Chapter 16

Money and Banking

Money is anything which is universally acceptable as a medium of
exchange that is generally acceptable as a means of payment.

Forms of Money
• Cash: Bank notes & coins are a physical form of money
• Bank Deposits: these are money reserves placed in commercial banks
accounts. Examples are Cheques, Bank Dra s, Debit Cards, Credit Cards
• Central Bank Reserves: These are money held by central banks and used by
commercial bank to make payments to themselves.
Func ons of Money
Medium of Exchange – When money is used to intermediate the exchange of
goods and services, it is performing a func on as a medium of exchange. It
thereby avoids the ine ciencies of a barter system. Exchange is easier and less
me consuming in a money economy than in a barter economy.

Measure of Value / Unit of Account – e.g. 1 pair of shoe is $120, while a can of
Redbull is $25.

Money acts as a measuring unit for value. Thus di erent commodi es can be
expressed in terms of money uniformly. This simpli es the comparison of the
value of two products or services.

Store of Value – To act as a store of value, a money must be able to be reliably

saved, stored, and retrieved – and be predictably usable as a medium of
exchange when it is retrieved. The value of the money must also remain stable
over me.

Standard for deferred payments – Future transac ons can be carried on in

terms of money. The loans, which are taken at present, can be repaid in money
in the future. The value of the future payments is regulated by money.
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 Money can be used to pay over me for commodi es. Goods and services can
be paid for in installments over a period of me e.g. hire purchase. This was
much more di cult and complicated in the barter system

Features of money
• Durability: Money must be durable, which means it should be usable for a
long me and must be of good quality. It should not be something that gets
damaged easily or spoiled in a short period of me. Since money is durable,
it can be used as a store of wealth/value.
• Scarcity: Since anything to have economic value, it must be scarce. Money is
scarce and that’s why it has value. People can accept something as money
only if it has value.
• Portability: Money must be something that people can easily carry with
them from one place to another. Today paper currency is used instead of
gold and silver because paper currency is more portable.
• Acceptability: Money must be something that everyone can accept for a
unit of account and medium of exchange.
• Divisibility: Money must be something that can measure all the goods and
services accurately. For this purpose, money must be something that we can
divide into small denomina ons.
• Stability: Money must be something which has a rela vely stable value over
me. It should not lose its value over me. Its func on as a store of value
can be ful lled only if its value is stable.
Central Bank
A central bank is a public ins tu on that manages a state’s currency, money
supply, and interest rates. Central banks also usually oversee the commercial
banking system of their respec ve countries. A central bank possesses a
monopoly on increasing the na on’s monetary base, and usually also prints the
na onal currency, which usually serves as the na on’s legal tender.

Func on of Central bank

1- Issuing Currency
The Central Bank in every country, now, has the monopoly note issue. The issue
of notes is governed by certain regula on which is enforced by the
government.
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 2-Banker to the state
A Central Bank acts as a banker to the government. It holds cash balances of
the government free of interest.

3-Bankers’ bank.
The central bank acts as a banker to the commercial banks.

4-Bankers’ clearing house

The Central Bank acts as a clearing house for the se lement of mutual
obliga ons of di erent commercial banks. If a di erence exists, it is paid by a
cheque drawn on the banks accounts carried at the Central Bank.

5-Lender of the last resort

The Central Bank helps the member banks in mes of crisis.

6-Financial agent
The Central Banks act as nancial agents for the government. It is an agent for
the government in purchasing and selling of gold and foreign exchange.

7-E ec ve monetary policy

The aim of the government is to create employment in the country, resist
undue in a on and achieve a favorable balance of payment.

Commercial Banks
A commercial bank is a retail bank that provides services to its customers such
as accep ng deposits and giving bank loans.

Primary Func ons

1. Accep ng Deposits: commercial banks accept deposits from their
customers. These deposits could be sights deposits which are always
available on demand or me deposits which comes with a xed period of
me.
2. Giving Loans: They provide loans to their customers which could be in form
of overdra or mortgage for acquiring proper es.
3. Credit Crea on: This process ensures that banks increase money supply in
an economy by making money available to borrowers.
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 Secondary Func ons
1. O ering nancial advise to clients and government
2. Providing money transfer avenues
3. Providing internet banking ac vi es
4. Providing safety deposit boxed for valuables
5. Collec ng and clearing cheques on behalf of their clients
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 Chapter 17
Households

TYPES OF PERSONAL INCOME

There are several ways of measuring personal income:

1. Gross personal income: This is the total personal income from all sources of
an individual.

2. Disposable personal income: This is the amount which remains after income
tax and national insurance contributions have been deducted from gross
personal income. Disposable personal income = Gross personal income –
Income Tax & NI contribution.

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 3. Real disposable personal income: This refers to the quantity of goods &
services which disposable income can buy. It is the purchasing power of
money income.

CONSUMPTION/SPENDING

• Consumption involves the using up of goods and services to satisfy wants

• People earn money to buy goods and services they want and need but do not
produce themselves in their work
• The income a person has left after income-related taxes and social security
contributions have been deducted is called disposable income
• The person may dispose of this income as they please
• The more disposable income a person has, the more their potential consumer
expenditure on goods and services is

FACTORS INFLUENCING CONSUMER SPENDING

1. Disposable Income - (more real income more spending). As income rises,

people usually spend more in total, but less as a percentage of their income.

2. Wealth – (more wealth held more spending)

Wealth generates income, eg dividends on shares which can be spent. Wealth
can be sold to generate money. Wealth also can be used as a security for

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 loans. Wealth also creates confidence in the people. If the value of a house
rises, people feel richer and will spend more on products.

3. Easy borrowing (easy borrowing, easy spending)

When it is easier to borrow money, people will tend to spend more with the
help of loans. Eg car loan

4. Hire-purchase facilities (easy installments, more spending)

5. Rate of interest (low rate of interest more spending)

When the rate of interest falls, people will spend more as borrowing
becomes cheaper and saving will be discouraged. With a rise in the rate of
interest, people will save more of their disposable incomes inorder to earn
higher interest income.

6. Changes in the rate of income tax (decrease rate of interest, more

spending)

7. Changes in the distribution of income (lower income household spend a

greater proportion of their income then higher income households)

8. Confidence- If people feel optimistic about their future career prospects

and income, they are likely to spend more.

SAVING

• Saving involves a person delaying consumption until some later time when
they withdraw and spend their savings plus any interest earned

• The more disposable income a person has, the more they will be able to save

• The savings ratio measures the proportion of the total disposable income
saved in an economy = S/Y

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 FACTORS INFLUENCING CONSUMER SAVING

• Disposable Income- if the amount of disposable income people have is high,

the more likely that they will save. Thus, rich people save more than poor
people

• Saving for consumption: people save so that they can consume later. They
save money so that they can make bigger purchases in the future (house,
car etc). Thus, saving can depend on the consumers’ future plans.

• Interest Rate: increased interest rate promotes saving

people also save so that their savings may increase overtime with the
interest added. Interest is the return on saving; the longer you save an
amount and the higher the amount, the higher the interest received.

• Consumer Confidence: they may save as a precaution if they predict an

uncertain financial future

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 • Age Structure

• Dependents/Family Structure

• Social attitude-

• Availability of Saving Schemes: the more ways people can save, the more
they may be tempted to.

BORROWING

• A consumer may borrow money to increase their expenditure on goods and

services

• They can then make repayments overtime from future earnings

• The total stock of accumulated borrowing by a person is called their personal

debt

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FACTORS AFFECTING BORROWING

• Interest Rates: interest is also the cost of borrowing. When a person takes
a loan, he must repay the entire amount with an extra amount interest, which
is fixed by the bank. When the interest rates rise, people will be more
reluctant to borrow and vice versa

• Wealth: a wealthy person will be more willing to take out a loan because they
will be confident they can repay. banks will be more willing to lend to wealthy
and high-income earning people, because they are more likely to be able to
repay the loan, rather than the poor. So, even if they would like to borrow,
the poor end up being able to borrow much lesser than the rich

• Consumer Confidence: how confident people feel about financial situation in

the future may affect borrowing, too. For example, if they think that prices
will rise (inflation) in the future, they might borrow now, so that they can
make big purchases

• Availability of Credit: the easier it is to borrow money, the greater the

demand for loans.

Expenditure pa erns between income groups

• The richer people spend, save and borrow more amounts than the
poor.

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• The poor spend more propor on of their disposable income,
especially on necessi es, than the rich.
• The poor save less propor on of their disposable income in
comparison with the rich.

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 Chapter 18
Workers
What are wages?
Wages are the reward to the factor of produc on – Labour. Wages are also
regarded as the Price of labour. Wages are payments made to labour. Price of
labour is determined by the market forces i.e. demand and supply.

Demand for labour

The demand for labour is a derived demand. It means that the demand for
labour is linked with the products or services they produce. If the demand for
those commodi es rises the demand for labour also rises.

Factors a ec ng the demand for labour

Derived demand

The demand for labour is always derived from the demand for the good or
service it produces. Thus if the demand for a par cular goods or service
increase it will lead to a rise in demand for labour used to produce those
commodi es. Recently there has been an increased demand for so ware
professionals due to the increased demand for IT products.

Wage rates
A fall in wages will cause an extension in the demand for labour while a rise in
wages paid to works will cause a contrac on in demand.

Technology used
In industries where there is improved technology can be used, the demand for
labour will tend to fall as producers will replace labour with sophis cated
machinery.

Supply of labour
Supply of labour increases with the rise in wage rate. The supply curve of
labour normally slopes upward to the right.
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 Factors a ec ng the supply of labour

Wage rate

In most cases the supply of labour will increase with the increase in wages. This
is because more workers will be a racted by a higher wage rate and moreover
the exis ng workforce may be willing to work over me at a higher wage rate.

Size of the popula on

An increase in popula on will lead to an increase in supply of labour.

Social factors
With more and more women entering the labour market the supply of labour
has increased in the recent mes.

Working age
Lowering the working age of will increase the supply of labour. An increase in
the re rement age will increase the supply of labour.

Educa onal requirement

Jobs which need special training or educa onal quali ca ons will see less
supply of labour as compared to jobs which don’t need high level of
educa onal quali ca on.

Why wages di er?

Reasons for di erences in remunera on:

• Skills/training: Jobs requiring higher level of skills and training usually

fetch higher remunera on
• Educa on/quali ca ons: Again jobs requiring higher level of educa on/
quali ca on are paid higher remunera ons.
• Experience: People with vast experience will get higher remunera on as
compared to a person with lesser experience.
• Level of responsibility: Jobs with greater responsibili es are usually paid
more.
• Geographical area: Jobs located in urban areas are usually carrying
higher remunera ons because of higher living costs in ci es. People
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 working in trecherous geographical areas may get extra remunera on in
the form of addi onal allowances.
• Trade union membership: Trade Union members might end up
nego a ng be er remunera ons then non-trade union members.
• Demand factors: Firms producing goods and services which are high in
demand usually pay be er remunera ons to their workers.
• Supply factors: Industries where there is a shortage of workers will
usually pay higher remunera on to a ract workers.

What is Specialisa on?

Through years, produc on has developed into a complicated process and thus
broken down into a series of highly specialised task. Each task is then
performed by a worker. This is known as Division of Labour.

Advantages of Division of Labour

• Prac se makes perfect: Worker specialises in a par cular task and gives
in the best, thus producing goods faster and less wastage of material.
• Use of machinery: Specialised machinery can be used which is further
increase the produc vity.
• Increased Output: with improvement in e ciency and use of machinery
output is increased.
• Saves me: There is no me wasted in switching of jobs and thus the
momentum of produc on can be maintained which leads to less wastage
of me.

Disadvantages of Division of Labour

• Boredom: Performing the same task over and over again may lead to
boredom for the workers.
• Lack of variety: Though the number of goods produced increases but
they are iden cal or standardized.
• Low mo va on for worker: Repeatedly performing the same task may
lead to low mo va on level for the worker. The worker might not have
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 the sense of ful lling a complete task as he is performing only a part of
the job.
• Lack of mobility: Due to specialisa on workers might nd it di cult to
switch between occupa ons.

Factors a ec ng individual's choice of job

An individual might be in uenced by many factors while choosing a job. These

factors are divided into wage factors and non wage factors.

Wage Factors

• Wages: A payment which an employer contracts to pay a worker. It can

be paid per unit of me ( Time rate) or per unit of output ( piece rate).

• Over me pay: It is paid to workers who work in excess of the standard

working week. It is usually paid at a higher rate.

• Bonuses: It is an extra payment received when a worker produces above

the standard output or contributes to increasing pro ts of the business.

• Commission: It is o en paid to sales sta as an incen ve to increase

sales of the business. It is a propor on of the sales revenue that they
make.
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 Non-wage factors
Here are some of the non-wage factors which might in uence an individual's
choice.

• length/number of holidays
• Job sa sfac on
• working condi ons/environment
• hours of work
• promo on/career prospects
• loca on/ travelling distance
• size of company
• Pensions
• Fringe bene ts
• Job security
• Size of the rm

How to wage rate is determined?

The wage rate in a par cular industry is determined by the market forces i.e.
demand and supply.

The point at which the demand and supply of labour will intersect will
determine the wage rate for that par cular industry.
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A rise in the demand for labour will lead to a rise in the equilibrium wage
rate.
A fall in the supply of labour will result in a rise in the equilibrium wage rate.
 Why would a person’s wage rate change over me?

As a beginner, the individual would have a low wage rate since he/she is new to
the job and has no experience. Over me, as his/her experience increases and
skills develop, he/she will earn a higher wage rate. If he/she gets promoted and
has more responsibili es, his/her wage rate will further increase. When he/she
nears re rement age, the wage rate is likely to decrease as their produc vity
and skills are likely to weaken.
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 Chapter 19
Trade Unions
Trade Unions are organiza ons of workers that aim at promo ng and
protec ng the interest of their members (workers). They aim on improving
wage rates, working condi ons and other job-related aspects.

The func ons of a trade union:

• Nego a ng improvements in non-wage bene ts with employers.

• Defending employees’ rights.
• Improving working condi ons, such as be er working hours and be er
safety measures.
• Improving pay and other bene ts.
• Suppor ng workers who have been unfairly dismissed or discriminated
against.
• Developing the skills of members, by providing training and educa on.
• Providing recrea onal ac vi es for the members.
• Taking industrial ac ons (strikes, over me ban etc.) when employers don’t
sa sfy their needs.

Collec ve bargaining: the process of nego a ng over pay and working

condi ons between trade unions and employers.

When can trade unions argue for higher wages and be er working
condi ons?

• Prices are rising (in a on): the cost of living increases when prices increase
and workers will want higher wages to consume products and raise their
families.
• The sales and demand of the rm’s products has increased.
• Workers in other rms are ge ng a higher pay.
• The produc vity of the members has increased.

Industrial disputes
When rms don’t sa sfy trade union wants or refuse to agree to their terms,
the members of a trade union can organize industrial disputes. Here are some:
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 • Over me ban: workers refuse to work more than their normal hours.
• Go-slow: workers deliberately slow down produc on, so the rm’s sales and
pro ts go down.
• Strike: workers refuse to work and may also protest or picket outside their
workplace to stop deliveries and prevent other non-union members from
entering. They don’t receive any wages during this me. This will halt all
produc on of the rm.
Trade union ac vity has several impacts:

Advantages to workers:

• Workers bene t from collec ve bargaining power by being able to

establish be er terms of labour.
• Workers feel a sense of unity and feel represented, increasing morale.
• Lesser chance of being discriminated and exploited.

Disadvantages to workers:

• Workers might get lesser wages or none if they go on strike – as the output
and pro ts of the rm falls and they refuse to pay.

Advantages to rms:

• Time is saved in nego a ng with a union when compared to nego a ng

with individual workers.
• When making changes in work schedules and prac ces, a trade union’s
coopera on can help organise workers e ciently.
• Mutual respect and good rela onships between unions and rms are good
for business morale and increases produc vity.

Disadvantages to rms:

• Decision making may be long as there will be need of lengthy discussions

with trade unions in major business decisions.
• Trade unions may make demands that the rm may not be able to meet –
they will have to choose between pro tability and workers’ interests.
• Higher wages bargained by trade unions will reduce the rm’s pro tability.
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 • Businesses will have high costs and low output if unions organise
agita ons. Their revenue and pro ts will go down and they will enter a loss.
They may also lose a lot of customers to compe ng rms.

Advantages to the economy:

• Ensures that the labour force in the economy is not exploited and that their
interests are being represented

Disadvantages to the economy:

• Can nega vely impact total output of the economy.

• Firms may decide to subs tute labour for capital if they can’t meet trade
unions’ expensive demands, and so unemployment may rise.
• Higher wages resul ng from trade union ac vity can make the na on’s
exports expensive and thus less compe ve in the interna onal market.

Realis c Approach

In modern mes, the powers of trade unions have dras cally weakened.
Globalisa on, liberalisa on and priva sa on of economies are making markets
more compe ve. Firms have more incen ve to reduce costs of produc on to
a minimum in order to remain compe ve and pro table. Therefore, it is much
harder for unions to force employers to increase wages. Most unions opera ng
nowadays are more focused on be ering working condi ons and non-
monetary bene ts.
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 Chapter 20
Firms
Classi ca on of Firms

Firms can be classi ed in terms of:

• the sectors they operate (stages of produc on)

• ownership

• the rela ve sizes.

based on stages of produc on

• Primary: all economic ac vity involving extrac on of raw natural materials.

This includes agriculture, mining, shing etc. In pre-modern mes, most
economic ac vity and employment was in this sector, mostly in the form of
subsistence farming (farming for self-consump on).
• Secondary: all economic ac vity dealing with producing nished goods. This
includes construc on, manufacturing, u li es etc. This sector gained
importance during the industrial revolu on of the 19th and 20th centuries
and s ll makes up a huge part of the modern economy.
• Ter ary: all economic ac vity o ering intangible goods and services to
consumers. This includes retail, leisure, transport, IT services, banking,
communica ons etc. This sector is now the fastest-growing sector as
consumer demand for services have increased in developed and developing
na ons.
• Quaternary: This is a subsec on of the services sector, and includes those
services which are involved with the collec on, processing and transmission
of informa on, essen ally informa on technology.

On the basis of ownership

• Public: this includes all rms owned and run by the government. Usually,
the defence, arms and nuclear industries of an economy are completely

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 public. Public rms don’t have a pro t mo ve, but aim to provide essen al
services to the economy it governs. Governments do also run their own
schools, hospitals, postal services, electricity rms etc.
• Private: this includes all rms owned and run by private individuals. Private
rms aim at making pro ts and so their products are those that are highly
demanded in the economy.

On basis of size of rms

• The age of the rms

• Availability of nancial capital

• Type of business organisa on

• Internal economies and diseconomies of scale

• Size of the market

Small Firms

A small rm is an independently owned and operated enterprise that is limited

in size and in revenue depending on the industry. They require rela vely less
capital, less workforce and less or no machinery. These businesses are ideally
suited to operate on a small scale to serve a local community and to provide
pro ts to the owners.

Advantages of small businesses:

• Independence: owner(s) are free to run the business as he/she pleases.

• Control: the owner(s) has full control over the business, unlike in a large
business where mul ple managers, departments and branches will exist.
• Flexibility: small businesses can adapt to quick changes as the owner is
more involved in the decision-making.
• Be er communica on: since there are fewer employees, informa on can
be in mated easily and quickly.

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 • Innova on: small businesses can tend to be innova ve because they have
less to lose and are willing to take risks.

Disadvantages of small businesses:

• Higher costs: small rms cannot exploit economies of scale – their average
costs will be higher than larger rivals.
• Lack of nance: struggles to raise nance as choice of sources of acquiring
nance is limited.
• Di cult to a ract experienced employees: a small business may be unable
to a ord the wage and training required for skilled workers.
• Vulnerability: when economic condi ons change, it is harder for small
businesses to survive as they lack resources.

Small rms s ll exist in the economy for several reasons:

• Size of the market: when there is only a small market for a product, a rm
will see no point in growing to a larger size. The market maybe small
because:
• the market is local – for example, the local hairdresser.
• the nal product maybe an expensive luxury item which only require small-
scale produc on (e.g. custom-made pain ngs)
• personalised/custom services can only be given by small rms, unlike large
rms that mostly give standardised services (e.g. wedding cake makers).
• Access to capital is limited, so owners can’t grow the rm.
• Owner(s) prefer to stay small: a lot of entrepreneurs don’t want to take
risks by growing the rm and they are quite sa s ed with running a small
business.
• Small rms can co-operate: co-opera on between small rms can lead
them to set up jointly owned enterprises which allow them to enjoy many
of the bene ts that large rms have.
• Governments help small rms: governments usually provide help to small
scale rms because small rms are an important provider of employment
and generate innova on in the produc on process. In most countries, it is
the medium and small industries that contribute much of the employment.
Growth of Firms
When a rm grows, its scale of produc on increases. Firms can grow in two
ways:

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 • internally

• externally.

Internal Growth/Organic Growth

This involves expanding the scale of produc on of the rm’s exis ng

opera ons. This can be done by purchasing more machinery/equipment,
opening more branches, selling new products, expanding business premises,
employing more workers etc.

External Growth

This involves two or more rms joining together to form a larger business.
This is called integra on. This can be done it two ways: mergers or takeovers.

A takeover or acquisi on happens when a company buys enough shares of

another rm that they can take full control. The rm taken over loses its
iden ty and becomes a part of what is known as the holding company. A well-
known example would be Facebook’s acquisi on of WhatsApp in 2014.
A merger occurs when the owners of two or more companies agree to join
together to form a rm.

Mergers can happen in three ways:

Horizontal Integra on:

Integra on of rms engaged in the produc on of the same type of good at the
same level of produc on. Example: a cloth manufacturing company merges
with another cloth manufacturing company.

Advantages:

• Exploit internal economies of scale: including bulk-buying, technical

economies, nancial economies.

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 • Save costs: when merging, a lot of the duplicate assets including employees
can be laid o and unnecessary equipment can be sold leading to more
e ciency- ra onalisa on
• Poten al to secure ‘revenue synergies’ by crea ng and selling a wider range
of products.
• Reduces compe on: by merging with key rivals, the two rms together
can increase market share.

Disadvantages:

• Risk of diseconomies of scale: a larger business will bring with a lot of

managerial and opera onal issues leading to higher costs.
• Reduced exibility: the addi on of more employees and processes means
the need for more transparency and therefore more accountability and red
tape, which can slow down the rate of innova ng and producing new
products and processes.

Ver cal Integra on:

Integra on of rms engaged in the produc on of the same type of good but at
di erent levels of produc on (primary/secondary/ter ary). Example: a cloth
manufacturing company (secondary sector) merges with a co on growing rm
(primary sector).
• Forward ver cal integra on: when a rm integrates with a rm that is at a
later stage of produc on than theirs. Example: a dairy farm integrates with a
cheese manufacturing company.
• Backward ver cal integra on: when a rm integrates with a rm that is at
an earlier stage of produc on than theirs. Example: a chocolate retailer
integrates with a chocolate manufacturing company.

Advantages:

• It can give a rm assured supplies or outlets for their products. If a co ee

brand merged with co ee planta on, the manufacturers would get assured
supplies of co ee beans from the planta on. If the co ee brand merged
with a co ee shop chain, they would have a permanent outlet to sell their
co ee from.

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 • Similarly, one rm can prevent the other rm from supplying materials or
selling products to compe tors. The co ee brand can have the co ee
planta on to only supply them their co ee beans. The co ee brand can also
have the co ee shop chain only selling co ee with their co ee powder.
• The pro t margins of the merged rm can now be absorbed into the
merging rm.
• The rms can increase their market share and become more compe ve in
the market.

Disadvantages:

• Risk of diseconomies of scale: a larger business will bring with a lot of

managerial and opera onal issues leading to higher costs
• Reduced exibility: the addi on of more employees and processes means
the need for more transparency and therefore more accountability and red
tape, which can slow down the rate of innova ng and producing new
products and processes
• It’s a di cult process: The rms, when ver cally integrated, are entering
into a stage of produc on/sector they’re not familiar with, and this will
require sta of either rm to be educated and trained. Some might even
lose their jobs. It can be expensive as well.

Lateral/Conglomerate integra on:

This occurs when rms producing di erent type of products integrate. They
could be at the same or di erent stages of produc on. Example: a housing
company integrates with a dairy farm. Thus, the rm can produce a wide range
of products. This helps diversify a rm’s opera ons.

Advantages:

• Diversify risks: conglomerate integra on allows businesses to have ac vi es

in more than one market. This allows the rms to spread their risks. In case
one market is in decline, it s ll has another source of pro t.
• Creates new markets: merging with a rm in a di erent industry will open
up the rm to a new customer base, helping it to market its core products
to this new market.

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 • Transfer of ideas: there could be a transfer of ideas and resources between
the two businesses even though they are in di erent industries. This
transfer of ideas could help improve the quality and demand for the two
products.

Disadvantages:

• Inexperience can lead to mismanagement: if the rms are in en rely

di erent industries and have no experience in the other’s industry,
coopera ng and managing the two industries may be di cult and could
turn disastrous.
• Lose focus: merging with and focusing on an en rely new industry could
cause the rm to lose focus of its core product.
• Culture clash: as with all kinds of mergers, there could be a culture clash
between the two rms’ employees on prac ces, standards and ‘how things
are done’.

Scale of Produc on

As a rm’s scale of produc on increases its average costs decreases. Cost

saving from a large-scale produc on is called economies of scale.

Internal economies of scale

Are advantages that occur in the form of lower long run average costs of
produc on as the rm increases in size.

• Purchasing economies: large rms can be buy raw materials and

components in bulk because of their large scale of produc on. Supplier will
usually o er price discounts for bulk purchases, which will cut purchasing
costs for the rm.
• Marke ng economies: large rms can a ord their own vehicles to distribute
their products, which is much cheaper than hiring other rms to distribute
them. Also, the costs of adver sing are spread over a much large output in
large rms when compared to small rms.

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 • Financial economies: banks are more willing to lend money to large rms
since they are more nancially secure (than small rms) to repay loans.
They are also likely to get lower rates of interest. Large rms also have the
ability to sell shares to raise capital (which do not have to be repaid). Thus,
they get more capital at lower costs.
• Technical economies: large rms are more nancially able to invest in good
technology, skilled workers, machinery etc. which are very e cient and cut
costs for the rm.
• Risk-bearing economies: large rms with a high output can sell into
di erent markets (even overseas). They are able to produce a variety of
products (diversi ca on in produc on). This means that their risks are
spread over a wider range of products or markets; even if a market or
product is not successful, they have other products and markets to con nue
business in.
• Managerial economies of scale:

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 External economies of scale

External economies of scale occur when rms bene t from lower long run
average costs resul ng from the en re industry growing in size.

• Access to skilled workers: large rms can recruit workers trained by other
rms. For example: when a new training ins tu on for pilots and airline
sta opens, all airline rms can enjoy economies of scale of having access to
skilled workers, who are more e cient and produc ve, and cuts costs.
• Ancillary rms: they are rms that supply and provide materials/services to
larger rms. When ancillary rms such as a marke ng rm locates close to a
company, the company can cut costs by using their services more cheaply
than other rms.
• Joint marke ng bene ts: when rms in the same industry locate close to
each other, they may share an enhanced reputa on and customer base.
• Shared infrastructure: development in the infrastructure of an industry or
the economy can bene t large rms. Examples: more roads and bridges by
the govt. can cut transport costs for rms, a new power sta on can provide
cheaper electricity for rms.

Internal Diseconomies of scale

Diseconomies of scale occur when a rms grows too large and average costs
start to rise.

• Management diseconomies: large rms have a wide internal organisa on

with lots of managers and employees. This makes communica on di cult
and decision-making very slow. Gradually, it leads to ine cient running of
the rms and increases costs.
• Too much output may require a large supply of raw materials, power etc.
which can lead to shortage and halt produc on, increasing costs.
• Large rms may use automated produc on with lots of capital equipment.
Workers opera ng these machines may feel bored in doing the repe ve
tasks and thus become demo vated and less coopera ve. Many workers
may leave or go on strikes, stopping produc on and increasing costs.

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 External Diseconomies of Scale

These occur when an industry grows too large in size, resul ng in increased
average costs.
• Increased tra c conges on- With an increase in number of rms,
transport of raw materials, nished products and workers increases
leading to increased tra c conges on resul ng in higher journey mes
and increased transport costs.
• Increased compe on for resources- More number of rms may cause
an increased demand for resources pushing up the prices of key sites,
capital equipment and labour resul ng in increased average costs.

In the short run:

A rm that doubles all its inputs (resources) and is able to more than double its
output as a result, experiences increasing returns to scale.
A rm that doubles all its inputs and fails to double its output as a result,
experiences a decreasing or diminishing returns to scale.

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 Chapter 21
Firms and produc on

Factors determining demand for factors of produc on

• The demand for the product: if more goods and services are demanded by
consumers, more factors of produc on will be demanded by rms to
produce and sa sfy the demand. That is, the demand for factors of
produc on is derived demand, as it is determined by the demand for the
goods and services (just like labour demand).
• Type of product:
• The availability of factors: rms will also demand factors that are easily
available and accessible to them. If the rm is located in a region where
there is a large pool of skilled labour, it will demand more labour as
opposed to capital.
• The price of factors: If labour is more expensive than capital, rms will
demand more capital (and vice versa), as they want to reduce costs and
maximize pro ts.
• The produc vity of factors: If labour is more produc ve than capital, then
more labour is demanded, and vice versa.

Labour-intensive and Capital-intensive produc on

Labour-intensive produc on is where more labourers are employed than other

factors, say capital. Produc on is mainly dependent on labour. It is usually
adopted in small-scale industries, especially those that produce personalised,
handmade products. Examples: hotels and restaurants.

Advantages:

• Flexibility: labour, unlike most machinery can be used exibly to meet

changing levels of consumer demand, e.g., part- me workers.
• Personal services: labour can provide a personal touch to customer needs
and wants.

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 • Personalised services: labourers can provide custom products for di erent
customers. Machinery is not exible enough to provide tailored products for
individual customers.
• Gives feedback: labour can give feedback that provides ideas for con nuous
improvements in the rm.
• Essen al: labour is essen al in case of machine breakdowns. A er all,
machines are only as good as the labour that builds, maintains and operates
them.

Disadvantages:

• Rela vely expensive: in the long-term, when compared to machinery,

labour has higher per unit costs due to lower levels of produc vity.
• Ine cient and inconsistent: compared to machinery, labour is rela vely
less e cient and tends to be inconsistent with their produc vity, with
various personal, psychological and physical ma ers in uencing their
quan ty and quality of work.
• Labour rela on problems: rms will have to put up with labour demands
and grievances. They could stage an over me ban or strike if their demands
are not met.

Capital-intensive produc on is where more capital is employed than other

factors. It is a produc on which requires a rela vely high level of capital
investment compared to the labour cost. Most capital-intensive produc on is
automated (example: car-manufacturing). Capital refers to the machinery,
equipment, tools, buildings and vehicles used in produc on. It also means the
investment required to do produc on

Advantages:

• Less likely to make errors: Machines, since they’re mechanically or digitally

programmed to do tasks, won’t make the mistakes that labourers will.
• More e cient: machinery doesn’t need breaks or holidays, has no demands
and makes no mistakes.
• Consistent: since they won’t have human problems and are programmed to
repeat tasks, they are very consistent in the output produced.
• Technical economies of scale: increased e ciency can reduce average costs

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 Disadvantages:

• Expensive: the ini al costs of investment is high, as well as possible training

costs.
• Lack of exibility: machines need not be as exible as labourers are to meet
changes in demand.
• Machinery lacks ini a ve: machines don’t have the intui ve or crea ve
power that human labour can provide the business, and improve
produc on.

Produc on and Produc vity

Produc on is the transforma on of raw materials (input) to nished or semi-
nished goods and services (output).
In other words, produc on is the adding of value to inputs to create outputs. It
is the produc on that gives the inputs value.

Some factors that in uence produc on:

• Demand for product: the more the demand from consumers, the more the
produc on.
• Price and availability of factors of produc on: if factors of produc on are
cheap and readily available, there will be more produc on.
• Capital: the more capital that is available to producers, the more the
investment in produc on.
• Pro tability: the more pro table producing and selling a product is, the
more the produc on of the product will be.
• Government support: if governments give money in grants, subsidies, tax
breaks and so on, more produc on will take place in the economy.

Produc vity

Produc vity measures the amount of output that can be produced from a
given amount of input over a period of me.
Produc vity = Total output produced per period / Total input used per
period

Produc vity increases when:

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 • more output or revenue is produced from the same amount of resources
• the same output or revenue is produced using fewer resources.
(Labour produc vity is the measure of the amount of output that can be
produced by each worker in a business).

Factors that in uence produc vity:

• Division of labour: division of labour is when tasks are divided among

labourers. Each labourer specializes in a par cular task, and thus this will
increase produc vity.
• Skills and experience of labour force: a skilled and experienced workforce
will be more produc ve.
• Workers’ mo va on: the more mo vated the workforce is, the more
produc ve they will be. Be er pay, working condi ons, reasonable working
hours etc. can improve produc vity.
• Technology: more technology introduced into the produc on process will
increase produc vity.
• Quality of factors of produc on: replacing old machinery with new ones,
preferably with latest technologies, can increase e ciency and produc vity.
In the case of labour, training the workforce will increase produc vity.
• Investment: introducing new produc on processes which will reduce
wastage, increase speed, improve quality and raise output will raise
produc vity. This is known as lean produc on.

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 Chapter 22
Firms, costs, revenue and Objec ves

Costs of Produc on

Fixed costs (FC) are costs that are xed in the short-term running of a business and have to
be paid even when no produc on is taking place. Examples: rent, interest on bank loans,
telephone bills. These costs do not depend on the amount of output produced.

Average Fixed Cost (AFC) = Total Fixed Cost (TFC) / Total Output

Variable costs (VC) are costs that are variable in the short-term running of a business and
are paid according to the output produced. The more the produc on, the more the variable
costs are. Examples: wages, electricity bill, cost of raw materials.
Average Variable Cost (AVC) = Total Variable Costs (TVC) / Total Output

Total Costs (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC)
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This is a simple graph showing the rela on between TC, FC and VC. The gap between the TC
and TVC indicates the TFC
Average cost or Average total Cost (ATC) is the cost per unit of output.
Average Total Cost (ATC) = Total Cost (TC) / Total Output or
Average Cost (AC) = Average Variable Cost (AVC) + Average Fixed Cost (AFC)

(Remember ‘average’ means ‘per unit’ and so will involve dividing the par cular cost by the
total output produced. In the graphs above you will no ce that the average variable costs
and average total costs rst fall and then start rising. This is because of economies of scale
and diseconomies of scale respec vely. As the rm increases its output, the average costs
decline but as it starts growing beyond a limit, the average costs rise).

Let’s calculate some costs in an example:

Suppose, a TV manufacturer produces 1000 TVs a month. The rm’s xed costs in rent is
$900, and variable cost per unit is $500. What would its TFC, TVC, AVC, AFC, AC and TC be, in
a month?

No. of units of TVs produced = 1000

Total Fixed Costs for one month = $900

Average Fixed Cost = $900 / 1000 = $0.9 per unit
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 Variable Cost of producing one unit of TV = $500
Total Variable Costs for producing 1000 TVs in a month = $500 * 1000 = $500,000
Average Variable Cost = $500,000 / 1000 = $500 (AVC is the same as VC per unit!)

Total Costs = Total Fixed Costs + Total Variable Costs ==> $900 + $500,000 = $500,900
Average Costs = Total Costs / Total Output ==> $500,900 / 1000 = $500.9
or Average Costs = AFC + AVC ==> $0.9 + $500 ==> $500.9

Revenue
Revenue is the total income a rm earns from the sale of its goods and services. The more
the sales, the more the revenue.

Total Revenue (TR) = No. of units sold (Sales) * Price per unit (P)
Average Revenue = Total Revenue (TR) / No. of units sold (Sales) (= Price per unit (P)!)

Suppose, from the example above, a TV is sold at $800 and the rm sells all the units it
produces, what is the rm’s Total Revenue and Average Revenue, for a month?
No. of units sold (Sales) in a month = No. of units produced in a month = 1000
Total Revenue = Sales * Price ==> 1000 * $800 = $800,000
Average Revenue = Total Revenue / Sales = $800,000 / 1000 = $800

Total Revenue – Total Cost = Pro t

Objec ves of Firms

Objec ves vary with di erent businesses due to size, sector and many other factors.
However, many businesses in the private sector aim to achieve the following objec ves.

• Survival: new or small rms usually have survival as a primary objec ve. Firms in a highly
compe ve market will also be more concerned with survival rather than any other
objec ve. To achieve this, rms could decide to lower prices, which would mean
forsaking other objec ves such as pro t maximiza on.
• Pro t: pro t is the income of a business from its ac vi es a er deduc ng total costs
from total revenue. Private sector rms usually have pro t making as a primary
objec ve. This is because pro ts are required for further investment into the business as
well as for the payment of return to the shareholders/owners of the business. Usually,
rms aim to maximise their pro ts by either minimising costs, or maximising revenue, or
both.
• Growth: once a business has passed its survival stage it will aim for growth and
expansion. This is usually measured by value of sales or output. Aiming for business
growth can be very bene cial. A larger business can ensure greater
job security and salaries for employees. The business can also bene t from
higher market share and economies of scale.
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 • Market share: market share can be de ned as the sales in propor on to total market
sales achieved by a business. Increased market share can bring about many bene ts to
the business such as increased customer loyalty, se ng up of brand image, etc.
• Service to the society: Some opera ons in the private sectors such as social enterprises
do not aim for pro ts and prefer to set more social objec ves. They aim to be er the
society by aiding society nancially or otherwise.
A business’ objec ves do not remain the same forever. As market situa ons change and as
the business itself develops, its objec ves will change to re ect its current market and
economic posi on. For example, a rm facing serious economic recession could change its
objec ve from pro t maximiza on to short term survival.
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 Market Structure
Market structure refers to those characteristics of a market that influence the
behaviour of buyers and sellers and the outcome they achieve in terms of
product, quality and price. These characteristics include:

 number and size of firms in the market

 the degree and intensity of price and non-price competition
 the nature of barriers to entry.

Firms can compete with each other in the following ways:

1. Price competition which involves offering lower prices for rival products.
cutting prices below that of rival products in other to boost sales and market
shares at the expense of the competing firms. f demand is price inelastic,
cutting price may not boost sales and it will reduce the profit margin
between price and average cost.
2. Non-price competition: This involves competing on all other products
features other than price. it can involve new product development, product
placements in trade fairs, promotional campaigns, after sales care etc. Non-
price competition is important because consumers do not just compare
product prices, they are also out for the best value for money.

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Competitive markets

A market with a large number of firms. That compete with each other.

Features

 Each firm has a relatively small market share, which means the change in
output of one firm has no effect on price.
 Consumers can switch between products of rival firms.
 There is free entry and exit from the market, i.e. there are no barriers to
the market
 In the short run, they earn super normal profit.
 In the long run, they earn normal profits.

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 Monopoly Markets

A market with a single supplier. It can set any price it wishes since it has all the
market power. Consumers do not have any alternative and must pay the price
set by the seller.

Pure monopoly- 100% market share

Dominant monopoly- 40% market share

Monopoly (some governments)- 25% market share

Features of monopoly

 The firm is the industry. It has 100% market share.

 The firm is a price maker. Its output is the industry’s output and changes in
its supply will affect the market price.
 There are high barriers to entry and exit, making it difficult for new firms to
enter the market.
 The firms will make supernormal profits in the long run duo the existence of
barriers to entry.

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Advantages of Monopoly

 Monopolies avoid wasteful duplication of capital equipment and hence

avoids wastage of resources.
 As monopoly produces on a large scale, its unit price and price may be
lower than a firm in a competitive market. It enjoys economies of scale
as it is the only supplier of product or service in the market. The
benefits can be passed on to the consumers.
 Due to high profits, monopolies can invest in research and development
and may introduce new products.
 Monopolies may use price discrimination which benefits the
economically weaker sections of the society.
 Source of revenue for the government- the government gets revenue in
form of taxation from monopoly firms.

Disadvantages of monopoly

 Less incentive to innovate than firms in competitive firms. The lack of

competition means that monopolist become complacent rather than
focusing on newer innovations for their survival.
 No incentive to reduce costs due to absence of competition resulting in
productive inefficiency.
 A monopoly may restrict the supply to push up prices and may produce poor
quality products knowing that consumers cannot switch to rival products.
 It may also fail to respond to changes in consumer tastes and not develop
new products making it allocatively inefficient.

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