A2 Economics for OCR
Answers to activities
ACTIVITY PAGE 5
The employment rate is lower than the economic activity rate. The economic activity rate measures the proportion of people aged 16–65 who are employed or unemployed and seeking work; the employment rate, as its name suggests, includes only those who are employed.
ACTIVITY PAGE 8 (ToP)
a) There are a number of similarities between the Norwegian and the UK labour markets. In both countries, average male pay is higher than average female pay. Also, in both countries there are more female workers than male workers in the public sector and in part-time employment. The passage does, however, show that the unemployment rate was lower in Norway than in the UK in February 2008. b) The Nordic countries were facing a shortage of workers at the start of 2008. Such a shortage would probably have encouraged firms to offer higher wages to attract scarce labour and encouraged unions to press for pay rises. Both effects would have been likely to increase wage rates. c) The table supports the view that the Nordic countries were facing not a shortage of jobs, but a shortage of workers to a limited extent. Both Norway and Denmark had unemployment rates below what is usually regarded to be full employment. If unemployment falls below 3 per cent, firms wishing to expand may find it difficult to recruit extra workers. This will place a supply constraint on the economy. The unemployment rate in the other two countries, however, while being below the EU27 average, is not that low and does not really indicate a shortage of workers.
ACTIVITY PAGE 8 (boTTom)
a) There are a number of possible reasons, including differences in the labour turnover of industries, differences in attitudes to older workers, and differences in what is happening to the industries. An industry, such as hotels and restaurants, in which many workers stay for only a short time tends to have a relatively young labour force. This contrasts with the field of education. Most teachers join the profession in their early twenties and a relatively high proportion continue to work as teachers until retirement. Industries in which ageism is more prevalent are likely to employ fewer older workers than those that do not discriminate. Age discrimination legislation, however, may reduce this difference. An industry that is expanding, such as financial services, will be recruiting new workers, and this may tend to reduce the average age of workers. In contrast, older workers may stay with declining industries, but such industries are likely to find it difficult to recruit new workers. In a number of countries fishing, for instance, is a declining industry. b) A country’s firms are internationally competitive if they are producing what people at home and abroad want and are willing to buy at attractive prices. An ageing population may reduce the international competitiveness of a firm if, as workers get older, they become less productive. This may occur if older workers are less flexible, less mobile and less up-to-date with new developments. Some older workers may be reluctant to change the hours they work and the tasks they do. With family commitments and a house, some older workers may be reluctant to move to
other parts of the country where there may be job opportunities with firms that are expanding. They may also be unwilling to learn jobs and to undertake training in, for instance, new technology. On the other hand, older workers may be more productive, given their experience. They may have been very well trained and may still be prepared to update their skills. Their greater tendency to stay with an employer may reduce firms’ costs and so help keep their prices competitive.
ACTIVITY PAGE 9
a) Occupational downgrading means moving from one job to a lower-paid and lower-skilled job. b) When a woman gives up managerial responsibilities for a time, the break may mean that she misses out on training, changes in working practices and advances in technology. This may make employers reluctant to place her in higher managerial positions in the future. There is a chance, however, that having a break may increase the ambition of some women, and their experience in lower positions may increase their understanding of how to motivate staff. If this is the case, employers may be more willing to promote them.
ACTIVITY PAGE 14
a) Groups who may have benefited are consumers of British Gas if the decision results in lower prices, shareholders of British Gas if it increases profits, and workers in other countries who will have more job opportunities. b) Offshoring has increased a number of companies’ profits, but there is no guarantee that it will always do so. Offshoring can raise a company’s profits by lowering its costs of production. A number of costs abroad may be lower, including rent of premises, business taxes and, of course, wages. If productivity levels are reasonably high, unit costs may be lower. There is a risk, however, that profits may fall if moving work abroad either increases costs or reduces revenue. Productivity levels may not be as high as anticipated, and costs may start to rise, especially if other firms start to move into the same area, competing for resources. As well as output levels possibly being lower abroad, the quality produced may also be lower. If the goods or services produced are poor, the company may lose sales.
ACTIVITY PAGE 16
a) The success of a tourist attraction can be judged by the number of visitors, by revenue and by profits. b) The opening of other wheels, particularly within the UK, will increase competition for the London Eye. Someone in Southampton, for instance, who would have gone to the London Eye may not do so if a Southampton wheel is opened. If the increased competition does reduce visitors, revenue is likely to fall. The higher competition would also make it difficult for the London Eye to raise its price to offset the effect of a fall in sales – demand will become more elastic. There is, nevertheless, a chance that having more wheels will develop a taste for this type of attraction. Someone who has enjoyed going on the Birmingham wheel may be encouraged to go on the London wheel when visiting the capital.
ACTIVITY PAGE 21
a) The passage mentions that revenue rose while the numbers of people going to the cinema fell. This means each person, on average, must have been paying more per ticket. b) The passage suggests that demand for a cinema ticket is relatively income-inelastic. It mentions that a spokesperson for the cinema industry was unconcerned that a fall in income would reduce demand. c) It is difficult to predict what will happen to the cross elasticity of demand between cinema going and the price of pay-TV in the future. There will be a number of influencing factors. One factor is changes in the relative quality of the films and programmes on pay-TV. Others include changes in the cost of transport to and from cinemas, the availability of parking spaces at cinemas, and how pay-TV can be received.
ACTIVITY PAGE 23
a) ITV – a 41.38 per cent fall. b) In April 2008, the BBC’s share was higher than 28 per cent because figures for only two of the BBC’s channels, albeit those with the largest audience share, are shown. c) The five-firm market concentration ratio, in terms of channels, fell from 84 per cent in 2000 to 57 per cent in 2008. This indicates a fall in market power and so an increase in competition. To analyse the share of the five largest TV companies, however, it would be necessary to have information on the share of the other channels run by the companies.
ACTIVITY PAGE 25
a) Staff bonuses are a variable cost, as they are likely to be related to output and sales. A firm is likely to pay out more in bonuses when workers are producing a higher output. b) Business rates and insurance.
ACTIVITY PAGE 28
a) The changes in the relative cost of producing television programmes are likely to encourage television channels to produce fewer television dramas and more quizzes and reality shows. This suggests that the changes in costs are reducing the quality of programmes being made. b) The impact of foreign television programmes on the cost of producing UK programmes will depend on price. If foreign programmes are being sold at a low price, this will put downward pressure on the cost of producing television programmes in the UK. UK production firms will have to keep their costs down in order to remain competitive.
ACTIVITY PAGE 36
a) The need for a considerable amount of funding; and stars already being signed up by competitors. b) There are a number of factors that could cause an increase in attendance at cricket matches. One is a reduction in ticket prices. This will cause an extension in demand, with consumers being more willing and able to buy tickets. Another factor is increased advertising. The Twenty20 tournament in India, for instance, has been heavily advertised. A third factor is a rise in the ticket price of other sports events that are a substitute for cricket. The second and third factors will cause an increase in demand.
ACTIVITY PAGE 40
a) One argument is to ensure high-quality programmes. Not relying on subscriptions or advertising revenue means the BBC can produce programmes that are not guaranteed to draw large audiences. Thus they can cater for minority interests, and can develop programmes that might start with small audiences but then grow in popularity. It should also mean, given a reasonable level of funding, that the BBC does not have to rely on game shows and reality programmes. b) Viewers may not necessarily experience disutility from watching adverts. Some advertisements provide useful information about both new and existing products, and some advertisements are amusing. c) It is debatable whether the licence fee creates allocative inefficiency. Some economists say that it does so by switching resources from popular to unpopular programmes. For instance, if people want to watch more soaps, commercial channels may be more responsive to their demand. Other economists argue that the licence fee can contribute towards correcting market failure. Some people may suffer from information failure. They may be unaware of the pleasure that can be gained from watching opera. Coverage by BBC2 may bring this to their attention.
The licence fee may also mean that the BBC produces more programmes that are merit goods and fewer that are demerit goods than the commercial channels produce. Watching documentaries, for example, may increase students’ educational performance and later their productivity, and so raise output for everyone. In contrast, some people argue that making violent films may encourage violent behaviour, and watching some reality shows can coarsen behaviour. This is a controversial area: results from studies on the connection between the two are inconclusive. There is also some debate about whether watching quizzes and reality shows can inform people and, by providing relaxation and amusement, raise their productivity.
ACTIVITY PAGE 44
a) The Australian cinema-operating industry is an oligopoly. The information in the passage indicates a high three-firm concentration ratio, particularly in terms of national box office takings. There are many small operators and a few medium-sized ones, but the industry is dominated by three large firms. There is less information on the Australian film-distribution industry, but what there is indicates that it is more competitive than the cinema-operating industry. There is reference to a ‘higher number of film distributors’. This may place the industry between oligopoly and monopolistic competition. b) Other information that would be useful includes the extent of barriers to entry and exit into the market, the amount of non-price competition, the degree of interdependency, and the type of profits earned in the long run. c) Film distributors vary their charges over time to take into account changes in demand for tickets. The charges are highest during the period when it is expected that demand will be highest. d) The merger activity among film distributors will result in fewer, larger distributors. This will increase their market power. Other things being equal, this will increase their bargaining power relative to cinema operators, and may enable them to charge the operators more. The distributors, however, may not be able to exploit their greater market power if demand for cinema tickets is falling. Their bargaining power relative to cinema operators may not increase if there is also merger activity among the operators.
ACTIVITY PAGE 45
a) Television programmes run phone-ins and quizzes to raise revenue, and because they are relatively cheap to make and can attract viewers. b) The fines and adverse publicity have reduced the number of phone-ins and viewer quizzes. Television companies are now more cautious in running phone-ins and quizzes because of their experience. They are also aware that these have become less popular because of the adverse publicity surrounding them. It remains to be seen whether, in the future, phone-ins and quizzes will regain their popularity among viewers and schedulers. c) Regulation of television phone-ins and quizzes is necessary because there is asymmetric information in their running. Viewers do not have the information or the time to check that they are being operated in a fair manner.
ACTIVITY PAGE 49
a) The employment of plasterers and bricklayers would have been expected to fall. This is because their labour is used to produce new houses, and house-building was declining. Labour, being a derived demand, usually declines when demand for its product declines. b) The demand for plasterers and bricklayers may not have declined if it was thought that the downturn would not last. If plasterers’ and bricklayers’ productivity and flexibility increased, they may have been retained, while other building workers were sacked.
Turkish teachers may also have strong bargaining power. One is that students enjoy the subject and are prepared to seek a geography-related job even if it is not very well paid. The arguments against are based on grounds of equity and market failure. heart attacks and health problems. Poor people are more likely to be discouraged from studying by high tuition fees. c) There are arguments for and against setting tuition fees on the basis of the marketability of degrees. since this where MRP equals the wage rate (£300). If this is the case.
. and benefits for third parties in the form of higher output and a more civilised society. by increasing the supply of graduates in some subjects by more than the demand for graduate labour in that field. Students and universities may incorrectly forecast which degrees will be in high demand in the future. In addition. b) There are two main reasons why some students undertake degrees in geography despite the relatively low return. There may also be information failure. This means the firm should recruit an additional two workers. ii) An external cost of overworking is lower potential living standards resulting from lower potential output. not all of which are financial. charging differential tuition fees may increase inequality of income. In addition. Another is that they may be planning to seek employment in a career that recruits graduates. the firm should employ five workers. and so they should be paid more.
ACTIVITY PAGE 55
a) i) The private costs of overworking include marriage break-ups. b) Workaholics Anonymous seeks to promote the income effect of a wage rate. This may influence the amount that the Turkish state and private sector schools are prepared to pay teachers.
ACTIVITY PAGE 59
a) The expansion of university education has reduced the value of some degrees. b) If the wage rate were to halve to £150. but is not concerned about what subject has been studied. for the students themselves. for instance. This would mean that a relatively higher wage would have to be paid to attract their services. creating more benefits. all education can be regarded as a merit good. Another is that the private benefit to those studying medicine will be higher than the private benefit to those studying geography. It tries to encourage people who tend to overwork to take more leisure time.ACTIVITY PAGE 52
a) Number of workers 1 2 3 4 5 6 Total output 8 20 40 55 65 72 MP 8 12 20 15 10 7 × MR × 15 × 15 × 15 × 15 × 15 × 15 = MRP = 120 = 180 = 300 = 225 = 150 = 105
The firm should employ three workers. One is that this will encourage universities to respond to market forces by offering more of the degrees that are likely to be in high demand. Turkish teachers may be held in high esteem.
ACTIVITY PAGE 60
a) Turkish teachers may be relatively well paid because they are in short supply. in large part because the poor are more concerned about debt. which their union or unions may be prepared to exercise in search of higher wages.
. It also does not have to take long for someone to be trained as a hairdresser. For instance.b) It is unlikely that many Norwegian teachers will seek to work in Turkey. c) Lawyers are paid more than hairdressers because demand for their labour relative to its supply is higher. limit their supply.2
Lawyers also belong to a strong professional body. partly because they are widely dispersed throughout the country. A small rise in the wage rate may attract significantly more workers into the industry. the services of accountants can be sold for a high figure. and this influences how much the two groups ask to be paid. for example.1
Figure A3.2 shows a low wage arising from the low demand and high supply of hairdressers. The high demand arises from high MRP. and may not be aware of the high pay in Turkey. Although the pay of Norwegian teachers is less than half the average Norwegian wage. and because of an inability to speak the language. inelastic supply results in lawyers being highly paid. Norwegian teachers may not be able to migrate to Turkey because of Turkish controls on immigration. The supply of lawyers is relatively low and inelastic. Figure A3. inelastic demand and low. the pay is noticeably higher in Turkey. while hairdressers. but most cannot. b) The occupations shown that have above-average earnings are in high demand and have relatively limited supply.
Wages of lawyers D W S Wages of hairdressers
W D S S 0 Q Quantity of lawyers’ labour 0 D Q Quantity of hairdressers’ labour
Figure A3. Norwegian teachers may also be reluctant to leave family and friends behind. hairdressers have relatively low MRP and are in relatively high supply. Lawyers are in high demand because a considerable amount can be charged for their services.
ACTIVITY PAGE 61
a) The earning differential between lawyers and hairdressers in 2007 was £37. Demand for and supply of their services is also relatively elastic. are not highly unionised. both its demand and supply are more inelastic. however. and working conditions and job prospects are better.336 or 209. most people believe that lawyers should be paid more than hairdressers. In addition. and chief executives can add considerable value to a firm. Even if this is not the case. This results in their MRP being high.51 per cent. they have more bargaining power and are held in higher esteem. If. as shown in Figure A3. There are some celebrity hairdressers who can charge high prices for their services. This demand is also inelastic. It would not be possible to replace a lawyer in a court case with an unqualified person. as they have to undertake a long period of training and be well qualified. The high. The relatively long period of training and qualifications to be a medical consultant. it may still be higher than that paid in Turkey.1. In contrast. and any qualifications required are normally relatively easy to acquire. some Norwegian teachers may seek to overcome the language and cultural barriers and move to Turkey.
and high qualifications have to be gained. however.
ACTIVITY PAGE 70 (lEFT)
a) Most nurses belong to the Royal College of Nurses and most are employed by the NHS. but the passage indicates that the number of hours worked per GP partner fell.
ACTIVITY PAGE 67
a) The BBC’s purchasing power in the market for the labour of television presenters has been reduced. It used to be a monopsonist buyer. that it could be better spent (has a high opportunity cost). This is because. This increases their bargaining strength. as noted above.55 per cent in 2006. In this case. s/he would probably have switched to being a salaried GP. The inelastic supply may have been the reason why the pay rise had to be high in order to attract the extra 4. concluded that Ross’s pay deal was fair because ITV and Channel 4 compete regularly for top entertainers. although a number work in the private sector. This would be expected. but the reluctance of nurses to take industrial action weakens it. ii) These figures indicate that the supply of GP partners is inelastic. less well paid BBC staff. If the pay to a GP partner fell below this level. b) The next best paid job for most GP partners is likely to be that of a salaried GP.
. which was a 58. a virtual monopsony bargains with a virtual monopoly.22 per cent. the BBC Trust. So in this case. the relative bargaining power of the two groups is influenced by a number of other factors.000. b) The marginal revenue productivity of Formula 1 mechanics has risen in recent years largely because their services can be sold for higher revenue. Its prestige and size. the number of GP partners rose from 18. Their pay rose by £24. This is a percentage change of 22. nevertheless make it a popular choice for employees. which offer a good and varied career path.33% = 0. this is the gap between what a GP is earning as a partner and what they can earn as a salaried GP. The change in the number of hours worked is a more reliable source. It did. b) The BBC would be overpaying Jonathan Ross if it could get his services for less and/or if the value he provides to the BBC in attracting viewers is less than his pay. but now it is only one of a number of buyers. as the BBC dominates the commercial sector which is largely composed of local radio stations. argue that radio is different.2 per cent in 2003. on the other hand.000 GP partners. It is interesting to note that an inquiry carried out by the BBC’s regulator. iii) It would have been more useful to have calculated the percentage change in the number of hours GP partners worked. It rose to £67.ACTIVITY PAGE 64
a) The wage differential between GP partners and salaried GPs was £26. One of these is the high regard the public have for nurses. as it takes a long time to train as a GP.22%/58.33 per cent increase.000. c) i) The elasticity of supply of labour is the percentage change in quantity of labour supplied divided by the percentage change in wages. there is high competition for the services of a presenter from other channels. This means that the elasticity of supply of labour was 22. As well as the size of membership of the union and the importance of the NHS as an employer. which suggests that overall. it may be necessary to pay a high salary to recruit and keep him or her. If. Figures were not given on hours. and that it may cause discontent among other. This would mean the probable economic rent earned by the average GP partner was £67. Such a presenter may increase not only the audience figures. the number of hours worked may have changed by only a small percentage.500 or 58.000 in 2006. however. and so may attract other staff.000 or 142.38. More and more money has gone into Formula 1 with extra sponsorship and more revenue from television deals. The transfer earnings were probably £47. but also the reputation of the channel. as it gives a better indication of how the ability of a firm or organisation to alter the output of the product has altered.000 to 22. It could. be argued that such a large pay award takes up a noticeable amount of the BBC’s licence fee revenue.
The country’s output of medium-value manufacturing and services is increasing. they do not have to pay those on the LEP scheme. may encourage some with disabilities and extreme shyness into the labour force. in turn. for instance. may reduce the number of trade unions in existence. There is a risk. Training tends to be under-consumed. c) Whether China will experience skill shortages in the future will depend on whether the supply of skilled workers keeps pace with the demand for skilled workers. This is partly because of information failure – workers and firms often fail to appreciate the benefits that training can provide. b) The structural factors that could cause unemployment to fall include supply-side reforms that make labour markets more efficient by. and the expansion of particular industries. unit labour costs will rise. In contrast. c) Sockelarbeitslosigkeit is equivalent to the non-accelerating inflation rate of unemployment (also called the equilibrium level of unemployment). Firms competing for the scarce labour may bid up wages. by poaching staff. A lack of skilled workers may also result in Chinese firms not being able to meet domestic demand for a range of products. or if employers take advantage of the scheme to obtain cheap temporary labour. by providing support. international unions are also likely to have more funds than national unions. lack of qualifications. rival firms can take advantage of training carried out. limited numeracy and written skills.
. This may increase their bargaining power and may enable them to provide more facilities and training for their members. a criminal record and a history of unemployment. however. This shortage.
ACTIVITY PAGE 71
a) Among the barriers to work are an inability to speak English. will be influenced by how much investment the government. Another advantage to employers is that they can assess people’s skills and reliability before deciding whether to offer them a job. similarly. a union may cease to exist. the cyclical factor is an increase in aggregate demand that has the potential to reduce unemployment in most areas of the economy. increasing labour mobility. As well as the greater number of members and greater spread of membership. If membership falls to a low level. Merger activity. may result in a rise in imports and a reduction in the country’s trade surplus. disability. b) Members may gain a variety of benefits from the merger of Unite and the United Steelworkers Union. It is also because training generates positive externalities – other. This may be the case if training and support are not of a sufficiently high standard. in turn.ACTIVITY PAGE 70 (rIGhT)
a) China’s economic development is resulting in its output moving up the value added chain. firms and workers put into education and training. If. for example. It is the unemployment that exists even when the aggregate demand for labour equals the aggregate supply of labour. a US-based pharmaceutical firm threatens to move to a UK branch if US workers refuse to accept new working conditions. while they have to support the workers. This means they are likely to obtain some work at a cheaper rate. It may do this by developing the skills and work habits of people who have been unemployed for some time and. which is likely to involve some cost. members in both countries can join together to try and prevent this.
ACTIVITY PAGE 73
a) An employment rate of 70 per cent would mean that 70 per cent of those of working age are in employment. b) One advantage to employers is that. This is causing a rise in demand for skilled workers. c) It is possible that the LEP may lead to a permanent reduction in unemployment and an increase in economic activity. One is that they will have greater bargaining strength in negotiating with multinational companies that operate in both the UK and the USA. b) The existence of skill shortages may result in cost–push inflation.
ACTIVITY PAGE 76
a) The two key reasons are a further fall in membership and more merger activity. and whether it is in the right areas. If wages rise by more than productivity. This. that the fall in unemployment and increase in economic activity may be only temporary.
All these factors should lead to a higher output per worker hour. and generally develops their thinking skills. ii) Advances in technology are enabling top executives to control larger firms that are spread out across the world. workers may not be brought up to date with the latest advances in technology and working practices. Pearson Education. should demand fall. In the long run. top sportspeople and entertainers. however. making it cheaper to fire staff will not raise employment in the longer term if aggregate demand remains low. some advances in technology are reducing demand for unskilled workers as machinery replaces workers. may bring fresh ideas to a firm. b) i) Globalisation has increased competition for chief executives. and the efficiency with which they can perform those tasks. In contrast. This lower demand is placing downward pressure on the pay of this group of workers. such legislation may make employers aware of the skills of a greater range of workers.ACTIVITY PAGE 79
a) Low-quality jobs may not provide training and may not provide long holidays. and those who are geographically and occupationally immobile may find it difficult to gain new jobs. b) Young workers may be very up-to-date with advances in technology.
ACTIVITY PAGE 80
a) Literacy and numeracy increase both the range of tasks workers can perform. It should raise the quality of the labour force. as it will mean that some 16–18-year-olds who would have joined the labour force will stay on at school. the pay of unskilled workers is being squeezed by firms’ increasing willingness and ability to engage in outsourcing and offshoring. wherever they come from. b) Temporary work may reduce productivity if it fails to provide training. If this is the case. b) The diploma may initially reduce the UK labour force. Firms may have to set in place procedures to ensure the recruitment and dismissal of workers are undertaken in a manner that does not conflict with the legislation. it will increase labour market flexibility. may increase unemployment. The uncertain nature of temporary work may also reduce effort and enterprise. Workers may wonder whether it is worth their while to work hard and to develop ideas and products if their employment will only be short term. knowing that. and may not be able to develop their skills. In addition. This is because it may encourage some employers to take on more workers. Such high competition is pushing up the pay of the top earners. This is because some workers who lose their jobs may become discouraged. and may be keen to work hard and undertake training in order to gain promotion. c) Anti-discrimination legislation may initially reduce the flexibility of labour markets. Being literate and numerate enables workers to follow written communications and interpret numerical data. There is a risk. It also enables them to communicate in writing. Manchester United and major concert venues will seek to recruit the best people. At the same time. and so making employers more willing to shed workers. c) Reducing the number of days’ pay to which a dismissed or redundant worker is entitled may increase employment. increases the benefits they gain from training. and increasing the audiences top sportspeople and entertainers can reach. There is also a chance that the labour force may increase in the longer term.
. This is because undertaking the diplomas and so raising their employability may make it less likely that some teenagers will later become discouraged workers or recipients of employment and support allowance.
ACTIVITY PAGE 83
a) Leanne Wilkinson was dismissed on the grounds that she was too young and too inexperienced for the job. that the cost of dismissing or making workers redundant. it would be cheaper to dismiss them. These effects are raising the MRP of these groups and so pushing up their pay.
ACTIVITY PAGE 85
a) The income share of 99 per cent of income recipients fell from 92 per cent to 84 per cent. In this case. however. as those who take the diploma should build up their skills before they enter employment.
on average. the Italian government should raise more tax revenue. aristocratic families move away from leaving their wealth largely to the oldest son. b) The poverty line is usually taken to be an income level that is 60 per cent of average disposable income. The more women move into high-earning industries and the more successful they are in gaining promotion. which would increase their ability to take industrial action and to provide benefits for their members.
ACTIVITY PAGE 91
a) Costs to the economy of a child’s poverty include an increased burden on the NHS (as a number of these children will suffer poor health).2 per cent in 2007.
. It should. Having a high proportion of workers as members gives unions credibility to speak on behalf of the workers. b) Among the factors that will determine the proportion of wealth owned by women in the future are the patterns of women’s employment. This may result in it spending more on the care of the elderly. and net emigration of young people. and the pattern of ownership of shares and property. hospitals and local government are among the biggest employers of low-paid workers’. The passage mentions that ‘schools. c) Raising the retirement age is likely to reduce the amount the Italian government spends on pensions. it is the first two factors. people become richer and wealthier. In practice. As an economy grows and develops. however. so the more assets women own. Other factors include a rise in employment. which would enable them to afford more than the basic necessities of life. the passing of legislation that increases the actions trade unions can legally take. this is likely to increase women’s share of wealth. for example the pattern of inheritance and divorce settlements. however. the idea of what constitutes basic necessities and what is needed to participate fully in society changes. Having more members would make the trade unions more powerful when bargaining with employers and putting pressure on the government. a higher proportion of the population should be able to gain access to reasonably well-paid jobs. decent housing and other essentials. They would also know that their bargaining positions. With people working longer. If rich. People living on an income below this are regarded as poor. but it is uncertain whether this trend will continue. and a loss of potential productivity. is a washing machine now a necessity?
ACTIVITY PAGE 93
a) Italy’s population may be ageing because of a fall in its birth rate. and the removal of legislation that restricts their activities. and any actions they may pursue or threaten to pursue in support of their claims. a fall in its death rate. Having more members would also increase the funds of trade unions.8. women’s promotion success. For example. the greater will be their ability to accumulate wealth.ACTIVITY PAGE 86
a) The percentage of women in the wealthiest 1. As. Divorce settlements in recent years have tended to become more favourable to women. and the more assets they will be able to accumulate. Wealth generates wealth. It is predicted that this will rise to 60 per cent by 2020. which would enable it to ensure that vulnerable groups can afford good nutrition. some people are poorer than others. d) It is impossible to eliminate relative poverty unless there is complete income and wealth equality. will not be undermined by non-union labour. at least for a while.000 was 9. This is a percentage point rise of 50. c) One possible government policy measure to reduce poverty would be for the public sector to raise the wages of its low-paid staff. be possible to reduce absolute poverty. b) One factor that would increase the power of a country’s trade unions is an increase in their membership. A growing and developing economy should also increase a government’s tax revenue. the more income they will earn from them. In every country of the world.
Price level AS AS1 AD AD1
AD 0 Y
AD1 Real GDP
Figure A4. in the light of this change. however. Figure A4.
ACTIVITY PAGE 95
a) Net immigration into a country will increase both aggregate supply and aggregate demand. German firms moving to Slovenia). There are. These factors include greater mobility of labour and capital. the effect of net immigration will be to increase the country’s output. Net immigration. is also causing wage rates to converge. Polish workers moving to the UK). this would increase the country’s labour force and reduce its dependency ratio – there would be more workers per retired person. more barriers to the movement of labour between other countries and the EU and greater differences in labour policies. and making it easier for people from outside the EU to settle in the country. Some Poles may decide. There is also the issue of how long the immigrants will stay in the country.1
As indicated in the diagram. that the financial return from working in the UK is not high enough. real GDP. They are generally mobile and may be tempted to move to another country if pay and conditions are found to be better elsewhere. If the pound then fell in value to £1 = 4 zloty. may also increase the costs faced by state schools. Workers moving to high-wage countries increase the supply of labour there. however may put pressure on the country’s housing stock and. as well as the tendency for poorer economies of the EU to catch up with the richer ones. The adoption of similar policies. The immigrants will also demand goods and services and this will shift the AD curve to the right. firms move to low-wage countries. which can put downward pressure on wages (for example. if initially £1 = 5 zloty. b) A fall in the value of the pound sterling against the Polish zloty will reduce the return that Polish workers gain in the UK in terms of their own currency. a Polish worker earning £300 a week in the UK who sends £100 home would be sending 500 zloty.d) One measure that the Italian government could take to reduce the costs of an ageing population is to encourage net immigration of young workers by advertising job vacancies to countries inside the EU. It would also mean that the purchasing power of incomes in Poland would increase in terms of sterling.
. If successful. the person would then be sending back only 400 zloty to their relatives.1 shows these two movements. giving out more work permits to non-EU residents. At the same time. The increase in the labour force resulting from a rise in people of working age will increase the country’s productive capacity and so shift the AS curve to the right. Most of the restrictions on the movement of workers and firms between the member countries of the EU have been removed. For instance. although wage differentials between skilled and unskilled workers in some countries may grow. the adoption of similar labour policies and economic convergence. including minimum wage legislation. if the immigrants are accompanied by their families. c) There are a number of factors that may lead to a greater convergence of wage rates between EU countries than with wage rates outside the EU. Whether real GDP per head rises will depend on whether the immigrants add more to AS than to AD. raising demand for labour there and so placing upward pressure on wages (for instance. d) Wage rates in the EU and in other parts of the world may move closer together in the future with globalisation.
there are no or only low barriers in a monopolistically competitive market and. If. as a result. the more uneven it is. A shorter period of training and rise in occupational and geographical mobility would also increase the pool of potential teachers. and other equipment that requires people to operate it. If the wage rate paid to the crew grows at a more rapid rate than productivity. the more television production workers they are likely to employ.42. while in monopolistic competition there is a high number of sellers. new equipment is developed that can be operated with fewer workers. ii) Magic experienced the greatest percentage increase in reach between 2005 and 2007: 0. 4. In contrast. as it means that markets will not be able to respond fully to changes in demand and supply conditions. and the higher the revenue they can get for them. The more television programmes the television production companies can sell. 8.35 to 0. The supply of teachers’ labour becoming more elastic would mean that it becomes more responsive to changes in the wage rate. 5. income has become more unevenly distributed. The other key influencing factors are the productivity and wages of the crew. For instance. A small rise in the wage rate would attract more people into the profession.24 per cent. The immobility of labour leads to market failure. The four most listened-to stations had a 40. as more people would meet its entry requirements. The groups of people of working age who are economically inactive include the retired. If a country’s Gini coefficient increases.6 per cent in 2007. while those made by monopolistically competitive firms are slightly differentiated. new firms will be attracted into the market. The closer the figure gets to 100%/1. If. This share had risen to 41. This will increase supply. The product produced by a monopoly is unique. itself.5/2. on the other hand.9 × 100 = 17. lower price and compete away the supernormal profits. will also enable more people to train as teachers in response to a rise in the wage rate. should supernormal profits arise. This means that there is the highest degree of market concentration possible in a monopoly. however. adults in full-time education and those too disabled or sick to work. whereas leisure is time people can spend as they want. In a pure monopoly there is only one seller. This will reduce supply. demand for skiing holidays in France may increase. losses are being experienced. for example. Work covers time when people are applying mental and/or physical effort in a job. A monopoly differs from monopolistic competition in a number of ways.
ExAm PrACTICE PAPEr PAGE 102 SECTIon A
1 a) i) The four-firm market concentration ratio increased in 2007 compared with 2005. This is because.
. Time. demand for production crew will decrease. 2. 7. A reduction in the qualifications and the skills needed to be a teacher would make supply more elastic. it rises from 0. 3. the firms earn normal profits in the long run. A monopoly has high barriers to entry and exit that enable the monopolist to earn supernormal profits in the long run. some firms will leave the industry. while the market concentration ratio is relatively low in monopolistic competition. demand for production crew is likely to increase. In this case there would be under-production of skiing holidays – the output would be below the allocatively efficient level.8 per cent share of the market in 2005. demand is likely to fall. the cost of capital equipment. There are a number of factors that influence the demand for television production crew. and workers in France pursuing other occupations are occupationally immobile.QuICk-FIrE QuIz PAGE 98
1. The absence of barriers to entry and exit is likely to mean that only normal profits will be earned in the long run. but it may be difficult to recruit more skiing instructors because instructors from other countries are geographically immobile. falls in price. raise price and restore normal profits. 6. it means that its income has become more unevenly distributed. and whether such equipment acts as a substitute or a complement to the crew. If cameras. So if. The key one is demand for television programmes.
for instance. that consumers may lose as a result of this change in the market structure. If the commercial radio stations are experiencing losses or low profits. Consumers are likely to have a relatively wide range of different brands to choose from under oligopoly. and ease of entry and exit into the market. d) An increase in trade union membership among radio journalists may increase their pay. Having more firms competing for the custom of consumers may result in them enjoying lower prices and higher quality. So an increase in trade union membership is likely to be more effective in raising commercial radio journalists’ pay if it results in most of the journalists belonging to the union. be more successful if it is difficult to replace unionised labour with non-unionised workers. product differentiation. it is unlikely that they will join together. the BBC may provide better holidays. however. The BBC may. A trade union’s power to raise journalists’ pay would be weakened if commercial radio station bosses get together to bargain as one. for example. There is also the possibility that trade union membership may increase. they cannot be replaced by non-unionised journalists. and they negotiate separately with one trade union. A small rise in trade union membership that means most journalists still do not belong to the trade union is unlikely to increase that union’s bargaining power. despite the greater level of competition. offer better promotion chances. This is because the commercial radio stations would find it hard to put out their news programmes if the unionised journalists went on strike and the stations could not recruit non-unionised journalists. ii) A market moving from oligopoly towards monopolistic competition will be introducing more competition. In such circumstances. and the degree to which commercial radio stations act together. Having more members may not be effective in raising pay if the members are not prepared to back up their pay claims with industrial action. The ease of entry into and exit from the market will mean that only normal profits are earned in the long run. including free gifts and competitions. the members are prepared to support any action they are called upon to take. and may enjoy some of the methods used by oligopolists to attract customers. c) A journalist may prefer to work for the BBC because the pay is better. including the extent of the rise in membership. Indeed. however. There is a chance. a union is unlikely to press for higher pay. The wage rate received is a key influence on the job selected by a worker. resulting in new and improved products. someone might be prepared to work as a journalist on BBC radio for a lower wage than that available on commercial radio if they believe it will enhance their future earnings or generate extra work opportunities by raising their profile. The increase may. the action they are prepared to take in support of any pay claims. the extent to which they can be substituted by nonunionised labour. Some of any supernormal profits enjoyed by oligopolists may be spent on research and development.
. so that the commercial radio stations can play one union off against another one. Larger firms can take greater advantage of economies of scale and so unit costs and prices may be higher under monopolistic competition. In addition. profits earned by the radio stations.b) i) Three characteristics of monopolistic competition are a large number of small firms. but it will depend on a range of factors. Someone starting as a journalist on. however. workers also take into account the non-pecuniary benefits of a job. Given their commercial rivalry. the commercial stations are earning high profits. The BBC is a large organisation. more sociable working hours and/or better pension entitlements than commercial radio stations. but may be fragmented among a number of unions. As well as the pecuniary reward. which should increase consumer surplus. Radio Solent may work their way up to be a presenter on a BBC1 TV show. they will be unable to raise pay. The relatively high prestige associated with working for the BBC may also make it easier to gain a good job with another media organisation.
2 a) Negative discrimination is one factor but other influences should be considered. etc. b) There should be a discussion of the factors that influence the long-run supply of labour. 3 a) The key factors that influence the number of hours a day an individual works include the number of hours on offer. using demand (MRP) and supply analysis.15 Retail Price Index: transport components Punctuality at UK airports Petrol and diesel prices and duties per litre National railways: passenger charter punctuality and reliability Local bus services: local authority support by area Local bus services: fare indices by area. and there will be more costs involved in employing young workers in the form of more training. and they may enter higher paid areas of the law. b) There should be a discussion of the factors that will influence what will happen to the gap based on demand (MRP) and supply analysis.
. They may. b) There should be a discussion of arguments for and against paying the same NMW to all those aged 16 and over.14 14. however. but also by the availability of work in the country.
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a) There are no explicit answers to this activity. It would be beneficial to include a diagram. and work in less lucrative areas of the law. Then the arguments for maintaining it should be explained. and a smaller proportion of them may belong to the career’s professional body. the qualifications and training gained by female solicitors improve. promotion opportunities. Female solicitors may work fewer hours. The following tables from Transport Statistics. the wage rate and the workers’ desire for leisure time. 4 a) The NMW should be explained (a diagram may be drawn).
Most of the above tables cover a ten-year period.and raising labour productivity. but may be discouraged by the difference in language. UK people are also likely to consider whether the relative advantages and disadvantages of the jobs in the two countries will change over time. The arguments for include avoiding age discrimination. reducing the costs of administrating and operating the law. and the likelihood of. job security. be encouraged by lower house prices in France and the relative ease of working in another EU country. including reducing poverty. Some UK workers may wish to work in France. These arguments are based largely on the assumption that the MRP of young workers is lower than that of older workers. may have career breaks to have children. countering the power of monopsonists and oligopsonists (and so correcting market failure).3 6. The reasons why this may or may not be the case should be explored. these changes should be examined. the qualifications needed.19 3. Whether more people will move to France in the future will be influenced not only by the holidays and working hours. Great Britain contain some relevant statistics on the determinants of demand for private car transport: 19.6 14. less training. and improving the morale. the pay on offer. training and productivity of young workers. the hours worked by female solicitors may increase.3 3. The reasons for. that geographical and occupational mobility of labour may be limited. cultural differences and family ties. and a recognition that pecuniary and non-pecuniary advantages and disadvantages can change over time. Demand for female solicitors relative to male solicitors may rise if negative discrimination falls. The MRP of female solicitors may be lower than that of male solicitors if they have fewer qualifications. Use should be made of the income and substitution effects. Arguments against include that it may discourage the employment of young workers and raise firms’ costs of production.
usually with a statistical commentary: 1.
Using some of the above data.
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a) The general determinants of demand are: • the price/cost of a mode of transport • the price of substitutes and complements • household income • taste. and the decline in the use of rail transport up to 1995.Transport Trends tables contain similar information. Consequently. The volume of traffic falls just 7 per cent. Historically. • Qualitative factors such as reliability.4 2. the relationship between journey purpose and derived demand should be understood.
b) Some points to note are: • Increases in household income allow more families to purchase cars. some new roads have been built for other valid reasons. by age and gender. convenience and flexibility tend to favour the car over most forms of alternative transport. In part b). such as providing environmental relief or to reduce accidents at a particular black spot. fashion.
. say. the private car and bus for particular types of journey. though.1–11 b) Congestion Changes in relative costs of transport Local bus reliability Bus passenger satisfaction A range of data on travel by household income and car ownership. b) The biggest benefit is a reduction in congestion. they have been the main reason why most new road schemes have been constructed.
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a) The main problem is that there are many determinants of the demand for road passenger and freight transport services. by trip purpose and accessibility. In recent years.6 3. Particular problems arise with respect to behavioural factors that govern travel behaviour.2 3. the benefits represent a very convincing case for the introduction of some form of road pricing. c) Road traffic forecasts provide a crude but essential estimate of future demand into the decision-making process for new roads. These are often difficult to estimate. These differ from the determinants of demand for private car transport insofar as car ownership/availability is usually the most important factor that determines whether a car is used for a particular journey. hence greater use of private car transport. In all cases. the ‘predict and provide’ approach that underpins new road development has been subject to increasing criticism.
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There are no particular answers to part a). This should be followed by an evaluation of the extent to which household travel demand is determined by the qualitative assessment of the comparative advantages of. • The increase in bus and rail fares relative to motoring costs might be used to explain the decline in bus transport over this period.3 4. the main determinants of demand for transport by local bus include: • the cost of bus fares • the cost of substitutes such as private car travel • household income • trip purpose • age and gender • reliability. but the intensity of congestion falls much more.
86 in 2006.433.775 1.400 1. 400 1. The shape of the AC and AVC curves is less pronounced than in this figure. 342. • An increase in discretionary income has meant that more people are able to fly. have increased market share.7 1.1. of planes 0 1 2 3 4 5 6 7 b) See Figure A6.000 1. although its shape is not as smooth as the MC curve in Figure 6.
Cost (£) 1400 1200 1000 800 600 400 200 0 1 2 3 4 5 AC AVC AFC 6 7 Number of planes MC
Average fixed cost – 1. It does not measure whether seats have been sold to passengers. 175 1. Ryanair and easyJet. the four curves follow the same pattern as in Figure 6.333. b) There are various reasons for these changes. British Airways’ market share has fallen significantly.7
Marginal cost – 400 150 100 50 300 600 800
Figure A6.200 1. 216.550 1 425 1 400 1.
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a) The four-firm concentration ratio is 0. The overall size of the market has increased by around 45 per cent over the four-year period. while two of the low-cost carriers.166.142.89 in 2002 and 0. particularly from low-cost carriers. 200 1.1 c) In general.
c) This is a compound measure of supply. It takes into account the seat capacity of each aircraft in an airline’s fleet and the total flights by distance made by that aircraft over a period of time.485.1 (page 120 in the textbook). 275 1.1 No.9
Average variable cost – 1.Chapter 6
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a) Table 6.1. The MC curve cuts AC at its lowest point. This represents a small decrease in the percentage of the total market of the four largest firms.3 1 250 1.7 1.500 1. due to the high fixed costs in relation to total costs.
Average cost – 1.7 1. 266. have encouraged more people to fly.3 1. • New routes. • Domestic rail fare increases have led to more people flying in the UK. • Fares are likely to have fallen in real terms. usually one year.
ii) P & O Ferries has about 30 per cent market share on the competitive short sea routes from Dover. On other longer routes. there would be a marginal impact. firms often have a route monopoly as far as that route is concerned. The important consideration is that the objective chosen is justified using appropriate evidence. The market today seems far removed from when it was investigated by the Competition Commission in 1996.72 c) Truronian has about 1. Its acquisition by First Group would lead to a small increase in the five-firm concentration ratio and First Group’s share of the national market. airlines) • the price of complements such as fuel • taste and fashion factors that might determine whether a family wishes to travel by sea. There is no correct answer. Overall. namely: • the price of the fare • the discretionary income of consumers • the price of substitutes (e. b) No explicit answer is available to this activity. other ferry routes. Data from operators is not easy to obtain.7 per cent of the buses owned by other bus operators.
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a) The following data can be collected from national sources such as Transport Trends and Transport Statistics. Great Britain: • trend in payments for unremunerative services • number of passenger vehicle operator’s licences • trend in real fare levels • average age of the bus fleet • bus miles operated.
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There are no explicit answers to this activity.g. although locally First Group may hold route monopolies.ACTIVITY PAGE 142
a) i) The usual determinants of demand can be applied. Channel Tunnel.
b) A short essay is required here. the outcome of which was that conditions were made for the proposed joint venture between P & O and Stena.
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a) The following statistical information can be used to evaluate the impact of rail privatisation since 1995: • growth in passenger kilometres and goods tonne kilometres • private sector investment in rail vehicles • public sector investment in Railtrack • change in subsidy payments • reliability and punctuality statistics • increasing concentration of ownership • new types of rail freight carried. There is also price variation depending on whether you look at the operator’s own website or that of a travel broker. Evidence from websites indicates intense price competition – this is not a feature of oligopolistic markets. b) 0.
It may. and will generate some votes among this group.1 ii) The introduction of the flat rate tax has led to some improvement in efficiency – the price paid has increased to P2 and the quantity demanded has fallen to Q2. particularly those located within the charging zone. A more environmentally acceptable transport policy would be one that encouraged the greater use of those modes of transport that produce low levels of CO2. it is likely that a search will come up with some of the following: • the LCC is not popular with certain businesses. it would be a more sustainable outcome. given their passenger volumes. there is a widening gap between car use and CO2 emissions. The costs seem negligible. mainly through more efficient vehicles. The cost to the government is the opportunity cost involved – the £2bn could have been allocated to other areas of government spending. b) For the individual. it means that their real income has increased. Figure 7. both of which would benefit older people. if they use the bus. encourage some over-60s to switch from using a car to the bus. such as health and social security. From a modal standpoint. the volume from the transport sector has actually been increasing in absolute and relative terms.Chapter 7
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Although total greenhouse gas emissions have been falling.7 (page 158 in the textbook). b) Although there is no explicit answer to this question. particularly for non-essential reasons.1.
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a) i) See Figure A7. produce significantly lower carbon footprints per head. There is also the nonquantifiable benefit to be gained through increased travel opportunities. It is also debatable whether there should be new constraints on the growth of air travel. If so.
Costs and price MSC
Y P1 P2 P Z X tax
D = MSB 0 Q1 Q2 Q Quantity
Figure A7. in a modest way. Rail and bus transport emissions are much lower in comparison and. loss of trade is often referred to • the LCC leads to congestion around the edge of the cordon • there may be some change in direction of policy following the change of mayor in May 2008.2 (page 153 in the textbook) shows that.
. over the past few years. the largest increase has been from air transport.
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a) This is clearly a popular policy with the over-60s. It should be stressed that this is still not an optimal outcome. However. The welfare loss has also been reduced – the new triangle XYZ is smaller than that shown in Figure 7.
The main determinants are likely to be cost.30 and 8 a.m.m. The estimate for travel between 9 a. quality of service and so on.m.m. including Transport Statistics. The zero estimate indicates that there is perfect inelasticity – those travelling between 7. namely between 7.ACTIVITY PAGE 165
Some possibilities are: For: • reduced CO2 emissions from air transport • boost to domestic tourism • enhances awareness of the negative externalities involved. more travel occurs.30 to 9 a. The congestion charge appears to have had a particular effect in reducing private car travel.30 and 9 a. is more inelastic and therefore likely to be more essential at this time.30 and 8 a. Against: • difficult to control – what about business travel? • direct intervention in working of the market mechanism • fewer flights will mean less employment in aviation and related industries • negative impact on recipient countries that rely on tourism • why only control flights – why not ban gas-guzzler cars?
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The main trends are: • a reduction in numbers using the private car. Travel between 8. and 9. e. ii) Maximum revenue will be generated by increasing charges in time periods with the lowest inelastic price elasticity of demand. and between 8.m.m. it will be considerably more in 2007/08. b) i) It seems logical to set the highest charges where the price elasticity estimates are most inelastic.. 8.30 and 9 a.g.
. This is probably due to car users delaying the start of their trip to wait for a lower charge to be in place. road users are getting a poor deal – they are paying at least three times more to the Exchequer than they are getting back in the form of road maintenance and new roads.
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a) This information can be obtained from various statistical publications. The positive estimate for 9 to 9. There may be a case for increasing the charge further during this period in an attempt to persuade some motorists to vary their journey time period.30 is unusual – it means that as price increases. might result in congestion during this period. are inelastic.
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a) All estimates for travel after 8 a. and qualitative factors such as convenience. (ii) Capital and current road expenditure in 2006/07 was around £9bn. especially since 2000 • a 20 per cent increase in those travelling by surface rail • an 80 per cent increase in those travelling by bus. have to do so.m. (i) In 2005/06. road users paid over £28bn in taxes (VED and fuel tax). Due to increased fuel prices.m. This well-worn argument fails to acknowledge that the purpose of taxation is to fund all types of government spending. and that hypothecation has never been seriously suggested in this case.30 a. b) On the surface.
This is because.
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a) i) Time savings are invariably the biggest benefit in most cost-benefit studies – ‘time is money’. It can apply to transport policies that encourage greater use of more sustainable modes of transport and promote a reduction in the demand for less sustainable modes. for example in the case of public goods. 2 A few large firms. Crossrail and which would have come about in any case. Some of the effects do not fit easily into the discrete categories above. As time does not command a market price. b) The wider-impact effects of a huge project like Crossrail are very difficult to measure. Private benefits: • reduced journey times for users • reduced costs for some users • less congestion for those not using new facility. it is difficult to establish which effects have come about just from. External costs: • loss of buildings to make way for construction • some blight and noise in city centre. from a scientific standpoint. 6 A method for assessing whether a project should go ahead where the market mechanism cannot be used. non-price competition.
. Indirect benefits: • wider benefits of new investment opportunities in the local economy. high barriers to entry. irrespective of the project going ahead. a value has to be imputed. 4 Because it internalises the cost of the negative externality onto the road user. Indirect costs: • less spending available for other projects.Chapter 8
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Private costs: • construction costs • annual maintenance costs • annual subsidy to operator.
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1 Billion passenger kilometres. 5 Meeting present needs without compromising the ability of future generations to meet their own needs. price rigidity. billion tonne kilometres. ii) This is because any time savings can be put to an alternative use that will be more productive than idle time in congested traffic. 3 Removal of regulations. External benefits: • less traffic noise and air pollution • improved work opportunities. for example barriers to entry into a market. say. interdependence.
In most markets. d) There appears to be some evidence in the two tables to suggest that the demand for passenger transport is becoming more sustainable. However. a rail operating company may have a local monopoly. b) Most transport markets do tend to be oligopolistic. In Table 1 (page 194 in the textbook). For full marks. c) i) Passenger transport is a derived demand because it fulfils some particular purpose. the answers should explain why the particular determinant has actually resulted in an increase in passenger transport by car. at best. only one of which is the change in real GDP. school or shopping. e. For example. The extent to which firms compete is variable.
.g. rail passenger transport. Air transport is a good example of where alliances have been formed. elsewhere demand has continued to fall or. though. To some degree. ii) In theory. be a short time lag. The demand for bus and coach transport has also increased. but this is not consistent. firms invariably compete through non-price competition. there has been a relatively small increase in demand for car transport compared with rail. Reasons for this can be explained through price rigidity and the kinked demand curve. An explanation using simple game theory is equally relevant. therefore. the transport data are very crude. as well as individual operations. it depends on how the market is defined. which is a more sustainable mode. rail freight. but may be an operating company of one of the main groups when looking at the whole market. the demand for transport for work as well as non-work reasons is likely to increase. A reason for the above is likely to be that the change in demand for passenger transport depends on a whole range of determinants. There seems to be a time lag of one year at some stages of the series. 2 a) Oligopolistic markets are characterised by having high barriers to entry for new firms. and not as accurate as those for real GDP growth. a decline in the annual rate of increase in demand for private car transport could be due to growing congestion problems. has been stable. Also. with branding prevalent. including: • an increase in car availability • a fall in the real cost of car use • an increase in the price of substitutes. there are typically a small number of large firms and differentiated products.g. Evidence of oligopoly can be shown through a three. the brand image. This is indicative of transport being a derived demand. bus. This is particularly so when considering the total markets for local bus transport. fashion and other non-price factors are predominant. customer service. There may.ExAm PrACTICE PAPEr PAGE 194
Section A 1 a) i) Rail ii) Cars b) Various possibilities. such as an increase in out-of-town shopping centres. In these circumstances. there is likely to be some limited competition. iii) There is no overwhelming evidence that this relationship applies to the data in Table 2 (page 195 in the textbook). it is expected that there is a positive relationship between the annual change in real GDP and the annual change in demand for passenger transport. When the economy is growing at a good rate. It is these alliances. An example of this will enhance the evidence base of the answer. Additionally. though. e.or four-firm concentration ratio. Table 2 seems to indicate a decoupling of the relationship between the change in real growth and the change in demand for passenger transport. journey to work. that actually compete with each other. rail • a deterioration in the reliability and punctuality of rail transport • non-transport factors. The data for bus and coach transport are also misleading – the increase in demand is mainly confined to London. changing work locations. air transport in the EU and crosschannel ferries.
the price level rises to P1. b) The underlying principles of the Crossrail cost-benefit study are in some respects well established. and the benefits in terms of travel time and cost savings to such users. would be equal to the difference between marginal social cost and marginal private cost. and the methodology that is used is relatively robust. Such costs and benefits are far from easy to calculate. Estimates are also made for the benefits that will apply to those travellers remaining on other modes of transport after some traffic transfers to Crossrail. (This can be shown on a diagram. They involve projecting the volume of traffic that would use the extended facility. This results in market failure. is the estimation of the indirect costs and benefits of Crossrail. They are. A second issue concerns the availability of public funding – resources are invariably scarce in relation to demand.
b) In theory. for example. rising inflation might coincide with falling economic growth if there is a leftward shift of AS1 (to AS2) caused by rising input prices. including: • an increase in CO2 emissions and contribution to global warming and climate change • oise disturbance to people who live in the vicinity and on the flight paths of airports that have n experienced increased traffic levels • various forms of environmental pollution and visual intrusion around airports • possible health risks to air passengers and crew arising from increased air travel. though. It is not hypothecated to provide for those affected by negative externalities – revenue is collected by airlines and goes straight to the Exchequer. Such a tax would be particularly efficient if it were hypothecated to offset the negative externalities referred to above. on the other hand. the rate of inflation might be expected to fall. the use of the market mechanism and raising investment funds on the open market is not appropriate. very important in the overall justification of the Crossrail project from a public funding standpoint. so some means has to be established in order to determine funding priorities. However. As the rate of economic growth falls. 4 a) Most major new transport projects are publicly funded or involve PPPs. As a consequence.3 a) A negative externality occurs when the marginal social cost of an activity is greater than the marginal private cost. What is new.) Various negative externalities arise from the increased use of air transport.and long-haul air passengers.
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a) Economic growth and the rate of inflation might be expected to be positively related. Real GDP in this case would fall to Y2 as the price level rises to P1. though. This relationship can be explained by increasing AD (to AD1 in the figure opposite). although from 2010 it will be calculated per flight rather than per passenger. Increases in AS. Higher economic growth would be expected to generate higher rates of inflation. The Air Passenger Duty is a flat rate indirect tax on short. As the economy is operating closer to its full capacity output.1
. At present it is not related to the cost of externalities. Cost-benefit analysis seeks to achieve these objectives by taking a long view and a wide view of all of the various costs and benefits involved.
Price level AS2 AS1
P1 P AD1 AD 0 Y2 Y Y1 Real GDP
Figure A9. if accurate. since the price that is paid by users does not reflect the true cost of that activity. this type of negative externality could be resolved through a green tax that. This approach is not new. would allow the economy to grow without any increase in the rate of inflation. the effects of its construction on employment in the City and the wider economic benefits on the community.
d) The standard of living can be thought of as the quantity and quality of the goods and services available to the population. but income inequality in one country might mean that the standard of living of the average person differs markedly. Material living standards will have increased. their ability to earn a living through farming. increased competition from China may result in falling sales for UK firms. To some extent. raising GDP and employment in the UK. Comparisons of the standard of living are made more difficult and less meaningful because of the wide range of different indicators. On the other hand. c) Rapid economic growth in China has a positive impact on living standards in the UK through increasing the supply of goods and services and reducing the price of imported goods.000 of the population • televisions per 1.
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a) Inflationary pressures might have been experienced in: • 1973–1974 • 1985–1990 • 1999–2000. income is not equally distributed and ‘average’ GDP can give misleading comparisons. These are periods in which the output gap narrowed. comparisons of GDP per capita will provide meaningful comparisons of the standard of living of the average person in two countries.
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a) Economic growth in China has led to an increase in average incomes in both urban and rural areas. b) Economic growth in China might have reduced the standard of living because some people in rural areas have been displaced from their homes by the building of reservoirs. as indicated by the increase in retail sales of consumer goods. which has a negative impact on the standard of living in the UK. c) There is no one answer to these questions.000 of the population • life expectancy at birth • adult literacy rate. Where income is equally distributed. has been reduced by the need to increase the production of energy for industry. comparisons are not meaningful because there is a degree of subjectivity in the interpretation of the different indicators. Chinese economic growth may also be responsible for increases in the world price of energy and oil.
Whether a deterioration of the UK’s current account of the balance of payments is a cause for concern depends very much on the causes and consequences of the current account deficit. It may also have provided a market for UK exporters.
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a) Five indicators might include: • GDP per capita • doctors per 1. For some. These may give conflicting pictures of the standard of living in two countries.
b. a deterioration in the current account might not be a problem if: • it results from imports of capital goods which raise the long-term rate of economic growth • it is sustainable because of long-term capital flows into the economy. GDP per capita could be the same in two countries. there will be higher standards of living because people in China will be able to consume more goods and services. for example. As a result of higher average incomes. reducing output and employment. However.b) A deterioration of the UK’s current account of the balance of payments might be a cause for concern if: • it results from a lack of international competitiveness • it is not matched by a capital account surplus • it constrains the rate of economic growth in the long run. However.
and guide policy makers in the setting of fiscal and monetary policy. Increases in consumption and investment add to AD. The difficulty of measuring the output gap. b) A reduction in interest rates reduces the cost of borrowing and the reward from saving. This will allow firms in the euro zone to lower prices to offset the impact of the appreciation of the euro on the price of goods produced. particularly important for an economy that is heavily dependent on imports for raw materials and components • it helps to reduce inflationary pressures • it forces domestic firms to be efficient and to strive to reduce costs in order to compete in international markets. Basing economic policy on only one indicator is likely to lead to inappropriate policy changes. such as immigration. Both of these will contribute to a lower level of AD. causing a reduction in AD. Domestic monetary policy must be used to support the exchange rate policy such that interest rates cannot be used to manage domestic demand. It may also lead to reductions in employment in industries unable to reduce unit labour costs by either raising productivity or reducing the growth of wages.b) Estimates of the output gap are useful because they indicate when inflationary pressures might be building up in the economy. b) Two reasons why euro zone net exports have risen despite the euro’s appreciation against the dollar are as follows. As a result. There are some circumstances in which economic growth will not be stimulated. The policy is more appropriate for an economy with a large exposure to international trade and capital flows. that are increasing the economy’s potential output. however. therefore. discretionary income is increased through a reduction in mortgage interest payments. particularly those with a high income elasticity of demand. A managed appreciation of the exchange rate. which will reduce economic growth in the short run. They might. For those with mortgages. give advance warning that the rate of inflation is likely to rise. provides problems for policy makers.
. however. This should lower the demand for euro zone exports and raise the euro zone demand for imports. however. This will offset the reduction in demand caused by the appreciation of the euro. creating short-run economic growth. • Growth in world demand – an increase in world demand will increase the demand for euro zone exports. It is also likely to raise investment by reducing the cost of borrowing for firms. leading to a slowdown in spending • expectations – the Bank of England’s warning of a slowdown in economic growth might have caused some consumers to reduce their expenditure for fear of rising unemployment in the future. For example. These include: • market interest rates may not be reduced following a reduction in the interest rate by the Bank of England (as happened in the UK in 2008) • a lack of confidence on the part of consumers and firms • offsetting reductions in the other components of AD. interest rates may be increased because the estimated output gap is narrowing and yet there are changes in the economy. it is likely to increase consumer spending.
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a) A stronger euro will raise the price of euro zone exports and reduce the price of euro zone imports. c) The case for a managed appreciation of the exchange rate includes: • it reduces import prices.
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a) Reasons for the slowdown in consumer spending in late 2007 include: • reduction in the availability of credit – consumers may have found it more difficult to finance expenditure through borrowing. might reduce economic growth by raising the price of exports and reducing the price of imports. • Productivity gains – increases in output per person will reduce euro zone unit costs. such that an independent monetary policy is difficult.
e. This might mean attracting investment from foreign multinational companies. which will limit the ability of firms to respond to rising demand. making the economy larger as opposed to making it richer. This is because changes in economic activity are more likely to bring about prolonged periods of unemployment. This is because they may encourage workers to spend more time seeking work once unemployed. Kenya is not doomed to low rates of economic growth if it can ‘plug’ the savings gap.g.8 = 7 per cent of national income to savings to achieve a growth rate of 2. However. labour costs and price of output • reduction in labour shortages. or borrowing from abroad.5 per cent. This is because a smaller working-age population will shift AS to the left. Increases in productivity improve the efficiency with which resources are used.ACTIVITY PAGE 216
a) Possible reasons for the projected decline in Bulgaria’s population of working age include: • a falling birth rate • emigration. Commentary might include: • benefits reduced by restrictions on immigration • benefits for whom? – impact on wage rates • dependent on who migrates – i. also shifting AS to the right.5 × 6. reducing labour mobility and flexibility.8 = 17 per cent of national income to savings to achieve a growth rate of 2.5 × 2. b) Low rates of savings due to low levels of income will constrain an economy’s long-run rate of economic growth according to the Harrod–Domar model. b) An increase in investment will increase AD. aid from foreign governments or international institutions. skills profile • consequences for social housing and benefits • context of ageing population/population of working age • extent to which there is an optimal population size • distinction between the impact on GDP and GDP per capita – e. b) A lack of labour mobility and flexibility is likely to result in lower rates of economic growth for these economies. but will also raise the productivity capacity of the economy. compared with those of the UK and the USA. Without either or both of these. c) Consequences might include: • potential output expanded • increased supply of labour • impact on wages rates.
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a) Generous unemployment benefits available in Germany and France are likely to shift the long-run aggregate supply curve to the left.5 per cent. Kenya needs to devote 2. Bulgaria’s long-term rate of economic growth will be constrained by the projected decline in the population of working age.
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a) According to the Harrod–Domar model of economic growth: ΔY/Y = s/k Rearranging this equation for savings gives: s = ΔY/Y × k The USA needs to devote 2. shifting the AS curve to the right.
including the interest elasticity of demand and the price elasticity of demand for exports and imports • the time-scale over which the policies might be effective. a deficit caused by a lack of international competitiveness would be considered a cause for concern because. it would be unsustainable.
. in the long run. Commentary on the policies could include: • the impact on other macroeconomic objectives.ACTIVITY PAGE 220
a) Market failures that would justify government intervention to raise the UK’s productivity might include: • short-termism of banks and financial institutions • positive externalities from investment. Since labour is probably a major input cost for Chinese firms. c) The gap between investment and savings in the USA first narrowed from 1993 to 2000.
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a) Since 1993. A growing deficit might not be a cause for concern if it is caused by imports of capital goods. However. This will increase the demand for exports. preventing incentive to poach trained workers from other firms • state provision of training loans – individuals can access funds for training by using state ‘credits’. A deficit caused by high level of US consumption. raising the demand for imports. raising interest rates • revaluation of the currency. reducing government expenditure and raising taxation • contractionary monetary policy. there will not be adverse consequences on growth or the exchange rate – the deficit is being ‘financed’ by the sale of assets abroad. particularly employment and unemployment • the responsiveness of the components of AD to changes in the interest rate and exchange rate. to raise export prices and reduce import prices • incomes policy.
b) Appropriate policies might include: • investment grants to firms – this would reduce the cost of investment for firms and make them less reliant on external sources of finance for investment projects • training ‘levies’ on firms – all firms required to contribute to training costs or share costs of training within industries. b) Rapid economic growth in China has created demand–pull inflation. which will enable the USA to generate higher levels of domestic output. to reduce the growth of wages. the deficit is simply a form of investment. which has increased wage rates. These policies would reduce inflationary pressure by reducing the growth in demand and limiting cost– push pressures. the US current account balance has deteriorated. the US capital account balance has improved.
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a) An under-valuation of the Chinese currency will make Chinese exports more price competitive than they would be otherwise. b) Since 1993. This has resulted in increases in the demand for labour and emerging labour shortages. d) Whether the current account deficit of the USA is a cause for concern depends on its causes and consequences. this has also created wage–push inflation. so long as the growing current account deficit is matched by a growing capital account surplus. might be thought of as a cause for concern. Inflationary pressures have been seen in construction due to the increased demand in this sector. In this sense. including investment in training • information failures constraining access to finance for training/retraining. as the economy has increasingly moved towards full capacity. as it is an indication that the economy is ‘living beyond its means’. c) Policies the Chinese government could use to reduce the inflationary impact of economic growth include: • contractionary fiscal policy. On the one hand. before widening to 2003.
a rule that simply states that the government’s budget must balance may create economic instability by requiring governments to tighten fiscal policy in a recession. The effectiveness of fiscal policy rules depends on the rules themselves. Government debt is the accumulation of unpaid borrowing over time. They provide a framework for the conduct of fiscal policy. contribute to economic stability. This is because of the way in which the financial system works. When interest rates come down. They limit the power of governments to make fiscal policy decisions based on short-term political considerations.
c) Fiscal policy rules can contribute to economic stability by limiting the expansionary and contractionary impact of government spending and taxation. which may be destablising.
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a) There are three key determinants of long-run economic growth: • the size of the labour force • the size of the capital stock • the efficiency with which the labour force and the capital stock are used to produce output (productivity). For example. By increasing the productive capacity of the economy. Disadvantages of Estonia’s fiscal policy rule include: • automatic stabilisers are not allowed to function • may make the economic cycle more pronounced as fiscal policy needs to be tightened in an economic slowdown or recession • removes the ability of governments to employ counter-cyclical policy • may limit public sector investments that could improve long-run economic growth • the exception to the rule for pensions allows the government to borrow to finance current consumption but not capital investment • may require short-term changes in government expenditure and taxation to ‘balance the budget’. the factors above determine the rate at which aggregate demand can increase in a sustainable way. because it will be cheaper to borrow funds to buy assets. Even more sophisticated rules that take account of the economic cycle may not promote economic stability because of the problems of measuring the underlying fiscal stance. thereby increasing the demand for assets.ACTIVITY PAGE 231
a) A rise in the interest rate should result in market rates of interest increasing. with the central bank providing funds to the banking system at the official base rate. they do not on their own guarantee it.
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a) Government borrowing arises when the expenditure of the government is greater than its revenue. which creates transparency in the way fiscal policy is conducted. This helps to create greater certainty and provides conditions that favour business investment.
. If the central bank charges the banking system higher rates of interest. b) Advantages of Estonia’s fiscal policy rule include: • no crowding out of the private sector • the avoidance of fiscal deficits. asset prices should rise. however. To be effective. these should be reflected in higher market rates of interest. under certain circumstances. While fiscal rules may. meaning that interest rates do not have to be raised in order to attract funds to finance the deficit • provides the conditions for economic stability by eliminating the possibility that fiscal policy contributes to the economic cycle. b) The rate of interest and asset prices should be negatively related. c) Rising interest rates will tend to generate expectations of a slowdown in economic growth and therefore they will reduce confidence in the economy. they must take into account the impact of the economic cycle on the fiscal stance.
Given the difficulties of measuring the rate of inflation. This is likely to reduce the rate at which wages rise. built into the target is a belief that low inflation is as much a concern as high inflation. growth of aggregate demand is likely to put upward pressure on prices. Continued growth of the economy would be possible without inflationary pressures. and must ensure that inflation does not exceed 3 per cent or fall below 1 per cent. and the impact on the distribution of inflation. A negative output gap occurs when actual output is below the productive potential of the economy. In this situation. The costs of high inflation include: the impact on long-term planning. with an upper ceiling of 3 per cent and a floor of 1 per cent. In addition. In short. a low rate of inflation risks a low rate of economic growth. thereby lowering unit costs and p allowing firms to be more price-competitive in international markets • overnment subsidy of research and development – this increases investment. A limited margin of spare capacity is therefore significant for the MPC. whereas inflation measures the rate of change of prices. inflation targets recognise the time-lags inherent in monetary policy. increased risks and borrowing costs. This is because an increase in labour force participation would increase the economy’s LRAS curve. an increase in the population willing and able to work would raise labour supply. d) Effective supply-side policies allow an economy’s AD to increase without creating inflationary pressure. would improve the economy’s price competitiveness in international markets. and may even reduce unit labour costs. In addition. The reduction in inflationary pressures. There could be commentary on the extent to which inflation targeting could be compromised in situations where the inflation target is set by the government. a symmetrical inflation target is likely to promote economic stability. Alternatively. It is set a target rate of inflation by the government of 2 per cent. c) Increased labour force participation would improve the competitiveness of a high-cost. the UK inflation target acts as a constraint on fiscal policy – policy makers are aware that any fiscal expansion that is likely to compromise the inflation target is likely to be met by monetary policy tightening. The advantage of a symmetrical inflation target. the objectives of this aspect of macroeconomic policy are clear and transparent. inflation targeting reduces macroeconomic instability created by manipulation of monetary and fiscal policy for short-term political objectives. promotes economic stability might seek to establish the problems in setting an appropriate target. There are difficulties in setting interest rates with a view to influencing future rates of inflation. The policy objective of the Bank of England’s Monetary Policy Committee (MPC) is to deliver price stability. Commentary on the extent to which an inflation target. and creating
. Implicitly. This would have two effects. They do this by increasing labour productivity and the productive potential of the economy. as it indicates potential inflationary pressure in the economy. This has an impact on inflationary expectations. as is the case in the UK. Where the margin of spare capacity is limited.
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a) The price level is a measure of the average price of goods and services produced in an economy. high-inflation economy such as Ireland. which could increase the g quality of goods and services produced. the MPC) could be explored in terms of accountability. both demand–pull and cost–push. spare capacity is said to exist. such as that in the UK. the composition of the body responsible for interest rate decisions (in the UK. c) The UK inflation target is symmetrical – the central target is 2 per cent. considered to be a key determinant of inflation in modern macroeconomics. the misallocation of resources. then. term of office and nature of appointment. Furthermore. As a result.
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Three supply-side policies that might improve an economy’s international competitiveness are: • ducation and training – this is likely to increase labour productivity. is that interest rate changes are likely to be less frequent and of a lower amount. b) The Czech Republic because it has the lowest level of prices in the EU. and ensures that monetary policy decisions are not unduly influenced by current macroeconomic conditions. allowing domestic firms to compete better in international markets. even though prices are rising quickly.b) The output gap is the difference between actual and potential output. reducing unit labour costs and so e improving price competitiveness of domestic firms • rivatisation and deregulation – provides incentives to increase efficiency. due to an increase in the productive capacity of the economy. In this way.
• he WTO exists to promote free trade and encourages countries to abolish tariff and non-tariff barriers T to trade. by reducing inflationary pressures in the economy. then this takes the pressure off monetary policy. First.
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Three key findings might include the following. if labour and product markets adjust more quickly to changes in demand and supply. However. These consequences may give rise to social and regional problems that have to be offset against the benefits for the conduct of monetary policy.000 Motor vehicles (M) 0
PPC 4. The consequences of effective supply-side policies create advantages for the conduct of monetary policy.more labour and product markets that are more responsive to changes in demand and supply.000
PPC 0 5. monetary policy can be eased. This will encourage greater investment. • he WTO also resolves trade disputes between countries – it can place trade sanctions on countries that T do not abide by its rulings. It may also be the case that labour market flexibility has adverse effects on factors such as job security. • The WTO runs global trade negotiations aimed at reducing trade barriers. levels of pay and welfare benefits.000 Motor vehicles (M)
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a) Answers are dependent on students’ own research. This means that interest rate changes do not need to be so large to manage AD.
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a) The PPC for each country should look this:
Clothes China (C) 5. Second. which itself will create the conditions for more sustainable economic growth.000 Clothes Italy (C)
1. supply-side policies take time to create the conditions under which these effects on monetary policy begin to be realised. b) Reasons students might give to explain the main exports and imports for a particular country might include: • natural resource endowment for exports or lack for imports • factor endowment for exports or lack for imports • geography or climate (although this is part of resource endowment) • labour cost advantages.1
. Interest rates can be set lower without the danger of an inflationary stimulus to AD.
although this would be inappropriate for a developing country such as Lesotho and may be prohibitively expensive for textiles firms themselves. This might be done through design. as its maximum output is higher than Italy’s.000 Motor vehicles (M)
TPC 0 10.
. low-value Chinese textiles. One option might be to lower wage rates offered to workers. c) China should specialise in the production and export of clothes. then each unit of clothing traded by China would allow it to purchase two motor vehicles – more than it could produce itself by transferring resources from the clothing to the car industry. the trading possibility curves for each country would look like this:
Clothes China (C) 5. b) Competition from China poses problems for Lesotho’s textile industry because of its much lower labour costs. although this might result in workers moving to other occupations where they exist.b) China has the absolute advantage in the production of clothes. Such products would allow Lesotho to command higher prices for its garments in world markets. e) Based on terms of trade equal to 1C:2M. less than the opportunity cost of domestic production of clothing. 1C:1M to 1C:4M. This is because it has a lower opportunity cost in clothes production (1 unit of clothing: 1 motor vehicle) relative to Italy (1 unit of clothing: 4 motor vehicles). reducing the competition from low-price. if the terms of trade were 1C:2M. d) The terms of trade that would benefit both countries would lie between the relative opportunity cost ratios. This could be done by the use of more capital-intensive methods of production. Similarly.000 Clothes Italy (C)
2. For example. A third option would be to diversify into production of fabric in order to reduce import and transportation costs. or the use of better quality or niche fabrics such as organic cotton. Students might review their answers to this question when they have studied Chapter 11 of the textbook – they will then be able to set these benefits in the context of a developing economy.000 Motor vehicles (M) 0
TPC 4. Another option is to increase efficiency by raising labour productivity.2
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a) The benefits of trade in textiles for Lesotho include: • greater economic efficiency in terms of resource allocation • employment • tax revenue for the government from taxation of income and profit • foreign exchange earnings • addition to aggregate demand. The only alternative to reducing production costs is to shift production into higher-value garments. Italy could purchase one unit of clothing for two cars.
. However. This is because the large depreciation will have significantly raised import prices and put the control of inflation at risk. domestic production at the world price Pw is Q1 and domestic demand Q2. A second benefit of a freely floating exchange rate is the idea that the exchange rate will tend to reflect purchasing power parity and reduce speculation. Such a dramatic depreciation in the exchange rate of the forint against the dollar in such a short period suggests that this benefit was not being realised. A tariff raises the price of imports to Pw + t. Unchecked. b) The winners from tariffs are: • domestic suppliers – price and output are higher. Imports consequently fall to Q4 – Q3. The impact on the cost of repaying borrowing in US$ would have been substantial. These effects are shown in Figure A10. This allows an extension of supply from domestic firms to Q2. The benefits of a freely floating exchange rate for the Hungarian economy depend in large measure on the reasons for the rapid and significant depreciation experienced in October 2008. the dramatic fall in the foreign exchange value of the currency is likely to have required central banks to raise interest rates to support the currency. Q2 – Q1 being imports. since more forints are required to buy each US$. A loss of confidence in the forint is likely to bring more costs than benefits. It is likely that the forint was under speculative attack.3 Without tariffs. with large capital outflows causing the currency to fall so far. b) A freely floating exchange rate is thought to benefit economies by allowing central banks to set domestic monetary policy to control the rate of inflation rather than the exchange rate. There is a contraction of domestic demand to Q4. it raises its prices. equal to area.
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a) The Hungarian forint has depreciated against the US$. reducing export revenue and profits • workers abroad – they are likely to lose jobs • governments abroad – they will lose tax revenue. in the case of Hungary. such a depreciation could have created deflationary effects on the economy. resulting in a reduction of consumer surplus of area 1 + 2 + 3 + 4 • exporters – exports are reduced in volume and value. so quickly – there would appear to be a run on the currency.
Pw+t 1 Pw 2 3 4 tariff
Ddomestic 0 Q1 Q3 Q4 Q2 Quantity
Figure A10. International trade is therefore reduced by tariffs. The forint has depreciated by 28 per cent against the dollar. The losers from tariffs are: • domestic consumers – they pay higher prices and are unable to consume as much as before. resulting in increased producer surplus of area 1 • domestic workers – there is likely to be higher employment as a result of tariffs • the government imposing the tariff – they earn tariff revenue on imports.ACTIVITY PAGE 253
a) When a country imposes a tariff on imports. lowering the demand for imports and allowing domestic firms to raise their supply and the level of imports fall.
and will limit the extent to which consumers engage in cross-border shopping. the harmonisation of product standards. the free movement of goods. • Differences in GDP per capita – these result in differences in effective demand. The extent to which economic integration tends to lead to the convergence of prices of consumer goods depends on a range of factors. The level of economic integration determines the extent to which a single market exists. Price differences should be eroded by trade.
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a. competition. the EU may create packaging and labelling rules that must be adhered to across the whole of the EU. making them less competitive • export subsidies – reduce the price of exports making them more competitive • rules of origin – determine the ‘nationality’ of goods and services in order to restrict imports from certain countries or give preferential access to goods from other countries • rules on packaging and labelling – increase the cost of production of imports above what would be necessary to supply the domestic market. Where product standards are not harmonised. This involves the removal of tariffs and non-tariff barriers to trade.
. reducing the total volume of sales for manufacturers. If prices were the same across the EU. This arises when manufacturers are able to prevent consumers buying in ‘low priced’ markets. and may be higher in countries where there is less competition. A lack of fiscal harmonisation will result in price differences remaining as a result of differences in expenditure taxes. making them less competitive against domestically produced goods • quotas – restrict the quantity of imports. and monetary union depending on the level of integration. Branding. In an economically integrated area. thereby raising their price • import bans – obviously a complete restriction on trade • public procurement policies – the public sector may favour domestic firms in buying goods and services • state monopolies – create barriers to entry that restrict domestic and foreign competition • import licences – restrict imports to licensed buyers only and raise the price of imports • minimum import prices – raise the prices of imports. raising the level of trade and competition. the affordability of cars would differ markedly.b) Other non-tariff barriers to trade and how they restrict trade: • border controls – add to costs of imports. There may be differences in regulation resulting in differences in costs in different parts of an economically integrated area. greater price transparency and the elimination of transaction costs. to the convergence of prices – the ‘law of one price’. Integration should result in the creation of a single market. c) Economic integration may seek to remove NTBs through removing them (negative integration) or creating common standards across the economically integrated area (positive integration). product differentiation and consumer loyalty may all play a part in the extent to which prices converge. Different product specifications allow price discrimination to continue. and this will limit price convergence. For example.ACTIVITY PAGE 262
Answers depend on students’ own research. charging high prices in countries where the price elasticity of demand is inelastic. • Possibility of price discrimination – car manufacturers may engage in price discrimination. prices should reflect demand and supply across the whole area as a result of consumers buying across borders and producers entering nations where prices are higher than average. Prices will also reflect the degree of competition within each national market. services and the factors of production. This is related to the concept of purchasing power parity. producers are able to engage in market segmentation across national borders. fiscal harmonisation. The price of cars is likely to be lower in countries with lower GDP per capita because effective demand is lower.
b) Economic integration refers to the process of blurring the boundaries that separate economic activity in one nation state from activity in another. The forces of demand and supply should lead. This way. Prices will always reflect transport costs. production for countries in the rest of the EU is not disadvantaged relative to production for the domestic market.
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a) Two reasons why the retail price of cars differs between countries in the EU are as follows. over time.
Link to development – improve life expectancy. Targets – reduce the death rate of those under five by two-thirds. Targets – reduce debt problems by making debt sustainable. Goal 6 – combat HIV/AIDS. Targets – reduce the proportion of people living on less than a dollar and the proportion of people who suffer from hunger by a half. Goal 5 – improve maternal health. Targets – get rid of differences in primary and secondary education for girls and boys. GDP per capita and the rate of economic growth • social objectives – to ensure the benefits of economic growth are shared more equally and to raise standards of living • environmental objectives – to reduce negative externalities of economic growth. the benefits of economic growth for both current and future generations is reduced
. Link to development – raise exports of developing countries.
b) Reasons might include: • economic objectives – to raise GDP. Goal 7 – ensure environmental sustainability. reduction of unemployment • social objectives – education.
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a) Additions to each category include: • economic objectives – efficiency. Link to development – improve life expectancy. to ensure development is sustainable. raise GDP per capita. Targets – ensure all children complete primary education. reduced CO2 emissions. Link to development – improve life expectancy.Chapter 11
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a) Some of the targets for each of the Millennium Development Goals include the following. Link to development – reduce poverty. Link to development – create conditions for sustainable development. Goal 1 – eradicate extreme poverty and hunger. Goal 4 – reduce child mortality. improve earnings potential and human capital. create tariff-free access to developed economy markets for developing countries. improve life expectancy. human capital and earnings potential. b) Answers dependent on students’ independent research. optimal use of non-renewable resources. improve lives of at least 100 million people living in slums. malaria and other diseases. stability. and reduce maternal mortality rate by 75 per cent. Targets – universal access to contraceptives and family planning. improve earnings potential and human capital. increase GDP per capita and improve life expectancy. In such cases. Link to development – improve literacy rates and reduce inequalities in income distribution between the sexes. Link to development – improve literacy rates and human capital. c) Economic growth may conflict with economic development where growth creates negative externalities such as air pollution. c) Answers dependent on students’ independent research. health. and create full employment. reduce dependency and raise living standards. Goal 2 – achieve universal primary education. Goal 3 – promote gender equality and empower women. security • environmental objectives – clean air. Goal 8 – global partnership for development. Targets – reverse the spread of AIDS/HIV and incidence of malaria. Targets – reduce biodiversity loss. reduce proportion without access to safe drinking water by 50 per cent.
but it has the second lowest GDP per capita. Yemen and Sierra Leone. HDI measures the components ‘positively’ and HPI measures them ‘negatively’. For example. raising the living standards of the owners of capital but providing little employment for the masses. or the different priorities of the two governments. can be reduced by government intervention such as taxation. b) Economic growth is necessary to achieve the three objectives of economic development set out by Todaro: an increase in the availability and distribution of basic life-sustaining goods. In addition. In the longer run. so it is not a sufficient condition. Higher GDP per capita is associated with higher life expectancy. which will tend to be undeveloped in countries with low GDP per capita. Chad. GDP per capita and Internet users per 100 people are also positively related. In the case of developing countries. For example. Population problems create demands on productive resources. Yemen has the third highest HDI value in the table. these problems arise because the need to provide for a greater number of dependents with a smaller workforce makes it difficult to raise living standards. which begin to outstrip their supply. an increase in levels of living. This is likely to be because of better nutrition arising from higher incomes. or totally absent in rural areas. and higher material living standards for some may coincide with continued poverty for others. b) Despite a similar GDP per capita. This might arise where economic growth is achieved by capital-intensive production. on its own economic growth does not guarantee development. which has the third highest HDI. and almost as high as that of Uganda. In the short run.
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a) GDP per capita and life expectancy are positively related. Internet usage is dependent on an advanced telecommunications infrastructure. However. either through the market or through government provision. high dependency ratios. c) HDI and HPI measure the same components. These differences might reflect more effective resource allocation in Uganda. and because richer economies are able to provide better health care.
. however. such that resources are not allocated efficiently.by the impact on health. migration and rising death rates. the technology required to reduce air pollution may be prohibitively expensive.
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Population problems of developing economies include rapid population growth. adult literacy and education enrolment by adult illiteracy and GDP per capita by measures of deprivation. but with different indicators. The external costs of production reduce economic welfare. on the other hand. and levels of health and education consequently fall. however. the benefits of economic growth may not be shared equally. there is increased pressure on governments to provide job opportunities to cope with greater urbanisation and to control the environmental impacts associated with some of these population problems. HPI replaces life expectancy by the probability of survival. due to PCs having a high income elasticity of demand. and an expansion of the economic and social choices available to people. adult literacy or educational enrolment. Uganda may have a higher HDI because it may perform better on life expectancy. The external costs of production. has the second lowest HDI value but has a GDP per capita higher than those of Benin. The marginal social cost of production exceeds the marginal private costs.
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a) The two countries that least support the relationship expected between HDI values and GDP per capita are Yemen and Chad. This is likely to be because ownership of PCs increases with GDP per capita. regulation or pollution permits.
and the urban and rural. This means the reallocation of resources between different uses and a change in the nature of output. while others may be almost impossible to overcome. Low levels of development often mean that there is a greater emphasis on primary. such as the neglect of agriculture or too high a rate of urbanisation. For example. traditional. insufficient funds. a lack of technology. the traditional and modern. Furthermore. there may be inadequate expertise. further limiting the development of the secondary sector. the formal and informal sectors. while others may be tackled only in the long run. particularly in the case of agricultural commodities. Primary commodities are subject to variations in supply. For example. factor immobility. trade barriers or a lack of comparative advantage. the lack of developed financial markets and financial intermediaries mean that what savings exist are not efficiently channelled into the secondary sector. Development leads to a move through the secondary to the tertiary sector. subsistence farming is the norm for many – almost 50 per cent of the population in Namibia are engaged in agriculture. more modern systems and country-to-city migration. where yields and harvests are subject to the forces of nature. a reduced importance for informal activities. b) Changes in the structure of production may involve the move out of primary into secondary or tertiary economic activity. In Figure A11. the size of the primary sector of developing countries results from their low level of development.
Price S1 S2
D 0 Quantity
Figure A11.ACTIVITY PAGE 290 (rIGhT)
a) There are a number of different sectors of the economy. since it is essentially starved of funds for investment. secondary and tertiary sectors. Developing countries may face obstacles in attempting this change. or even changes in the ownership of productive resources. Low levels of savings constrain the ability of the secondary sector to grow. including the primary. The result of low incomes is low levels and rates of saving.
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a) Primary commodities are likely to have price inelastic demand and supply. The primary sector. therefore.1
. Rich elites in developing countries tend to invest savings outside the domestic economy (capital flight). With a large proportion of the population living on low incomes (in Namibia. Changes in either demand or supply are therefore likely to bring about large changes in price. informal and rural sectors of the economy. Volatile prices can also be caused by a swing in demand because of price inelastic supply in the short run. 35 per cent living on less than $1 a day and over 55 per cent on less than $2 a day). Some of these problems may be overcome relatively easily. remains large. a switch to export-oriented output.1 a shift in supply from S1 to S2 causes a large change in price from P1 to P2. The change itself might create problems. It may be possible to address some problems immediately.
It is concerned with intergenerational welfare/equity and the optimal use of resources over time. c) By regulating the supply of rice. a reduction in supply will result in a proportionately greater increase in price than the decrease in consumption. The outcome would be faster growth. reversing previous development.
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a) Structural adjustment programmes are promoted by the World Bank to restructure the economies of developing countries. they help to increase international competitiveness. As a result. human and natural capital. net exporters may stand to benefit from higher export revenue. A move from state control to the market is thought necessary to enable greater development. These have been linked to the lack of market influences and a weak supply side of the economy. It may also be interpreted as applying industrial methods to all forms of production. Since the demand for rice is likely to be price inelastic. creating the conditions for economic growth. higher incomes. However. trade deficits and resistance to change. so that manufacturing predominates over agriculture.b) A cartel of rice producers would involve a group of producers agreeing to regulate the supply of rice to the world market. devaluations. inflexibility. higher productivity. They are sometimes said to reflect the needs of the developed world at the expense of developing countries and they may increase dependency. It has been the traditional method of achieving growth. budget deficits. lack of competitiveness. This involves maintaining the stock of man-made. They favour market solutions. revenue from sales will increase. the benefit to net exporters is dependent on the ability to regulate and police supply decisions in a cartel. greater reliance on private enterprise and extensive use of markets. The outcome of the present structure has been poor living standards and low levels of development. improve efficiency and raise levels of development. and may involve deflationary policies.
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Answers depend on students’ independent research. it may be that the cartel regulates supply in order to stabilise rather than raise prices. Marginal producers have an incentive to produce more than their quota in order to increase revenue further. b) The poor economic performance of developing countries has been blamed on excessive state control. bringing more employment. with the potential for higher living standards and greater development. technical progress and greater value added. Loans and assistance may be conditional on their implementation. This will be of benefit to net importers in the long run. which will deliver macroeconomic stability. the cartel will break down. The benefits therefore depend on the actions of the members of the cartel. Supply restrictions require quotas to be successful.
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a) Development raises the quality of life across an economy. Although net importers may lose out from higher prices. Net importers stand to lose. If significant numbers of producers act in this way. reduction of government intervention. Sustainable development involves meeting the needs of the present generation without compromising the ability of future generations to meet their own needs. Economic growth may increase
. Structural adjustment programmes are criticised for harming poorer citizens. In addition. Structural adjustment is necessary to speed up change. Manufacturing is seen as an engine for growth. c) Structural adjustment programmes are thought to promote economic development by enabling market forces to deliver greater economic efficiency and to promote sound management of the economy. and concentrating on economic growth rather than human development.
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Industrialisation is the process of moving production from the primary to the secondary sector.
. Against this. co-operate with government policies. such as GDP. and a misallocation of resources towards growth. resulting from increased traffic congestion. and may create greater inequality. b) These impacts represent the negative externalities of economic growth. or on noise or ill-health caused by stress. may encourage urban migration. true economic welfare is lower than GDP per capita would tend to suggest. As long as they act ethically. they may encourage sustainable development. These effects would be anti-developmental and are linked to the concept of sustainability. Damage to sustainability may be irreversible. such as damage to the environment and monetary values of unrecorded economic activity. species and biodiversity loss. b) MNCs invest in developing economies to make profits.development in some ways. treating the environment as if it had no price is a recipe for continued environmental sacrifices at the altar of economic growth. d) By taking into account the negative and positive aspects of economic growth. and informed choices between different policies with different environmental and social impacts. Their policies may reveal awareness of the issues of sustainability. The measures are also useful in forcing policy makers to address issues related to the environment and sustainability. however. c) The Index of Sustainable Economic Welfare (ISEW) adjusts national expenditure figures. They may introduce efficient methods of production.
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a) Possible environmental impacts of economic growth include: • air pollution • water pollution • noise pollution • global warming • destruction of wildlife habits. it is difficult to put a monetary value on the loss of species. may create external costs. so harming development permanently. indicators of sustainable economic development provide a better indication of progress than measures that simply value the total level of production and consumption taking place. improve human capital and the capital stock. The usefulness of such indicators is tempered by the difficulties of measurement inherent in quantifying impacts that do not have a market price. While material living standards are increased by economic growth. The conflict arises from the contrasting aims of profit maximisation and sustaining levels of development. As a result. and raise the quality of life. the social benefits of economic growth are less than the private benefits.
Possible social impacts of economic growth include: • income inequality • associated crime • impact on the family • health effects such as stress • greater time spent commuting. they may exploit developing economies by paying low wages. but harm future development. but there is no agreement on the reliability of such valuations. the usefulness of the measures is undermined. but also the quality of life. by deducting the value of the negative impacts of economic growth and making additions to represent the value of the positive impacts of economic growth. The ISEW requires monetary values of the costs of negative externalities of economic growth. Nevertheless. Valuations can be made by calculating ‘shadow prices’. Combined with the problem of what environmental and social impacts to include in composite measures of sustainable development. and the social costs of production and consumption are greater than the private costs. Failure to make development sustainable might mean falling quality of life for future generations. Both result in over-production and over-consumption. This makes such measures useful in judging whether economic growth is delivering increases in not just the material standard of living. may avoid paying taxes through transfer pricing. may exhaust natural resources. Judgements about the extent of ‘progress’ in well-being can be made. may harm local cultures. For example. such as the value of work done in the home. They may allow better policy decisions to be made. particularly in terms of the stock of natural resources and the environment.
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a) Student’s own research.
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a) A possible disadvantage of the corporate tax rates being driven down to a low level is that governments may not raise enough tax revenue to finance an adequate social welfare system. c) Globalisation may or may not reduce unemployment in a country. This creates a market for pollution. and puts a price on CO2 emissions. unemployment may fall. they will lose out to producers in China. Freer trade. For a carbon emissions trading scheme to be effective: • it must be possible to measure pollution and to monitor it • it must be possible for authorities to enforce permits • there must be a clear target set for emissions. If globalisation and other factors keep inflation low. Knowing that consumers can now buy products more easily from foreign rivals means that firms have to keep their costs low. Firms not using their ‘quota’ of pollution are allowed to sell permits to those firms that exceed their quota. and this should correspond to an output at which the MSB = MSC • there should be a large number of firms involved in the scheme so that a ‘correct’ market price can be determined by a large number of buyers and sellers • there should be firms that find it easy and less costly to reduce pollution than others • there should be few ‘transactions’ costs in trading. If. This tendency for globalisation to drive down tax revenue. If firms and their workers can respond more quickly and fully to changes in comparative advantage and changes in demand. A gradual reduction in the supply of permits over time raises their price. and there should be perfect information and knowledge for the market to function well. The increased ability to locate production processes in different parts of the world helps them to keep costs low. for example. b) Globalisation may keep inflation low by increasing the competitive pressures on firms. c) The benefits to firms and the environment include: • firms are rewarded through the market mechanism for reducing CO2 emissions • firms are able to choose the most cost-effective way of reducing emissions • a price is put on the environment. which is dependent on a number of conditions being fulfilled. it means that central banks do not have to raise interest rates as a counter-inflationary measure. is sometimes known as social dumping. and so the standard of the social welfare system. unemployment may rise.
d) The problems of carbon emissions trading schemes mainly relate to their effectiveness. UK-based car producers do not innovate and reduce costs by means of greater mechanisation and improved training.
. ETS therefore works with the market mechanism and internalises the negative externality by allowing the market to determine a price for pollution. which means environmental impacts are internalised in firms’ costs structures – the environment ceases to be treated as if it were a ‘free’ resource. If. b) The EU’s ETS sets a limit on CO2 emissions for the largest industrial polluters in the EU. and workers lack skills and mobility. firms do not pick up on market signals. new production methods and new products are creating more products and more employment opportunities. India and other countries. The outcome will be determined largely by how the economy responds to the challenges of globalisation. ‘Clean’ firms are rewarded with revenue from the sale of quotas and ‘dirty’ firms are penalised. however. This creates incentives to reduce emissions of CO2 over time. Firms are then allocated permits by the governments of the EU member states.
as the country is likely to remove some of its capital equipment and relocate some of its key staff. b) If Unilever pulled out of South Africa. it will not have workers in the country.ACTIVITY PAGE 315
a) Two factors that have made it easier for firms to act transnationally are improved communications and a reduction in transport costs. driving down tax rates in order to attract and keep firms in the country.
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a) Unilever may enjoy low production costs and a growing market by operating in South Africa. and it will stop contributing to South Africa’s exports. Other production costs. By having a presence in the country. Governments may engage in tax competition. b) Firms acting transnationally has a number of implications for governments. Figure A12. Being able to contact a branch abroad easily makes it simpler to co-ordinate production. the country’s aggregate supply is likely to fall. Given the high rate of unemployment in the country. to deal with any difficulties quickly and to exchange information about new techniques. As well as AS decreasing.1
. These arise largely from production being more mobile.1 shows South Africa starting with a negative output gap. and to create a favourable business environment by. for instance. Unilever may gain brand loyalty before other MNCs seek to locate and sell in the country. The increase in firms acting transnationally also puts pressure on governments to increase the skills of the labour force by improving education and training. and if the productivity of workers is reasonably high.
Price level South Africa AS1 AS AD1 AD
AD1 AD 0 South Africa’s real GDP
Figure A12. The decrease in AS and AD reduces the country’s real GDP. reducing regulations. The effect on AS will be greater if the factories and offices that it closes down are not bought and re-opened by other firms in the country. labour unit costs are likely to be low. AD will also fall. Wage rates are lower than in the EU and USA. Falling transport costs make it cheaper to move items and staff around during the productive process. given its high level of unemployment. including rent and rates. South Africa is a growing economy. it is relatively easy to recruit workers there. with rising incomes. Unilever will no longer be demanding supplies and services from local producers. are also likely to be relatively low.
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1 Boom. 5 GDP per capita. whereas economic growth in the short run assumes that the productive capacity of the economy is unchanged. informal sector activity declines and the urban sector grows. which in turn will reduce potential GDP and discourage MNCs setting up in the country. 4 Benefits include access to a larger market.
. 6 The primary sector shrinks as a proportion of total output as first the secondary sector grows and then the tertiary sector. there are no tariffs on trade between partners but each country retains an independent trade policy with other countries. In a single market. b) One of the functions of the IMF is to promote international monetary stability and co-operation. It may lead to a shortage of skilled workers. The country will experience lower and more stable inflation. may harm developing countries. have a steadier and more sustainable economic growth. however. earning $300 a week will be sending back $60. educational attainment. always lead to freer international trade. they may also bring back new ideas. The skilled workers may leave behind children and elderly relatives. Other countries’ cotton producers will be forced to reduce the price of the cotton they seek to sell in order to remain price competitive.
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a) US cotton subsidies will reduce the price of US cotton. This is because it permits countries to improve tariffs on countries that engage in what are considered to be unfair trading practices. Remittances are a major source of finance for some developing countries. Every year it publishes a report on individual countries. 2 Economic growth in the long run is related to increases in LRAS. It will also mean that other countries will benefit from the training that the developing countries have given. however. economies of scale. regions and the global economy. As well as providing information and advice to governments in pursuit of this aim. he/she will send back $30. however. recession. be closer to full employment. and be closer to a balance of payments equilibrium. Income inequality may increase as the pay of skilled workers in the developing countries may rise due to their shortage. Its actions do not. recovery. 3 In a free trade area. For instance. and they may have developed skills and qualifications while working abroad. They may borrow to finance them and get into difficulty repaying the loans. It surveys and monitors economic and financial developments.
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a) i) Balance of payments difficulties usually refers to countries experiencing large current account deficits over a period of time. slowdown. an unskilled worker may send back 60 per cent of his/her disposable income each week. an unskilled worker earns $50 a week. while the pay of unskilled workers may fall due to a reduction in economic activity. more trade (trade creation). while a skilled worker may send back only 20 per cent. monetary and supply-side policies. ii) Improved economic management refers to better control of the economy through more efficient and appropriate fiscal. there is a common trade policy (and common external tariff) and further economic integration in terms of common policies in other areas. greater competition. b) The WTO seeks to promote free trade. b) The emigration of skilled workers may benefit developing countries by bringing money back into the country. it also organises meetings of governments and central banks to discuss key developments and issues in international monetary markets. and do not stop them when instructed to do so by the WTO. but this does not necessarily mean it is a higher amount. They send back a higher proportion.ACTIVITY PAGE 318
a) It does not necessarily indicate that unskilled workers send more money back to developing countries than skilled workers. life expectancy. If. whereas a skilled worker. thereby increasing the dependency ratio. If workers return to the country after a number of years. In addition. The emigration of skilled workers.
greater efficiency and higher economic growth. these problems may be more severe at times of global economic uncertainty. economic activity tends to be much more concentrated in the secondary and tertiary sectors. the information requirements to assess present and likely future performance of key economic indicators. reducing Brazilian exports. Furthermore.
Price level AS
Figure 1 c) Setting interest rates to promote economic stability involves a number of problems. there might be a deterioration in the balance of payments on current account. Costs include: developing countries may struggle to compete in international markets.
. causing a fall in FDI in Brazil. The diagram below shows a leftward shift in AD as a result. The primary sector therefore remains large in developing economies and marks them out from more developed nations. The reasons for this relate to the special characteristics of developing economies. but a reduction in the price level (or more realistically a reduction in the rate of inflation). and globalisation contributes to increased use of non-renewable resources. including the length of time over which the monetary transmission mechanism operates. It is normally used to describe the period of slower economic growth preceding a recession. 8 The WTO seeks to encourage free trade.
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1 a) An economic slowdown occurs when there is a reduction in the rate of economic growth. The focus of its activities is on financial support for. Low incomes cause low levels and rates of saving. They tend to have a structure that is less dependent on the primary sector of the economy. and the responsiveness of economic agents to changes in interest rates. It does this by providing loans and grants to developing countries that would otherwise find it hard to raise capital on international markets. 2 a) The World Bank exists to promote economic development by providing financial assistance and technical assistance for developing countries. It settles trade disputes between countries and reduces the barriers to trade through international trade negotiations. b) An economic slowdown in the USA would lead to a reduction in aggregate demand in Brazil. internal investment projects such as building new roads. and US companies would be less likely to invest during a slowdown. a possible increase in unemployment. as it is essentially starved of funds for investment.7 Benefits include greater trade and competition between economies. the lack of developed financial markets and financial intermediaries means that what savings exist are not channelled efficiently into the secondary sector. b) Developed countries have a different economic structure from developing countries. among other things. Reliable economic modelling will help to reduce the extent of these problems. leading to lower prices. The Brazilian economy suffers a reduction in real GDP (or a reduction in the rate of economic growth). This is because there would be a reduction in the demand for Brazilian goods and services in the USA. In addition. the possibility of external shocks. improving port infrastructure and constructing new health facilities. However. The size of the primary sector of developing countries results from their low level of development. Low levels of savings constrain the ability of the secondary sector to grow.
for example. 3 Rapid economic growth results in an increase in GDP per capita. Countries that have changed their economic structure have avoided these problems successfully.
. The validity of the Prebisch–Singer hypothesis has also been challenged. In addition to volatile prices. and the impact of this change has been positive rather than negative. The extent to which economic growth is consistent with sustainable economic development depends in large part on the ability of developing countries to manage growth in a way that minimises its negative impact. it raises material standards of living and contributes to economic development by raising average incomes. The result of the volatility in the price of primary commodities is largely negative for developing countries because of the impact on export revenues. Future generations can therefore be left with a stock of natural capital that reduces their ability to satisfy basic human needs. As a result. but exhausts the land to the extent that future generations are unable to use it for productive economic activity. However. Rapid economic growth may involve a rate of depletion of natural resources that is less than optimal. This is caused by the low-income elasticity of demand for primary commodities. However. widening access to goods and services. and allowing resource allocation decisions that can increase life expectancy and educational attainment. even if economic growth is consistent with economic development. Sustainable development requires that the needs of the current generation are met without compromising the ability of future generations to meet their own needs. it has been argued that commodity prices exhibit a long-term downward trend. combined with increased supply. This may take the form of government intervention to internalise the negative externalities of growth and to ensure that benefits of growth are shared widely among the population. provides income for the current generation. this does not guarantee that it is consistent with sustainable development. such that it is difficult to argue that genuine development has taken place. The Prebisch–Singer hypothesis suggests that developing countries that specialise in the production and export of primary commodities are trapped in a low level of development as a result of such changes. the extent to which developing countries are affected by such changes in commodity prices depends on their economic structure and their ability to change this. Recently commodity prices have increased dramatically. Rapid economic growth may also cause an increase in inequality.c) Commodity prices tend to be volatile because of the interaction of changing demand and supply with low price elasticities of demand and supply. Slash-and-burn agriculture.