TABLE OF CONTENTS

2
CHAPTER 1

Basic Economic Ideas And Resource Allocation

2
CHAPTER 2

The Price System & The Micro Economy

7
CHAPTER 3

Government Microeconomic Intervention

9
CHAPTER 4

The Macro Economy

15
CHAPTER 5

Macroeconomic Policies
 CIE A2-LEVEL ECONOMICS//9708
Refer to AS section 1.4 and 3.2 for A2 section 1.4 (Market
1. BASIC ECONOMIC IDEAS AND RESOURCE failure) and 1.5 (Externalities).
ALLOCATION
2. THE PRICE SYSTEM & THE MICRO ECONOMY
1.1 Efficient Resource Allocation
2.1 Utility
 Utility: is the satisfaction gained from consumption of a
product.
 Total utility: is the satisfaction gained from the
consumption of all units of a product over a particular
period of time.
 Marginal utility: is the satisfaction gained from the last
unit of a product consumed over a particular period of
time.
o Note: Consumers purchase products when 𝑷 ≤ 𝑴𝑼
o Individual demand curve = Marginal utility curve
 Law of diminishing marginal utility: states that as the
quantity consumed of a product by an individual
increases, marginal utility decreases.
 Equi-marginal principle:
𝑴𝑼𝑨 𝑴𝑼𝑩 𝑴𝑼𝑪
= = =⋯
𝑷𝑨 𝑷𝑩 𝑷𝑪
(True for rational individuals only)
 Limitations of marginal utility theory:
o Unit of measurement.
o Habit and impulse.
o Ceteris paribus
1.2 Social Costs & Benefits o Enjoyment may increase as consumption increases.
 Social cost/benefit: is total cost/benefit to whole society o Quality and consistency of successive units of product
due to an economic activity. (Social cost = Private consumed.
cost/benefit + External cost/benefit)  Note: Diminishing marginal utility → Kinked demand
 Private cost/benefit: is internal cost/benefit of an curve.
economic activity. Diminishing marginal rate of substitution → Kinked
 External cost/benefit: is 3rd party cost/benefit of an indifference curve.
economic activity.
2.2 Behavioral economics
1.3 Cost-Benefit Analysis  Behavioral economics: attempts to explain choices and
STEP ADVANTAGES DISADVANTAGES decisions by individuals particularly when they
Identification All cost/benefit Identification is contradict traditional economic theory, i.e. irrational
considered tough behaviour.
Monetary Most will have Shadow prices  Rational behaviour: is the assumption made in
evaluation market prices economics that individuals and firms will always carefully
Forecast Future Uncertainty in take into account marginal costs and benefits in making
consequences estimation decisions in order to maximize total utility with perfect
Interpretation All info. useful Bureaucracy information.
Decision making Investment projects Public expenditure

PAGE 2 OF 15
 CIE A2-LEVEL ECONOMICS//9708
 Note: Imperfect information, often caused by framing PRICE EFFECTS
(incorrect representation) leads to bounded rationality, Price Good Price effect (on Demand
so individuals have to resort to heuristics (mental change type demand) change
shortcuts) to take decisions. Fall Normal Both effects ↑ Rise
 These include: Sub. effect ↑ > In.
Fall Inferior Rise
o Anchoring effect ↓
o Availability Sub. effect ↑ > In.
Fall G/V Fall
o Representation effect ↓
 Other aspects of behavioral economics: Rise Normal Both effects ↓ Fall
o Endowment effect. Sub. effect ↓ > In.
o Loss aversion. Rise Inferior Fall
effect ↑
o Reference points. Sub. effect ↓ > In.
o Certainty vs. uncertainty. Rise G/V Rise
effect ↑
o Over-confidence.
o Too much choice. 2.4 Types of Cost, Revenue & Profit;
o Herd instinct & competition.  Profit: is the difference between total revenue and cost,
o Implications for policy. i.e. 𝑻𝑪 − 𝑻𝑬. It is of 2 types.
 Normal profit: is the amount of profit that can be
2.3 Indifference Curves & Budget Lines earned in the next most profitable enterprise, so just
 Marginal rate of substitution: is the quantity of one covers opportunity cost. 𝑻𝑹 = 𝑻𝑪
product an individual is prepared to give up in order to  Supernormal profit: is any profit in excess of normal
obtain an additional unit of another leaving the profit. 𝑻𝑹 > 𝑇𝐶
individual at same utility. It is diminishing.  Note: Payment to enterprise is normal profit.
∴ Total cost = Rent + Wages + Interest + Profit
 Production function: is the relationship between
quantity of inputs of factor of production and result
output over a time period.
 Isoquant: is a curve which shows a particular level of
output over a combination of inputs. It is similar to
indifference curve. Output refers to total physical
product.

 Substitution/Income effect: is the change in quantity

demanded of a product due to change in relative
price/real income.
 Price effect = Substitution effect + Income effect.
 Giffen/Veblen good: are goods whose price and demand
are directly related as they are necessary/luxurious.

PAGE 3 OF 15
 CIE A2-LEVEL ECONOMICS//9708
TYPES OF BUSINESS STRATEGIES EMPLOYED TO
STRUCTURES FULFILL AIMS
 Sole trade  Barriers to entry.
 Partnership  Improve quality & lower
 Private limited company price.
 Public limited company  Advertise.
 Takeover.

 Objectives: are standardized to profit maximisation.

 This may not be possible as:
o 𝑀𝐶 & 𝑀𝑅 difficult to calculate.
o Could encourage takeover.
o May encourage new entrants.
o May attract investigation by competition commission.
 Other objectives, such as:
 Note: In long-run there are no fixed/sunk costs. So, the o Growth
LRAC is a combination of a series of SRAC. o Revenue maximisation
 Note: o Sales maximisation
𝑴𝑷𝑷 𝑭𝒂𝒄𝒕𝒐𝒓 𝑨 𝑴𝑷𝑷 𝑭𝒂𝒄𝒕𝒐𝒓 𝑩 o Profit satisficing
𝐿𝑒𝑎𝑠𝑡 𝑐𝑜𝑠𝑡 𝑐𝑜𝑚𝑏𝑖𝑛𝑎𝑡𝑖𝑜𝑛 → = =⋯
𝑷 𝑭𝒂𝒄𝒕𝒐𝒓 𝑨 𝑷 𝑭𝒂𝒄𝒕𝒐𝒓 𝑩
o Managerial utility maximisation
Economies of scale Diseconomies of scale o Survival
 Technical  Lack of communication o Loss minimisation
 Financial  Demotivation o Ethical responsibilities
 Managerial  Alienation o Strategic monopolization
Internal

 Marketing  Slack management (X-  These other objectives are due to divorce of ownership
 Purchasing inefficiency) and control, causing the principal-agent problem of
 Risk-bearing  Non-flexibility conflicting interests of managers & shareholders.
 Increased dimensions  Labour disputes &  The organizational slack gives rise to X-inefficiency, but
 Economies of scope turnover strict AGMs (annual general meetings) can prevent this.
 Transport
 Concentration
2.6 Growth & Survival of Firms
External

 Competition for inputs  Growth: of firms is a key objective of managers as their

 Knowledge
 Congestion salaries and status are directly related to size of firm.
 Ancillary industries
 Pollution  Survival of small firms:
 Specialised labour
o Low startup costs. o Full ownership and
 Reputation
o Small niche markets. independence.
 Revenue:
𝑻𝑹 ∆𝑻𝑹
o Personalised services. o Provide employment.
𝑻𝑹 = 𝑷𝑿𝑸 𝑨𝑹 = 𝑴𝑹 = ∴ 𝑨𝑹 = 𝑷 o Government support. o Are flexible.
𝑸 ∆𝑸
o May grow. o Good labour relations.
2.5 Differing Types of Business Structures & o Act as ancillary firms. o Training for labour &
their Objectives enterprise.
 Firm: is a business which hires factors of production to o Combine with other
produce goods and services. firms
 Industry: is a group of firms producing similar goods and
services.

PAGE 4 OF 15
 CIE A2-LEVEL ECONOMICS//9708
 Lack of variation – limits consumer choice.
 Unable to take advantages of economies of scale.
 Shutdown – Short run: 𝑷 = 𝒎𝒊𝒏. 𝑨𝑽𝑪, Long run: 𝑷 =
𝒎𝒊𝒏. 𝑨𝑪
 Acts as efficiency benchmarks for other market
structures.

Monopolistic competition:
 Many firms – low concentration ratio
 Price makers – 𝑨𝑹 > 𝑀𝑅
2.7 Different Market Structures
 Heterogeneous, i.e. differentiated products – 𝑷𝑬𝑫: −𝟏
 Market structure: is the way in which a market is
to −∞
organized in terms of the number of firms and the
 Excess capacity – Industry should have fewer & larger
barriers to the entry of new firms.
firms.
• Perfect Many firms, no barriers.  Low startup costs – Permits entry and exit.
competition:  Allows short run profits & losses to be offset.
• Monopolistic Many firms, few barriers.  Nonprice competition – advertising, branding, packaging,
competition: servicing.
• Oligopoly: Few firms, high barriers.  Normal profits in longrun – 𝑨𝑪 = 𝑨𝑹
• Monopoly: One firm, very high barriers.  Inefficient – Allocative: 𝑴𝑪 < 𝐴𝑅, Productive: 𝑴𝑪 >
 Imperfect competition: is any market structure except 𝐴𝐶.
perfect competition.
Oligopoly:
 Concentration ratio: is the proportion of a market’s
 Few firms – high concentration ratio
output controlled by the largest firms.
 Mixture of price takers and price makers (leaders).
Perfect competition:  Barriers to entry – excess capacity.
 Many buyers and sellers – low concentration ratio.  Abnormal profits in long & short run – 𝑨𝑹 > 𝐴𝐶
 They are price takers – no preferential treatment.  Inefficient – Allocative: 𝑨𝑹 > 𝑀𝐶, Productive: 𝑴𝑪 >
(𝑨𝑹 = 𝑴𝑹) 𝑀𝐶.
 Perfect knowledge – of prices & profits.  Mutually interdependent – kinked demand curve.
 Homogenous product – no product differentiation  Knowledge – of competitions – maybe collusion – by
𝑷𝑬𝑫 = ∞ cartels.
 No barriers – free entry and exit.  Price stability/rigidity – fear of price war.
 No transport costs – perfect factor mobility.
Monopoly:
 Same technology for all firms.
 Pure (single)
 Normal profits in long run.
(𝑴𝑪) = (𝑨𝑪) = (𝑴𝑹 = 𝑨𝑹 = 𝑷)  Legal (SOE)
 Short run abnormal profits or losses offset by hit & run  Natural (competition winner)
competition.  Dominant (40%+ share)
o Efficient – Allocative: 𝑴𝑪 = 𝑨𝑹,  Price maker – 𝑨𝑹 > 𝑀𝑅 – 𝑷𝑬𝑫: 𝟎 to −𝟏, so, no
Productive: 𝑴𝑪 = 𝑨𝑪 substitutes.
o Low prices and high quality.  Excess capacity – productive inefficiency.
o Lots of suppliers – cost reduction. 𝑴𝑪 = 𝑺
o Responsive to changes in demand due to flexibility.
 High turnover for firms – creates uncertainty.
 Lack of research – innovation is copied.
PAGE 5 OF 15
 CIE A2-LEVEL ECONOMICS//9708
2.8 Detailed Properties of Ogligopolies & 𝑷 ↓, 𝑷𝑬𝑫 ↓ & 𝑷 ↑, 𝑷𝑬𝑫 ↑
Monopolies

 Types of oligopolies:
1. Perfect → Homogeneous goods.
2. Imperfect → Differential products.
 Note: Kinked demand curve model ignores non-price
competition.
 Non-price competition:
o Sponsorships.
o Post-sale services.
o Branding.
o Advertisement.
o Research & development.
o Credit arrangements.
o Packaging.
o Lotteries.
o Free gifts.
 Collusion: is mutual agreement on price & output fixing.
o Illegal.
o Risk govt. investigation.
o Cheating may break it.
o Unpopular with consumers.
o Information cost.
o Cost differences.
Public monopoly Private monopoly o Product differences.
Predatory o High profits may attract new firms.
𝑴𝑪 pricing 𝑨𝑹 = 𝑴𝑪 𝑨𝑹 = 𝑷𝑿  Barriers to entry:
pricing
Normal Abnormal o Location o High sunk costs
𝑨𝑹 = 𝑨𝑪 𝑨𝑹 > 𝐴𝐶 o Brand loyalty o High fixed costs
profits profits
o Control over resources o High minimum efficient
Productive Spare
𝑨𝑪 = 𝑴𝑪 𝑨𝑪 > 𝑀𝐶 o Patents scale
efficiency capacity
o Legislation o Restrictive practices
 Mutual interdependence: is a characteristic of o Economies of scale o Limit pricing
oligopolistic markets where firms are anticipative
reactions of rival firms to their actions.
So, in fear of losing customers due to price war, firms
keep prices stable, giving rise to the kinked demand
curve where

PAGE 6 OF 15
 CIE A2-LEVEL ECONOMICS//9708
 Monopoly: o Short run – abnormal profit, but long run – normal
ADVANTAGES DISADVANTAGES profit.
o Lower costs due to o Higher prices due to o No sunk costs, i.e. non-recoverable entry costs.
economies. diseconomies.  Note: The potential threat to ogligopolies and
o R&D to gain protected o Less R&D as no monopolies from contestable markets forces them to
profits. pressure. benefit consumers more than what perfectly
o Avoids wasteful o Less consumer surplus competitive markets would.
duplication. & choice.
o Can compete against o Irresponsive to 2.9 Game Theory
MNCs changes in demand.  Game theory: is the analysis of strategies and decision-
 Deadweight loss: is reduction in consumer surplus when making by rational players in any activity or situation in
a monopoly restricts output and raises price. which those involved know their decision will have an
 Price discrimination: is the practice of selling some impact on other players and the way their reactions will
product in different markets at different prices. affect the original decision.
o 1st degree: each consumer pays maximum prepared  Zero-sum game: is one of pure conflict in which player’s
to. gain will equal other players’ loss.
o 2nd degree: different prices for successive blocks of  Prisoner’s dilemma: is a competitive situation in which
consumption. attempts by 2 players to find best strategy for their own
o 3rd degree: different group of consumers pay
selves by acting independently, results in a worse final
different prices.
outcome than if they had colluded.
 Conditions:
 Two-player pay-off matrix: is a table showing the
o Market separation
o Price maker outcomes (pay-offs) for 2 players of their respective
o Different 𝑃𝐸𝐷s strategies or decisions.
o Arbitrage impossible  Maximin strategy: is a conservative strategy chosen by a
 Issues: player which provides best of worst possible outcomes
o Deadweight/welfare loss. of a decision.
o Some pay higher/lower.  Maximax strategy: is an aggressive strategy chosen by a
o Higher revenue & profits. player which provides the best of the best possible
o Affordability & income equality increased. outcomes of a decision.
o Profits finance research.  Dominant strategy: leads to best possible outcome for a
o Some paying higher benefits all. player irrespective of strategy adopted by other player.
 Price leadership: is a situation where a  Nash equilibrium: is a solution in a non-cooperative
dominant/accurate firm changes its price and others
situation in which each firm’s best strategy is to maintain
follow. It is informal collusion, cartel is formal.
its present behaviour.
 Limit pricing: is adopted by monopoly/oligopoly to deter
new entrants by setting prices below max. profit. 3. GOVERNMENT MICROECONOMIC
 Predatory pricing: is adopted by monopoly/oligopoly to INTERVENTION
force competitions out of market thereby exploit
monopoly power by setting prices well below average 3.1 Policies to Achieve Efficient Resource
cost. Allocation & Correct Market Failure
 Contestable markets:  Prohibition: is banning of a certain product from a
o No barriers to entry – threat of competition. country.
o Pressure removes organizational slack, preventing X-  License: is a restricted permission to supply a product in
inefficiency. an economy, by the government.

PAGE 7 OF 15
 CIE A2-LEVEL ECONOMICS//9708
 Property rights: ensure owners of economic goods have 3.3 Labour Market Forces & Government
a right to decide how such assets are used. Intervention
 Pollution permit: is a license for a firm to bring about a
reduction in the level of pollution over a period of time. Labour demand conditions Labour supply conditions
 Information:  Demand/price of product.  Population size & structure.
o helps utility maximization by ensuring rational  Training/education/skill.  Labour force participation.
decisions.  Productivity.  Taxes and benefits.
o prevents market failure concerning merit & demerit  Restrictive practices.  Migration.
goods. 𝑷𝑬𝑫𝑳 conditions 𝑷𝑬𝑺𝑳 conditions
 Nudge theory: is an attempt by a government to alter  Proportion of labour costs  Occupational &
the economic behaviour of people in some way. to total cost. geographical mobility of
 Regulating bodies: are organisations that are set up to  Factor substitution. labour.
enforce particular policies and regulations in an  𝑷𝑬𝑫 of product.  Unemployment.
economy, especially about monopolies, environment,  Time.  Time.
consumer & transportation.  Demand for labour is derived from the final good or
 Efficiency: is the most economic use of resources. service it contributes in producing.
Derivation: Wage=MC labour MR labour=MRP
3.2 Equity & Policies Towards Income & Equilibrium: MC labour=MR labour Wage=MRP
Wealth Redistribution
 Equity: is idea of justice, in terms of distribution of  MRP (Marginal revenue product): is the extra output
output. produced by an additional worker (MPP, i.e. Marginal
 Redistribution of income and wealth: is a government physical product) multiplied by additional income
policy which involves taking money from wealthier earned by firm from this output. (MR)
members of an economy through taxation and giving to  Note: Demand curve for labour is MRP curve.
the poor by benefits.  Pecuniary advantages: are monetary rewards obtained
 Inheritance tax: is paid on value of inherited property. in a particular occupation, e.g. salary, wage, bonus,
 Capital tax: is paid on increase in resale value of asset. overtime, etc.
 Tax credit: is a payment from a government to a unit  Non-pecuniary advantages: are non-monetary rewards
that is dependent on low income. obtained in particular occupation, e.g. status, fringe
benefits, working conditions, flexible hours, holiday
length, job satisfaction, ease of transport, in-service
training, etc.
 Net advantages: are overall advantages to a worker of
choosing one job over another. It includes both
pecuniary and non-pecuniary advantages.

PAGE 8 OF 15
 CIE A2-LEVEL ECONOMICS//9708
 Wage differentials:  Closed shop: is when employment in an industry is not
o Personal: Age, qualifications, experience, skills, hours possible without trade union membership.
worked.  Collective bargaining: is a process of negotiation
o Firm: Factor mix, profitability, non-pecuniary between trade union and employer representatives.
advantages.  Arbitration: is involvement of 3rd party seeking to reach
o Geographical: Different mix of industries, mobility agreement.
affected by social ties and housing.  Bases of bargains:
o Occupational: 𝑀𝑅𝑃, strength of trade unions & o Living cost.
employers, mobility affected by qualifications and o Comparability.
skills. o Profitability.
ADVANTAGES DISADVANTAGES o Productivity.
 Encourage employers  Unemployment.  Governments may seek to influence wages by income
to train labour, raising  Wage-cost spiral policies, regulations against gender discrimination,
productivity. causing inflation. public sector wages and rational minimum wage.
 Reduce poverty.  Reduction in  It aims to reduce poverty and counterbalance
 Raise employment by international monopsony power but problems are faced in setting its
increasing 𝑨𝑫. competitiveness. rate and enforcing it on industries where profits are low
 Motivates workers. or competition is fierce.
 Enable firms to  Note: All government policies are set counter-cyclically
compete on equal to the business cycle to offset effects.
terms.
 Monopsionist: is sole buyer, in a market.
4. THE MACRO ECONOMY
∴ 𝑾 ≠ 𝑴𝑹𝑷
4.1 Economic Growth, Development &
𝑾 = 𝑴𝑹𝑷 − (𝒔𝒉𝒂𝒅𝒆𝒅 𝒂𝒓𝒆𝒂)
Sustainability
 Economic growth: is increase in national output of an
economy over a period of time, calculated by changes in
𝑮𝑫𝑷.
o Actual economic growth: is an increase in real
𝑮𝑫𝑷 shown by outward shift of production point on
𝑷𝑷𝑪 𝒂𝒏𝒅 𝑨𝑫 shifting right with space capacity.
o Potential economic growth: is an increase in
productive capacity shown by rightward shift of 𝑷𝑷𝑪
and 𝑨𝑺.
 Trade unions: are organisations of workers active in  Economic development: is an increase in welfare and
protecting member interests, such as: (even provide quality of life.
training)  Sustainable development: ensures that needs of the
o Wages and pay differentials between skilled & present generation can be met without compromising
unskilled. well-being of future generations.
o Working conditions and safety.  Economic growth factors:
o Job security and nonpecuniary benefits. o Increased mobility & flexibility
 Their strength is determined by: o More efficient allocation
o Level of employment. o New export markets
o Size and proportion of membership. o Corporate tax reduction
o 𝑃𝐸𝐷 of final product. o Upturn in business cycle
o Industrial action, e.g. overtime bans, work to rule & o Increase in labour force
strikes.
PAGE 9 OF 15
 CIE A2-LEVEL ECONOMICS//9708
o Labour quality improvement Problems involved in making comparisons
o More research & development  Price changes (inflation adjustment)
o Technological advances  Population changes (per capita adjustment
o Net investment in capital stock  Shadow economy

over time
o Capital-intensive production  Working hours and conditions
 And everything that shifts 𝑨𝑫 & 𝑨𝑺 to the right.  Externalities
BENEFITS COSTS  Distribution of income
 Higher living standards  Opportunity costs of  Product quality
 Poor gain without forgone consumer goods  Labour & capital balance
income redistribution  Pollution

 Reduced cyclical
unemployment
 Greater international
power
 Increased tax revenue
between countries
 Depletion of resources
 Stress  Different currencies (Use purchasing power parity)
 Structural  Different tastes
unemployment  Different climates
 Differences in accuracy.

 Exploiting resources:
o Increase employment, output, income and tax
revenue.  National debt: is amount of money government & public
o Improve trade position and living standard. sector owes domestically and abroad accumulating over
o Develop other industries using income. a number of years.
 Conserving resources: o It increases during economic downturns & military
o Prevent reduction in quantity & quality of resources conflicts.
sustaining development. o Opportunity cost of tax revenue.
o Avoid over-dependence. o Balance of payments deficit.
 Exploit resources when: o Debt burden on citizens.
o Poor and in debt. o Caused by budget deficit.
o Have comparative advantage. Measurable economic Human poverty index:
o Have current world demand. welfare: -Longevity
-Real GDP per capita -Adult literacy
4.2 National Income Statistics -Leisure time -Deprivation
 National income: is total income of an economy over a -Unpaid work Multidimensional poverty
given period of time. -Depletion of natural index:
THE STATISTICS ARE USED THE METHODS USED TO resources -Replaced HPI in 2010.
TO: CALCULATE THESE ARE: -Changes in development -Child mortality & nutrition
 Calculate economic  Output Human development index: -Schooling & attendance
growth.  Income (excluding -Life expectancy -Electricity, water,
 Make international transfer payments) -Per capita 𝐺𝑁𝐼 sanitation, fuel, flooring &
comparisons.  Expenditure: -Years of schooling assets
 Formulate economic (+) – exports, subsidies
policy. (−) – imports, taxes

𝑮𝑫𝑷 = Total domestic income − imports

𝑮𝑵𝑷 = 𝐺𝐷𝑃 + net foreign property incomes
𝑮𝑵𝑰 = 𝐺𝐷𝑃 + primary foreign incomes
𝑵𝑵𝑷 = 𝐺𝑁𝑃 − depreciation (fall in value of capital)
𝑵𝑫𝑷 = 𝐺𝐷𝑃 − depreciation
PAGE 10 OF 15
 CIE A2-LEVEL ECONOMICS//9708
4.3 Classification of Countries 4.4 Employment/Unemployment
 Developing economy: has low 𝐺𝐷𝑃 per head.  Labour force: is all the people eligible of working in a
 Developed economy: has high 𝐺𝐷𝑃 per head. country, employed and/or receiving unemployment
 Emerging economy: has rapid growth rate providing benefits.
good investment opportunities, e.g. BRIC, MINT, etc.  Participation rate: is the proportion of population either
 Dependency ratio: is the proportion of economically employed or officially registered as unemployed.
inactive to labour force.  Working population: are the people willing and able to
 Optimum population: maximizes GDP per head. work.
 Infant mortality rate: is the no. of deaths of infants  Size of labour force depends on:
below one year old in a given year per thousand live o Population size o Availability and value
births. o Birth rate of unemployment
 Natural increase: is the difference between: o Death rate benefits
 Birth rate (no. of live births per thousand population per o School leaving age o Attitudes to working
year) & Death rate (no. of deaths per thousand o Retirement age women
population per year) o No. of people in post- o State of economy
 Migration: is the difference between: school education
 Immigration (people coming into country) & Emigration
(people leaving country)  Labour productivity: measures efficiency of labour in
 Population structure: shows population of a country by terms of output per person per period of time. It is
age and gender in a pyramid. affected by:
Characteristics of developing economies o Education o Technical knowledge
 High national increase  Employment in primary o Skills o Level of capital available
 Population above optimum sector o Training o Working methods & practices
 More young people than  Exports of narrow range of o Experience o Motivation
old goods
 High dependency ratio  Rural-urban migration  Unemployment: is a situation that occurs when people
 Low incomes  Net emigration are able and willing to work but, are unable to gain
 High income inequality  High external debt employment.
 Dependent on developed ∴ 𝑼𝒏𝒆𝒎𝒑𝒍𝒐𝒚𝒎𝒆𝒏𝒕 𝒓𝒂𝒕𝒆
 Less working women
𝑵𝒐. 𝒐𝒇 𝒑𝒆𝒐𝒑𝒍𝒆 𝒖𝒏𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅
economies =
𝑾𝒐𝒓𝒌𝒊𝒏𝒈 𝒑𝒐𝒑𝒖𝒍𝒂𝒕𝒊𝒐𝒏
 Low quality of life. × 𝟏𝟎𝟎%
 Note: Unemployment rate may show a pattern affected
by the trade cycle.
 Full employment: is level of employment when
everyone (except frictionally unemployed (around 3%))
who is willing and able to work have a job.
 Natural rate of unemployment (𝑵𝑨𝑰𝑹𝑼): i.e. non-
accelerating inflation rate of unemployment is
unemployment rate at macroeconomic equilibrium
which prevents rate of inflation from rising.
 Note: NAIRU is shown on expectations augmented
Philips curve/long-run Philips curve/very long-run
aggregate supply curve of new-classical economists.
 Note: Emerging economies share some of these
properties, while developed economies have
characteristics contrasting to aforementioned.

PAGE 11 OF 15
 CIE A2-LEVEL ECONOMICS//9708
Policies to correct unemployment
Demand-side Supply-side
 Lower interest rate.  Cut unemployment
 Increase growth of benefit.
money supply.  Reduce income tax.
 Lower exchange rate.  Improve education &
 Reduce taxes. training.
 Increase government  Trade union reform.
spending.  Increase labour market
 Causes of Unemployment: information.
o Education o Technical knowledge
o Skills o Level of capital available 4.5 Circular Flow of Income
o Training o Working methods & practices
o Experience o Motivation
 Consequences of unemployment:
o Lost output o Lower incomes
o Lost skills o Hysteresis
o Lost tax revenue o More time to search
o Unemployment for job
benefit o Fewer strikes
o Outdated skills. o Less inflation
o Health problems o Easy recruitment  Circular flow of income: is a simple model of the process
 Claimant count: measures unemployment in terms of by which income flows around the economy.
unemployment benefit receipts.  Multiplier: is a numerical estimate of a change in
spending in relation to the final charge in spending. ∴
𝟏 ∆𝒀
Accuracy problems 𝒌 = 𝒎𝒑𝒘 = ∆𝑱
Includes Excludes  Open economies: conduct foreign trade, while
 Those not actively  Discouraged workers Closed economies: don’t conduct foreign trade.
seeking work  Partners of employed  Injections(𝑱): are money of outside circular flow of
 Those working in  Government trainees income that increases 𝐺𝐷𝑃, i.e. Investment(𝐼),
informal economy Exports(𝑋), and government spending(𝐺).
 Leakages(𝑳/𝑾): are incomes withdrawn from circular
 Labour force survey: measures unemployment flow of income reducing GDP, i.e. Savings(𝑆), Taxation(T)
according to those who say are actively seeking work. and Imports(𝑀).
Method Advantages Disadvantages  Note: Income: 𝒀 & Consumption: 𝑪.
 Quick  Not very accurate  Note: Marginal – additional; Propensity – proportion of
Claimant
 Cheap  Not useful for income.
court
comparison Injections 𝑨𝑬 Multiplier
Sectors
 More inclusive  Costly and (𝑱) components (𝟏/𝒎𝒑𝒘)
Labour
 Useful for time-consuming Households (−)𝑆 𝑁𝑌 = 𝐶 + 𝑆 N/A
force
international  Subject to sampling (+) Firms 𝐼 𝑁𝑌 = 𝐶 + 𝐼
1
or
1
survey 𝑚𝑝𝑠 1−𝑚𝑝𝑐
measures errors 1
(+) Government 𝐼+𝐺 𝑁𝑌 = 𝐶 + 𝐼 + 𝐺 𝑚𝑝𝑠 + 𝑚𝑝𝑡
𝐼+𝐺 𝑁𝑌
(+) Foreign 1
+ (𝑋 =𝐶+𝐼+𝐺 𝑚𝑝𝑠 + 𝑚𝑝𝑡 + 𝑚𝑝𝑚
trade − 𝑀) + (𝑋 − 𝑀)

PAGE 12 OF 15
 CIE A2-LEVEL ECONOMICS//9708
𝑨𝑷𝑪 𝑴𝑷𝑪 𝑨𝑷𝑺 𝑴𝑷𝑺 𝟏  Income determination:
𝐴𝑃𝐶
𝐶 ∆𝐶 𝑆 ∆𝑆 + 𝐴𝑃𝑆;
𝑌 ∆𝑌 𝑌 ∆𝑌 𝑀𝑃𝐶
+ 𝑀𝑃𝑆
∴ 𝑨𝑬 = 𝑪 + 𝑰 + 𝑮 + (𝑿 − 𝑴)
 Note:
o 𝐴𝐷 − 𝑃𝑟𝑖𝑐𝑒; 𝐴𝐸 − 𝐼𝑛𝑐𝑜𝑚𝑒
o 𝐷𝑖𝑠𝑝𝑜𝑠𝑎𝑏𝑙𝑒 𝑖𝑛𝑐𝑜𝑚𝑒 = 𝑖𝑛𝑐𝑜𝑚𝑒 + 𝑠𝑡𝑎𝑡𝑒 𝑏𝑒𝑛𝑒𝑓𝑖𝑡𝑠 −
𝑑𝑖𝑟𝑒𝑐𝑡 𝑡𝑎𝑥𝑒𝑠.
 Consumption: is spending by households on goods and
services.
 Saving: is income that is disposable after consumption.
 Dissaving: is spending financed by borrowing on past
savings.
 Paradox of thrift: is the contradiction that increase in  Autonomous investment: is made independent of
savings lead to fall in savings in long-run due to lower income.
spending and income.  Induced investment: is made in response to changes in
 Consumption function: 𝑪 = 𝒂 + (𝒎𝒑𝒄)𝒀; (𝒂 = income.
autonomous consumption)  Accelerator theory: is a model that suggests a change in
 Saving function: 𝑺 = −𝒂 + (𝒎𝒑𝒔)𝒀; (𝒂 = autonomous income, hence demand will cause a greater
dissaving) proportionate change in induced investment.
 Note: autonomous – when income is zero.  Capital-output ratio: is a measure of the amount of
 As income rises, 𝑨𝑷𝑺 & 𝑴𝑷𝑺 rises while 𝑨𝑷𝑪 & 𝑴𝑷𝑪 capital used to produce a given amount/value of output.
falls. It is considered to be constant in the accelerator theory,
 Investment: is spending by firms on capital goods. but may vary as:
 Government spending: is total local & national o Interest rates change o Demand change may
expenditure on goods & service. o Technological be temporary
 Net exports: is income from exports minus income spent advancement o Capital goods
on imports. o Machinery costs industries at full
Determinants of components of 𝑨𝑬 (& AD) change capacity, preventing
Consumption (𝑪) Net exports (𝑿 − 𝑴) o Spare capacity exists buying machines
 Disposable income  𝐺𝐷𝑃 of a country  Note: Influence of investment may be yield, i.e. return,
 Distribution of income &  𝐺𝐷𝑃 of other countries e.g. interest, dividends, etc. from an asset shown as a %
wealth  Relative prices of exports of investments cost, market price or face value.
 Interest rate  Quality of exports
 Credit availability  Exchange rate 4.6 Money Supply
 Expectations Quantity theory of money: 𝑃 ∝ M is derived from the
Investments (𝑰) Government spending (𝑮) Fisher equation 𝑀𝑉 = 𝑃𝑇 or 𝑃𝑌 by monetarists as they
 Interest rate  Government policies assume 𝑉 and 𝑇⁄𝑌 are constant.
 Technology  Tax revenue 𝑀 = money supply
 Cost of capital  Demographic changes velocity of circulation, i.e. no. of times money
𝑉 =
 Consumer demand changes hand
 Expectations 𝑃 = general price level
 Government policies 𝑇 = no. of transaction
𝑌 = real 𝐺𝐷𝑃

PAGE 13 OF 15
 CIE A2-LEVEL ECONOMICS//9708
There is a time lag.-Keynesians disagree. o Active balances: is the money held for transactionary
 Narrow money: can be spent directly, i.e. notes, coins & motive of buying day-to-day goods & services and
current accounts. precautionary motive of unexpected events. Denoted
 Broad money: used for spending sand savings i.e. notes, by(𝑇).
coins and all bank deposits. Influences on demand of money
 Money supply may increase due to: Transactionary Precautionary
 Credit creation, i.e. lending by banks.  Prices.  Credit cost.
o Budget deficit financing by banks of government  Products.  Insurance cost.
spending.  Frequency of pay.  Expectations.
o Quantitative easing by purchase of government  Income.  Income.
securities (used to raise money) from private sector to
raise money supply.
o Total currency inflow into country.
 Monetary transmission mechanism: is the process by
which a change in monetary policy works through
economy via change in 𝐴𝐷 thus, the price level and 𝐺𝐷𝑃.
 Central bank:  Commercial bank:
o Controls money o Accepts deposits
supply o Lends (even mortgage)  Monetarists: are economists who believe that control of
o Issues notes & coins o Bill payments money supply by monetary policy is essential to avoid
o Sets interest rate o Selling insurance & inflation as markets clear easily. They support the
o Settles external debt foreign currency loanable funds theory.
o Holds gold & foreign o Holds important
currency reserves documents &
valuables.
o Helps with wills and
tax.

𝑪𝒓𝒆𝒅𝒊𝒕 𝒎𝒖𝒍𝒕𝒊𝒑𝒍𝒊𝒆𝒓
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑛𝑒𝑤 𝑎𝑠𝑠𝑒𝑡𝑠 𝑐𝑟𝑒𝑎𝑡𝑒𝑑 100
= 𝑜𝑟
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑙𝑖𝑞𝑢𝑖𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 𝑙𝑖𝑞𝑢𝑖𝑑𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜

𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑙𝑖𝑞𝑢𝑖𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 4.8 Policies of Trade & Aid Towards

𝑳𝒊𝒒𝒖𝒊𝒅𝒊𝒕𝒚 𝒓𝒂𝒕𝒊𝒐 = × 100%
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 Developing Economies
 Multinational corporation (MNC): are usually large
4.7 Interest Rate Determination public limited companies that produce in more than one
 Keynesians: are economists who think that government country.
intervention by fiscal policy is needed to achieve a full Advantages Disadvantages
employment as markets are too slow to adjust. Demand
 May raise output,  Pollution & depletion of
for money is explained by liquidity preference theory.
employment, exports and non-renewable resources.
o Idle balances: is the amount of money held for
tax revenue.  Profit diversion & top-level
speculative demand(s); i.e. interest elastic demand for
 Low price, high quality & employment, non-local.
holding money with a motive to make future gains
choice due to competition.  Drive out domestic firms &
from buying financial assets.
 Brings new ideas & capital. unduly influence
government.

PAGE 14 OF 15
 CIE A2-LEVEL ECONOMICS//9708
 Foreign aid: is assistance given to developing economies  Exchange rate falls due to reduced demand and
on favourable terms. They can be tied (conditional), increased supply of currency.
untied (unconditional), bilateral (2 countries) &  Fall in unemployment increases 𝐴𝐷, thus causes
multilateral (many countries). inflation.
It is best untied and multilateral.  Timbergen’s rule: is that there must be at least one
 Foreign direct investment (FDI): is setting up of policy measure for every macroeconomic objective.
production units or purchase of existing production units  Refer to AS section 5 for more.
in other countries.
 World Bank: is an international organization that lends
money to developing economies for projects that will
promote development.
It consists of:
o International Bank for Reconstruction and
Development
o International Finance Corporation
o International Development Association
o Multilateral Investment Guarantee Agency
o International Centre for Settlement of Investment
Disputes
 International monetary fund (IMF): is an international
organization that promotes free trade and helps
countries in balance of payments difficulties.
lt aims to:
o promote international monetary cooperation.
o facilitate expansion and balanced growth of
international trade.
o provide exchange stability.
o assist setup of multinational payment system
o make resources available to members experiencing
balance of payments problems.
IBRD & IDA loans & grants cover:
o Health & education, e.g. sanitation, combating AIDs.
o Agriculture & rural development, e.g. irrigation.
o Environmental & rural development, e.g. irrigation.
o Infrastructure, e.g. roads, railways, electricity.
o Governance, e.g. anti-corruption.
Lack of strong legal framework in an economy can give rise to
corruption, thus activities such as bribes, aid-fund diversion, etc.
which can hinder development can occur.
5. GOVERNMENT MACRO INTERVENTION
5.1 Interconnectedness of Macro-economic
Problems
 Inflation reduces internal value of money.
 Exports become dearer and imports cheaper.
 Current account deficit occurs if ML-condition met.

PAGE 15 OF 15