AS Economics Summary

Cambridge International AS Economics Syllabus code: 9708
Economics is the social science that deals with the study of choice and taking decisions, as
well as how scarce resources should be allocated
Syllabus content 1) a) & 1) c)
The Economic Problem deals with the fact that the scarce resources we have cannot satisfy
our unlimited wants, leading us to making a choice
1. Land: - Is the natural resource in an economy, including the land and the natural
deposits underground
2. Labor: - Is the human resource in production, made up of the nation’s population
3. Capital: - Is any man-made aid in the process of production, that also includes capital
goods, which are goods that help in the production of other goods
4. Entrepreneur: - A group of risk-taking individuals that organize production and think
innovative idea
Scarcity is a situation in which the wants and needs are greater than the limited resources
available – scarcity is not a shortage of money
First of all, we need to identify how goods satisfy a consumer’s needs. Production is the
process of creating goods and services in an economy, while consumption is the process in
which consumers satisfy their needs by consuming certain goods.
Since we as humans grow, get married, raise families, and so on, our wants and needs
change and expand. This leads us to never getting to a point where we are satisfied, and
that’s why the economic problem exists. The list of things that we want keeps on going. This
“list” of unlimited wants will cause us to make choices, otherwise called opportunity costs.
Opportunity cost: - is the second best choice that we give up in order to choose the first
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© 2018 – Arranged and Edited by: Omar Minawi
Syllabus content 1) a)
1. What to produce? Due to having limited resources, we’ll need to produce goods which
we think are the most important
2. How to produce? In relation to unlimited wants, we’ll need to satisfy as many of them
as possible, which means that we’ll have to maximize our production. However, we’ll
also need to note that our maximized production needs to come in an environmental
way.
3. For whom to produce? Limited resources force us to produce only a specific amount.
This leads us to thinking about who’s wants we want to satisfy, and whether we want
everyone to have an equal share or not.
Is when everything is deemed constant, other than one factor. Economists use this in order to
simplify more complex situations.
Thinking at the margin is defined as “what your next step means for you”. In this case, it is
how much your next choice will benefit you at that moment in time. For example, you’re
walking in the heat and are extremely thirsty. You find a shop that sells one water bottle for
0.5JDs. The first water bottle might be worth 1JD for you, however, as you reach your 3 rd or
4th, it’ll start losing its Marginal Benefit, while its Marginal Cost will keep increasing.
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The short run: is defined as the time dimension where only one factor of production can be
changed, while all other factors and key inputs are held constant ‘ceteris paribus’
(i.e. Increasing labor to increase output)
The long run: is defined as the time dimension where all factors of production can be
changed, while all other key inputs are held constant (i.e. Building a new factory)
The very long run: is defined as the time dimension where all factors of production and all
key inputs can be changed, such as government regulations, technology, and social
considerations.
Syllabus content 1) b) & 1) c)
Positive statement: One that is based off of empirical or proved evidence
Benefit of a positive statement Drawback of a positive statement

It is evidence that is more reliable, as it is If there is one fault in the calculations, the
based off of numbers and calculations whole statement is wrong
Normative statement: one that is based off of opinions, basically, “your gut”
Benefit of a normative statement Drawback of a normative statement

Are usually correct, and sometimes, can It isn’t really “reliable”, as it isn’t based off
cause a business to grow massively of any empirical evidence, and is only an
opinion
The process of specialization is one way goods and services can be produced in a country or
a region. Specialization is a process by which individuals, firms, and economies concentrate
on producing those goods and services which they have an advantage over others. In any
office in the world, you’ll have specialized workers, those who are delivery drivers, those
who are accountants, and those who are managers. In this way, if everyone focuses on
producing what they are best at it, we can get an efficient economy with many high quality
goods.
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However, with specialization, no one is self-sufficient, meaning that everyone will

overproduce and have a surplus.
Before, this was an issue, however with the development of the market and the finding of the
internet, surpluses produced at one end in the world can be sold to people at the other end of
the world.
Market: where buyers and sellers get together to trade
Specialization led to higher living standards worldwide and allowed us to start producing
more types of products, however, it doesn’t come without disadvantages. The fact that our
world is always advancing due to technology means that many specialists can be replaced by
machines over-night simply due to production costs. This is why these specialists need to be
multi-skilled, and if their job becomes redundant or machines can replace them, they should
be able to find another occupation in which they’re able to specialize, otherwise we’ll have a
high level of unemployment and social issues which the government will need to deal with.
Most modern-day factories undertake the process of division of labor, where a manufacturing
process is split up into a sequence of individual tasks. This means that instead of each
individual doing the whole process, each individual does one part of the process to contribute
to the final product. This is a great strategy for production, as not only is it quicker and
cheaper, but employees could also specialize over time and produce high quality products at
a faster pace, thus increasing production and revenue. Henry Ford’s conveyor belt has seen
such a monumental effect in the car production industry, and is still used by many
businesses. However, the division of labor can create dissatisfaction among employees and
bore them, as they’ll be doing the same job over and over, and they may eventually leave the
firm. Moreover, since every employee is different, the quality of the end product may be
questionable.
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Syllabus content 1) d)
We have three different types of economic systems, Free-Market economy, Command or

Planned economy, and Mixed economy. They can be represented using the line below:
Planned Mixed Free Market
As we go from planned and towards free market, the government intervention decreases, and
the freedom of suppliers increases
Economic system: the means by which choices are made in an economy.
The economic structure is the way in which an economy is organized in terms of its sectors.
The sectors are:
1. Primary sector: More reliant on natural resources, such as fishing, mining, and oil
extraction.
2. Secondary sector: Describes the manufacturing activities that are found in an
economy, such as food processing, cloth making, etc…
3. Tertiary sector: Is the sector of services and covers activities from public transportation
and education, to hair dressing and banking.
4. Quaternary sector: Is a still developing sector, and includes everything that has to do
with the knowledge based part of the economy, such as NPD and ICT.
In a market economy, most decisions are taken through the market force. There will be an
established connection between suppliers and consumers, where the market mechanism,
where decisions on price and quantity are made on the basis of demand and supply alone,
controls which products are sold and at what price. For example, if a product is to be sold at
low supply with a high demand then the price will be high, while if a product is to be sold at
high supply with low demand, then the price will be much lower.
Adam Smith’s theory of the “invisible hand of the market” brings together private and social
interests by underpinning the workings of the market economy. Smith states that
governments should not intervene with how the market works, and only have limited tasks
such as providing national defense, issue money, and raise taxes. Due to globalization and
the internet, it is very difficult to be a free market economy, and the best example of this is
the USA, however, the government does intervene in the USA by setting law and order, and
providing national defense.
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What to produce?
This is based on what the consumers want
How to produce?
In a way which profits producers
For whom to produce it?
To whoever has the greatest purchase power and is able to buy the good
Advantages of Free-Market economy Disadvantages of Free-Market economy

Firms are likely to be efficient, as they need to Public goods which are usually loss making are not
provide goods wanted by consumers, and will provided in the market – e.g. lighthouses
usually lower prices to stay competitive, and Merit goods are usually underprovided in the
they’ll also make better use of scarce resources market e.g. public libraries
Government bureaucracy is avoided Monopolies could firm which firms can exploit by
charging very high prices
The freedom gained by free market economy for There could be a large consumption of demerit
suppliers allows more personal freedom. goods – e.g. tobacco
The free market ignores inequality, it tends to favor
those with the highest purchasing power, and does
not give social benefits to the poor
In a planned economy, resource allocation is undertaken by a central body, using central

planning, such as the government. The economist behind this theory “Karl Marx” saw that
the market economy is unfair, as it benefits the wealthy, and ignores the poor who get the
wealth for that upper class we’re talking about. He was also critical about the built-in
unemployment, as firms would try and replace manual labor with machines, wherever
possible, in order to reduce costs of production.
Central planning: where the allocation of resources is determined by a comprehensive plan
which states how resources should be allocated, and the desired output of production.
The market economy also seemed to never give sufficient or high wages to manual labor,
and tried to give them the bare minimum. It was why Karl was convinced that some aspects
of an economy need to be centralized, such as:
1. Allocation of resources
2. Determination of all production targets for all sectors
3. Distribution of income and determination of wages
4. Ownership of most of the productive resources and property
5. Planning the long-term growth of an economy
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When we look at it, some of these decisions do have to be centralized. Some products such
as bread need to be heavily subsidized in order for people to be able to buy them. However,
this does create excess demand which means queuing becomes a way of life as supply isn’t
sufficient for everyone.
At some point, the government will need to allow some enterprises to be privately owned,
such as hairdressing, restaurants, and shops. These types of enterprises are hard to make
public because of the benefits a private sector provides, as it can serve its consumers better
and attract foreign investment more, as the ownership is shared between the state and the
private sector.
What to produce?
Determined by the government
How to produce it?

Government and its employees

For whoever the government prefers
Advantages of Planned economy Disadvantages of Planned economy

Might be easier to coordinate resources in the Governments fail, and may not have enough
time of crisis, e.g. wars information to determine what to produce
Government can compensate for market failure, They may not meet the preferences of all
by reallocating resources consumers
As the government distributes income and Limits democracy and personal freedom, a large
manages wages, inequality may be reduced and example of this is China, where most people just
welfare might be maximized by the society work to live, and have no freedom of speech.
Abuse of monopoly power is prevented
The overall result? It can be seen that the planned economy sets goals that are very different
from that of the free market economy, and usually sacrifices current consumption and
standards of living, in order to maximize growth so that they can catch up to more developed
free-market economies. Basically, the current population will sacrifice its wellbeing in order
to benefit future generations. Current examples of planned economies are North Korea and
Cuba, however since the planned economy is an extremity, the internet and globalization is
also slowly causing most planned economies to shift towards becoming mixed.
In a mixed economy, both the market forces and the government, the private and public
sector, are involved in the allocation of resources.
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Although we’ve said that planned and free-market economies do not exist in their pure form,
the mixed economy is probably the most common type of economy in the world. Here, there
is a shared allocation of resources between the government and the private sector, and
usually, the government would provide:
1. Merit goods e.g. education, public libraries, etc…
2. Public goods e.g. public transportation, streets, national defense, etc…
3. Direct provision of nationalized industries e.g. coal production and energy production
4. Support for large areas of manufacturing e.g. vehicles
On the other hand the private sector would be more responsible for providing consumer
specific goods and services such as hairdressing shops, café’s, restaurants, and retails. Since
the mixed economy is a mix of both planned and free-market economies, it holds the
advantages and disadvantages of both. To some degree, the US is a mixed economy, as its
government is involved in providing public goods, in regulation, control, and provision of
some essential services such as telecommunications, and gives indirect support to
strategically important firms. Currently, most economies are heading towards becoming
mixed or free-market, because of the amount of foreign investment they can attract which
allows for economic growth.
What to produce?
Determined by consumer preferences and the government
How to produce it?

Determined by profit-making producers and the government

Depending on the purchasing power of consumers and who the government prefers
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Currently, the central bank is encouraging many economies to make the shift from planned
or command towards the free market, as it has many benefits and just makes the overall
world economy more competitive. The picture can show how a reform of an economy to one
that includes less government intervention can be beneficial. Here are some ways in which an
economy can reform:
1. Reduced dependence on state owned firms
2. Less dependence on state-driven construction
3. Removal or decrease of price controls
4. Phasing out caps on interest rates
However, this doesn’t mean that reforming an economy to become one that has less
government intervention is a painless task. First of all, the costs of transition that will need to
be covered by the government will be monumental. Moreover, many employees which were
involved with the government will lose their jobs, as the government intervenes less now,
and thus, requires less employees. In order to pass through this in the least damaging way
possible, the government needs a robust tax regime that will stand for a while, as this process
will not be short.
Since we’re currently in a world which is constantly developing and economies worldwide
are reforming, entrepreneurship is also a developing aspect. Entrepreneurship is the reason
behind why we have so many innovative goods and services in the market, and can help
create wealth and jobs in an economy (e.g. Tesla and Elon Musk). Many entrepreneurs have
found successful opportunities due to taking risks which allowed them to achieve substantial
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success, while others benefited from their governments encouraging them to invest and open
companies, to get into enterprises such as hairdressing, restaurants, and other personal
services. However, many have failed due to the competitive nature of the newly established
free-market economies, as it is too risk to open enterprises in the currently – very competitive
– market.
Syllabus content 1) e)
A production possibility curve or frontier displays the maximum level of output that an
economy can reach given that it is being efficient with its resources.
The curve represents scarcity, trade-offs, opportunity costs, and efficiency
It shows scarcity as, for example in the graph, we cannot reach point F due to limited
resources. As for trade-offs and opportunity costs, it shows that as you go between points on
the curve you will be giving up something. For example, going from point B to point A,
you’ll be producing more sugar, but the opportunity cost or the trade-off of doing so is
producing less pizza. Lastly, it represents efficiency in 3 ways. When you’re producing below
the graph, you are inefficient, when you’re producing on the graph, you’re efficient, and
producing above the graph is impossible. In the example stated above, as you start outputting
more sugar, the opportunity cost will be higher, and it’ll be harder to go back to the same
output of pizza again, this is called the law of increasing opportunity costs
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Before we know how PPCs can shift, we need to know the 4 key assumptions of PPCs,
which are:-
1. Only two goods can be produced
2. Resources are fully employed
3. Resources are fixed
4. Technology is fixed
Well, what happens if we change the last two factors?

1. Quality and/or quantity of resources changes
2. Technology changes
With this in mind, we can decide whether the PPC will shift outwards, or inwards, based on
whether this change is positive or negative
Production Possibility Curve

600
500
400
Sugar
300
200
100
0
0 100 200 300 400 500 600 700 800 900
Pizza
Look at the example above. The original PPC in this example is the yellow one, while the
dark green one is the one that shifted upwards, and the light green one is the one that shifted
downwards.
Dark green: - An increase in the quality and/or quantity of resources, or a change in
technology that caused production to be quicker shifted the PPC outwards. This is described
as economic growth
Light green: - A decrease in the quality and/or quantity of resources, or a change in
technology that caused production to be slower (i.e. a machine is outdated and starts to
malfunction) shifted the PPC inwards.
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In any economy, the goods or resources used in production will be used out at some point in
time, and have to be replaced. The capital that is needed to replace the one that was used up
to maintain its production is called capital consumption. The process in making capital goods
(capital consumption) in order to continue production is called investment. However, if there
are not sufficient resources devoted to investment, then the standard of living will not rise
and might even fall, due to a decrease in capital goods.
Syllabus content 1) f)
Before we ever had money, we were in a barter economy,

where people would trade goods based on a coincidence of
wants. For example, person 1 produces nets and wants fish
to feed his family, while person 2 catches fish and wants
nets to do so, and that leads to them trading their goods.
In the case that person 1 does not want fish, they can find a 3rd party which could turn it into
a cycle.
However, it reached a point where people were unable to find a
3rd party or it was just too hard, and so, this lead humanity into a
credit economy, where we’d tell each other that we’d “pay at a
later date”, for example, if person 1 (in the same example above)
wants fish while person 2 doesn’t need fish right now, person 1
tells person 2 that they’ll pay them at a later date with either nets
(when they need them) or another good that they buy through
their nets. This is completely based on trust.
But, a credit economy only works with small populations, and when an outsider comes,
they’ll ruin the whole concept and people won’t know who to trust, and so, people started
using objects and giving them a value, and this was the first step towards what we have
today, money.
Money: is a good that is widely accepted for the purposes of exchange
Back then, money could be anything, and not necessarily paper. Rocks, seashells, and
anything that didn’t have a use other than having a value could be considered money.
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1. Acceptability – it is accepted widely as a unit of exchange

2. Portability – how easily it can be obtained and transferred between people
3. Scarcity – the fact that it is not available in an infinite amount
4. Recognizability – it can be recognized by anyone as a unit of exchange
5. Relative stability of value – its value is not always fluctuating and changing
6. Durability – is a physical asset
1. A medium of exchange: it is accepted by the general public, where buyers use it to

purchase and sellers accept it as an exchange for these purchases
2. A unit of account: it accounts for the value of something specific, and allows us to
compare certain goods and their values/prices
3. A store of wealth/value: it shows how much value a person has, and when stored,
shows the value over time, and thus, it’s considered wealth.
As we advance, we create other ways to pay, such as “near money”, which is described as
non-cash assets that can be quickly turned into cash, such as bank time deposits, foreign
currencies, money funds, bonds, certificates of treasury, etc…
Liquidity describes how fast you can get your hand on money, and this is usually measured
by the amount of assets you have. This is usually done to pay liabilities, known as debt
obligations
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Syllabus content 1) g)
Goods, are what are produced by the suppliers, and what are used by the consumers to
satisfy their needs. Goods fall under 3 main types, and they are:-
1. Private goods: are goods that are consumed by a specific group of individuals, and are
not available for others.
It’s important to note that private goods should have rivalry, where the consumption of a
certain good by one individual reduces its availability for others (i.e. food, when bought,
will be less available for others once the transaction is complete), and excludability, where
a specific group of individuals can be excluded from consumption (i.e. Insulin shots and
non-diabetic individuals)
2. Public goods: a good that is neither excludable nor rivalry, used by the general public
and usually hard to set a price tag for
For public goods, they are non-rival goods, meaning if an individual consumes a certain
product, the availability for that same product will not decrease (i.e. Streets), and they are
non-excludable, meaning the general public will be able to use them (i.e. Street lights
can’t be excludable, because when they provide light for a certain car on a certain street,
all other cars on the street will see that light)
3. Quasi-Public goods: are goods that have some characteristics of public goods, but not
all of them.
Since not all products can be described as public or private goods, quasi goods are
like public goods but not fully. A quasi-public goods is something like a mall, it is
non-excludable as you do not need to pay to enter it, but it is non-rival only
periodically. If you go to the mall at an early time of the day, you’ll be able to enjoy
shopping freely as there won’t be many people, however, as time goes on, the mall
will be crowded and goods will start to vanish, making it a rival good.
Public goods Quasi-Public goods Private goods
Since public goods are non-excludable, they can be used by the general public. However,
we’ve reached a point where some public goods are not being produced due to the free rider
issue, where someone who does not pay for the public good gets to use it anyway.
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Take this example, there is a new neighborhood around the city, but it is sort of far away and
needs to be connected to the city in a way. At the moment, it is only connected to the city
through a desert way that has no roads built. One of the consumers in the area decides to
build and pay for a road in order to benefit from it. However, since roads are a public good,
all other consumers in the same neighborhood will get to use it and they’ve gotten a free ride
However, it has reached a point where all consumers will wait for each other to pay for a
public good so they can all get a free ride, which leads to the public good not being
purchased or produced, and everyone will play the waiting game forever.
From a beneficial point of view, goods can be classified into 2 types:

1. Merit goods: are goods that have a positive or advantageous effect when consumed.
These are goods that benefit the consumer when used, and these can be things such
as libraries, education, free nutritional school meals, etc…
2. Demerit goods: are goods that have a negative or disadvantageous effect when
consumed.
These are goods which do not benefit the consumer when used, and can be things
such as junk food, smoking, etc…
Information failure: where people do not have complete information about a specific product
The issue of information failure has happened many times in the world where people do not
know the side effects of a specific product. With merit goods, it is when a person consumes
a good but does not realize how beneficial it is (i.e. Education) , while with demerit goods, it
is when a person consumes a good but does not realize how disadvantageous it is (i.e.
Smoking). The issue of information failure recently happened with the vape/electronic cigar,
where most people think it is a good alternative to smoking and helps smokers quit, while in
actuality, it is not.
Paternalism: is a situation in which the society knows best and has the right to make some
value judgement
Paternalism often happens with demerit goods, where the society agrees that a certain good
is bad. This happened specifically with drugs and smoking. If we’re allowing society to make
a comment or decide on if the product is beneficial or not, then we are allowing paternalism.
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Moral hazard: in the case of a moral hazard, it is when someone exposes themselves to
greater risks knowing that there is someone who will bear the costs of these risks.
Moral hazards specifically happen with medical conditions, where people smoke but say that
it is fine because they have a doctor to back them up, or do dangerous sports and say that
there are other people that can back them up such as assistants or helpers.
Adverse selection: is when information failure leads to someone inexperienced or unsuitable

to obtain insurance.
The information failure in this case is reversed, where the seller or supplier does not have to
provide all the information to the seller in order to establish risk. For example, there may be a
disease that could be easily prevented, but doctors or health insurers will withhold this
information in order to get people to buy insurance, which means greater profits and revenue
for the business.
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Before anything, we need to know how the market works and how it operates. To begin
with, the first “seed” of a market is the price mechanism, in which resources are allocated in
a market economy. After these resources are allocated and products are made, we’ll have a
market, where buyers and sellers come together to trade
Demand describes the quantity of a product that purchasers are willing and able to buy at
different prices with ceteris paribus applied
The definition of Demand can be split into 8 small parts that identify how it works: -
1. Quantity: - The numerical quantity of the demanded product
2. Product: - The item that is being demanded and traded
3. Purchases: - The buyers demanding the product, known as the “consumers”
4. The will to buy: - Before entering a market, purchasers must have the intent of buying
a product in that market
5. Ability to buy: - The demand must be effective, and not notional
6. Prices: - Decides whether the product is worth the value of the money it is listed at or
not
7. Period of time: - AKA, the demand is dependent on time, meaning that if there are 20
pieces of a product demanded at the same minute, that’s high demand
8. Ceteris Paribus: - In order to have a better understanding of demand, all other things
should be kept constant
Notional demand: - Demand that is not always backed up by the ability to pay, and is usually
hopeful
Effective demand: - Demand that is backed up by the ability to pay
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The demand curve represents a negative relationship

between Price and Quantity demanded (law of Demand graph
demand), as well as the fact that it shows a 600
continuous and linear relationship, based on time 500
400
with all other factors being equal. This curve can be
Price
300
drawn from data in a demand schedule, and gives us 200
the market demand (overall amount of a product 100
0
demanded by consumers) for a certain market. It 0 100 200 300 400 500 600
also allows companies and businesses to know how Quantity demanded
much revenue they will receive from selling their
product at a certain demand
1. Income: - The ability to pay is one of the most important things when considering
demand, and the income of consumers (after taxing) is something that can shift
demand either ways. With income, goods can be split into two kinds:-
a. Normal goods: - goods you buy when you’re well off, (i.e. jewelry, fish,
premium meats, etc...). With these types of goods, there is a positive
relationship, as income increases so does the demand for them
b. Inferior goods: - goods you buy when you have minimal income, (i.e. low
quality foods, used clothes, etc...). With these types of goods, there is a
negative relationship, as income increases, the demand falls.
2. Price of related goods: - This describes how the demand and price for a product has
an effect on the other, and can be split into two categories: -
a. Compliments: - are goods that complete each other (i.e. tea and sugar, petrol
and cars, etc...), and when the price of one of these increases, it’ll have a
negative effect on the demand of the other. For example, if the price of tea
falls, the demand for sugar will increase
b. Substitutes: - are goods that can substitute each other (i.e. Pepsi and Cola), and
when the price of one of these increases, it’ll have a positive effect on the
demand of the other. For example, if the price of Cola increases, the demand
for Pepsi will increase.
3. Tastes and preferences: - This doesn’t really depend on anything other than the
consumers themselves, and whether they like something or not. For example, most
people like fast food and that’s a reality, so the demand for fast food will (most of the
time) be high.
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4. Number of consumers: - This is a basic mathematical formula, the more consumers

you have, the higher the demand, unless there is something else that is affecting it
such as high prices or moral issues.
5. Future expectations: - When people expect the price of something will fall, they’ll
demand it less, and when they expect the price of something will rise, they’ll demand
more of it.
Supply describes the quantities of a product that suppliers are willing and able to supply (sell)
at different prices, with ceteris paribus applied
The definition of Supply can be split into 6 small parts that identify how it works:-
1. Quantities: - Information will need to be displayed in numerical data so that the
supplier knows how much to distribute
2. Product: - The product that is being sold or supplied
3. Suppliers: - The individuals selling the product, known as producers.
4. Willing to supply: - Opposite to consumers, suppliers control the supply. So, if the
price is too low, a consumer can withhold the product
5. Period of time: - Same as demand, the supply depends on time. If 200 pieces of a
product are supplied in a day, that’s high supply.
6. Ceteris paribus: - Because so many things are changing, it is simpler to
(hypothetically) keep all other factors constant
Supply graph
The supply curve shows a positive relationship
between Price and Quantity supplied (the law of 600
500
supply), as well as the fact that it shows a
400
continuous and linear relationship based on time
Price
300
with all other factors being constant. The data is 200
drawn from data in a supply schedule and shows 100
companies how many units of a product they 0
should supply at a specific market price. 0 100 200 300 400 500 600
Quantity supplied
1. Prices and availability of resources: - The amount of a product supplied by a certain

company will be determined by how much it costs them to produce it, and the
availability of resources to do so. If it’s costly or there are not enough resources,
supply will decrease
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2. Number of sellers: - As with the number of consumers, this is a basic mathematical

formula. If you have more sellers in the same market, the quantity of the supplied
product will be higher
3. Technology: - Right now, technology plays a great factor. When you have a robot
making a product 3 times faster than the average worker, your supply is going to
increase
4. Taxes and subsidies: - When the government gives subsidies (increase in supply) to a
certain company, or taxes (decrease in supply) them more than usual, the quantity
supplied will change
5. Opportunity cost of alternative production: - With supply, you need to make sure that
the opportunity cost doesn’t go to high, so that you’re able to shift back when it’s
necessary. So, companies will supply at a point where it is not too high
6. Expectations of future profit: - If a company knows that the market price will go up
during the next period of time, they won’t supply at a high rate because they know
they can make more profit
Syllabus content 2) b) & 2) c)
Elasticity refers to the responsiveness of one variable after the other variable has been
changed, and includes 4 types
When a graph is elastic, the change in demand or supply is greater than the change in price,
and when it’s inelastic, the change in demand or supply is smaller than the change in price
Is a measurement of the consumer’s responsiveness to a change in price, and this depends on

whether the demand is elastic or in elastic. With inelastic demand, a great
change in price will only cause a small change in demand, and this means
that people will continue to buy it no matter what. These kinds of goods
have the following characteristics
1. Few substitutes
2. Necessities
3. Small portion of income
4. Required at the moment
5. PED value of 1
20
This goes for goods such as diapers, paper, gasoline, milk, etc…
Inelastic = Insensitive to a change in price
With elastic goods, a great change in price will cause a great

change in demand and this means that the amount people buy
depends on the price. These kinds of goods have the following
characteristics: -
1. Many substitutes
2. Luxuries
3. Large portion of income
4. Plenty of time to decide on
5. PED value greater than 1
This goes for products such as soda, boats, beef, etc…
Elastic = Sensitive to a change in price

PED = %change in quantity demanded of a product
% change in price of that product
Unit elastic demand graph Perfectly inelastic demand graph

600 600
Quantity supplied
500 500
400 400
Price
300 300
200 200
100 100
0 0
0 100 200 300 400 500 600 0 20 40 60 80 100 120
Quantity demanded Quantity demanded
Shows how sensitive a product is to a change in the income of its consumers. Through the
formula shown below, it identifies whether the product is normal with a positive value or
inferior with a negative value
21
YED = % change in quantity demanded

% change in income
Shows the responsiveness of the quantity demanded for one product following a change in
price for the other. Through the formula shown below, if the coefficient is negative, the
products are compliments, and if the coefficient is positive, the products are substitutes
XED = % change in the quantity demanded for product A
% change in price of product B
Describes the responsiveness of suppliers to a change in price of a specific product. In the

formula shown below, if the coefficient is >1 then the supply is price elastic, and if it is <1
the supply is price inelastic. If the quantity does not change, then it is perfectly price inelastic.
PES = % change in quantity supplied
% change in price
Price elastic supply Perfectly Price Inelastic Supply

600 600
500 500
400 400
Price
Price
300 300
200 200
100 100
0 0
0 100 200 300 400 500 600 0 20 40 60 80 100 120
Quantity supplied Quantity supplied
22
Price Inelastic Supply

600
500
400
Price
300
200
100
0
0 50 100 150
Quantity supplied
Factors influencing Price Elasticity

1. Stocks, as they allow companies to meet variations in demand
2. How easily a company can increase production
3. Increasing productive capacity through either: investing in capital equipment or an
increase or decrease in the amount of companies in a certain industry
4. The time scale, in the short run, you cannot really increase supply as it is usually
inelastic
5. Barriers of entry to the market are also effective, because the stronger the barrier, the
harder it is for new firms to enter the market, and thus, the lower the supply
Syllabus content 2) d) & 2) e)
As supply and demand have been explained above, this section talks about the interactions of
demand and supply, more known as the market. Usually, it focuses on the stage of
equilibrium, where the quantity demanded and the quantity supplied are equal, and so, no
changes need to be made. However, sometimes, some businesses or companies will become
ambitious, and might raise the prices without the consumers being able to adjust. This will
lead to disequilibrium, where supply and demand are not equal.
How does a business solve an equilibrium? Well, they’ll need to do it bit by bit. First off, (in
the example listed above), they’ll lower the prices and stop supplying as much of their
product in order to return to equilibrium.
When the market is clear, consumers and producers will be trading at an equilibrium price,
the price at which demand and supply are equal. The quantity traded at said price is called
the equilibrium quantity.
23
Now that we’ve known the things that determine the market equilibrium, we’ll need to draw
it, through the following steps:-
Before the change
1. Draw original supply and demand
2. Label the original equilibrium price and quantity
The change
3. Did it affect supply, or demand
4. Did a determinant of supply, or a determinant of demand cause the shift
5. Draw the increase or decrease
After the change

6. Label the new equilibrium
7. Did the price increase or decrease
8. Did the quantity increase or decrease
Let’s take an example and draw the market analysis

Before the change
We’ve done the first step, we drew the original demand and supply graphs and labeled the
original equilibrium
In this case
 Equilibrium Price = 1400

 Equilibrium Quantity = 4000
Market Analysis
 2200
2000
1800
1600
1400
Price
1200
1000
800 Market
600 Equilibrium
400
200
0
0 2000 4000 6000 8000
Quantity
24
The change
Now, suppose the business wants to raise the supply up to 5000 from 4000, due to the
government taxing them more this year. What would occur?
Market Analysis
2200
2000
1800
1600
1400
1200
Price
1000
800 New Market
Equilibrium
600
400
200
0
0 1000 2000 3000 4000 5000 6000 7000 8000 9000
Quantity
After the change

Now that we’ve labeled the new equilibrium, we need to figure out the new quantity and
price. The new quantity in the graph seems to be around 4600 while the new price in the
graph seems to be 1300. This has caused an overall increase in supply and a decrease in
price.
25
So far, we’ve only talked about movement along the demand curve, however, if we want to
talk about a shift in demand, it means consumers are willing to buy more of a product at
each and every price, we talk about a shift in demand rather than a shift in the quantity
demanded.
Shifts in demand
600
500
400
Price
300
200
100
0
0 100 200 300 400 500 600
Quantity demanded
Shifts in supply are very similar to shifts in demand, where suppliers are willing to supply
more of a product at each and every product, it is described as a shift in supply
Shifts in supply
600
500
400
price
300
200
100
0
0 100 200 300 400 500 600
Quantity supplied
26
Consumers’ surplus refers to the difference between

what the consumer payed and what the consumer was
willing to pay
CS = Buyer’s maximum – Price
Producers’ surplus refers to the difference between the
price that the supplier/seller received, and how much
they were willing to sell at
PS = Price – Seller’s minimum
27
This chapter speaks how the government intervenes into the economy. The reason behind
why the government even does this is due to market failure, where the free market is unable
to allocate its resources efficiently, and the government has to use various regulations to
control production and consumption. In order to do this, the government will impose charges
on incomes, profits, and services to fund the production. These charges are more known as
taxes.
Price ceiling: - Is a maximum legal price that the government enforces on a seller to sell their
product, and this is usually below equilibrium
However, as can be seen in the graph above, this will cause a shortage and the consumers’
demands will not be satisfied. This will lead to an underground or informal market selling the
products at a higher price, more known as a black market
28
Price floor: - Is a minimum legal price enforced by the government on a seller to sell their
product, and this is usually above the equilibrium
However, as can be seen on the graph, there is a surplus. To compensate for this, the
government will give suppliers a subsidy or special treatment (i.e. free water, free electricity,
etc...)
As a general rule, a market must maximize producers’ surplus, and consumers’ surplus, in
order to get the best results.
With price floors, there is a deadweight loss on producers’ surplus, and that means you’re
being inefficient.
29
With price ceilings however, there is a deadweight loss on consumers’ surplus, and that also
means that you’re being inefficient
Subsidies are money that the government gives to producers in order to produce more of
their product (i.e. Agriculture, Pharmaceutical companies, etc...) because the government
thinks that these goods are important. This, obviously, causes the supply curve to shift to the
right as there will be more production.
30
Excise taxes are taxes that the government enforces on a product for every unit of it, and not
a lump sum, causing the producer to produce less of their product (i.e. Alcohol, Cigarettes,
etc...). This is done to goods that the government thinks are dangerous or unwanted.
Syllabus content 3) b)
Taxes are charges imposed on consumers and businesses by the government, in order to fund
government spending on public goods, merit goods, administration, welfare benefits and
subsidies.
Taxation is not new by any means and in the UK, it was implemented in the 18th century, so
the well-known economist Adam Smith came up with the cannons of taxation, a criteria to
evaluate a “good” tax or taxation system, which needs the tax to be:
1. Equitable – those who can afford to pay more should pay more
2. Economic – the revenue should be greater than the costs of collection
3. Transparent – tax payers should know exactly what they are paying
4. Convenient – taxes should be easy to pay
There are two main types of taxes which are:

1. Direct tax – this is an unavoidable tax, and is usually paid directly from the firm or
individual to the government. Examples are income tax, corporation tax, and national
insurance contributions.
31
2. Indirect tax – this is a tax that is imposed on goods and services instead of being
collected immediately. Usually, the government will collect this tax from retailers, and
when the goods are sold to consumers, the price will usually include the tax. An
example of this is VAT on food products, which, in Jordan, is 16%. There are two
main types of indirect taxes as well:
a. Ad valorem taxes – this a percentage of the price charged by retailers to
consumers, such as value added tax in Europe or general sales tax in the USA
and Canada, the price of the good or service will be inclusive of such a tax.
b. Fixed tax per unit – this is just a tax per unit bought, so for example, each pack
of 20 cigarettes is taxed individually, and the price of the packet will
incorporate this tax.
The government often uses indirect taxes in order to discourage the consumption of demerit
goods, by taxing them heavily in order for the market to receive a higher price, however, it is
usually producers that handle the burden of the tax and not the consumers, and this is known
as incidence.
Incidence – the extent to which the tax burden is borne by the producer or the consumer or
both.
The incidence of taxes depends heavily on the PED and PES, so when the PES or PED is
perfectly elastic, then the tax burden falls wholly on the consumer:
32
However, when the value of PED is >1 then the incidence of tax mainly falls on the supplier,
and when it is <1 then the incidence mainly falls on the consumer
PED > 1 PED < 1
The reason behind why this even happens is because when PED is inelastic, then suppliers
can increase the price a lot because consumers will buy the product anyway as it is essential,
so consumers will absorb most of the indirect tax through high prices, however if PED is
elastic, then if suppliers increase the price heavily then consumers will stop buying the
product as much and the supplier will lose out on revenue, thus, the supplier has to absorb
most of the tax, due to the fact that they cannot heavily raise prices, as they cannot afford to
lose consumers.
Maybe the most important thing when collecting taxes is equity, one of the four cannons of
taxation described above. We usually have two types of rates of taxation, the average rate
which is an average percentage of the total income payed by all people, while marginal rate
is a proportion of an increase in income which is paid in taxes to the government. It can be
seen that the average rate is more advantageous for the poorer side of the economy, because
as the income keeps growing, so will the proportion taken from it, even though the
percentage stays constant. There are 3 main relationships which can be defined with taxes,
which are:
1. Proportional tax: one that takes the same percentage from all who have to pay it, even
if income increases, therefore the tax rate is constant.
2. Progressive tax: this tax takes a higher percentage from those with higher incomes, so
as income increases the tax rate increases, meaning that the marginal rate is higher
than the average rate.
3. Regressive tax: this tax takes a higher percentage from those on lower incomes,
meaning the marginal rate and average rate will be falling.
33
For both proportional taxes, it means that not only do the poorer have to pay less as the
percentage at lower income means the amount of tax is lower, it also gives an incentive for
people to gain higher incomes, because you are getting taxed with the same percentage.
With proportional taxes, the average rate is equal to the marginal rate, and the incidence of
taxes is equal.
However, for progressive taxes, they have the ability to reduce inequality, and can distribute
income better in an economy, as the rich have to pay more. These taxes are usually direct,
such as income tax in Jordan, where as your income increases, you get into higher tax
brackets and thus pay more. On the other hand, progressive taxes, when too high, can force
people with high income out of the country to other countries with lower tax rates, or might
decrease their incentive to work as the majority of their income is taken by the government.
As for regressive taxes, because people on lower income pay more taxes, it leads to an
unequal distribution of income. This doesn’t exactly relate to the income of the person, but
relates to how the tax is placed, and with regressive taxes, it is usually indirect. For example,
the tax on a medium box of pizza at Domino’s is the same for everyone, however, if person
A is at an income of 1,000$ and person B is at an income of $10,000, and the tax is $1.5,
then person A will feel the tax more, due to the fact that they have less disposable income.
Lastly, Adam Smith’s cannons of taxation were recently updated to include the following:
1. The taxation system should, in no way, limit efficiency or if it does, the loss should be
minimal
2. The taxation system should be compatible with those of other countries
3. The taxes should adjust with inflation
34
Syllabus content 3) c)
These are another form of government intervention. Subsidies are direct payments to
producers of goods and services, in order to allow them to produce more and thus, grant
consumers a lower price. Subsidies have the exact opposite effect of indirect taxes, where
they cause the prices to fall and the quantity supplied to increase, as the costs of production
have decreased. Governments use subsidies in order to:
1. Keep down the market prices of essential prices
2. Encourage more consumption of merit goods
3. Contribute to a more equitable distribution of income
4. Provide services that are usually not provided by the free market
5. Raise producers’ income, especially in the case of farmers
6. Provide an opportunity for exporters to sell more goods
7. Reduce dependence on imports, by paying subsidies to domestic producers of close
substitutes.
The problem with subsidies is that they interfere with the market mechanism, and even
though they can be sometimes necessary, they might have opportunity cost implications.
Moreover, since they are lump-sum payments by the government, they cannot be easily
linked to the ability to pay and incomes. In addition, subsidized prices are the same for
everyone, so people who can pay more are missed out on. Another argument is that if
subsidies are payed to producers, there is no incentive for them to become more efficient,
because they are getting the money anyway.
However, subsidies do have their advantages. When services such as transport are subsidized,
they can give low earners access to employment opportunities, give social mobility to those
in need of it, and reduce road congestion and thus the environmental effects due to it.
Obviously, different goods benefit differently due to subsidies, however, there are common
benefits, such as a lower price, more quantity so more consumers are satisfied, and producers
can gain more and do not have surpluses.
35
Syllabus content 3) d) & 3) e)
The government is involved in many of the economy’s operations, and is the sole reason why
many economical activities even happen.
These are tax payments received by specific members of the community, usually those who
face low income issues or are from vulnerable groups. Examples include: old age pensions,
unemployment benefits, and child benefits.
Transfer payments: a hand-out payment made by the government to specific members of the
community.
However, these payments are completely dependent on how much tax is paid to the
government during that period of time. This is especially seen in developing countries with
bad taxation systems, where people who receive these payments won’t receive them at a high
amount, and are usually not enough. Transfer payments are specifically a way to redistribute
income from the rich to the poor, and results in less poverty in the economy, however,
payments such as unemployment benefits are seen to discourage working, if they are high
enough, and may lead to workers quitting the workforce and becoming unemployed simply
because unemployment benefits are enough for them, which leads to the economy outputting
less, and being less efficient.
This is another way of the government to reduce inequalities in a society, by providing

important services, such as healthcare and education, free of charge for the consumers, and
will be financed through the taxation system. If used equally, low-income citizens will have
the most benefit, and makes merit goods accessible for everyone. However, it could be
argued that this is very expensive for the government, and the costs funneled into the
provision of these goods could’ve been used elsewhere to develop the economy. Moreover,
the market usually overprovides where a charge is not made, meaning if a charge were to be
placed, many consumers would stop demanding the service or good, but if a charge is not
placed, it is in surplus.
Healthcare is a large example of this, when we compare healthcare in many European
countries such as Germany to the USA, we can see that people in Germany have a large
portion of healthcare free of charge, while in the USA, only a very small section of
healthcare is free of charge. In many developing countries, only a base amount of healthcare
is free of charge, then individuals will be divided into healthcare levels based on how much
they’ve paid. It’ll be seen that most individuals are in the base level, because they refuse or
36
cannot pay in order to get to higher levels. However, it is argued by many that consumers do
have the ability to pay for these services, so the government would be wasting money.
Nationalization is when the government takes over a private sector and transfers it into a
public sector.
Nationalization especially happens with railways, airlines, mining, electricity, and water
industries. Nationalization has many benefits for the country and its citizens:-
1. Public services that are essential for citizens such as transportation, and the essentials
of any house (electricity and house) should be in the possession of the public sector
2. The services that benefit the public, from a socialist point of view, should be in the
possession of the public sector
3. You can’t really duplicate public services, as they are costly, so competition won’t be
present.
4. Profits made by the public sector will be reinvested to benefit the citizens
5. Employees, since they are part of the citizens, will feel a sense of responsibility and
will work hard
6. Even if they are loss-making, the government will probably provide services that
benefit its citizens
Privatization is when a state-owned public sector is bought out by and transferred to the
private sector.
A very strong case of privatization happened in Jordan, when the government was unable to
sustain the production of oil, and so, Manaseer bought the sector and took it over, and most
of the time, privatization will happen as re-privatization, where the sector would originally be
privatized, then it’d be nationalized, then privatized again. Under our modern days,
privatization has been redefined as:-
1. Direct sale of government owned activities to the
private sector, and this can include offering shares to
the public
2. Removal of barriers of entry allowed private sectors to
compete with the public sector
3. Franchising allows a private sector to own a certain
service for a limited amount of time (Salik in the UAE
has gates in the streets which they own, and allow
them to maintain the street, these will vanish in 10
years’ time)
37
4. The government could contract out, meaning they’d hire a company to build a service,
and they can own it for a set amount of time
Many people seek for privatization as it has the following benefits

1. It reduces government involvement in the economy
2. Widens the share ownership and the employment of private sectors around the
country
3. Lower prices, wider variety, and better quality of goods and services
4. Can generate great amounts of income for the economy and the government
5. More efficient than state owned organizations
38
The macroeconomy is the economy as a whole, on a larger scale, and this is where aggregate
demand and supply come into play, in the macroeconomy. The economy’s overall output
within a period of time is made by the efforts of the private and public sector, and is one of
the defining factors of a macroeconomy (GDP), as demand and supply are the reason why
prices in an economy even change.
Aggregate demand is the total spending of an economy on goods and services throughout a
certain period of time at a given price level. It is made up of four factors:
C which defines consumer expenditure or consumption, and consists of the spending of
households on goods and services such as gasoline, clothes, groceries.
I which defines investment, and this consists of spending of private sector firms on capital
goods which help the growth of economy, such as streets and schools
G which defines government spending, because the government is a unit itself, and has to
serve itself first to survive before serving the community. This consists of the goods and
services needed to support the government. Examples of this are healthcare, military goods,
government wages.
(X-M) which defines the net exports, which is the difference between exported goods and
services and imported goods and services. For example, Japan is a net exporter of electronics,
because it exports more electronics than it imports
These 4 factors give us the following formula which calculates AD:
AD = C + I + G + (X-M)
39
Well, since the four factors mentioned above C/I/G/(X-M) are what changes the aggregate
demand curve, let’s see why these factors change:-
Consumer expenditure (C)
1. Interest rates: the lower the interest rates, the easier it is for consumers to borrow and
the more money will be circulating around the country, whereas when interest rates
rise up, it’ll be harder and more punishing to take loans or borrow money
2. Consumer confidence: the more confident consumers are about the economy of a
country, they’ll invest as they are almost sure that they will get their money back with
some profits, whereas if consumers are not confident, and fear the loss of their
money, they’ll save it and will not invest
3. The wealth effect: if a consumer owns something that is fairly expensive, such as a
luxury car or a house, an increase in its price will make the employee feel wealthy,
which leads them to, for example, mortgage their house and spend money, whereas a
fall in the price of these things would cause consumers to save, as they feel pressure
due to not having enough money
Investment (I)
1. The rate of economic growth: the more an economy grows, the more money firms
and people will have, and the more they will invest
2. Business expectations: If businesses are expecting very high revenue, they’ll invest,
however, if they predict a big economic issue to happen, such as the falling of a
government, they’ll keep their investments for a later time
3. Demand for exports: the higher the demand, the more the supply, and the more sales
the firms will make. This leads them to investing.
4. Interest rates: The lower the interest rates, the easier it is for consumers to borrow
money and the more purchases they will make, meaning the firms make more sales.
This leads the firms to investing, while if interest rates rise, the opposite happens.
5. Access to credit: If lenders and banks are unwilling to lend, businesses and firms may
be in tight financial situations and will not even consider the risk of investing.
However, if consumers are saving a lot, there will be money to lend, and so, firms
would be able to borrow money
6. Government regulations: if the tax rates are low, the amount of money taken by the
government won’t be that great, and so business get to keep most of their profits, and
are able to invest
40
Government spending (G)

1. The trade cycle: The trade cycle (shown on the
right) decides how a government would spend.
In the time of a boom, there would be a very
great economic growth, which is sometimes
unsustainable. During a drop or a recession,
the government would have to spend a lot to
cover the recession that has happened, but
during a boom, the government wouldn’t have
to spend much, as there is already a lot of
money circulating in the economy.
2. Fiscal policy: With fiscal policy, the government changes the direction of its spending
to something else as well as changing the taxation. The government may use
expansionary fiscal policy during times of economic decline, and contractionary fiscal
policy by decreasing expenditure on purchases and transfer payments.
Net exports (X-M)

1. Real income: when the income of people rises, they’ll consume more domestic and
imported products, whereas when it falls, they’ll consume less, increasing the net
exports value
2. Exchange rates: If the value of the local currency drops, it becomes more expensive to
import and less expensive to export, and so, the country would be looking to export
more and would gain a greater net export value, but only against currencies that it’s
cheaper than
3. State of the world economy: A fall in sales on the inside will mean less goods will be
exported to the outer world, and more will be imported to repair the damage, and so,
the value of net exports falls
4. Degree of protectionism: This refers to when a country puts a quota and tariffs on
imports from other countries, and so, will be importing less. Supposedly, this would
increase the value of net exports, however, if a country with very high degree of
protectionism is exporting to other countries but isn’t importing from the other
countries, the other countries would stop importing from that country, and would seek
business elsewhere
5. Competitiveness of a country: If a country is innovative, efficient, and has low costs,
it’ll have competitive goods and services, which means it’ll export more as it’ll be
known on the market for its goods. In addition, if a country is part of trade deals, it’ll
become known for a certain product and has a higher chance of exporting
41
The aggregate demand curve is what makes it different from normal demand, and looks
something like this
Notice some things are different about this graph. First of all,
it compares Price level with Real GDP. Next, the curve is
curved out and not a straight line like normal demand, so a
change in the price level will not yield the same exact change
in the Real GDP.
If the price level decreases, the value of real income would
increase as people would need to spend less and the overall
demand would rise.
With shifts, this differs. The aggregate demand curve is shifted due to one of the above
determinants, C, I, G, (X-M). For example, if consumers become more confident due to the
GDP rising up, and they start spending more, then the aggregate demand curve will shift to
the right. However, if interest rates rise up for example, investment will be lower, as it is
harder for firms and consumers to borrow, and so, the curve would shift to the left.
Aggregate supply is the total amount of output that producers are able and willing to supply
within a given period of time at a given price level.
Aggregate supply can be split into two types, short-term aggregate supply (SRAS) and long-
term aggregate supply (LRAS). When we’re talking SRAS, it defines the total output of an
economy that will be supplied, without the prices of factors of production being changed, as
they didn’t have enough time to change. With LRAS, it defines the total output of a country
supplied within a period of time where the prices of factors of production have changed and
adjusted, due to time passing by.
The aggregate supply curve is upwards SRAS curve
sloping, because as the price level increases, 400
suppliers are willing to supply more, as they 350
300
get more profits at higher prices. As u move
Price level
250
throughout the curve, you’ll see that the 200
increases are not linear, which is a key feature 150
100
in the aggregate supply curve. Movement 50
along the curve will happen when the AD 0
increases, due to one of the AD factors (C, G, 0 100 200 300 400 500 600
Real GDP
I, (X-M))
42
Shifts in the SRAS curve

However, shifts in the AS curve will happen 400
when the conditions of supply (their cost) is
300
altered. For example, shifts would happen in the
Price level
curve if the wages of the employees increased, 200
the cost of materials for production dropped, or
100
the product was heavily taxed. When the costs or
the conditions of supply are disadvantageous, the 0
0 100 200 300 400 500 600
curve will shift to the left, and when they’re
Real GDP
advantageous, it’ll shift to the right.
Reasons why movement happens along SRAS curve
1. The profit effect: When the price level increases, the costs of factors of production
usually stays unchanged, so the price used for input will be much less than the price
gained from output, and so, supply would increase
2. The cost effect: In the long run, if a company wants to increase its supply level, it’s
price input will increase, as they’ll need more workers and they’ll also need them to
work for longer periods of time, as well as more materials to make their product
3. The misinterpretation effect: some producers would think that an increase in the
overall price level means the price of their product in relation to another has
increased, so they become confident and supply more
Reasons why the SRAS curve shifts

1. A change in the price of factors of production would definitely shift the curve. For
example, if the price of materials needed for production increased, but the
productivity of the firm did not, then the curve would shift to the left.
2. An increase in taxes placed on the product by the government would make it more
expensive to produce the same amount as before, so supply will shift to the left
3. A rise in productivity of the firm would shift the supply to the right, because at all
levels, the amount of supply would increase
4. Since resources define the product a firm produces, an increase in their amount would
cause the curve to shift to the right as there are more resources to produce from, and
so, more product.
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With LRAS, there is time for the factors of

production to change and so, the price level
compared with the output will not be the
same as that in SRAS. There are two
different approaches to LRAS, the
Keynesians approach, which displays the
curve as perfectly elastic at low output rates
and then upward sloping at high output
rates. With Keynesians, they believe that the
government has to intervene in order to
achieve full employment of resources,
otherwise, the economy doesn’t reach its full potential. With the new classical economists,
they display the curve as a vertical line, because in the long run, they think that the output
will stay the same even if the price level is altered, because supply is assumed to not change.
The new classical economists think that the economy can move towards full employment
without the need of government intervention, which is happening in some countries at the
moment.
Reasons why the LRAS curve shifts
1. Net immigration:- More people of the working age means higher productivity and
higher employment, thus, shifting the curve to the right
2. Increase in retirement age:- This keeps the current workforce working for longer,
which keeps productivity at its level and may shift it to the right in comparison to
what it used to be
3. More women entering the workforce: - With more women in the workforce, the
percentage of workers available in the society is higher, there will be more
employment, higher productivity rate, and the curve shifts to the right.
4. Net investment: Other than the fact that investment needs to be used in paying for
capital goods and depreciation, if investment exceeds that, there will be a shift to the
right because firms can use this increased investment to buy more resources and
increase their productivity rate
5. Discovery of new resources: For example, finding new oil mines will always shift the
curve to the right as there has been a sudden increase in the amount of resources in
the economy
6. Land reclamation: If the country has land that was bought by another, but takes it
back, this land can now be used to support the country’s economy through building of
factories, mining of resources, etc…
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In the short run, the equilibrium between AD and AS is where the price level and the output
level (through the real GDP) is determined. If the AS is higher than the equilibrium, there will
be excess supply, some items are not bought, and the suppliers are forced to decrease the
price level. If the AD is higher than the equilibrium, the increased demand will push the price
level upwards to force more supply into the economy, and the macroeconomic equilibrium is
established. A change in the AD or in the AS will always force the macroeconomic
equilibrium changes because one will force the other to shift, the size of that shift however,
depends on what exactly happened. For example, the shift of the macroeconomic equilibrium
in a civil war is much different than the shift of the macroeconomic equilibrium when some
firms close down.
Macroeconomic equilibrium: when AD is equal to AS, and the output and price level are
known and achieved.
When we’re talking about inflation, we’re speaking of a sustained rise in the economy’s price
level, at a stage where the purchasing power of its currency decreases at a certain rate. For
example, if the inflation rate is higher by 6%, prices of all things will be higher by 6%.
There is a healthy inflation rate, and at around 2% is always fine, as a steady increase in
price levels will shift supply to the right and encourage suppliers to supply more of their
product to the market, more known as creeping inflation. However, sometimes, the inflation
rate may go up so high that the currency has little to no purchasing power in comparison to
the dollar, such as the case of Venezuela right now, where it costs so much to buy normal
things that are often priced at low prices, due to hyperinflation.
Creeping inflation: a low rate of inflation
Hyperinflation: an exceptionally high rate of inflation which may result in the purchasing
power of the currency to disappear as people stop using it.
The usual solution to hyperinflation is the introduction of a new currency that can overpower
the old one, as what is happening with Lebanon and the dollar overpowering the Lebanese
Lera.
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A rise in inflation will increase the living costs and governments will construct price indices
in order to assess it through the following stages:-
1. Selecting a base year: This is when the government chooses a year to compare the
current year to, a year in which nothing unusual happened and the economy did not
experience great changes
2. Carrying out surveys: These surveys are done to see people’s spending patterns and
on what they spend their money, so that the government can gain data about its
citizens.
3. Attaching weights to survey categories: This is done to see on what things people
spend the most, so if someone spends 200$ out of 1000$ on their car, then the car
takes 20% of the budget
4. Finding out price changes: The price change from the base year is compared with the
price change this year through asking suppliers and recording the current price
compared to the old price
5. Multiplying weights by price changes: This is done to see the consumer purchase
index (CPI)
Consumer purchase index (CPI): is an index to see the change in the price of a basket of
normal goods as a representative in comparison to the base year.
When inflation happens, people who may not understand how the economy works will think
they got a pay raise, however, they only got this raise because the inflation has increased the
values of everything in the country. The money values are those dependent on the previous
economical period, while the real values are those that are adjusted for inflation. For
example, when inflation occurs, the normal living standards may rise, which is why most
employees during a period of inflation will get higher wages.
There are 2 main reasons why inflation may happen:-

1. Cost-push inflation: This sort of inflation happens because the overall price of
producing one unit of a product increases. This can be due to an increase in wages,
material prices, etc… without the productivity of the employees changing
2. Demand-pull inflation: An increase in aggregate demand will cause the price level of
an economy to increase as more people are demanding but are not being satisfied at
the current level of aggregate supply. Most Monetarists, who are economists that
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believe inflation is caused by money only, believe that if there is more money in the
country, AD will increase as people have more money and will demand more things.
Inflation has saved some countries but drowned others, and it needs to be controlled in a way
which is beneficial. Some of the benefits and consequences are listed below
Benefits of inflation:
1. Stimulating output: a healthy inflation rate due to increased AD will make firms and
businesses confident, and so, they’ll supply more and that may get them more profits.
2. Reducing the burden of debt: as inflation places more money into the country, the
interest rates on borrowing will go down noticeably, so for people who burrowed
before the inflation has occurred, payments for their debts will go down, which means
they’ll have more money and thus, consumer expenditure increases elsewhere.
3. Prevent some unemployment:
Consequences of inflation:
1. Reduction of exports: a country with inflation will start exporting less and may start
importing more, which results in the net exports decreasing
2. Unplanned redistribution of income: as interest rates and wages start differing,
borrowing and lending becomes much different, and in times of inflation borrowers
may gain and lenders may lose
3. Menu costs: since inflation changes the prices of everything, the cost of firms doing
them and the time it takes is a consequence on its on (i.e. Changing price tags)
4. Shoe leather costs: this is the cost of people moving their money from one institution
(i.e. bank) to other, seeking better interest rates to make more money.
5. Fiscal drag: as said before, people do get higher wages in times of inflation to keep
their living standards the same. However, if the tax brackets are not fixed in
accordance to the inflation, people will get into higher tax brackets due to their
increased wages
6. Discouragement of investment: inflation creates uncertainty as people don’t exactly
know how the economy is performing, so they choose to save their money rather than
invest
7. Inflationary noise: this happens when people are unable to know what the exact
reason for a change in the price of a product is, and so, they make wrong decisions.
For example, a product may have become cheaper even though it has increased in
price, but has increased by less than the inflation. Some people may think it has
become more expensive, including the supplier, which may start supplying more, even
though the demand for their product has not actually increased.
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8. Inflation to cause inflation: the acts of the people is what determines if an inflation is
good or bad. Inflation itself may cause inflation because people start preparing for it,
demanding higher wages, purchasing products so that they don’t need to when they
increase in price, and firms start to raise prices in order to cope with the shock when
the inflation hits, of an increase in the price of production.
There are certain factors which affect inflation, it depends on the following:-
1. Cause of inflation
2. Rate of inflation
3. Accelerating or stable inflation
4. Was the rate expected?
5. Rate in comparison with other countries
If inflation does accelerate, due to the country not dealing with it well enough, it may
become hyperinflation, people may lose confidence in the currency and the government
eventually fails. However, if the country deals with inflation correctly and expects everything
following inflation to happen, inflation can be beneficial even on a worldwide competitive
scale.
With deflation, the price level of a country starts falling
Healthy deflation
down and each unit of currency has greater purchasing
power. This is due to a reduction in aggregate demand and
will increase the value of money. However, with
disinflation, it usually follows inflation where the inflation
rate starts to drop, but still stays positive. For example, if
the inflation rate changed from 4% to 2%, it’ll differ by 2%
but it’s still positive.
Deflation also has its consequences, opposite to inflation,
it’ll increase the burden of debt as banks start attracting investment and so the interest on
saving increases and the interest on borrowing decreases,
Unhealthy deflation
so some people may need to pay more. Deflation can also

result in menu costs as firms will need to lower their prices
and change price tags. However, deflation can be healthy
if it is caused by aggregate supply increasing, and can be
unhealthy if it is caused by aggregate demand decreasing.
If aggregate demand decreases, people want less products
and so the real GDP will drop as the output of the country will be less, employers start firing
workers and the unemployment rate increases.
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The price level of a country affects its balance of payments, which is a record of all of the
country’s economic transactions with the rest of the world for a calendar year. There a certain
format in which countries present their account, including the current account, the capital
account, the financial account, and net errors and omissions. Exports are positive in the
balance of payments, as they are an inflow of money, while imports are negative as they are
an outflow of money.
1. The current account: Includes all transactions between countries.

a. Trade in goods: Here, you’ll calculate the difference between the value of
goods exported to other countries, and goods imported from other countries. A
surplus will exist when you have a greater export value than your import value,
and these goods can range from cars, to refrigerators, TVs, and so on.
b. Trade in services: So called “invisible” exchange, here is when countries trade
things such as shipping, banking, insurance, etc… The same way of calculation
of trade in goods happens here
c. Income: Here, we’re talking about the foreigner point of view, where if you
have shares in a foreign country and are paid dividends, you’ve added to the
accounts value, but if you’re paying dividends for a foreigner’s account in your
country, you’re adding a deficit.
d. Current transfers: Usually with foreign workers, this is when you give money
back to your country. As a worker, if you’re abroad and send money back to
your country, you’re adding to the accounts surplus, but if a foreign worker in
your country sends money back to their country, their adding to the deficit in
your country’s account.
2. Capital account: The capital account measures the difference in inflow and outflow of
assets. For example, if a Jordanian were to sell a land to a Syrian for $1B then the
Jordanian capital account would have its value increased, but if a Jordanian were to
buy a land in Mexico for $500M, then the value of the Jordanian capital account
would decrease, and remember, with capital accounts we’re talking about assets only
and not goods (i.e. Lands, stocks, etc…)
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3. Financial account: The financial account is a large part of the balance of payments,
and focuses mainly on investment of large funds inside or outside the country.
a. Direct investment: This mainly focuses on direct forms of investment such as
building a factory in another factory or taking over a firm in another country,
or a foreign firm building a factory or taking over a firm in another country. In
the case of the former, it adds to the value of the financial account, but the
latter takes away value from the financial account
b. Portfolio investment: this usually includes the purchase and sale of
government bonds, stocks and shares that do not have to do with the legal
ownership of a firm
c. Other investment: this part contains shorter-term investment between countries,
such as bank loans from one country to another.
d. Reserve assets: These are assets held by the country’s government such as
gold, foreign exchange reserves, etc… that are used to settle international
debts and balance the foreign exchange rates
The balance of payments as a whole will always net out, and this is because whenever you
gain credit, a debit item will match it. For example, if your country exports $700 of mango
and imports $600 of potato. You’d think that your country would have a surplus of 100$
because you’ve exported more, however, the foreigners that you’ve exported your mangos to
will need to buy the mangos with your currency, so they use your currency from the central
bank, which decreases the official (your currency) reserves in other countries, thus,
decreasing the value of your capital account, and netting out the balance of accounts to 0.
However, the balance of accounts cannot be 100% accurate, as surveys are done and people
are asked in order to get information for the balance of accounts. This is why, if there was a
deficit or a surplus, a net errors and omissions figure would be added to match out that deficit
or surplus, so that the balance of accounts would equal to 0.
Net errors and omissions figure: a figure included in the balance of payments, to make sure it
nets out.
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Here, we’ll be discussing a deficit on one or other of the accounts within the balance of
payments, usually the current account.
1. Current account deficit may happen due to:
a. A growing domestic economy: To grow an economy, the GDP must increase
and so, the output of firms in that specific economy. To do this, firms will start
importing more raw materials in order to produce more goods, and will start to
sell domestically more than abroad as they want to grow their own economy.
This however, may attract foreign investment and in most cases, will not last
long, so this would usually not be the reason behind a disequilibrium
b. Declining economic activity in trading partners: Here, a country will be affected
by a ripple effect from the countries which trade with it. For example, France
and Germany are very strong trade partners, so if France experiences economic
recession, Germany might have a short-term current account deficit, as
France’s import expenditure may fall or may rise but at a slower rate.
c. Structural problems: with this kind of problem, we’re speaking long-term, as
the structure of economy is holding back the current account and putting it
under deficit, due to many issues such as a small workforce, low productivity,
high inflation, which all causes a country to borrow or import more resources,
while exporting less to the outside, and this cannot be quickly self-corrected,
as the whole economy will need to be restructured in order for the deficit to
vanish
2. Financial account deficit: This type of deficit is usually easily self-corrected and only
temporary, as investors may be investing outside the country due to higher interest
rates, but when investors lose confidence in the ability of the country to give back, it
is when the problems start happening. Here, foreign investors will start to pull away
from that certain country, and will sell their shares in this country to other investors.
This is scary, because in that case, total investment in the country will decrease as
investors are putting their money somewhere else, which causes a financial account
deficit.
A country with a current account deficit will have its citizens living above its highest standard
of living, which forces it to borrow money and attract investment, opposite to a country with
a current account surplus, where citizens are living below its highest standard of living.
Moreover, countries with a current account deficit will eventually give back money, in the
form of debts or investment income, while countries with a current account surplus may need
to change their policies due to inflationary pressure or other countries with a current account
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deficit pressuring them to do so as countries are interdependent. This inflationary pressure

may be due to reduced aggregate demand which leads to lower employment, and higher
costs of production.
Syllabus content 4) d)
Essentially, nominal exchange rates describe the value of a currency in terms of another
currency (usually the $US). For example, in Jordan, the value of $1 is 0.70JDs. If the value of
the JD increases, for example, becomes $1=0.60JDs, the value of Jordan’s exports in terms of
the US$ increase and the value of the US’s imports in terms of the $US would decrease.
However, economists don’t measure exchange rates in this way only, they have other ways of
exchange rate measurement, described below.
In words, the trade weighted exchange rate is the value of a currency compared to a basket
of currencies, based on trade. For example, if Jordan traded with the US 3 times as much as
it does with Kuwait, then the value of the $US in the equation will be 3 times as much as the
Kuwaiti dinar.
Here, the price changes in the economy as well as the currencies foreign exchange rate are
taken into account when calculating the competitiveness of a countries products in the global
market. When the foreign exchange rate of a currency drops, it is due to the fact that the
country wants exports to be more competitive, because a countries exports shouldn’t be
extremely expensive, so that people will be able to purchase. When countries experience
inflation, the price of their exports becomes high and they become less competitive,
decreasing purchases.
Real exchange rate = nominal exchange rate X domestic price index
foreign exchange rate
Here, the value of the currency will change in accordance to its supply and demand in a
certain country, and this is why the value of a currency can change across different countries.
Usually, these currencies can be obtained at financial institutions in each country (e.g.
Western Union). Sometimes, currency traders will buy the domestic currency, as to purchase
goods and services from that country, to invest in the country, or if they speculate that the
value of this currency will increase, as to profit from it.
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For example, if you’ve exchanged 100$ for 70JDs, and the day after that, the value of the JD
increases so that each 0.6JD is equal to 100$, then you’ve profited.
If the value of a currency appreciates, or increases in value as in our previous example, it is
due to the market demand of that currency increasing and/or the market supply of that
currency decreasing. The opposite happens if the value of the currency depreciates, or
decreases in value, where the market demand for that currency decreases, and/or the market
supply of it increases.
Appreciation Depreciation
A floating exchange rate does come with benefits, in the sense that if a country has a current
account surplus and the value of its currency drops, imports become more expensive and
exports become cheaper, so import expenditure decreases, while export expenditure
increases. Moreover, if the government does not influence this floating exchange rate, it can
use its foreign currency reserves to benefit the country. However, floating exchange rates do
come with disadvantages. For example, if two businessmen are trying to make a deal that is
going to come through 6 months later, it’d be hard to determine the value of that deal as you
don’t know how much it is worth. Moreover, if the floating exchange rate falls, inflationary
pressure will occur as imported raw materials will be more expensive (i.e. costs of
production) and firms will not restrict their price rises, so domestic finished products will
greatly increase in price.
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The fixed exchange rate basically tells you that the domestic currency will always exchange to
a certain amount of another currency. For example, 1JD in Qatar will always exchange to 5
Riyal, because this value is set by the government where each 0.20 JDs are equal to 1 Qatari
Riyal. However, this needs to be maintained by the central bank, which does the move that is
opposite to the market in order to stay at the current exchange rate. So,
if the markets demand for the currency increases, the government will
try and increase the supply of the currency in hopes of keeping it at the
current exchange rate.
This, certainly comes with advantages and disadvantages. To begin
with, a fixed exchange rate promotes certainty in a country, so
investment and business is a country is going to increase as
businessmen will be sure of the revenue they’ll make if, for example,
they open a branch in that country. Moreover, the government will keep
the inflation low as a byproduct of international competitiveness not
putting downward pressure on the exchange rate. However, a fixed
exchange rate means that governments will have to keep reserves in order to maintain the
same exchange rate in the long-term. They may also need to sacrifice certain objectives in
order to maintain a fixed exchange rate, so for example, they’ll impose higher interest rates
which will strongly hit businesses who need loans, thus decreasing the demand for
employment, which decreases aggregate demand in the country.
A mix between a fixed exchange rate and a floating exchange rate, where the government
will allow the market to determine the value of the currency, but within upper and lower
bounds, where if the value exceeds these bounds, the government will take action in order to
bring it back.
There are many reasons as to why the value of a certain currency might increase, and one of
these reasons is just increased demand for the currency. This could come due to low rates of
inflation, which not only means that exports are competitive, but also means that foreigners
are confident in the economy and will be willing to buy shares in it or open branches of their
businesses, because employment and productivity (due to high GDP) is increasing in that
economy. Speculation, whether it was right or not, plays a large part in increasing the value
of a currency. If speculators think that the value of the currency will rise, people will start
demanding it in hopes of profiting, which increases the demand for it. Lastly, hot money
flows, where flows of money will be moved around the world in search for good exchange
rates and interest rates may also appreciate the currency.
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However, the value of a currency may also decrease if its supply increases. The value of a
currency depreciating is not necessarily a bad thing, it may depreciate because the country is
trying to attract foreign investment, travel, or is trying to open branches worldwide, so it’ll
need to buy foreign currency (using its currency) to do this, thus increasing the supply of
their currency in the market. The country may also want to devalue its currency in order to
increase international competition to improve its current account position.
When you decrease the value of the exchange rate, imports become more expensive and
exports become cheaper in terms of the home currency. This may enable suppliers to sell
more domestically and even abroad, as some citizens may now purchase the home products.
An increase in exports causes an increase in output, which increases aggregated demand,
however this may lead to inflation, as the economy approaches full efficiency or capacity,
and imported raw materials are expensive, costs of production will keep increasing and firms
do not feel the competitive pressure to lower their prices.
Usually, people think that lowering the exchange rate improves
the current account position, however, this is only true with the
sum of PED of imports and PED of exports are >1. Here, a
devaluation, where the government lowers the international
value of the currency, or a depreciation, where the market forces
lower the international value of the currency, can improve the
current account position. This is called the Marshall-Lerner
condition, and is linked to the J-curve effect, which describes
that when the value of the currency drops, the current account
deficit gets even worse in the beginning as imports and exports
are inelastic. However, as people start to notice price changes,
import and export expenditure start changing and the current account position becomes
better.
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An appreciation, where the international value of the currency is increased by market forces,
or a revaluation, where the government raises the international price of the currency, can
cause many changes to the economy. First of all, appreciation and revaluation can decrease
inflationary pressure, as imports become cheaper and exports become more expensive,
people start buying from other countries instead of the domestic products, and this means
that aggregate demand won’t increase as much. It can also shift the aggregate supply to the
right as imported raw materials are cheaper, so more firms can produce more products,
competition increases and firms are forced to keep their prices low. With appreciation and
revaluation, the opposite of the Marshall-Lerner condition and the J-Curve effect happen,
where if the sum of PED of exports and PED of imports <1, the current account deficit would
increase or the current account surplus will decrease. Moreover, the current account surplus
increases at the beginning then starts to fall, as imports and exports are relatively inelastic.
Syllabus content 4) e)
The terms of trade is a relationship between the numerical prices of imports and exports,
done in the following formula:
Terms of trade = index of export prices/index of import prices x 100%
If the terms of trade increases, it is described as a favorable movement and when it decreases,
it is described as an unfavorable movement. A favorable movement occurs when the price of
exports increases more than the price of imports, or the price of imports stays as is and the
price of exports increases. This could be beneficial as it ensures that domestic products are sold
and that you can import more than you export. However, in the long run, this can cause a
current account deficit which could be consequential. When an unfavorable movement occurs,
the price of imports increases more than exports, or the price of imports increases and the price
of exports stays as is. This could be disadvantageous, because it means that domestic products
are not being sold, and the price of these products will need to be lowered in order to be
competitive, as people are exporting more than they are importing. However, in the long run,
this could decrease the current account deficit as exports are more than imports.
The Prebisch-Singer hypothesis states that some countries will have a decrease in terms of trade
specifically due to time, especially developing countries, since most of their products are from
the primary sector, and due to falling commodity prices for these types of products, as most
people now buy invisibles such as services, the price of exports decreases and thus the terms
of trade worsen.
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The differences between absolute and comparative advantage need to be established. An

absolute advantage is when a country can produce more of a product than another country,
using the same amount of resources and cost. However, a comparative advantage is when a
country can produce more than another country at a lower opportunity cost, thus giving up
less. When a country has a comparative advantage, it can specialize in producing the product,
thus gaining an absolute advantage. For example, if Jordan can produce 7 tons of phosphate
while only giving up 1 ton of coffee, but Brazil can produce 4 tons of phosphate while giving
up 3 tons of coffee, it means that Jordan has a comparative advantage, as it gives up less
coffee to produce phosphate. However, if both Jordan and Brazil had 500 tons of resources
to produce, and Brazil produce 700 tons while Jordan produces 600 tons, then Brazil has the
absolute advantage
Comparative advantage Absolute advantage
When countries establish free trade between each other, it means that these countries can
trade with each other without any tariffs or taxes being imposed. This can come with many
benefits, beginning countries having the ability of increasing their comparative advantage as
opportunity costs will be less, which results in higher output, more employment, a higher GDP
and a better overall standard of living. Moreover, free trade can increase competition in the
market as suppliers keep their prices low, and this gives consumers a variety of products to
choose from, which increases consumer welfare. Lastly, countries are able to specialize which
means they can take advantage of economies of scale and lead to high rates of economic
growth.
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The trading possibility curve is a diagram which shows the effects of a country specializing
and trading, it assumes that both countries produce a certain product, and there is a constant
price in the production of these goods, which makes the graph a straight line, and shows that
different nations face different (opportunity) costs of production.
Countries aim to create trade blocs which are regional groups of countries which have
entered into trade agreements. There are different types of trade blocs, and each have their
benefits and reasons as to why they are created
Free trade areas
When countries have a free trade area between them, member governments will remove
trade restrictions between them completely, meaning no tariffs or taxes. Members can decide
on policies against non-members. An example of this is NAFTA, the North American Free
Trade Agreement, including Canada, Mexico, and the USA
Customs union
This goes a step further from free trade areas, and not only allows free trade between
members, but imposes a common external tariff on non-members. An example of this is the
SACU, the South African Customs Union. Any product imported from outside the union will
have a tariff on it, and the revenue of the tariffs is shared between the member countries.
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Economic union
Here, member countries will have free trade, will place a common external tariff on non-
members, and will even inherit common economic policies for some aspects, including the
same currency. The most know example of this is obviously the European Union, or the EU,
containing many European countries which share the same currency, the Euro. The EU
basically acts as the one market instead of many, and other countries will deal with it in that
way.
When countries create trade blocs, trade creation might

happen, where high-cost domestic production is replaced by
more efficiently produced imports from within the trade bloc.
Even though this might harm domestic suppliers of the
product, it will increase the consumer surplus as it is less
expensive to import the product. Moreover, since imported
resources become less expensive firms might shift their
production towards another product, so it is beneficial for both
groups. Moreover, this increases welfare in the country as
consumers are being able to import and consume more.
However, trade diversion might also happen when a trade bloc
is created, where trade with a low-cost country outside a
customs union is influenced by higher-cost products supplied
from within. This shifts trade to a country which produces
inefficiently, and this will have a couple of effects. First of all,
the consumer surplus will increase because the consumers get
the product at a lower price, however, the producer surplus
will decrease as the consumers demand less of the product
from domestic producers. Lastly, the government will also lose
out as the tariff imposed on the low-cost producing country is
gone, as the inefficient country is part of the trade bloc.
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Syllabus content 4) g)
Protectionism seeks to protect domestic producers from foreign competition by restricting

free trade and placing a higher price and tariffs on imported products.
Tariffs
Probably the most know and best way of protectionism is placing tariffs on imports and
exports. A tariff is basically a tax placed on imports or exports, which increases their price.
When tariffs are imposed on exports, they’ll raise revenue and increase the supply of the
product in the domestic market. When taxes are imposed on imports however, it is done in
order to discourage the consumption of imports and encourage the consumption of the
domestic product. When a tariff is placed, the consumption of the world supply will decrease
and firms are able to supply a higher quantity of the product.
Quotas
A quota is basically a physical limit on the amount or value of imports or exports. When an
import quota is placed, the price of the imported product increases as there is a lower supply
of it and the demand is the same so consumers compete for it, and become worse off due to
the higher price, and so, they’ll buy the domestic product instead
Exchange control
A government can limit the amount of purchases of foreign country (less exchange
opportunities), which is used to buy foreign products or invest abroad.
Export subsidies
Export subsidies are given to firms which export their product to outside markets, but
subsidies can also be given to domestic producers. This causes them to feel a fall in the price
of production, which will encourage them to increase the supply of their product and lower
its cost, which enables them to attract more consumers abroad, who will benefit in the short
run due to the lower price of the product.
Embargoes
An embargo is a complete ban on the importing or exporting of a particular product, or a ban
on the trade with a particular country. For example, the USA has an embargo on Iran,
because of certain political issues.
60
Voluntary export restraints (VER)

This is basically a limit placed by the government of a country to limit the amount of imports
from country which it is exporting to, during a certain period of time. This is usually done to
protect firms from imports from other countries that could harm domestic production
Economic and administrative burdens (“red tape”)
This is a more invisible type of protectionism, where governments will have importers sign
many documents and set high product standards to restrict foreign competition. This
increases the cost of trading and the time it takes, which discourages imports.
Keeping the exchange rate below its market value
Governments may manipulate their exchange rates in ways which give the producers a
competitive advantage.
To protect infant industries

Infant industries are new industries which have a low output and a high average cost, so
countries use trade restrictions in order to stop foreign firms from overtaking the industry and
shutting down any domestic production, and this infant industry can act on the comparative
advantage that is possible to achieve. However, this can come with disadvantages. First of all,
firms can become way too reliant on protection from the government, that when the point
comes where foreign firms enter the industry, they completely shut down. Moreover, you
can’t really identify which new industries will develop a comparative advantage, because the
long run average costs of firms is difficult to calculate.
To protect declining industries
The opposite of an infant industry is one that is declining and no longer has a comparative
advantage, and this may lead to a large rise in unemployment. However, if the country
imposes trade restrictions, it could control the damage as some employees retire and others
will go to other industries to work in. However, this could disadvantage other industries. For
example, if the flour industry is declining and no longer has a comparative advantage, the
baked goods industry might get disadvantaged if trade restrictions are imposed as flour
becomes more expensive, causing loses domestically and externally.
To protect strategic industries
Governments will look to protect industries which they are believe are strategic, such as food
and fuel or gas. This is done because the government doesn’t want to rely on foreign firms
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for such things, because if a trade dispute or a political conflict occurs and food is cut off the
country, it can lead to many internal issues.
To prevent dumping
Dumping is the selling of products at a price below their cost of production in foreign
markets by firms. Even though this allows consumers to enjoy low prices on these products,
in the long run, these foreign firms will drive domestic firms out of the market and the
foreign firms will be able to establish a monopoly on the market and play with the price
however they like. Foreign firms are able to do dumping because they can balance the losses
with supernormal profits from earlier, by increasing the price of the product in the market at
home, or by getting subsidies from the government
To improve terms of trade
If a country buys a lot of another country’s exports, it can decrease the demand for it and
thus, gain a lower price on that country’s exports, meaning that it can buy more imports for
the same amount of exports. Moreover, if a country accounts for a large amount of export
supply of a product, it can put a quota on its exports and increase the price of exports, thus
improving the terms of trade
To improve the balance of payments
If trade restrictions are imposed e.g. tariffs, then consumers might switch from buying
exports to buying domestic products, which can improve the current account position, but
only in the short-run because the governments on which tariffs were imposed can react and
impose tariffs as well, thus decreasing the terms of trade and global output.
To provide protection from cheap labor
Here, trade restrictions are imposed on products which are produced by cheap labor, because
it isn’t always true that cheap labor means lower costs of productivity and higher profits.
However, this isn’t always true because low wages could lead to lower productivity and thus,
lower profits.
Other reasons
Governments can sometimes impose tariffs if the demand for exports is inelastic, to gain
more revenue. A government can also impose trade restrictions to retaliate to another
government’s trade restrictions, in hopes of removing the restriction, however, there is
potential that a trade war could develop.
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This chapter will discuss policies which governments use in order to achieve:
1. Full employment
2. Low and stable inflation
3. Balance of payments equilibrium
4. Steady and sustained economic growth
5. Avoidance of exchange rate fluctuations
6. Sustainable economic developments
Usually, governments will try to focus on one objective using the policies that’ll be talked
about below, and then they’ll move on to the next, from most to least important
There are 3 main policies which governments use in order to achieve certain objectives, and
each one of them has its effects and uses
AD2  AD3: Expansionary

AD2  AD1: Deflationary
This type of policy addresses governments using spending and
taxation in order to improve the position of the economy by
influencing aggregate demand. There are two different types of
fiscal policy, expansionary fiscal policy which aims to increase the
aggregate demand by increasing government spending or
decreasing taxes, which shifts the aggregate demand to the right,
increasing the GDP, and deflationary fiscal policy where
governments aim to decrease aggregate demand by decreasing
government spending or increasing taxes. Any deliberate change
in government spending or taxation in order to influence
aggregate demand is called discretionary fiscal policy.
However, the government can also influence aggregate demand through automatic stabilizers,
which are changes that occur in government spending or taxation without changing any
government policies. For example, if there is a large amount of unemployment, government
spending on unemployment benefits will increase while the amount of tax gained from firms
will decrease as the productivity isn’t that high. Here, the government didn’t actually do
anything to alter aggregate demand, but the nature of the economy altered government
spending and taxation on its own.
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Lastly, we’ll need to speak of the budget, which is a fiscal policy document released by the
document every year to outline its plans for spending and tax revenue. Many consumers and
a large sector of the media is on the lookout for this, as they need to know how the
government will treat them this year, so that they are able to understand their financial
capabilities. When the government spending exceeds the tax revenue, we’ll have a budget
deficit and when the government spending is less than the tax revenue, then we’ll have a
budget surplus. Most governments aim to have a balanced budget, and in the short run,
they’ll welcome a budget deficit if it means that the economy will grow, because this deficit
will be fixed later by the increase in real GDP.
If the government has a budget deficit, it can be of two types. Cyclical deficits usually occur
due to automatic stabilizers and have nothing to do with the government’s policies, so they’ll
usually fix themselves as economic activity increases. However, structural deficits are what
governments are scared about because it means there is an imbalance between government
spending and taxation, and this type of deficit will not disappear when the real GDP
increases.
Here, government takes measures using interest rates, money supply, and the exchange rate
to influence the price or quantity of money in the economy. Expansionary and deflationary
monetary policies also exist here. For an expansionary monetary policy, the government will
try to increase aggregate demand by decreasing interest rates to encourage borrowing,
increasing the money supply in the country, and decreasing the exchange rate so that the
aggregate demand rises. However, for a deflationary monetary policy, the government will
increase interest rates to encourage saving, decrease the money supply in the country and
increasing the exchange rate so that the aggregate demand falls.
Interest rates: the price of borrowing money and the reward for saving it
Money supply: the total amount of money in the country
This type of policy focuses more on increasing aggregate supply to benefit the economy. In
some cases, an increase in aggregate supply could cause an increase in aggregate demand as
well, as sometimes, decreasing or (sometimes) increasing government intervention may
attract investment which increases both AD and AS. The following methods can be used in
supply side policy, to influence aggregate demand
Cutting corporation tax
This will encourage firms to invest as they know that they’ll be able to keep more of any of
the profits earned which increases both AD and AS
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Cutting income tax

Cutting income tax may encourage already existing workers to increase their working hours
and take up greater responsibilities, as well as persuade them to stay in the labor force, as
they know that increase in wage will be significant due to lowered income taxes. It may also
persuade unemployed workers to enter the work force, as money earned from wages is
greater.
Reduction in welfare payments
A reduction in welfare payments may encourage unemployed workers to search harder for a
job and put more effort into it, as the welfare payments are not sufficient.
Increasing spending on education and training
This may increase the quality of education and training which produces workers that are
more efficient and mobile which can increase the overall productivity.
Trade unions reform
If the trade unions are reformed to be more beneficial for their members, the days lost on
strikes may decrease and the flexibility of workers can increase.
Privatizing public sectors and deregulating
This could allow for competition in the market which means there is a variety of the same
product for consumers to choose from, given that there are strict government rules set to
counter monopolies.
Improving infrastructure
This may decrease the amount of money spent by firms on transportation (of products)
Government subsidies
This decreases the amount of money used by firms in the production process which could
allow firms to supply more of their product.
65
The balance of payment disequilibrium means when the components of the account don’t
add up to one. To fix this, we have to types of policy approaches.
Expenditure switching policies are designed to switch the consumers’ spending from imported
or foreign products to the home or domestic products. This could include any policies needed
to decrease the import expenditure and increase the export expenditure, to make imports
more expensive and the exports cheaper to improve the terms of trade, as well as any policies
which attempt to persuade households to spend more on domestic products and less on
foreign products. If import expenditure is decreased, the supply of the country’s currency in
the market will decrease as well, and if the export expenditure is increased, the demand for
the currency’s currency will increase, leading to upward pressure on the exchange rate.
An expenditure “dampening” or decreasing policy tries to decrease the total level of spending
in the economy, and a reduction in spending will mean that there are fewer purchases of
imported and foreign goods. Moreover, this might mean the market is dampened, so
suppliers won’t find as many consumers to buy their product domestically, so they’ll start to
supply to foreign consumers in order to cover up the lost sales, which increases export
expenditure and decreases import expenditure, thus decreasing the disequilibrium.
To switch consumer spending, a government may use the fiscal policy to impose tariffs on
imported or foreign products in order to switch consumer spending from imported and
foreign products to domestic products, however this could lead to retaliation from the
countries which own these foreign products, where they’ll also impose tariffs and taxes. The
government may also use the fiscal policy to decrease overall spending, by decreasing
government spending and increasing income tax. Increasing income tax will leave less
income for households to use on domestic and imported products, while decreasing
government might decrease demand for goods and services as it decreases the aggregate
demand, which reduces imports, and puts pressure on suppliers to export to foreign markets.
How effective is the fiscal policy?
Since fiscal policy measures are temporary, they’re likely to solve the disequilibrium for the
short-term, however once the policy is lifted, consumers will go back to their old spending
habits, including spending on foreign and imported products. Moreover, imposing tariffs on
trading partners can reduce the pressure on domestic firms to be efficient.
66
Raising taxes can cause lower demand as consumers do not have as much money, which may
increase unemployment and can slow down economic growth. Lastly, if “Green taxes” are
imposed, such as a minimum price on pollution permits, firms may be unable to produce as
much and thus, the domestic output is decreased.
The monetary policy specifically has to do with the money supply and how the government
controls it. If we’re talking about expenditure switching policies, then we’d want consumers
to switch from importing foreign goods to purchasing domestic goods, and if we’re talking
about expenditure reducing, then we’re looking to reduce the amount of money consumers
spend on imports. We have two ways of controlling the money supply, and thus the current
account position:
1. Interest rates: If the country has a current account deficit and low rates of inflation,
it’ll decrease interest rates in order to encourage borrowing and depreciate its
currency. This will cause exports to become internationally competitive. Moreover, hot
money flows may occur where investors pull their investment out of the country as
they aren’t generating that much from it. On the other hand, if we want to increase
interest rates, the demand for imports will fall as borrowing is more expensive and
thus consumers do not have as much money, and the inflationary pressure will
decreases. However, this could increase the floating exchange rate and the demand
will be reversed. Lastly, some households can adapt to interest rates and high interest
rates can sometimes have an adverse effect on unemployment, and there is a time lag
when using interest rates, before they have their effect.
2. Exchange rates: Countries will try to alter the exchange rate in order to switch
expenditure. If the country has a current account surplus, then the government will try
to increase the rate of exchange, making exports more expensive and imports cheaper.
However, if the country has a current account deficit, then the government will try to
lower the exchange rate as to lower the price of exports and increase the price of
imports. On the other hand, playing with the exchange rate will not work if the
demand for imports and exports is price inelastic, as it means that even if the price
increases or decreases the amount of exports and imports will barley change.
Moreover, monetary policies usually have short-term effects unless the government
tries to stop maintaining the exchange rate
67
The supply side policy aims to make domestic products more competitive and make domestic
firms more attractive to invest in. There are many ways in which supply side policy can
decrease a current account or financial account deficit:
1. Deregulation, privatization, and trade unions: This may increase competition and so,
the pressure on domestic firms to keep prices low, improve quality, and become more
responsive to changes in demand will increase. However, if firms are privatized and a
firm forms a monopoly, efficiency might drop as they will not take into account
external costs and benefits. Moreover, deregulation and trade unions could cause
increased inefficiency if there is market failure in the product and labor markets,
which laws and trade union power countered.
2. Increased spending on training and education: This may increase exports and
encourage foreign investment as inefficiency will be lower and capital equipment will
increase, which increases the overall output. This is likely to increase the domestic
firms’ share in domestic and worldwide markets. However, these effects do not
appear in the short run, and will probably appear in the very long run if not at all. If
the quality of developed labor is not high enough, or if they possess assets that will
not be needed in the future, then that is just money wasted.
Lastly, supply side policies are usually very uncertain, as they do not have a determined
outcome. For example, if you cut income taxes, workers who are happy with their current
wage will start to work less hours.
In order to decrease the demand-pull inflation in a country, the government could use
deflationary fiscal and monetary policies. This can be done through the following ways:
1. Government spending/Income tax (fiscal):- In order to decrease demand pull inflation,
the government could lower its overall spending, so that the aggregate demand can
be lowered, or it could increase the income tax applied on its workers. However,
raising income tax can backfire in two ways. First of all, if you raise the income tax,
workers may start to demand more wages, and if these demands are satisfied then the
costs of production for firms will increase, which can generate cost-push inflation.
Next, higher income taxes may create disincentive effects where if workers see that
the income tax has been increased, they’ll leave the workforce which decreases the
overall productivity of the country, which decreases aggregate supply. Governments
may also be worried that, if they increase income tax more than their competitors in
68
different countries, that a good amount of the workforce would migrate, thus
reducing the productive capacity.
2. Interest rates (monetary): - If the aggregate demand is to be decreased, the
government should increase interest rates. What this does is that it increases the price
for borrowing and increases the reward for investing, which means consumers will
start saving more and buying less. Moreover, this could also bring hot money flows
into the country as interest rates are high, so investors get high reward. However, this
strategy is bad for consumers who are optimistic about the future. These consumers
will not reduce their spending, they’ll just cut down on saving to save up the deficit
because they are confident that borrowing will become cheaper in the future (this also
applies for income taxes, where consumers are confident that income will rise in the
future). Lastly, for countries with a fixed exchange rate, the central bank might be
scared to increase interest rates as it might put upward pressure on the exchange rate
3. Increasing spending on education/training (supply-side): - Spending on training and
education could be increased in order to increase the quality and scope of skills of the
workforce. This could lead to economic growth, lower unemployment rates, reduce
inflationary pressure (greater AS), reduce the current account deficit, and promote
development. However, with supply-side policy, all of its effects will be long-term, in
the short-term it may increase government spending which will increase the aggregate
demand. Moreover, the results of a supply-side policy are not determinant and they
could lead to nothing.
Governments could also employ supply-side and monetary policies to correct cost-push
inflation, using the following methods:
1. Raising the exchange rate (monetary): - When you raise the exchange rate, it reduces
the price of imports and thus, imported raw materials and capital costs which puts
pressure on firms to find ways to decrease costs. However, this could backfire if
producers decide to keep the price of their exports unchanged in the country’s
currency, and not respond to the competitive pressure of keeping down their costs
and price raises.
2. Increasing spending on education/training (supply-side): - governments could increase
the spending on training of the workforce to improve productivity and thus, decrease
labor costs or reduce the upward pressure on labor costs. The government could also
lower corporation tax so that firms can buy more efficient capital equipment which
decreases costs in the long run. However, these methods could fail. If the wages of
the workforce rise by more than their productivity, then the labor costs will increase
once more. Moreover, low corporation tax may not result in more investment if firms
are pessimistic about the future
69
3. Subsidies (supply-side): - the government may decide to provide to subsidies to firms

facing higher costs, so that they do not have to raise their prices. It may also hope
that the firms use some of the subsidies to buy capital equipment which lowers costs.
However, subsidizing may increase the aggregate demand as the government is
spending more, but may not increase the aggregate supply if firms do not react
positively to the subsidizing.
If a government wants to correct bad deflation, it’ll use reflationary fiscal and monetary
policy measures, using the following methods:
1. Increasing government spending: increasing government spending will raise the
aggregate demand and is the most powerful of these methods.
2. Cut tax rates: if the government cuts tax rates, the consumers will have more
disposable income and thus they can spend more. However, consumers are usually
pessimistic during times of deflation, so they might not spend more even though they
have greater disposable income
3. Decrease interest rates: a decrease in interest rates makes borrowing cheaper and so,
allows consumers to get more money in order to spend on goods. However,
consumers may be pessimistic and sometimes the interest rate is so low that you can’t
decrease it more than what it’s already at, and even if you decrease it, it is unlikely to
stimulate increased borrowing and spending
4. Increase money supply: Increasing money supply means there is more money flowing
in the economic circle, so more money will be spent by consumers on certain goods,
thus increasing aggregate demand. However, even if central banks increase the money
supply to allow commercial banks to have more funds to lend, the commercial banks
may be reluctant to lend as they think that there is an absence of creditworthy
borrowers.
70
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Cambridge International AS Economics Syllabus code: 9708

Positive statement: One that is based off of empirical or proved evidence

Benefit of a positive statement Drawback of a positive statement

Benefit of a normative statement Drawback of a normative statement

However, with specialization, no one is self-sufficient, meaning that everyone will

We have three different types of economic systems, Free-Market economy, Command or

Planned Mixed Free Market

Advantages of Free-Market economy Disadvantages of Free-Market economy

In a planned economy, resource allocation is undertaken by a central body, using central

How to produce it?

For whom to produce it?

Advantages of Planned economy Disadvantages of Planned economy

How to produce it?

For whom to produce it?

Well, what happens if we change the last two factors?

Production Possibility Curve

Before we ever had money, we were in a barter economy,

1. Acceptability – it is accepted widely as a unit of exchange

1. A medium of exchange: it is accepted by the general public, where buyers use it to

From a beneficial point of view, goods can be classified into 2 types:

Adverse selection: is when information failure leads to someone inexperienced or unsuitable

The demand curve represents a negative relationship

4. Number of consumers: - This is a basic mathematical formula, the more consumers

1. Prices and availability of resources: - The amount of a product supplied by a certain

2. Number of sellers: - As with the number of consumers, this is a basic mathematical

Syllabus content 2) b) & 2) c)

Is a measurement of the consumer’s responsiveness to a change in price, and this depends on

Inelastic = Insensitive to a change in price

With elastic goods, a great change in price will cause a great

This goes for products such as soda, boats, beef, etc…

Elastic = Sensitive to a change in price

Unit elastic demand graph Perfectly inelastic demand graph

YED = % change in quantity demanded

Describes the responsiveness of suppliers to a change in price of a specific product. In the

Price elastic supply Perfectly Price Inelastic Supply

Price Inelastic Supply

Factors influencing Price Elasticity

Syllabus content 2) d) & 2) e)

After the change

Let’s take an example and draw the market analysis

 Equilibrium Price = 1400

After the change

Consumers’ surplus refers to the difference between

There are two main types of taxes which are:

PED > 1 PED < 1

Syllabus content 3) d) & 3) e)

This is another way of the government to reduce inequalities in a society, by providing

Many people seek for privatization as it has the following benefits

Government spending (G)

Net exports (X-M)

Shifts in the SRAS curve

Reasons why the SRAS curve shifts

With LRAS, there is time for the factors of

There are 2 main reasons why inflation may happen:-

With deflation, the price level of a country starts falling

so some people may need to pay more. Deflation can also

1. The current account: Includes all transactions between countries.

deficit pressuring them to do so as countries are interdependent. This inflationary pressure

The differences between absolute and comparative advantage need to be established. An

Comparative advantage Absolute advantage

When countries create trade blocs, trade creation might

Protectionism seeks to protect domestic producers from foreign competition by restricting

Voluntary export restraints (VER)