests that e#uilibrium &hen the output of firms is e-actly matched by household e-penditure! in an economy can only be obtained by mana$ement of a$$re$ate demand and a$$re$ate supply" >hen an economy is &or'in$ as it should, then 4eynes and his follo&ers are happy to leave &ell alone" %f ho&ever, there is inflation or the reverse, deflation, then 4eynes su$$ests actions, &hich &or' a$ainst the cycle see section on cyclical unemployment!" 0e ar$ues that inflation occurs &hen a$$re$ate demand e-ceeds a$$re$ate supply" Effectively there is $reater demand than the supply side can produce" =rices are bid up" To reduce inflation 4eynesians su$$est that Government must act to reduce consumption e-penditure, investment e-penditure and $overnment e-penditure" This can be done throu$h 3iscal and Monetary =olicies" 4iscal Policy Cecrease Government E-penditure %ncrease Ta-ation (ffects on the (conomy
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+onetary Policy %ncrease %nterest +ates Bontrols on 2an' ?endin$ 0ire =urchase +estrictions imposed
Unemployment &ill rise Economic $ro&th &ill fall %nflation &ill fall 2alance of payments &ill fall because consumers &ill be less able to afford forei$n $oods or services"
11
>hat &ould 4eynesians recommend in the event of deflationE >hen an economy suffers reduced $ro&th!
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&he +onetarist ?ie: This is effectively the Blassical Economist School vie& as modified by Milton 3riedman and his associates" %t is essentially a simple proposition" %nflation is a monetary phenomenon" The cause of inflation is that there is too much money in the economy" %nflation is not caused by &a$e demands or increases in other costs" %t is simply caused because money obeys the ?a&s of Supply and Cemand" %f there is too much of it, its value &ill fall and it &ill buy a smaller number of $oods and services than previously" %f there is too little of it in the economy then the reverse situation &ill apply" This e-planation of inflation operates throu$h the <3%S0E+ EQUAT%)1," That is: M"F" H ="T" M H Money Supply F H Felocity of circulation = H =rice level T H Transactions or output Monetarists assume that F and T are fi-ed and that there is therefore a direct relationship bet&een the $ro&th of the money supply and inflation" %f <M, increases the only &ay balance can be restored is if <=, also increases" 3or monetarists the control of the money supply is crucial to ensure that there is neither inflation nor deflation" Therefore if there is inflation then the correct &ay to $et rid of it is to reduce the supply of money; To ensure that there is neither inflation nor deflation, monetarists believe it is necessary to ensure that the supply of money matches the $ro&th or reduction of output in the economy" %f the supply of money remained the same in circumstances of reduced $ro&th then inflation &ould be li'ely because the same amount of money &ould be available to be spent on a smaller #uantity of $oods and services"
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Summary of +onetarist ?ie: on /o: to ,educe Inflation 4iscal Policy 2alanced 2ud$et or as near as can be achieved! 1o attempt to counter economic cycles Other Policies Government intervention to be drastically reduced" This &ill prevent the Government distortin$ the mar'ets!" Mar'et is more effective : responds to consumer needs" To carry out the policies recommended by monetarists to reduce inflation &ill have the same effects on the economy as the 4eynesian policies" +onetary Policy Slo& steady $ro&th in line &ith $ro&th of real output"
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)utline the contrastin$ beliefs of the 4eynesian and Monetarist vie&s on %nflation" 2riefly state the policies each vie& recommends to combat inflation"
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2.' &he (ffects of Inflation on Ausiness and Indi#iduals

O">ecti#e To be able to e-plain the effects of inflation on business and individuals" Some evidence of &hat &ill happen has already been su$$ested" %t is possible to dra& up a list of the effects inflation has on both business and individuals" Ausiness Bosts rise materials, &a$es! %f importin$, imports cost more Greater uncertainty +educe investment Cifficult to plan ahead &hat fi$ure to use for inflation! =roblem may be made &orse if you have to deal in other currency >ill try to shed labour
Indi#iduals Those on fi-ed income suffer Falue of &a$es*salaries drop +educed savin$s unless interest rates rise;! ?ose confidence : reduce consumption Greater chance of bein$ unemployed
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2.-
,ecent &rends on Unemployment and Inflation in the UG
O">ecti#e To be able to e-plain the recent trends on unemployment and inflation in the U4" All U4 Governments in the past t&enty or more years have accepted broadly the same economic obAectives" These are: 3ull employment ?o& inflation Stable economic $ro&th" Most economies have a tendency to $ro& around a particular fi$ure" 3or the U4 this is some&here around . : ."@D Satisfactory balance of payments" This means that an economy is neither ma'in$ lar$e surpluses nor lar$e deficits in terms of a$$re$ate demand and a$$re$ate supply"
3ull employment &ithin the U4 economy has $enerally been accepted as e-istin$ &hen /D or less of the available &or' force is unemployed" This follo&ed the 2everid$e +eport in the late 1K65s" 0o&ever since then $overnments have found tryin$ to maintain this fi$ure to be both very difficult and cause infle-ibility" %n attemptin$ to follo& 4eynesian policies in the 1KL5s the results &ere sta$nation no movement in the economy! accompanied by hi$h inflation, until then thou$ht to be not possible" Bonversely the Thatcher Government in the 1KI5s follo&ed broadly monetarist policies and made determined efforts to control the money supply" ?ar$ely it failed because lenders found many &ays around the supposed restrictions" %n both these periods inflation &as, as su$$ested, #uite hi$h" Unemployment certainly $ot much &orse in the early 1KI5s" The $overnments of that time made a point of reducin$ the si8e of the Government portion of the economy by <sellin$ off, =ublic )r$anisations such as 2ritish +ail and 2ritish Steel bac' to the private sector of the economy" %n order to try and ma'e the or$anisations they had purchased more efficient most of the ne& businesses made lar$e numbers of staff redundant" E#ually the Boal industry has run do&n to the e-tent that there are very fe& coalmines left across the U4" The U4 had been seen for a lon$ time as an economy &ith lo& $ro&th, hi$h unemployment, hi$h interest rates and lac' of mobility in the labour force" %n the last 15 91. years ho&ever the position has chan$ed fairly dramatically and the U4 is seen as currently one of the more successful economies in Europe"
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%t has been su$$ested that economies &ith independent central ban's have better economic $ro&th &ith lo&er inflation" %n 1KKL the ne& ?abour Government passed control of interest rates to the 2an' of En$land" Government borro&in$ is e-pected to not e-ceed /D of Gross Comestic =roduct" The focus of ta-ation has shifted from direct income ta- to indirect ta-ation e$ Falue Added Ta- FAT!" The main priority has been to 'eep control of inflation" =rior to .55/ the 2an' of En$land &as tas'ed to 'eep inflation at ."@D" 3ollo&in$ a chan$e insti$ated by the Bhancellor of the E-che#uer to allo& direct comparisons &ith international competitors e$ 3rance and Germany, certain items &ere removed from the inflation measure e$ mort$a$e repayments" The rate aimed for has been reduced to around 1"@D" These are historically lo& rates for the U4" !ote The 2an' of En$land is currently increasin$ interest rates $ently to try and slo& do&n house price inflation currently runnin$ at around .5D per annum" Governments have therefore learned to use both 4eynesian and Monetarist Theories to $ro& the economy and 'eep inflation under control" )ne e-ample is the Minimum >a$e, &hich monetarists predicted &ould lead to a rise in both unemployment and inflation" %t has not" As mentioned earlier the consensus is that the U4 economy is performin$ reasonably &ell;
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Section
.1
5 (#aluate 6o#ernment Use of ,e#enue and (%penditure

4iscal Policy and UG 4iscal Policy +ethods
O">ecti#e To be able to e-plain &hat 3iscal =olicy is and 3iscal =olicy methods used in the U4" This concept has been mentioned earlier &hen dealin$ &ith 4eynesian or Monetarist =olicies" 7ou should therefore broadly be a&are of &hat this means and the features of both these policies" )ne definition of fiscal policy is <Governments actin$ in a direct manner to create an economy that is in e#uilibrium," 7ou should return to the ar$uments outlined in section @". on the &ay in &hich 3iscal =olicy operates under the t&o different approaches to ensure you understand them" 7ou should also be a&are that as is pointed out the U4 economy is a <Mi-ed, economy tryin$ to use the most appropriate method of recovery &henever the economy veers a&ay from e#uilibrium" >e have also already noted that a Government has both +evenue and E-penditure"
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12
Ma'e a list of the thin$s you spend money on" >hich of them are ta-ed by the GovernmentE
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The Government,s %ncome is derived from Cirect Ta-ation and %ndirect Ta-ation" Simply put, Cirect is ta-ed at source e$ income ta- &hile %ndirect Ta-es are re$arded as Bonsumption Ta-es" %f you don,t consume you &on,t pay the ta-" e"$" Falue Added Ta-"! Government E-penditure is mainly spent on such areas as Social Security, 0ealth Services, Education and Cefence" There are areas, &hich our society believes, are the responsibility of the Government to provide on a 1ational 2asis" 2ecause &e have already defined &hat 3iscal =olicy is, &hat are its aims in practiceE Mainly they are to mana$e the economy &ithout creatin$ lar$e surpluses in the economy or lar$e deficits both of &hich &ould cause maAor problems" The maAor &eapons in any Government,s armoury usin$ 3iscal Methods are either to use Ta-ation or Spendin$ to achieve stability and ordered $ro&th" The U4 Government as a member of the European Union has a$reed to try and maintain any spendin$ e-cess over its income to no more than /D of Gross Comestic =roduct value of the total output produced in a country!" !ote The United 4in$dom Gross Comestic =roduct fi$ure for .551 &as around GK@5 2illion =ounds" Burrently most U4 economists are ar$uin$ that the Bhancellor of the E-che#uer is li'ely to e-ceed the /D limit for financial years .5569.55@ and .55@9 .55J" The Bhancellor is ar$uin$ that $ro&th in the economy &ill in fact mean that he meets his tar$ets for the =ublic Sector 2orro&in$ +e#uirement The amount the Government has to borro& to cover the $ap bet&een Government e-penditure and tarevenue!" 0is critics say it &ill not" This ar$ument has ra$ed for some t&o years no&" So far the Bhancellor seems to have been borne out, but as someone &ho is studyin$ this subAect you must have 'no&led$e of these issues and be able to ar$ue around them"
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The Bhancellor ar$ues that he &ill need to borro& around G/5 billion in .55/*6 to enable him to increase spendin$ on Education, 0ealth and other areas such as Transport" 0is critics ar$ue he &ill need to borro& more" ?et us assume that the Bhancellor is actually forced to ta'e action to reduce Government spendin$" >hat tools can he useE %f he uses them &here &ill the impact fallE
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.2
6o#ernment Spendin0 and What it (ffects
O">ecti#e To be able to evaluate Government spendin$ and its effects" The follo&in$ table is dra&n from the U4 Treasury 3inancial Statement and 2ud$et +eport for 1KII9K sho&in$ the e-penditure of the various Government Cepartments in terms of amount and as a percenta$e of the total Government e-penditure" 3or e-ample it ma'es clear that the lar$est sin$le e-penditure is for Social Security purposes" H Aill Social Security 0ealth Services Cefence Education +e$ional Scotland, >ales, 1orthern %reland! )ther Cepartments e$ 0ome )ffice, Employment! =rivatisation =roceeds +eserve contin$ency! Cebt %nterest AdAustments Total 6I"@ .5"L 1K". 1I"5 1L"1 /6"K 9 @"5 /"@ 1L"@ I of &otal .J"@ 11"/ 15"@ K"I K"/ 1K"1 9 ."L 1"K K"J
I"J 6"L RRRRRRRRRRRRRRRRRRRRRR 1I."K 155"55
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As a Percenta0e of 6ross .omestic Product D6.PE J
$1.2'I
)ne of the reasons for usin$ this particular year is that it &as durin$ the Thatcher Government term of office &hen it &as tryin$ to follo& broadly monetarist policies" An interestin$ aspect is that the e-penditure is 61".@D of GC=" 2y today,s standards that is considered to be hi$h" Governments since that time have tried to stay &ith an e-penditure level, &hich is less than 65D of GC=" To an e-tent this is a reco$nition that $overnments cannot rely upon monetary policy solely because the evidence seems to be that it does not al&ays &or'" %t is li'ely that fiscal policy &ill be re#uired as &ell" %t is also to be noted that at this time unemployment had been reduced from 11D in 1KIJ to some LD in 1KIK and fell further to JD in 1KK5" )ne conse#uence of this &as that &or'ers, no lon$er fearful of Aob losses, demanded lar$e &a$e raises, employers conceded, feelin$ risin$ profits could be threatened by a lac' of s'illed labour and inflation e-ceeded 15D in 1KK5" The above information is $iven to sho& that follo&in$ one philosophy &ill not necessarily &or'" The 1KL5s are su$$ested as a classic case of 4eynesian policies not &or'in$ effectively and the result in that period &as both an increase in unemployment and rises in inflation up to around .JD at its ma-imum!" 7ou &ill note from the table that there is an item entitled <Cebt %nterest," >henever a Government borro&s money it &ill clearly have to pay a rate of interest for that money" )ver a period of time if all of that money is not paid up it &ill accumulate into the 1ational Cebt, &hich &ill re#uire interest to be paid" Bhancellors ma'e $reat play &hen &ith a surplus rather than a deficit they can repay some of the 1ational Cebt" 3or an economist ho&ever there are t&o aspects to this debt" 3irstly, the Government is al&ays $uaranteed to $et its money from the money mar'ets and does so by issuin$ Treasury 2ills or 2onds, &hich $uarantees a return to those &ho purchase them" The Government &ill usually have to pay a premium rate to borro& the money and this may have an influence on the $eneral rates" This may feed into money mar'ets &hich could cause a rise in interest rates reducin$ the ability of consumers to afford $oods and services or forcin$ them to pay hi$her prices settin$ off bouts of inflation" )ther effects may follo& rises in $overnment spendin$" %t has already been pointed out that the current Bhancellor has indicated hi$her spendin$ on 0ealth, Education and Transport" There can be $ood effects and not so $ood effects" %f the money is spent upon Bapital $oods e$ 0ospitals, Schools, +ail and +oad Systems then suppliers should do &ell" 2uildin$ the ne& facilities &ith better #uality materials and improved layouts should see a considerable rise in effectiveness e$ treatment of patients in hospitals" Technolo$y advances should enhance methods and efficiency e$ E9line tic'etin$ and %nternet boo'in$" %mproved transport systems should mean faster times and better e-periences for businesses" All of these thin$s should mean $reat increases in productivity and #uality of output; Bonversely if the money is purely spent on &a$es and there is no correspondin$ increase in #uality or output then the end result &ill almost certainly be a rise in interest
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rates and a rise in the rate of inflation" Another area &here Government Spendin$ may influence factors is Cefence" Burrently the U4 is a maAor contributor to the Boalition 3orces in %ra#" The Bhancellor has indicated that he has had to ta'e money from the Bontin$ency 3und to the tune of GJ billion up to date" A$ain this may have $ood and bad effects" %f spent on improvin$ e#uipment then manufacturers &ill continue research and development and of course use all the factors of production they employ to build military e#uipment" >e need to be a&are that many of our technolo$ical advances have been derived from the needs of military re#uirements and also space e-ploration" A poor effect is that the U4 never seems to be able to meet either its timescales or bud$ets &ith re$ard to defence e-penditure" This means an increase in costs and a reduction in the effectiveness of the Armed 3orces" %t also has implications for the suppliers to the Ministry of Cefence" 3or e-ample the 1imrod Maritime +eplacement Aircraft is due in .55@" %t is not li'ely to see Service no& until .55L at the earliest! and is nearly G6 billion overspent currently" The Eurofi$hter combined proAect is many Gbillions overspent and is also very late orders for it have been reduced because it is much more e-pensive than bud$eted for and this may affect the U4,s future ability to defend itself!" Social Security spendin$ is, as you can see, the lar$est proportion of Government spendin$" The purpose of this spendin$ is $enuinely to carry out a redistribution of income" 2road obAectives &ould be to levy ta-es on those earnin$ income to distribute benefits in cash or 'ind to poorer $roups in society" Amon$ the problems it $enerates is that it is often difficult to separate out those most deservin$ of help from the $eneral public" An e-ample of this mi$ht be Bhild Support in &hich allo&ances may be $iven to all re$ardless of income" 1evertheless society $enerally supports the vie& that everyone should be $uaranteed some ade#uate minimum level of income and no one in a family should suffer undue hardship" 2y .551 Government spendin$ has risen to some G/L5 billion" 7ou should note ho&ever that this &as a smaller percenta$e of $ross domestic product /KD! than the 1KII9IK e-penditure" The maAor spends &ere still in the same area ie G15/ billion on Social Security, G@6 billion on the 1ational 0ealth Service and G6J billion on Education"
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1 =
3or the follo&in$ areas of Government E-penditure construct a list of &hat you consider to be possible $ood and bad points for each area" Social Security
Cefence
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0ealth Services
Education
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+onetary Policy Aims and +ethods in the UG
O">ecti#e To be able to e-plain monetary policy aims and methods in the U4 The maAor aims of monetary policy can probably be summarised as follo&s: To achieve economic e#uilibrium in an economy To reduce the si8e of the $overnment sector To reduce ta-ation To allo& individuals to ma'e their o&n decisions on ho& much to spend on e$ 0ealth and Education To control the supply of money To eliminate $overnment deficits To allo& money supply to $ro& at only the same rate as the $ro&th of the economy To allo& the mar'ets to operate freely"
Monetarists believe that follo&in$ the above aims &ill better meet the four obAectives that the U4 and other $overnments set themselves" To reiterate: 3ull employment ?o& inflation Stable economic $ro&th Satisfactory balance of payments
96 S Scottish Qualifications Authority 9 All ri$hts reserved"
There have been attempts to use Monetarist =olicies either as a &hole or partly in the U4 since around the early 1KI5s" The Thatcher Government in the late 1KI5s particularly attempted to follo& a monetarist policy but discovered that ban's, for e-ample, could find &ays around attempts to control the money supply, by findin$ different &ays of lendin$ to customers" Secondly they found that the trade unions and employers &ould combine to increase &a$es because the employers feared that they &ould lose s'illed labour" )ther combinations of interested $roups also acted to prevent mar'ets operatin$ as freely as monetarists &ould &ish" The main tar$ets of monetarists after money supply &as to ma'e the labour mar'et more mobile by le$islatin$ a$ainst trade unions and to assist this by not aimin$ for full employment but havin$ an unemployment rate &hich encoura$ed the &or' force to relocate" They also attempted to 'eep the =ublic Sector 2orro&in$ +e#uirement to an absolute minimum so that the Government &as not competin$ for funds in the Money Mar'et &ith =rivate %ndustry and thus pushin$ up interest rates" =erhaps their most successful policy has been the one re$ardin$ mobility of labour" The U4 is certainly seen as an economy in &hich labour 'no&s that there is no lon$er <a Aob for life," This has been achieved by dere$ulatin$ the economy e$ in Transport" Summary U4 Governments have learned that bein$ either Monetarist or 4eynesian is not really appropriate" 2oth have turned out to put Government Economic =olicy into <StraitAac'ets, from &hich it is difficult to escape" E#ually $overnments have learned that upon &innin$ elections s&itchin$ s&iftly from one approach to the other has been neither efficient nor effective" =erhaps the best e-ample of this is that &hen the ?abour Government came to po&er in 1KKL it decreed that it &ould live &ithin the medium term bud$etary restrictions, &hich the previous $overnment had indicated &ould be its strate$y" The private sector &as clearly relieved that there &ould be no very lar$e increase in $overnment spendin$"
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Section $ 5 &he Scottish (conomy

E-amine the differences in economic policy bet&een the U4 Government and the devolved Scottish Government : the Scottish E-ecutive" Sources : U4 7ear 2oo's and the )ffice for 1ational Statistics" The Government elected in 1KKL had pled$ed devolved Government for Scotland and >ales" The Scotland Act of 1KKI created the form of Government, &hich &as to be established in 1KKK" This set up the Scottish =arliament, the Government body &as named the Scottish E-ecutive" )nly certain areas &ere devolved and then not al&ays fully" The U4 Government reserved to itself, 3orei$n Affairs, Cefence and )verall Economic =olicy" Cevolved to the Scottish E-ecutive &ere Education, 0ealth, Trainin$ and most aspects of 0ome Affairs, e$ the ?e$al frame&or' and =olice" The Annual 2ud$et for the Scottish E-ecutive comes in the form of a 2loc' Grant from the U4 Treasury" 3or the 7ear .55/*6 it is G.."I 2illion and is scheduled to rise to G.J 2illion for the year .55@*J" The only other maAor source of revenue for the Scottish E-ecutive comes from the collection of 2usiness +ates" The 2loc' Grant is currently the source of discussion bet&een the U4 Government and the Scottish E-ecutive" The fundin$ is based on the 2arnett 3ormula established prior to the settin$ up of the Scottish =arliament, &hen it &as established the Scottish population &as close to 15D of the U4 population" 0o&ever as Scotland,s population has remained relatively static the U4 population has $ro&n" This means that the Scottish population is no& Aust over ID of the U4 total" %n 1KKK the Gross Comestic =roduct in Scotland &as GJ6"K 2illion and by .551 this had risen to GJK". 2illion" %t has al&ays been difficult to tease out the economic details of Scottish fi$ures from the U4 fi$ures, but there are a number of fairly constant differences" Gro&th in Scotland has traditionally been lo&er than that of the U4 as a &hole" Burrently, Peremy =eat, the +oyal 2an' of Scotland,s Bhief Economist is forecastin$ a $ro&th rate of ."ID for the Scottish Economy in .556*@" U4 economic forecasters e$ the %TEM or$anisation, usin$ the same model as the U4 treasury, is predictin$ /9/"@D for the U4 economy for the same period"
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%n unemployment too Scotland has traditionally la$$ed behind the U4" The current fi$ure for unemployment in the U4 is @D and for Scotland it is @"JD" =art of the reason for this is that until recently a lar$e part of the Scottish Economy &as based on Manufacturin$" This is rapidly chan$in$Q some 66D of Scottish Aobs are no& in the Service Sector as a$ainst 16D in Manufacturin$" Also risin$ fairly rapidly is employment in the 3inancial Sector, &hich no& employs around 1JD of the Scottish &or'force" An area &here Scotland has al&ays been seen to do very badly is 0ealth" +ecently Scotland &as su$$ested as havin$ the &orst 0eart Cisease rates in the &orld; Statistics from other 0ealth areas su$$est e#ually poor fi$ures e$ asthma, cancer etc" 0ousin$ is yet another area &here Scotland is attemptin$ to catch up &ith the rest of the United 4in$dom" The proportion of =rivate to =ublic 0ousin$ has been lo& and you &ill no doubt be a&are that this &ill have an effect on =ublic E-penditure as =ublic 0ousin$ is provided by ?ocal Authorities &ho are funded lar$ely from the E-ecutive" Education is an area &here Scotland has a reputation for hi$h standards and &ould &ish to be seen to be increasin$ e-penditure in that area" The Scottish E-ecutive has seen as its tas' to tac'le these areas specifically to brin$ them into line &ith U4 fi$ures or even better them!" Unemployment can of course lin' into the other areas of 0ousin$, 0ealth and Social Security" Tac'lin$ it can involve dealin$ &ith the areas above but also provide fundin$ for e-ample for Trainin$ and ?earnin$" =roportionally therefore the Scottish E-ecutive is spendin$ more in these areas than the U4 Government, because it has to"
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0ere are some aspects dra&n from the .5559.551 2ud$et of the Scottish E-ecutive" =rovision of 1ursery places for all 6 year olds and tar$ets to do so for all / year olds G1J million to cut class si8es to /5 for the seven and under G.K million to increase number of 3urther Education Students Establish 10S Cirect )ne Stop Blinics and Electronic Appointment Systems Establish a Cru$s Enforcement A$ency More +efu$e spaces for Comestic Fiolence Fictims =roposal for t&o 1ational =ar's %mprovements in livin$ conditions for lo& income house holders particularly =ensioners 3ive maAor trun' road schemes costin$ G165 million over / years
!ote The Scottish E-ecutive also claims it has $one further than the U4 Government in fundin$ free personal care for the elderly"
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1 1
%n &hat areas does the e-penditure of the Scottish E-ecutive differ from that of the U4E Su$$est &hy this mi$ht be necessary"
101
Additional ,eadin0 +aterial

(lectronic ,esources and the Internet 0ere are some useful subAect $ate&ays &hich can be accessed via the %nternet" Ai@*(d http:**bi8ed"ac"u'* %nternet +esources Gate&ay coverin$ business and economics related subAects Au"l 1in3 Ausiness http:**lin'"bubl"ac"u'*business* The $ate&ay to 2usiness resources on the %nternet Au"l 1in3 +ana0ement )nline Mana$ement resources http:**lin'"bubl"ac"u'*mana$ement*
Pina3es http:**&&&"h&"ac"u'*lib>>>*irn*pina'es*pina'es"html =rovides lin's to most of the maAor %nternet SubAect $ate&ays Ausinessed http:**&&&"businessed"net* Bontains &ee'ly business and company ne&s plus archive Sosi0 http:**&&&"sosi$"ac"u'*&elcome"html The Social Sciences $ate&ay to information on the %nternet" Bontains sections on 2usiness and Mana$ement AAC Ausiness %nformation from the 22B /uman ,esources )nline version of the ma$a8ine http:**ne&s"bbc"co"u'*1*hi*business* http:**&&&"humanresourcesma$a8ine"com
,esource .isco#ery !et:or3 http:**&&&"rdn"ac"u'* ?in's to %nternet resources on a variety of topics includin$ 2usiness
102
)ther >ebsites that may be helpful include: &&&"ban'ofen$land"co"u' &&&"treasury"$ov"u' &&&"tutor.u"net Encyclopaedias are also useful reference sources" Bandidates must 'eep up to date both &ith current economic trends but also the predictions bein$ made by economists re$ardin$ the future" Bandidates should therefore be readin$ the financial pa$es of the #uality ne&spapers and $leanin$ information from ma$a8ines such as <The Economist,"
103
7 Solutions to Self5Assessed Questions and Acti#ities

Ans:er to Acti#ity 1
Althou$h house prices are no lon$er part of the inflation measurement they demonstrate some economic fundamentals" 3irstly they sho& that &hen there is $reater demand then supply prices &ill rise" They also demonstrate that &hen an economy is performin$ &ell and interest rates are historically lo& consumers are prepared to ta'e on fairly lar$e debts"
4i%ed costs Salaries +ent Machinery ?aria"le costs >a$es +a& Materials =o&er %nterest
Ans:er to Acti#ity
Total Bost is derived by addin$ 3i-ed and Fariable Bosts" Mar$inal Bost is the cost of addin$ one e-tra unit to output" Mar$inal +evenue is the $ain from sellin$ one unit more"
Ans:er to SAQ 1
Total Bost &ill rise because Fariable Bosts &ill" Avera$e Bost is li'ely to fall because 3i-ed Bost &ill be smaller per unit" Mar$inal Bost may rise or fall dependin$ upon #uantity increase"
104
Ans:er to Acti#ity $
2ecause it &ill not be able to obtain the necessary increase in production to meet an increased demand"
Ans:er to SAQ 2
%nternally is to $ro& by ma'in$ better use of factors of production or by increasin$ ran$e of products" E-amples mi$ht be Tesco,s or Asda or any firm, &hich you 'no& to be e-pandin$" Externally is to grow by means of Mergers, Amalgamations or Takeovers. It is interesting that at this time a very well known UK entrepreneur, Phillip Green, is trying to raise sufficient finance to make a bid to takeover Marks and Spencer. Financial press speculation is that he will need to find some 9 Billon. Example of a merger might be Chevron/Texaco.
Ans:er to Acti#ity '

Cesire to achieve economies of scale" Cesire to attain $reater mar'et share" Greater security in the mar'et place by e-tendin$ ran$e of products and mar'ets"
Ans:er to Acti#ity 7ou could also su$$est )il %ndustry, Electricity Suppliers, Tyre Suppliers, Tobacco Bi$arettes!"
105
Ans:er to SAQ
Perfect Competition Many buyers and sellers 3reedom of entry and e-it 0omo$enous products =erfect 'no&led$e 2uy or sell any amount 1o control of price +onopoly )ne supplier 1o substitutes Supplier can control price Bannot control demand Ban decide &hat output to produce Ban ma'e abnormal profit Oli0opoly 3e& suppliers 2rand differentiation 0eavy advertisin$ =rice ri$idity +educin$ prices may lead to price &ars
7ou hopefully &ill have found e-amples from &ithin the unit and the sources su$$ested"
Ans:er to SAQ $
?imited numbers of buyers and sellers : sometimes very fe&; May be restricted entry : barriers erected; Governments may restrict entry or erect tariffs" 4no&led$e on part of buyers or sellers may be limited" Amounts may be restricted because of physical aspects or deliberately limited to 'eep prices hi$h" Some firms may try to monopolise production" Monopoly )ne seller )ne commodity 1o substitute Bontrol of all aspects relatin$ to $ood or service )li$opoly 3e& sellers and buyers Ban earn super profits Ban erect barriers to entry May use non9price competition
Earlier you identified that avera$e revenue e#uals price" 7ou also identified that the price at &hich a unit sells contains an element of profit" Therefore profit &ill continue to be earned until avera$e revenue and avera$e cost become e#ual"
106
Ceman d =rice Total +evenu e I5@ II5 K6@ 1555 156@ 15I5 115@ 11.5 11.@ 11.5 L@ J@ @@ 6@ /@ .@ 1@ @ 9@ Mar$inal +evenu e Total Bosts Avera$ e Bosts K"L K". I"L I"/ L"K L"@ L"/ L". L"6 L"I @@ @5 6@ 65 /@ 6@ J@ K5 1/L Mar$in al Bosts =rofi t
L5 I5 K5 155 115 1.5 1/5 165 1@5 1J5
11"@ 11 15"@ 15 K"@ K I"@ I L"@ L
JLI L// LI/ I.I IJI K5/ K6I 151/ 115/ 1.65
1.L 16L 1J. 1L. 1LL 1LL 1@L 15L .. 91.5
Ans:er to SAQ '

1" ." /" <Satisficin$ 2ehaviour," Those responsible &ithin or$anisations and firms 'no& they could do better but they and o&ners shareholders! are satisfied &ith &hat is achieved" Social +esponsibility : %nterest Groups need to be considered e$ Bonsumers, >or'ers, Environmentalists, ?ocal +esidents, Shareholders" Ma-imise Gro&th to obtain &hat is seen as best <mi-, of benefits for sta'eholders"
107
Ans:er to Acti#ity 1=
4rictional ?ac' of mobility Time to train Time to learn ne& s'ills
Cyclical 3ollo&s the trade cycle Bommon in depressions +ises as economy shrin's
Structural Bhan$es in economy )ld industries die 1e& %ndustries need time to $ro& May include some frictional and cyclical aspects"
Ans:er to SAQ Ban use Cemand9Side or Supply9Side policies or both" .emand2Side 4iscal %ncrease $overnment e-penditure Cecrease ta-ation Supply5Side 4iscal 2alance bud$et +educe ta-ation +onetary Policies +estrict supply of money Gro& money supply at same rate as $ro&th of economy +educe costs of money %nterest rates! +onetary Policies +educe interest rates Assist ban' lendin$ +educe 0= restrictions
108
109
Ans:er to SAQ 7
.emand Pull Inflation Unemployment is caused by a rise in a$$re$ate demand, &hich outstrips a$$re$ate supply, and this forces prices up" 1ote : it is su$$ested that this mi$ht occur in a period of time &hen there is full employment because labour feels it can press for &a$e increases &ithout fear of unemployment" Cost Push Inflation Unemployment is caused by a rise in the costs of production" May be &a$es or ta-ation rises or increased material costs" E-chan$e rates may play a part in pushin$ up prices, as may industries pushin$ for hi$her prices to increase profits"
%ncrease Government Spendin$ +educe Ta-ation But %nterest +ates 0elp ban's to lend 3ree up 0ire =urchase"
110
Ans:er to SAQ 8
Geynesian ?ie: %nflation is caused by a$$re$ate demand e-ceedin$ a$$re$ate supply" %t is then up to the Government to mana$e these t&o areas" %n the case of inflation by: 4iscal Policy +educe Government Spendin$ %ncrease Ta-es +onetary Policy %ncrease %nterest +ates Bontrol 2an' ?endin$ %mpose 0= +estrictions
+onetarist ?ie: There is too lar$e a supply of money in the Economy" This needs to be reduced by: 4iscal Policy 2alance the 2ud$et no deficits, no surpluses! Co not counter cyclical aspects +educe %nflation +onetary Policy +educe Money supply 4eep money supply $ro&th slo& and steady
111
3ood Blothes Motorin$ Sport and ?eisure Entertainment 0oliday 0ouse maintenance +ent and +ates 0ealth and Education
Ban you avoid ta-ation on any of theseE
Ans:er to Acti#ity SAQ 9

+educe spendin$ e$ Cefence, Transport, Employment" Bould increase ta-es, direct or indirect" %f he does this he may affect U4,s ability to defend itself, affect producers of military e#uipment, create $reater bloc'a$es in road and rail systems and force people out of &or' &here they need to be supported by Social Security System" %f unemployment rises then those forced out of &or' &ill no lon$er be ta-ed" This could force Bhancellor to raise ta-es a$ain"
112
Ans:er to Acti#ity SAQ 1=

Social Security 6ood Points =rovides a safety net for unemployed 1o one should have 8ero income Ban assist those &ho 'no& they have to move Allo&s people to still be consumers Ban protect families May help people not to fall into hands of unscrupulous .efence 4eeps up hi$h level of technolo$y 4eeps firms in business Transfer of 'no&led$e to industry 0elps =ersonal Cevelopment ?ar$e employer =rofessional ima$e 2ases help re$ional areas /ealth Ser#ices 0elp increase ho& lon$ people live %mprovement in patient treatment 1e& technolo$y Shorter time for in9patients %mproved services (ducation %mprovement in s'ills Greater spread of provision Bover broader population sector Education for life Focational areas important %mprovement in 'no&led$e %s money &ell spentE =roductivity is not increasin$; %s Education ta'in$ finance a&ay from other areasE Are &ell9educated movin$ to more prosperous areas or abroadE %nefficiency 2ureaucracy >aitin$ lists Falue for money Ta'es funds from other areas Spendin$ may not be &ell controlled May have adverse effects on ima$e abroad Aad Points May create a lac' of mobility Some may learn to live &ith <benefits, May remove finance from more efficient use May cause friction =eople may refuse to accept lo& paid Aobs
113
Ans:er to SAQ 11
There is $enerally $reater e-penditure on 0ealth, Social Security, 0ousin$, Trainin$ and Education" These are devolved areas and they are, apart from Education, the areas in &hich the Scottish Economy is seen to function poorly"
114
Copyri0ht ,eferences
All materials in this $uide are author,s ori$inals
9 Ac3no:led0ements
SQA $ratefully ac'no&led$e the contributions made from the Scottish 3urther Education Sector in the authorin$, editin$ and publishin$ of this material"
115

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Economics 1: Micro and Macro Theory and Application Unit Student Guide

Scottish Qualifications Authority

Section $ 5 &he Scottish (conomy

Additional ,eadin0 +aterial Solutions to Self5Assessed Questions and Acti#ities

Scottish Qualifications Authority

Copyri0ht ,eferences Ac3no:led0ements

1 Introduction to the Scottish Qualifications Authority

Scottish Qualifications Authority

Introduction to the Unit

What are the Outcomes of this Unit?

What do I !eed to "e A"le to do in Order to Achie#e this Unit?

Scottish Qualifications Authority

Appro%imate Study &ime for &his Unit

The nominal study time for this Unit is 65 hours"

()uipment*+aterial ,e)uired for this Unit

Scottish Qualifications Authority

Sym"ols Used in this Unit

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Scottish Qualifications Authority

Assessment Information for this Unit

Scottish Qualifications Authority

Su00ested 1esson Plan

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. hours . hours 1 hour

' 1earnin0 +aterial

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Scottish Qualifications Authority

Scottish Qualifications Authority

Scottish Qualifications Authority

Costs of Production 2 Classification of Costs

Scottish Qualifications Authority

Scottish Qualifications Authority

Scottish Qualifications Authority

Scottish Qualifications Authority

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Scottish Qualifications Authority

Scottish Qualifications Authority

Therefore Mar$inal Bost H G15

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Scottish Qualifications Authority

Scottish Qualifications Authority

Scottish Qualifications Authority

input of one more factor of production in this case labour!"

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Chec3 your ans:ers in section 7 2 Solutions to Self Assessed Questions and

Scottish Qualifications Authority

Scottish Qualifications Authority

Chec3 your ans:ers in section 7 2 Solutions to Self Assessed Questions and

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Scottish Qualifications Authority

Costs of the 4irm 2 Short ,un and 1on0 ,un

Mar'et =roducers 3actor =rices Bonsumers

Scottish Qualifications Authority

Scottish Qualifications Authority

Scottish Qualifications Authority

SAB 6! SAB 1! A A C Cost SAB .! SAB /! ?AB

Q Output .iseconomies of Scale

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point &here this no lon$er applies and costs be$in to rise"

Scottish Qualifications Authority

Scottish Qualifications Authority

Scottish Qualifications Authority

Scottish Qualifications Authority