International

Baccalaureate
Higher Level Economics
Bible
0917804-0004

Supply and Demand

1. PPC (Choice Scarcity and Opportunity Cost)
Production Possibility Curve (PPC) - the boundary between attainable and unattainable
levels of production.
Scarcity - human wants exceed the amount that available resources can produce.
Opportunity Cost - cost of any economic activity measured in terms of the best
alternative that is foregone. When the best alternative is chosen from a range of
alternatives, the second best choice is the opportunity cost.

Point A and any point inside the PPC: attainable, but inefficient
Point B and any point along the PPC: attainable, maximum efficiency
Shift from Point A to PPC1: actual economic growth

Originally, Germany produced nuclear energy at N1 and coal powered energy at C1

However, _____
Due to finite resources and scarcity, govt was forced to make a choice
Decreased nuclear energy production to N2, opportunity cost represented by loss
Increased coal powered energy production to C2, represented by gain

Point D and any point outside the PPC: unattainable in the SR due to scarcity of FOPs
However in LR, can shift out the PPC1 to PPC2 and attain point D: potential economic
growth
Through increase in FOPs, increase in efficiency or production of new technology

2. Actual and Potential Growth: w/ or w/o Development

Define
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 Economic Growth one of the five macroeconomic objectives is an increase in Real

GDP per capita of a country
Economic Development one of the five macroeconomic objectives is an increase in
Real GDP per capita of a country and an increase in the standard of living
Draw

Explain
The graph on the LEFT represents economic growth w/ development
PPC shifts out to PPC1 for two merit goods- textbooks and vaccinations
Which can improve adult literacy rates and increase life expectancy at birth, respectively
- two areas measured in the HDI
An improvement in the HDI shows an improvement in the standard of living and thus,
economic development

The graph on the RIGHT represents economic growth w/o development

PCC shifts out to PPC1- only increasing output for weapons
Weapons are a demerit good and may reflect an ongoing conflict, which would decrease
the life expectancy at birth - a measure of HDI
This shows a decrease in the standard of living and thus, economic growth but no
economic development

3. Exceptions to the Downward Sloping Demand Curve

+ PED:
Veblen goods (snob appeal e.g. mona lisa)
Giffen goods
Future expectations

4. Maximum Price
Price Ceiling (aka maximum price) is a price imposed below the market equilibrium
price designed to help the consumer
E.g. PH: Mackerel Scad 120PHP/kg

E.g. PH: Electricity 32PHP/kWh

Originally, the market for ___ in ___ cleared at equilibrium EQ at price P and quantity Q
As ___ is a staple food / necessity good, govt wanted to keep it affordable for low
income people
Thus, govt imposed a price ceiling below the equilibrium price
Price decreases to 120 PHP/kg, quantity supplied decreases to Qs and quantity demanded
increases to Qd
Thus creating a shortage (as shown)
In a free market w/o intervention, the market forces will clear the market
However, govt intervention of a price ceiling prevents price signaling mechanism from
clearing the market

Shortage: Knock-on Effects

Parallel market
Rationing Lines, etc
Auction / lucky draw
Favoritism
Extreme cases: corruption and riots

Minimum Price
Price Floor (aka minimum price) is a price imposed above the market equilibrium price,
designed to help producers
E.g. US: $8 per gallon of milk

Explain
Originally, the market for ___ in ___ cleared at equilibrium EQ at price P and quantity Q
As ___ is considered a demerit good, the govt wanted to decrease quantity consumed
Thus, govt imposed a price floor above equilibrium price
Price increased to P1, quantity demanded decreased to Qd and quantity supplied
increased to Qs
Thus creating a surplus (as shown)
In a free market w/o intervention, the market forces will clear the market
However, govt intervention of a price floor prevents price signaling mechanism from
clearing the market
Surplus: Knock-on Effects
Govt buys
Store
Buffer stock (can be released in shortage)
Destroy
Convert to another good (tomato ketchup)
Export
Donate as aid
Extreme: pay producers not to produce (large OC)

5. Determinants of Supply and Demand

Determinants of Demand
Fashion
Taste
Advertising
Income
Price for substitutes
Price for complementary goods

Determinants of Supply
Weather
Price of FOPs
# of producers
Technological progress
Disease
Unexpected events

 Weather
Population

Availability of fops
Change of price of other goods
Indirect tax
Subsidies

6. Movements of, and along, the demand and supply curves

Demand - is the relationship between the quantity demanded of a good or service and its
price
Quantity Demanded - is the amount of a good or service that consumers plan to buy at
each given price in a given period of time
Law of Demand - Ceteris Paribus, as price of a product increases the quantity demanded
of the product decreases, vice versa.
Negative or inverse casual relationship due to willingness and ability to buy
Marginal Utility Theory or Marginal Benefit
The shape of the demand curve can be found in the principle of decreasing
marginal benefit
Since marginal benefit falls as quantity consumed increases the consumer will be
induced to buy each extra unit ONLY if price falls
Supply:
Slopes upwards
o Profitability
Vertical curve:
o Fixed quantity as there is no time to produce more in the SR
Fixed quantity as there is no possibility of ever producing more

7. Complementary/substitute goods and movements of demand curves

Complementary Goods or Service - exists when the change in the price of one good or
service results in the opposite change in quantity demanded of another good or service
E.g. Cars and Gas
Substitutes - goods and services that may be used in place of another
E.g. PS3 and Xbox

8. Elasticity: changes in revenue

Define
Elasticity measure of the responsiveness of one variable to a change in another variable
Relatively price elastic:

Originally
E.g. Coach wallet (luxury good)
Cut price by half big increase in quantity
Can more than double revenue

Relatively price inelastic:

Originally
E.g. Rice (necessity good)
Cut price in half small increase in quantity
b/c not going to buy/eat more rice if its cheaper
Can more than double revenue

9. How useful is knowing elasticity for firms (evaluation)

Cross Price Elasticity of Demand (XED) a measure of the responsiveness of the
quantity demanded of a good or service to a change in price in a related good or service
XED = (% change in QD of Good A / % change in P of Good B) x100
Income Elasticity of Demand (YED) - the responsiveness of the quantity demanded of a
good or service to a change in income.
YED = (% change in QD / % change in Y) x 100
Price Elasticity of Demand (PED) - the responsiveness of quantity demanded of a good or
service to a change in its price
PED = (% change in QD / % change in P) x 100
Price Elasticity of Supply (PES) - the responsiveness of the quantity supplied of a good
or service to a change in its price
PES = (% change in QS / % change in P) x 100
Veblen Goods - goods that have snob value and are bought to display wealth. Their
demand curve slopes upwards from left to right, as the higher the price, the greater the
quantity demanded
E.g. Mona Lisa
Giffen Good - goods where the income effect of a price change of inferior goods is
greater than substitution effect. When PED is positive.

E.g. Instant noodles

Normal Good- a good or service for which demand increases when income increases.
E.g. Cars

PED
+ Setting new prices / altering prices
+ PED has a direct effect on total revenue
Used for price discrimination
- Not always accurate
E.g. Flat screen TVs: cut price 20%, increase sales
- TR still less than before recession
+ Govts can estimate the impact of an indirect tax sales, tax rev, overall consumption

YED Countries
If country has LR trend of growth (ceteris paribus)
- Decrease of inferior goods
+ Increase consumption of normal goods
Goods w/ highest YED increase most
E.g. health care, education, holidays, entertainment, foreign travel
- Poor countries
b/c produce goods w/ low YED
E.g. agriculture, fishing, mining
If LR trend of growth, only small increase in demand
- Widens Y inequality between rich and poor countries

YED Firms
National output/income increases/decreases
(as shown) Business Cycle
High YED goods greater swings in demand
E.g. furniture, cameras
Low YED goods less^
E.g. food, alcohol
Recession: chicken > beef, milk > fancy yogurt concoctions, less organic, private label
products (30-50% cheaper) > branded goods
+ Private labels will sell more
- But raw materials = high proportion of cost & less advertising, may still suffer

PES
(as mentioned^)
Shows how much a firm reacts to change in market conditions
XED
Shows if should buy up rival businesses that produce substitutes
Reduce # of competitors PED more inelastic increase market share

E.g.
Shows if should collaborate / merge w/ producers of complements
E.g. Nike: tennis rackets & tennis clothes
E.g. airplane charters & holiday hotels

10. Buffer Stocks

E.g. PH: 2014 bad rice harvest
Prices reached record high
Import 800,000 tons of rice maintain buffer stock, control price

 Originally, the market for ___ in ___ cleared at equilibrium at the target
price TP and quantity 100
Good harvest:
Supply is at Supply shifts out from S to S(good harvest)
govt has to buy the surplus create the buffer stock and
maintain price floor
Bad harvest
Supply shifts in from S to S(bad harvest)
B/c necessity good, want to maintain low price for low
income people
Govt releases the buffer stock restore equilibrium,
increase quantity available, decrease price to TP

Market Failure
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11. (De)Merit goods/externalities/ Marginal social benefits, marginal social

costs
Negative Externality Consumer Side
E.g. Paris, France: legislation banning even and odd plate numbers every other day

Originally market was at equilibrium EQ at price P and quantity Q

o Socially and allocatively inefficient
o Over allocation of resources
As a demerit good is overproduced and over consumed and the eq quantity of
output is greater than the socially optimum level
Name the externality
As MPB is greater than MSB, there is a deadweight welfare loss as a result of
the negative externalities of the good being consumed
Overproduced/over consumed as a demerit good
Socially efficient allocation is achieved at point A, with lowered quantity
consumed

Negative Externality Producer Side

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E.g. Norway: increased tax from 210 to 410 NOK/ton of Carbon

Originally market was at equilibrium EQ at price P and quantity Q

o Socially and allocatively inefficient
o Over allocation of resources
As a demerit good is overproduced and over consumed and the eq quantity of
output is greater than the socially optimum level
Name the externality
As MSC is greater than MPC, there is a deadweight welfare loss as a result of
the negative externalities of the good being produced
Overproduced/over consumed as a demerit good
Socially efficient allocation is achieved at point EQ1, with lowered quantity
produced

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Positive Externality Consumer Side

E.g. Vaccines

At original Eq, there is a market failure

o Socially and allocatively inefficient
o Under allocation of resources
As a merit good it is under consumed under produced in a free market
Therefore market equilibrium quantity of consumption is lower than the socially
optimum level
Name the positive externality
o (MSB > MPB)
o Potential welfare gain
Consumption of a product creates benefits for society beyond those enjoyed by
the individual consumer
Socially optimal Q exceeds the private free market equilibrium Q
Therefore at new EQ socially optimal level of consumption

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Positive Externality Producer Side

E.g.

At original Eq, there is a market failure

o Socially and allocatively inefficient
o Under allocation of resources
As a merit good it is often under produced in a free market and the equilibrium
quantity of production is lower than the socially optimal level of production
Name the externality
o MPC > MSC
o Potential welfare gain
Production has less cost for society than those cost to the individual producer
Socially optimal Q exceeds the private free market equilibrium Q

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Therefore at new EQ -- socially optimal level of production

12. Subsidies and Taxes (Flat Rate and Ad Valorem): Tax Incidence
Supply the relationship between the quantity supplied and its price
Indirect tax a tax imposed by the government directly on spending. This includes both
fixed tax and ad valorem tax.
Ad Valorem Tax an indirect tax on a good or service imposed by a government, where
the amount of tax depends on the value of the good or service.

Subsidy
E.g. USA: 20 billion USD subsidy on agriculture

Originally, the market for ___ in ___ cleared at equilibrium EQ at price P and quantity Q
However, as ___ is a merit good and has positive externalities, such as __
The govt wanted to increase production by providing a subsidy of ___
As subsidy is a determinant of supply, supply shifts out from S to S + subsidy
This decreases price to P1 and increases quantity to Q1
The market for __ now clears at equilibrium EQ1 at price P1 and quantity Q1

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Tax (Flat Rate)

E.g. $3.50 on Cigarettes in Rhode Island

Originally, the market for ___ in ___ cleared at equilibrium EQ at price P and quantity Q
However, as ___ is a demerit good and has negative externalities, such as __
The govt wanted to decrease consumption by imposing a tax of ___
As tax is a determinant of supply, supply shifts in from S to S + fixed tax
This increases price to P1 and decreases quantity to Q1
The market for __ now clears at equilibrium EQ1 at price P1 and quantity Q1

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Tax (Ad Valorem)

E.g. Sin Tax Philippines

Originally, the market for ___ in ___ cleared at equilibrium EQ at price P and quantity Q
However, as ___ is a demerit good and has negative externalities, such as __
The govt wanted to decrease consumption by imposing an ad valorem tax of ___
As tax is a determinant of supply, supply shifts in from S to S + ad valorem tax
This increases price to P1 and decreases quantity to Q1
The market for __ now clears at equilibrium EQ1 at price P1 and quantity Q1
This creates consumer and producer burdens (as shown)
The consumer burden is much greater than the producer burden
Because ___ is a necessity good (due to its addictive quality), and thus, is relatively price
inelastic
Therefore, producers can push the burden onto the consumers
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13. Methods to deal with externalities

Market Solution: Taxation
Advantages

Disadvantages

Increases government revenue

reused to tackle negative externality

Goods are price inelastic; quantity reduced

may be negligible

e.g carbon tax in US would increase

govt revenue by 150 USD annually

Taxes are regressive

aggravate income inequality
Reduces quantity good is consumed and
produced

e.g. 23AD carbon tax expected to raise fuel

and energy bills for households
Distorts market forces; clears in LR only
Tax assumes 1 constant externality; almost
not always the case

Market Solution: Subsidy

Advantages

Disadvantages

Incentive for producers to produce merit

goods

Incurs opportunity cost as producers shift

products

Creates more substitutes for consumers

Distorts market forces; clears in LR only

Benefits local producers/industries

Governments arent good at picking

winners
e.g. US subsidizing Solyndra; 850b USD
failure

Non-market Solution: Legislation

Advantages

Disadvantages

If strictly enforced, may be very

successful
e.g. Singapore, no chewing

LR solution only; takes a long time to process

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gum/smoking
Does not interfere with market forces
and allows market to clear

Does not guarantee success

e.g. China has seen pollution increase 20-25%
annually despite anti-pollution laws

Non-market Solution: Public Education/Awareness

Advantages

Disadvantages

Does not interfere with market forces

e.g. graphic images on cigarette packets in Australia

Not guaranteed success

Time lag to take into effect

Conclusion:
No single solution will resolve the negative externality; requires a combination

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Theory of The Firm

14. Economies of Scale vs. Diminishing Returns (SR and LR Cost
Curves)
Define: Economies of scale, Diminishing returns
Draw:

Explain:
Increased output results in lower costs
Economies of scale typically experienced by large firms
At high production numbers, fixed costs spread out over increased units of output
This lowers cost and MC shifts out from MC to MC1

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Explain:
Diminishing returns can only happen in the short run because in short run, 1
FOP is fixed; initially when you apply 1 variable FOP to 1 fixed FOP, firms may
experience increase in output but there comes a point where Marginal Output
(MO) goes below Average Output (AO)

In economies of scale, inputs change proportionally because all factors are

variable; this means that EOS can only happen in the LR and diminishing returns
can no longer apply.
DR is short run while EOS is long run

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15. Shutdown Point / Breakeven

Define

Shutdown Point
Average Variable Cost
Short Run

Draw

Explain
Normally, a firm will seek to operate at normal profit at MC= MR (AC=AR)
But can earn above that - supernormal profit - or below - subnormal profit
Firms can earn a subnormal profit in the SR as long as it doesnt hit the shutdown
point
As it is still covering fixed costs and making a contribution to variable costs
Shutdown point: firm is no longer able to make a contribution to variable costs
Only occurs in SR b/c in LR: exit industry

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16. Motivation of Firms: MC=MR (Profit Maximization and Alternative

Objectives)
Profit Max
= Firms primary objective
Produce output at MC=MR
Up to this point: revenue produced by every additional unit of output > cost
Beyond this point: cost of every additional unit of output > revenue produced
E.g. Kohlberg Kravis Roberts: private equity that takes over firms profit max
Sales Max
= prioritizes # of sales
AC = AR
Increase customers, increase brand loyalty, creates a barrier can increase
market share
o E.g. PH: 7/11 Summer Slurpee Promo - 5PHP slurpees
Newspapers: advertising fees depend on the size of circulation
o E.g. NY Times
Revenue Max
MR = 0
Shortrun cashflow problem
Maximize cash flow and revenue, rather than profit
SR: money needed to prevent hitting shutdown point
E.g. Norman AS, IT security company
Profit Satisficing
Achieve minimum rather than optimum levels
For non-greedy producers
o E.g. independent musicians such as hoodie allen: release music for free
Ethical Business Objectives
Social enterprises
Purpose: improve environmental/social well-being
E.g. Greenpeace: protect environment, but only receives revenue from donations
E.g. PH: El Nido Foundation teaches locals skills for jobs, protects reefs

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17. Price Discrimination (1st, 2nd, 3rd Degree)

Define:
Conditions for Price Discrimination:
Producers must be price-makers to some extent- there must be pricing power and
therefor it is not Perfect Competition
Consumers must have different Price Elasticity of Demand for the products
Producers must be able to separate consumers so one consumer doesnt buy all the
goods at a low price and then sell at a higher price. Creating barriers between
consumers to avoid parallel market
Price Discrimination: When producers sell the same product to consumers at different
prices
1st Degree: When each consumer pays the price he or she is willing and able to pay.
Usually the maximum price they are able to pay. There is no consumer surplus
because it is all consumed/absorbed by the producer
2nd Degree: When the firm charges different prices according to the amount of
consumption (higher rates with lower consumption, lower rates as consumption
increases)
3rd Degree: When consumers are divided into different market segments (age, gender,
geographical regions)

Perfect segmentation of the market

Every customer charged their willingness to pay

No consumer surplus

You do not have to lower the price to the higher value customers to sell more

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More goods are sold in total but the price is higher to some consumers

Total output is higher than under profit maximization

Example: TukTuk (motorbike taxi) in Thailand. There is not set price thus the customers
have to negotiate in order to ride it.
2nd Degree Explanation:
Exists when sellers try to off load their excess output to buyers
Examples: cheaper prices menus at lunchtimes in restaurants, hotels offering
winter discounts
Not always the case that prices are lower if consumers delay their purchase:
advance discounts on season tickets for soccer clubs, discounts for early booking
of plane tickets
We assume a fixed supply capacity in the short run
There are 2 demand curves: peak demand (higher demand, less elastic), off peak
demand (lower demand, more elastic)
Peak demand occurs at predictable times:
Higher prices are charged at peak times to extract consumer surplus to take
advantage of their willingness to pay and suppliers may cut prices when there is
less pressure on demand and therefore excess capacity

Monopolist seeks to maximize profits in each sub-market

Sell additional output in elastic market (lower price)

Reduce sales in inelastic market (increase price)

Prevent resale

Example: Movie theaters may provide different prices for different groups with similar
characteristics. May give a lower price for seniors and students as they have lower
purchasing power.

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Evaluation:
Possible Advantages for Welfare:

Potential for cross subsidy- Postal services

Making use of spare capacity- Railway networks

Bringing some new consumers into the market- Cheaper air travel

Use of monopoly profit for research- Pharmaceuticals

A way of breaking into a market- Cross Channel ferries

Costs for Welfare:

Exploitation of the consumer- Usually price > MC

Possible use as predatory pricing- Illegal under UK and EU competition law/Antitrust law

Reinforces monopoly power in the long run- higher prices and profits if
competition is eroded

Advantages:

Some consumers are brought into the market who otherwise could not have
afforded the good or service e.g. cheaper drugs in LDCs

Higher total output than under a single price monopoly

Dynamic efficiency from supernormal profit

Profits may help cross subsidize other activities e.g. doctors may charge lower
fees for poorer patients supported by higher fees for wealthier patients

Consider impact on allocative and productive efficiency

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18. PC (Sub/Supernormal to Normal)

Draw

Explain
Originally, market for fish at Tokyo cleared at QE where firm is earning super normal profit
assumed firm is profit maximizing at MC = MR
b/c of perfect information, other firms hear about supernormal profit and enter market which they

are able to do so b/c no barriers to entry or exit

As a result of competitors entering market, there will be more suppliers, a determinant of supply,

causing supply to shift out from S to S1

this will create a new equilibrium to form at E(LR) where price has fallen.
due to decrease in price, firm is only earning normal profit in LR seen in diagram 3

If subnormal profit is being made;

o Firms exit the industry b/c no barriers to entry or exit
o Supply will shift in
o Firms will only earn normal profits in the LR

20. PC to Monopoly/Oligopoly
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when firms in PC are monopolized, it is assumed that there is no economies of scale.

b/c no economies of scale, MC and AC between monopoly and PC are same.
in PC, EQ(PC) is at profit maximizing point where MC=MR.
after monopolization, AR(PC) and MR(PC) are replaced by downward sloping curves AR(mon)
and MR(mon) as the individual firm represents the industry as a whole
As the industry is monopolized, Qmon is lower than Q(PC) but price P(mon) is higher than
price(PC)
consumers pay more for low quantity productively and allocatively inefficient

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21. Monopolistic Competition (Sub/Supernormal to Normal)

Draw
Panel 1: Short Run

Panel 2: Long Run

Explain:

In the short run, firm earning supernormal profit at profit maximizing point MC=MR

Outside firms hear about this and enter the industry due to low barriers to entry and exit

As a result, supply in the industry shifts out as there are more producers

Individual firms demand shifts in due to a change in fashion as consumers have more
substitutes to choose from (more firms in the industry = more substitutes)

D=AR shifts in until tangent to AC curve; firms then will only earn a normal profit at
profit maximizing point in the long run

Subnormal profit:
o

If earning subnormal profit, firms exit the industry (low barriers)

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Supply shifts in, demand of individual firms shift out as there are less substitutes

In the long run, only normal profit can be made regardless of if either supernormal or
subnormal is being made in the short run

22. Non-collusive oligopoly including kinked demand curve

Define:
Oligopoly

The kinked demand curve states that at higher prices demand is elastic
This is because in oligopolies once a firm raises prices other firms would not
follow
However, if a firm chooses to lower prices
Other firms would have to follow as the firm with the low price would crowd out
the market

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This may induce a price war

23. Cartels
Cartels exist when a group of producers come to a collusive agreement to limit output and control
supply in order to increase prices and profits. Results in increased producer sovereignty.
E.g: OPEC
Cartel of

Firms in an oligopoly may choose to collude in order to get rid of uncertainty by fixing the price
and output they produce.
On the industry graph, the cartel has chosen to produce at output q0 at price P0 which is where
MC=MR meets the demand curve where it acts as a virtual monopoly

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As seen on the firm graph, the cartel has set a quota at price P0 and quantity Q1.
As the firm is producing at MC=MR, they are profit maximizing

24. Oligopoly Good Or Bad?

Definition:
Oligopoly is a type of market structure in which a small number of firms compete with
each other. It is when there are high barriers to entry or exit, high product differentiation
and high concentration.
Example: US cellular phone market Verizon, AT&T, Sprint, T-mobile

P1: characteristics of oligopolies

+high barriers to entry or exit are good for producers able to control a bigger portion
market
may lead to supernormal profits
supernormal profits may be used for R+D good for consumer
-high concentration bad for consumers b/c they have fewer options
-oligopolies are generally allocatively and productive inefficient = deadweight welfare
loss
P2: interdependence between firms when behavior of one firm will affect the
decisions of another

Firms rely on game theory to determine biggest payoff from different possible decisions
Interdependence in non-collusive oligopolies results in a kinked demand curve
Kinked demand curve
If a firm increases price, other firms will not follow therefore demand is price elastic
If a firm decreases price, other firms will follow therefore demand is price inelastic
Results in price stability; beneficial for producers as they reduce risk.
Disadvantageous for consumers who will always have to pay high price
Example: Nike and Adidas (70% of sportswear industry) maintain price rigidity and have

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similar prices

P3: firms in an oligopoly may opt to cut price in SR and have a price war aka predatory
pricing.
firms may do this to earn more market share, stop other firms from entering or increase
brand loyalty
+good for producers are they are able to take their competitors market share and
wipe them out
Example: Shell and Esso who are facing allegations of predatory pricing.
+ good for consumers in SR b/c they pay less
- bad for consumers in the LR b/c there may be less competitors meaning market
is less contestable
- market is more monopolistic bad for consumers = more allocatively and socially
inefficient
Example of price war: Australias supermarkets Woolworths and Coles cutting
prices (2013)
P4: B/c of uncertainty in an oligopolistic market, collusion may occur.
Collusion is when firms or cartels such as Organization of Petroleum Exporting
Countries, fix the price of goods with the aim to maximize joint profits.
+good for producers stop other firms from entering market and they are able to
discuss market share
+good for producers reduces risk and uncertainty
- bad for consumers no incentive to control quality and can have high prices as
their market share is not at risk
+good for producers high producer sovereignty
-bad for consumers low consumer sovereignty and market is less contestable
Example: It was recently found that Philips, Panasonic and Samsung were holding
back the supply of cathode ray tubes between 1996 and 2006.
P5: +Non collusive oligopoly no discussion of market share is good for
consumers, but undesirable for producers
+good for consumers more market contestability
Firms such as Coca Cola, Pepsi are forced to have low prices and high quality
goods +good for consumers
-undesirable for producers more risk

P6: firms in oligopoly may make use of economies of scale increase in output
results in lower unit cost
large companies have high production levels fixed costs are dispersed over more
units of output meaning average cost per unit decreases MC SHIFTING OUT +good
for producers are they are able to increase output/R+D
Example: Walmart and Safeway in US benefitting greatly esp with costs of
shipping
On the contrary, if firm gets too big, they may experience diseconomies of scale.

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Example: Goldman Sachs who put a limit on the amount of partners to appoint to
reduce costs (2013).
b/c as a firm grows, it will need more staff and facilities. eventually lead to diminishing
returns and an increase in price per unit of output.

25. Monopoly Barriers

Define
Barriers to Entry - refers to obstacles placed to make it difficult for firms to enter an
industry and provide competition to existing suppliers of a good or service.
Draw

*can also draw natural monopoly graph

Explain: Economies of Scale

Monopolies are large receive economies of scale (increase in scale of production
decreases price)
= Barrier to entry b/c others cant compete
Increase Q & decrease P, shifting the curve MC1 to MC2
E.g. U.S. Postal Service, receiving EOS for delivery cars.

Explain: Other Barriers

Reputation and name brand - firm is popular and well established
E.g. search engine: Google
E.g. social networking site: Facebook
Legislation government restricts firms from entering market

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 E.g. Meralco only electricity company allowed to supply to NCR

Patents & Trademarks laws prevent other firms from copying idea & thus, from
entering the market
E.g. Christian Louboutin red sole high heels
E.g. Microsoft Office
Natural Monopoly one firm can supply an entire market at a lower cost than two or
more firms
E.g. NY Subway system (run by MTA)
E.g. EDSA Highway

R&D hard for firms to enter market w/o info

E.g. Merck & Co. Integrase Inhibitors drugs
Technical Skill / Product Specialization
E.g. Fukushima Daichi produces very specific part of nuclear plants
Ownership of natural resources hard for firms to enter w/o resource
E.g. China Rare Earth Holdings Limited for rare earth metals

26. Monopoly good or bad?/ possibly compare to PC

P1: characteristics

+high barrier to entry or exit + for producers

barriers include patents and trademarks provide legal protection for firms
ideas, preventing others from copying.

Example: Shire PLCs adderall to treat ADD.

+ high barriers good for producers = earn supernormal profits in the LR

o

may use supernormal profits for R+D dynamically efficient

+good for consumers b/c they reap benefits

Lack of competiiton no incentive to R+D and be dynamically

efficient bad for consumers

Ex: Sirius XM w/ market share of 90% in the satellite radio industry

are investing in R+D to provide consumers w/ better content

P2: (PCS are allocatively and productively efficient) Monopolies are known to be
inefficient b/c they have ability to increase prices above marginal cost and to restrict
output
Allocative inefficiency

35

high price + low output = decline in consumer surplus and deadweight welfare
lost (in PC, both consumer and producer are maximized)

ability to charge above marginal cost bad for consumers have to pay more
(whilst in PC, they get cheapest price)

+beneficial for monopolist generate more revenue

also known to be productively inefficient

lack of competition no incentive to operate at base of AC curve bad for

consumers (have to operate at base of AC in order to compete)

monopolies being productively and allocatively inefficient do not benefit

society unless they are demerit goods
o

if monopolies produce demerit goods, + can be socially efficient

P3: monopoly may be cross inefficient as AC is higher than it should be, may take
advantage of EOS to be more efficient

when an increase output results in lower unit costs

monopolies have high levels of production so fixed costs are spread over more
units of output avg cost per unit decreases shifting out MC to MC1

+ good for producers able to increase output (bad in PC as they may

not be able to increase output?)

Example: YKK where 1 out of 206 companies produce over 7 million

zippers a day.

however, if company expands too much, it may experience diseconomies of scale

P4: Natural monopolies may be beneficial for consumers.

This is when a single firm supplies the entire market at lower price than 2 or more
smaller firms

Example: NYC subway

+productively efficient having 1 subway as opposed to 2 competitive systems

+allocatively efficient b/c production costs are lower for nat monopolies
36

DRAW NAT MON

natural monopolies don't have an incentive to charge prices close to cost and
may opt to charge profit maximizing prices in this case, governments have
to regulate the natural monopoly so society can benefit

P5 : monopolies may engage in price discrimination

when a different price is charged to different consumers for same product

example: US airways diff price for seats even if theyre next to each other

monopolies can charge separate profit maximizing prices for each type or group
of consumers with different income levels, profession and education levels

+good for producers earn greater profits than by charging a single price to
all consumers (- producers are only able to charge single price to all
consumers)

+ beneficial to consumers who pay less b/c monopolies charge the price on
consumers ability and willingness to pay

Ex: students that take EuroRail as they get a discount compared to standard
fares and business users

P6: b/c 1 dominant firm consumer sovereignty is minimized b/c no other choice

-bad for consumers b/c they have to pay more w/ less choice

+ producer sovereignty is maximized able to influence decisions of buyers

Conclusion: consumers are disadvantaged but not always true in natural monopolies and
dynamically efficient monopolies

27. Natural monopoly

NATURAL MONOPOLY occurs when a monopoly can supply the entire market at
a lower price than two or more smaller firms.
E.g. MTA subway system new york

37

In a natural monopoly, the firm can operate at EQmon at price Pmon and quantity
Qmon
This is because they can take advantage of economies of scale curved LRAC
If multiple firms were operating within the market in place of 1 firm dominating
the market, they would produce at lower quantity Q and higher price P
In order to reach same output as 1 industry, multiple firms would all need to
operate a higher price P allocatively and productive inefficient
thus the natural monopoly can supply the entire market more efficiently, at a
lower price

28. Economic efficiency e.g. productive and allocative efficiency

Productive efficiency is MC=AC (Memorize it as MyC=AC (My Cock) produces

babies)

Productive inefficiency occurs when MC < AC

Allocative efficiency is MC=AR (Memorize it as MyC=AR (My car) allocates

me)
38

Allocative inefficiency occurs when P > MC

Macroeconomics
31. National Income Flow
Define

39

 Gross Domestic Product (GDP) - the value of a countrys total output of goods and
services before depreciation
E.g. Germany: 3.4 trillion USD (2012)
E.g. Madagascar: 10.1 billion USD (2012)
Draw

Explain
There are two main parts in a countrys economy: businesses and households.
clockwise = flow of money
counterclockwise = flow of goods and services
Entering and exiting the cycle = injections and leakages, respectively

32. How to Calculate GDP

Economic activity / GDP of a nation can be measured in 3 ways

Income Approach
National Income = Wages + Interest + Rent + Profit (FOP Payments)
National Y = W + I + R + P
Output Approach11
National Output = Output of Primary + Secondary + Tertiary Sectors
Expenditure Approach
Aggregate Demand = Consumption + Investment + Govt Spending + (exports - imports)
AD = C + I + G + (x - m)
Theoretically, three methods should produce the same GDP value, but doesnt happen in real life

33. Usefulness of GDP

Introduction
GDP is useful when comparing countries, but only to a certain extent
This will be explained based on statistics only from 2012
P1: Using nominal instead of real b/c not adjusted for inflation
inflation = sustained increase in general price level measured by CPI

40

 inflation should be about 1 to 3% in LR and spending in economy should increase by

assigned rate
for ex: if inflation rate is 3% then spending should increase by 3% but does not mean
economy is growing b/c distorted by inflation rate
if country has high inflation rate such as Iran with 35.5% (December 2013) nominal
GDP would look like it is growing but real GDP is either flat or falling
thus, better to use real GDP b/c adjusted for inflation by using GDP implicit price deflator
P2: Does not take into account population
E.g. Italy & Russia - $2.0 & $2.1 trillion USD - similar GDP
Russias population is more than double Italys
Thus, each persons economic activity in Italy > Russia
GDP cant be used to compare
GDP per capita: average GDP per person b/c gives a clearer indication of which
country is doing better
P3: Parallel Market
Market activity: activity not reported to the government
Parallel markets impt especially in developing countries b/c large portion of economy
comes from parallel market activity
seen in India where it is estimated that 30% of GDP comes from parallel market
- GDP is inaccurate, lower than true value
for ex: 10 billion Pounds would be added to UK economy if counted prostitution and
drugs(2014)
some countries like Moldova deliberately undercount to gain aid from other countries
govt have been creative in determining size of parallel markets look at size of roof,
electricity consumption, etc
P4: Doesnt show Quality of Life
E.g GDP of China is second highest worldwide, but relatively low of HDI of
0.699 (2012)
HDI measures quality of life (adult literacy rate, life exp. at birth, Real GDP Per
Capita PPP) 0-1/low-hi
GDP doesnt correlate w/ standard of living
use GDP and HDI
P5: GDP does not show Income Inequality
incomes and earning may be unequally spread but GDP does not show
Use Gini coefficient & Lorenz Curve instead
Gini measures inequality within population
Lorenz is a graphical representation to show disparity between rich and poor
E.g. SG GINI - 0.435 (2013)
E.g Denmark GINI - 0.24 (2013)
Important b/c people may favor more equal distribution of income- likely have social
implications i.e. less poverty and crime
P6: Double Counting (of a nations goods)

41

 problem b/c output could be double the value if countries have diff way of counting their
G&S
one country may count individual pieces of G&S as it goes through diff stages of
assembly whilst other country may count final product only
also, some goods counted as final good at one but as intermediate good at another
For ex: sugar may be counted as final good when sold at supermarket but intermediate
good when used in production of candy
maybe occurring in Brazil largest sugar producing nation w/ GDP of $2.43
thus, double counting may show that there is more economic activity than actual
only include final goods in GDP

P7: Net income property from abroad

GDP only calculates economic activity within national borders; however, there are
citizens overseas that are making money for that nation.
GDP does not calculate all economic activity of a country; calculates the economic
activity of what is happening within borders
Gross National Product (GNP) measures the value of all goods and services made by a
nation; GDP plus net income property from abroad minus income from domestic foreign
residents
Example: GDP of Philippines (2012) approx. 250 billion USD, GNP is approx. 392
billion USD (2012)

Conclusion
GDP is good when comparing output of countries, but has limitations
You need a mix for a better picture of quality of life

34/35. Inflationary and deflationary (Output) Gaps

Define:
Aggregate Demand (AD) - the relationship between the aggregate quantity of goods and
services demanded or Real GDP and price level the GDP deflator holding
everything else constant
AD = C + I + G + (x m)
Aggregate Supply (AS) - the sum total of planned production for an economy
AS = Output of Primary + Secondary + Tertiary Sectors
Macroeconomic Equilibrium - occurs where the quantity of Real GDP demanded and
supplied meet. It is where AD = SRAS.
Full Employment (FE or Yf) also known as the natural rate of unemployment is one of
the five major macroeconomic objectives. It exists when the labor market clears allowing
for structural, seasonal and frictional unemployment.

42

 Recession - decline in Real GDP in two or more successive quarters.

Note:
Usually starts with a problem
Multiplier: SRAS AD
Accelerator: AD SRAS

Cost Push - Deflationary Gap

E.g: HK increased minimum wage from 28HKD to 30HKD per hour b/c of rising living
costs
E.g Bolivia increase minimum wage by 22% (2014)
Draw:

43

Explain:

Originally, assumed to be at macroeconomic eq at full employment YF and price level PL

b/c of high income inequality and rising living costs gov brought up hourly minimum wage
costs from 28khd to 30hkd in 2013.
as this is component of SRAS SRAS shifts in from SRAS to SRAS 1
results in pl to increase from PL to PL1 and output to decrease from yf to y1 resulting in
deflationary gap + possible stagflation b/c of cost push inflation
possibility of knock on effect of negative multiplier where AD shifts in high costs for firms
seek to cut variable costs by firing workers less employment less consumer expenditure
(component of AD)

Demand Pull - Inflationary Gap

44

originally, economy of SK assumed to clear at macroeconomic eq at full employment yf and price

level PL
As SK hits 4 year high on consumer confidence, AD shifts out to AD1 as consumer expenditure is
component of AD
new macroeconomic eq to form at PL 1 and Yf1 where PL increased from PL to PL1 and output
increased from yf to y1 creating inflationary gap aka demand pull inflation
not in isolation possible knock on effect of positive accelerator where SRAS shifts out to meet
new supply

45

Increase in Capital Stock - LRAS shift out

Increase in Capital Stock in Brazil

Originally, the economy of Brazil was assumed to be at macroeconomic eq at full

employment yf and avg price level PL
However, as Brazil is hosting the 2014 World Cup and 2016 Olympics, there are new
investors increasing capital stock
capital stock is a component of LRAS causing LRAS to shift to LRAS1
additionally, the economic growth also shifts AD to AD1 and SRAS to SRAS1 whilst still
maintaining price stability
as a result, increase in capital stock economic growth w/ price stability at higher full
employment of Yf1

46

36. Cost-push and Demand-Pull Inflation

Define:
Demand-Pull Inflation - sustained increase in the general price level resulting from an
increase in aggregate demand
Cost-Push Inflation - sustained increase in the general price level resulting from an
increase in the cost of the inputs of FOPs
* = similarities
Demand pull

cost push inflation

benign higher prices but output increases

may result in hyperinflation

malign less output + higher prices =

possible stagflation

* loss of price stability

* loss of price stability

over employment

under employment

inflationary gap

deflationary gap

results from increase in spending

results from increase in factor costs

* trigger foreign purchases effect loss in ext.

eq

* trigger foreign purchases effect loss in

ext. eq

47

37. Multiplier Vs. Accelerator

Multiplier and accelerator effects from a FALL in Aggregate Demand

Originally at AD1; when component of AD falls shift is expected to be from AD1

to AD2; however due to multiplier effects, the shift may be even larger, and AD1
may in fact shift out to AD3

to meet fall in demand, businesses and enterprises will reduce planned capital
investment, causing ID1 to shift in to ID2 - negative accelerator

48

38.

Laffer Curve

When the tax rate is 0% the tax revenue is 0 duhh

When it is 100%, it is a disincentive for people to purchase products and may lead
to parallel markets to appear
growth maximizing point is somewhere which enables the economy to grow the
most (growth maximizing does not equal revenue maximizing)
revenue maximizing is when the tax revenue to the government is the max.

Cons

Cannot find out the tax rate that makes it revenue maximizing. Governments find
out after implementing a new tax rate

Keynesian view not neo-classical

49

39. Demand or supply side policies

Define:

Demand side policies refer to government policies designed to increase aggregate

demand.
Supply side policies refer to government policies designed to increase output.
Examples include tax reductions and concessions.

P1: Govt may tackle economic fluctuations with neoclassical or keynesian economics
Keynesians believe in govt intervention w/ demand side policies
Neoclassical economies would fix itself in the LR
o if govt should intervene neoclassical believe that supply side policies
should be used
P2: demand side shocks must be fixed with demand side policies and supply side shocks
must be fixed with supply side
+both have the ability to fix respective shocks
- both have knock on effects
o For ex: fiscal policy of French govt to cut corporate tax by 3% (2013)
may have knock on effect AS
Similarly, supply side policy mave have involuntary effect on AD b/c hard to
determine size of accelerator or multiploer beforehand
- meaning a govt may under or overshoot its injection - not achieve macro eq
at full employment
P3: - demand side policies sometimes inflationary b/c multiplier is unknown except
for 3.6 for defense spending in US
- meaning price stability may not be achieved through demand side policies
o however, govt may prefer inflation over unemployment
+ supply side policies able to obtain economic growth w/ price stability shift
out LRAS
o shift out LRAS by investing in infrastructure like 100bn in UK for
infrastructure projects like Crossrail (2013)
o + resulting in higher efficiency + econ growth w/ price stability
P4: time lags
- supply side large time lags b/c govt inefficient at implementing chnages
o -meaning only efficient in LR
+ demand side shorter time lag b/c govt can decide to increase spending and
influence AD asap
- demand side policies may not be an option for countries that are heavily in debt
like Portugal & Spain
o dont have money to increase govt spending to impact AD
- both are very expensive incur in high OC
50

P5: income inequality

- supply side aggravate income inequality
o b/c supply side policies focus on capital spending on infrastructures
o Ex: Mexicos 972-million Peso highway project
-unfair for lower income people b/c majority of users who will benefit are those if
higher income
+demand side policies reduce income inequality
through wealth redistribution by govt spending
o ex: USA spends $80 bn on food stamps for those below poverty line
P6: crowd out
-demand side policies like govt spending risk of crowding out private sector
o b/c govt expenditure drives down consumption + less investment in
private sector
o Ex: USA increased Medicaid and ObamaCare = less availability of health
insurance
Concl: both have to be used in order to achieve 5 macro objectives

40. Business cycle diagram

BUSINESS CYCLE refers to the fluctuations in economic activity over a
period of time. Usually measured by Real GDP and other macroeconomic
variables.

51

41. Unemployment v inflation (deflation)

Hyperinflation and price stability

o

Hyperinflation when there is excessive increase in price level

E.g. Venezuela experiencing 45.50% inflation in 2013

Losing consumer confidence, falling exports and rising imports harder

to achieve external equilibrium

However low and controlled inflation rates are good; creeping inflation 13% refers to price stability

Food price inflation

o

Food price inflation leads into poverty cycle

Unable to purchase sustenance at same level of income

E.g Uganda August 2013, inflation rose 2.2% after crop prices rose 16%

E.g. 18% food inflation January 2014 India

Malnourishment + disease cant work/schooling poverty cycle

lowered HDI

Opportunity costs
o

Menu costs OC incurred upon businesses as a result of changing

nominal prices

Shoe leather costs OC incurred upon consumers as they spend

time/effort to counter-act inflation

E.g. Zimbabwe hyperinflation, only $Z500, 000 allowed to be withdrawn

at once (around 25 US cents). OC is the time people spend going to the
bank to withdraw more money

Stakeholders of inflation
52

Fixed income disadvantage

Uncertainty for investors

Debtors benefit; conversely creditors will lose out

Social and economic costs of unemployment

o

Decline in living standards due to loss of income poverty cycle again

Potential economic growth

o

Unemployment = country not allocating resources to their full potential; a

waste of scarce resources therefore within production possibilities frontier
(PPF)

Negative shift in actual economic growth loss in national output

May cause people to leave labour market early (e.g. early retirement)
negative potential economic growth

Government affected by unemployment

o

Fall in taxation revenue and increased welfare spending budget deficit

and have less money to spend on economic policies

E.g. 2013, welfare in 35 US states pays more than minimum wage

Encourages people to leave the labour market permanently

-Hysteresis and brain drain

o

Hysteresis single disturbance affecting whole economy

Unemployment people adjust to lower standard of living socially

acceptable to be unemployed discourages people from working

Could discourage people from working in their own country brain drain

100 million Portuguese moving to Angola and other former colonies

Natural unemployment
53

Natural unemployment is essential to any dynamic functioning economy

Equilibrium unemployment is benign full employment still achievable

Structural unemployment biggest concern govt can intervene

Polk County, Florida suffers from structural unemployment with the ban
of phosphate mining in late 2013

+Larger work force and creative destruction

o

Unemployment = larger available workforce, good for businesses and

firms to get new workers

Creative destruction; resources reallocated in different parts of the

economy

Encourages people to become entrepreneurs

E.g Spain 2013 saw 8.2% increase in companies despite 26%

unemployment

Social problems
o

Being an outcast and slippery slope

Which may lead to worse things in extreme cases like suicide

Japan and the suicide forest, a lot of the deaths are due to economic
problems

Conclusion
o

Unemployment is worse because of social problems

Phillips curve! Resolving one issue would only aggravate the other

54

42. Phillips Curve (both SR and LR, expectations augmented)

Phillips curve is the graph showing the relationship between unemployment and inflation.

7% is the natural rate of unemployment (can be any value depending on the country)
At this point this is when the economy is price stable
Short run (SRPC)
as interest rate increases rate of unemployment decreases and vise versa
external economic shock leads to a shifting out of the SRPC
Long Run (LRPC)
the unemployment rate does not change no matter what the inflation rate rockets
(stagflation does nothing to the unemployment rate)
the unemployment rate stays at its natural rate of unemployment

55

43. Unemployment graphs

Cyclical unemployment:

The graphs above illustrate cyclical unemployment aka demand deficient aka
Keynesian unemployment occurs when a decrease in demand for certain goods or
services would result in a company to contract their output causing there to be no
jobs available even with a possible workforce.
In graph above, ___ economy is slowing down b/c ___ causing AD to shift in to
AD1
results in firms seeking to cut variable costs by cutting employment
may result in firms cutting employment in an effort to cute variable costs,
this should shift Labour Demand to LD and cause involuntary cyclical
unemployment.

56

Real wage:

Another type of disequilibrium unemployment is real wage unemployment aka

classical unemployment
This is seen in the graph above as the average real wage rate of Greece is at W1
where it is higher than the equilibrium wage rate of WE at QE due to
governments legislation of minimum wage or trade unions actions.
As the real wages is higher than market-clearing level, this results in aggregate
demand of labour to decrease to Q2
Means that there are more job seekers than job openings aggregate supply of
labour increased to Q1
The difference between Q2 to Q1 is the disequilibrium unemployment level.

57

44. NAIRU (Natural rate of unemployment)

Unemployment may not be harmful to a nations economy if its unemployment rate fell
under full employment, also known as the natural rate of unemployment, or equilibrium
unemployment. A country close to full employment is Thailand with an unemployment
rate of 0.62% in January 2014.

It consists of frictional, seasonal and structural unemployment

Frictional unemployment: people are in between jobs. E.g. banker who quit his job in
HSBC and is looking for a job elsewhere.

Seasonal unemployment: workers are employed on a seasonal basis. E.g. a ski

instructor who only works in the winter.

Structural unemployment: workers are fired due to a long run decline in demand in
an industry. Polk County, Florida suffers from structural unemployment with the ban of
Phosphate mining in late 2013

58

45. Demand or supply side policies

Define

Demand: refer to government policies designed to increase aggregate demand.

Supply: refer to government policies designed to increase output. Examples

include tax reductions and concessions.

Neoclassical/Keynesian
When economies experience D/S side shocks
Neoclassical economists - the market will clear by itself in the long run wont
interfere
Keynesian economists - market will not clear by itself fast enough will
interfere
o Through D/S side i.e. legislation, fiscal/monetary policy
Time

+ D: fast in SR
o b/c govt expenditure can change immediately (increase spending
influence AD)
- S: time lag
o b/c infrastructure takes a long time to build or govt takes time to
implement change

Output, Economic Growth

- D: only temporarily increase output
+ S: effective in achieving economic growth, while maintaining price stability
KO Effects
Solve S side shock S side policies
E.g. PH: net FDI increased to $2.2 billion (2013)
E.g. UK: invest 100 billion GBP in infrastructure project- Crossrail
go into capital stock & infrastructure shift out LRAS
- KO effect on demand
o b/c investment is a component of AD AD shifts out

Solve D side shock D side policies

E.g. UK: cut main rate of corporation tax from 28% (planned to reach in 2014) 23%
E.g. France: cut corporation tax by 3% (2013)
59

- KO effects on supply
o b/c invites the creation/expansion of firms shift out supply

Over/Undershoot

(as shown) Originally, the economy of Japan had a deflationary gap at EQ1
E.g. Japan: govt decided to decrease interest rates to 0 increase MPC on BTI
Increase consumer expenditure (component of AD) shift out AD1 to
AD2 close gap
- hard to know how much a govt should increase or decrease interest rates
o b/c govt usually doesnt know the size of the multiplier in advance
o E.g. ^unlike US: military expenditure multiplier (known by research) = 3.6
Thus, w/o knowing final impact on economy, govt can
o Undershoot - not close deflationary gap and not reach FE
o Overshoot - turn deflationary gap into inflationary gap AD3
o

60

Income Inequality

- S: aggravate Y inequality (as shown)

E.g. India: govt approved $28 billion for infrastructure railways, roads, E
programs (2013)
E.g. Mexico: 972 million MXN highway project
o Utilities are used more by rich increase disparity between rich and poor
+ D: targeted to the poor
E.g. Oregon, USA: $1.2 billion annually to fund food stamps for the poor
E.g. USA: $80 billion food stamps for the poor
o Alleviate Y inequality

Crowd Out (Private Sector)

- D & S^
E.g. USA: increased Medicaid & Obama Care
Increase govt spending increase GDP govt is involved in
- private sector efficiency > public sector
Efficiency (component of LRAS) shift in LRAS negative economic growth
61

Expensive
- D & S^
Policies not available for govt's in debt no money to increase govt spending
(shift out AD, or if in infrastructure- shift out LRAS)
o E.g. Portugal, Spain, Greece
- High OC
- Govt not good at choosing successful projects
E.g. USA: $132 million on A123 battery making company for electric cars
bankrupt
Conclusion
D & S: + & -, dont work in isolation
combination to achieve 5 macro objectives

62

46: Inflation versus deflation (For inflation arguments, use the same
from Unemp vs Inflation)

Inflation is a sustained increase in the general price level, and is measured by

Consumer Price Index.
o In August 2013, Thailands inflation rate was 1.59%.
Deflation is a sustained decrease in the general price level. It is often
accompanied by a fall in total output and an increase in unemployment.
o Average price levels in Greece have been failing by an annual rate of 0.5%
since early 2012.

1 - Food price inflation

Food price inflation aggravates income inequality
o India - food inflation rose to a three year high of 18.2% in August 2013.
o DRAW POVERTY CYCLE
Consequences on the HDI and development of countries.
2 Hyperinflation - firms hesitant about expanding production capabilities
hyperinflation e.g. Venezuela where the inflation rate was 45.4% in August 2013.
With inflation at such a high rate, the cost of new capital goods and new
equipment have increased
Firms are more hesitant about expanding production capabilities in the future
May limit economic growth
3 Hyperinflation shoe leather/menu costs
There is a high opportunity cost of inflation, e.g Syrias hyperinflation rate of
257% Sep 2013
For consumers, these are presented in shoe leather costs, as consumers must
spend time trying to find the cheapest option to spend their money.
This may also impact producers from menu costs, as prices are changing by the
hour.
Often countries become more efficient by cutting costs, and may gain in the long
run as a result.
4 Creeping inflation beneficial
Creeping inflation refers to a sustained low rate of increase in the general price
level.
It is considered not only acceptable but also good for an economy.
o e.g Singapore 1.90% July 2013.
employees may see pay rise as prices increase motivation to work
5 Deflation: consumers postpone demand
63

Future expectations demand shifts in

due to decreased prices firms experience lower profit margins
firms may try to decrease average variable costs (AVC) by cutting minimum
wage unemployment/SRAS shift in
o e.g Greece, which reduced minimum wage in February 2012 or laying
off workers.
6 Deflation: Real value of debt/borrowing increases
value of debt rises
o e.g. Japan, whose inflation rate was 0.9% in August 2013.
price level falling debt builds up consumer confidence falls AD shift in
As debt increases, the real cost of borrowing increases
Firms may be discouraged from investing
Consumers are discouraged from buying big ticket items (usually bought on
loans)
Mortgages will also fall, important because take up a lot of economy in
US/UK/Europe
o e.g. Spain, with 0.7% inflation rate in October 2013, has experienced this.
Investment falls AD shift in

Conclusion
Inflation and deflation both have downsides; however inflation has more upsides,
and is thus more desirable than delfation

64

Trade
47. Comparative/absolute advantage/specialization (gains from trade) PPC or trade
Comparative advantage exists when a country can produce a good or service at a lower opportunity cost
when compared to another country.

France has an absolute advantage exists when one country can produce a good
or service with less resources or factors of production compared to another country
Specialization is a method of production where a business or area focuses on the
production of a limited scope of goods and services in order to be more productively
efficient. Few countries produce enough goods to be self-sufficient, so they specialize.

65

48. Appreciation/depreciation
Define:
Appreciation - increase in the value of a domestic currency in terms of other currencies.
Occurs as a result of market forces in a free float exchange rate system
E.G South Korean Won b/c of its strong economic performance

Originally, the market for SKW on the Forex market cleared at Price P and quantity Q
However, as SK has had strong economic activity , the currency has appreciated against
the USD
This means that the Won is now more fashionable which is a determinant of demand
As a result, D shifts out to D1 where price increases from P to P1 and quantity bought
and sold increases from Q to Q1
Market now clears at EQ at price P1 and quantity bought and sold at Q1

66

Define:
Depreciation is a decrease in the value of a currency as compared to another
Occurs as a result of market forces in a free float exchange rate system
E.g. India: 54.3INR/1USD (2013) - 60.6 (2014)
E.g. Russia: 31.1RUB/1USD (2013) - 36.6 (2014)
E.g llilippine Peso

Explain
Originally, the market for PHP on the forex market cleared at equilibrium EQ at price P
and quantity bought and sold at Q
However, due to the improvement of the US economy, people began taking their money
out of PHP and investing in USD - representing capital flight
Thus, the PHP is less fashionable which is a determinant of demand causing demand to
shift in from D to D1
Price of PHP decreases to P1 and quantity bought and sold decreases to Q1
The market now clears at equilibrium EQ1 at price 44.4PHP/USD and quantity Q1 representing depreciation

67

49. Trade creation/diversion

TRADE DIVERSION/CREATION in ZAMBIA

Originally, Zambia was trading at price PZ and q1

Then it forms a trading bloc with south africa where supply shifts to SZ+A
Price falls to PZ +SA and quantity increases from q1 to q2
If Zambia traded freely on world market than quantity would be q3 and price
pw as world output is at ws.
However, this has been prevented by the creation of a trading bloc with SA

68

50. Pros and cons of a free float/govt intervention in forex market

Good

Bad

External equilibrium always achieved

Balance of payments always fixes itself
Foreign purchases effect people buy
less, exports fall, imports rise

Assumes Marshall Lerner Condition is

being met
if MLC is not being met and the
currency is losing value, external
equilibrium will never be achieved
price inelastic goods being sold, our
currency will continue to increase

ex.

ex. Hong Kong to US dollar 0.128942 in

Feb 2011
No need for high level of foreign currency
reserves
no need to worry about reserve levels
no involvement needed in Forex market
resources can be allocated into other
areas of the economy

No stopping capital flight

people move their capital abroad
and convert savings into foreign
currency
ex. Venezuela

e.x. China has 3.8 trillion USD in reserves

Reduce inflationary pressures
price stability is achievable; if price goes
up domestically but stays same
internationally less inflationary
pressures
works in the converse fashion

Uncertainty of business planning and

investment risk
harder to make accurate predictions
volatile exchange rates will reduce
investment internationally

69

51. Marshall learner condition- J Curve effect following a

depreciation /devaluation of the exchange rate
Define

Marshall-Lerner Condition - states that if the PEDx + PEDm > 1, then a

depreciation of the exchange rate will improve the balance of payments. If the
PEDx + PEDm = 1, then the BOP will remain unchanged. If the PEDx + PEDm
<1, then a depreciation will worsen the BOP.

J-Curve Effect - the way and the time frame in which the trade balance may initially
worsen before improving, after depreciation in the exchange rate

The J-Curve above shows that a deficit may be reached before a surplus.

70

54. Free Trade: Good or Bad/ Trade bloc good or bad

Define
Free trade - movement of goods and services without protectionist barriers
Protectionist barriers - restrictions made on free trade imposed by government
action

+ Incentive to Specialize / Comparative Advantage

Minimize OC
Can take advantage of geographical and human specialization
World economy allocatively & productively efficient
Increase supply receive economies of scale pass on to consumer
- Changes of Overspecialization
- Need Diversity (even if inefficient)
o E.g. Malawi: 70% of agriculture, 37% of GDP = Tobacco
o In case of bad harvest etc.
+ Need to maintain food security
o To insure conflicts dont affect countrys supplies
o E.g. USA: 20 billion USD annual subsidy agriculture
+ Domestic Economy economic growth
Specialize more efficient (component of PPC shift out graph?)
o Economic growth economic development (if merit good?)
Reallocate resources to merit/public goods social efficiency
- govt is corrupt
- Domestic Unemployment
Creates structural unemployment
o E.g. USA: 750,000 call center jobs offshored to India b/c cost advantage
b/c Infant Industries cant compete w/ world efficiency or MNCs w/ the
economies of scale shut down
+ Foreign Employment
E.g. Mexico: best jobs in sectors that export 60%+ of production pay 39%
higher wages
+ Increased Consumer Sovereignty
More competition incentive to be
o Productively, allocatively efficient
o Invest in R&D dynamic efficiency

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Deters monopolies- market failure

+ more choices at lower prices for consumers
+ Political Benefits
Free trade w/ trade blocs improve diplomatic relations
o E.g. UK: easier for Romanians to get jobs b/c political relations of EU
+ Doesnt Distort PSM
Tax, tariff prevents PSM from clearing market
o

57. Who wins and loses from a tariff?

Effects of tariff imposed:
+domestic output increase = higher employment
increases market share can increase supply expand more workers
82% on poultry imports in South Africa (2013) need more workers to raise
and take care of the chickens

+ Promotes the infant economy of a country which would then lead to

economic development.
when a country protects the industry until they have the economies of scale
to compete with overseas producers
Chinas 6.5% tax on imports of US raw materials used to make solar panels
(2013)
70% car imports in Nigeria (2013)
The tariff would help local producers increase their revenue and the overall
production
+ producer surplus increase

+ govt revenue increase

Governments may collect revenue from the tariffs and this money may be re
allocated into the investment of merit goods and infrastructure
In the United States the American government collects revenue from 12 000
tariffs in order to invest on infrastructure (2013)
- consumer surplus decreased
more expensive goods for consumers
increases inflationary pressure
Loss of choice -> with a tariff in place then the quantity of imported goods
will drop and only the QS of domestic products would increase
- welfare loss
depends on what type of good
if it is a demerit good it might be a pro
-aggravates income inequality domestically
tariff = regressive tax which burdens those people with lower income

72

 Aggravate income inequality especially if the good is a necessity

Tariff on Turkish flour in The Philippines raised from 7% to 20% (2013)

-foreign producers are worse off

quantity of imports is reduced meaning smaller quantity sold = less revenue
the exporting country would lose export revenue
- inefficiency due to no foreign competition
there is less incentive for domestic firms to be dynamically efficient or
productive + allocatively efficient
Dynamic: R+D innovation
P+A: restrict specialization leading to less economies of scale resulting in
less quantity of the product
- parallel markets may arise
smuggle stuff in like rice in the PH

Effects of tariff removed:

+ welfare gain
Cheaper fops
+ consumer surplus increase
more choice + lower prices
lower prices may lead to economic development if the tariff is removed on
merit goods such as vaccines
+ promotes income equality
People with lower YED would be able to afford more as price of goods go
down
+ incentive to specialize
In a free market countries would be able to specialize as it is assumed that
there is a reciprocity agreement between countries and therefore through
comparative advantage countries would be able to focus their resources in
the most efficient way to produce more of a good or service
There would be lower opportunity cost
- govt revenue decrease
governments would lose revenue from tariffs = lose money that could have
been reallocated to the construction of infrastructures and public goods
- Local employment decrease
The demand for local goods would decrease cause those who work in the
sector to be structurally unemployed
- domestic producers suffer
less domestic production with higher imports

73

 imports normally have lower prices = domestic producers lose out

conclusion: how developed the country is and the situation (ex: EU due to the
economic crisis it might be good to put a tariff on it)
whether it is a merit good or demerit good

Development
57. Gini Coefficient / Lorenz Curve for showing relative poverty / inequality
Define

Lorenz Curve - measures the Y inequality within a population

E.g. Sweden - 23.0
E.g. Finland - 23.8
E.g. Nepal - 33.0
E.g. Chile - 52.1
E.g. South Africa - 63.1

Draw

Explain
The lorenz curve (as shown) shows that Sweden is more Y equal than Nepal
because it is closer to the line of perfect distribution

74

58. Poverty cycle

Poverty Cycle is the set of factors or events by which poverty, once started, is likely to continue
unless there is outside intervention.

According to this diagram, Haiti has trouble breaking out of this poverty cycle due to the lack of
food. This would lead to poor nutrition and a loss of productivity this would entail a low income
and cause most of ones income to be spent on necessities. Therefore to break out of this poverty
cycle external intervention is needed.

59. Barriers to development

Poverty Cycle
Its hard to break
Unless outside intervention
Political and institutional instability
Ukraine because of Russia
Inefficiency of infrastructure such as airports and roads in The Philippines
Protectionism
Tariffs such as a Japanese rice tariff (767%) prevent LEDCs from exporting
LEDCs rely on the primary sector
Cultural and Religious reasons

75

 Like the RH bill lowers population in The Philippines so now there is education
Replacement rate is 2.2 and some countries like Niger have a birth rate of 7.01 children
per woman
Countries like Pakistan and Saudi Arabia PPC is artificially low because of womens
rights
Cant drive and shit
Financial Barriers
A lot of LEDCs are in high amounts of debt and therefore would not be able to afford it

60. Aid or trade? (Debt relief is a form of aid so same arguments)

AID - is money and/or goods and services provided to a country. It can be
tied-that is, certain conditions are imposed by the donor-or untied. It can
come from private investment and/ or Overseas Development Assistance.

GOOD

BAD

may help overcome the savings gap

b/c more money + technology is given
can improve the difference between
marginal propensity to save and

marginal propensity to consume

closing is beneficial promote more
investments economic

growth/development

targeted aid may achieve economic

growth
may also achieve econ dev (as said by
Paul Collier) improve human +
physical capital if spent on
infrastructure or merit goods
capital deepening effects and higher
productivity (whats needed for econ

dev)
targeted aid = good b/c growth will
benefit donor countries as trade grows
EU giving 30 million euros to Jordans
education sector to help cover the
education costs for Syrians (2014)

may lead to dependency hysteresis

effect as people know that they will get
money no matter what
Dambisa Moyo states this in her book
dead aid

Can play a role in stabilizing post

conflict environments and disaster
relief
UK gave 55m Pounds to PH to help with

Lack of transparency
leads to high levels of corruption
Consumers are hurt as they do not get
the intended good Lower quality
goods
Example: government officials in Malawi
were arrested for pocketing an estimate
of $250m of British given aid (2014)
Tied aid
lowers the sovereignty of the donee
country
may be used for negative things such
as how Japan gives aid to ___ so they
could vote for them in the whaling
commission
Lead to distortion of market forces
loss of economic efficiency + risks
inflation

76

Typhoon Haiyan (2013)

61. MNCs: Good or bad?
MULTINATIONAL COMPANIES/CORPORATIONS (MNC) refers to companies that have
production units in more than one foreign country.
FOREIGN DIRECT INVESTMENT (FDI) refers to the investment by overseas firms in
another country.
GOOD

+ Creates wealth and jobs around the world /

reduces domestic unemployment
ex. Foxconn is one of the largest factories in
China, where thousands of workers are employed

BAD
- MNCs have been criticized for using slave
labor workers who are paid low by western
standards
ex. Foxconn was accused from a series of studies
linked to low pay in 2010

+profit can be used to R+D -> dynamic

efficiency

+size enables them to benefit from economies of

scale enabling lower costs and prices for
consumers

eg. Toyota highly technical economies of scale

that uses highly specialized machinery to produce
an exponentially large number of products
meaning that the high set up costs can be spread to
release cost per unit

- their market dominance makes it difficult for

local firms to thrive (crowd out)
ex. more than 90% of operating systems for
desktops are windows brand
MNCs may crowd out local industry or unallow
local firms from entering the market if theyre
direct competitors.

+MNCs often invest in the countries known as

foreign direct investment
in order to overcome the savings gap and result in
potential economic growth

+Ensures quality control consumers often

like MNCs as they know that there are
standards for their products

-in the pursuit of profit, MNCs often

contribute to pollution and use of non reusable resources which is putting the
environment under threat
ex. China punished 53 MNCs for violatinv the
nations environmental laws and regulations in the
last 30 years

+Can improve upon local technical skills,

management skills and technology

they bring technical and managerial expertise

when they set up in an MNC improves human
capital
production technologies which can be adopted
and learned by local labour force improves
efficiency
shift out PPC
+ can lead to greater tax revenues for host
country if they tax the MNC (more money for
government)

- MNCs may assume monopoly power

eg. shell earned 14 billion pounds of profit in 2008
by increasing profits prices
-reduce of domestic entrepreneurship due to
high levels of competition of a high standard
from MNCs
- Govt may not get greater tax revenue
MNCs enjoy tax privileges and benefits as an
incentive for investing in the country

77

62. Economic growth good or bad?

Benefits of Economic Growth:
Increase in GDP
More jobs: Growth creates new jobs although the pattern of employment will also change
The accelerator effect of growth on capital investment: Rising demand and output encourages
investment in capital this helps to sustain GDP growth by increasing LRAS
Greater business confidence: Growth has a positive impact on profits & business confidence
The fiscal dividend: A growing economy boosts tax revenues and generates the money to
finance spending on public and merit goods and services without having to raise tax rates.
Potential environmental benefits as countries grow richer, they have more resources available to
invest in cleaner technologies. And, as nations develop, energy intensity levels fall
Consequences of growth:
Pollution and Environmental degradation
o Developed economies with high consumption demand cause environmental damage, as
do countries developing from modest foundation
Deforestation- caused by clearing of trees to create factories/farm land, use for
fuel and the exporting of timber causes soil erosion and contributes to global
warming and loss of biodiversity
o Hazardous waste products are released by unregulated industries and slums
o POLLUTED WATER!!! I THINK THIS IS POVERTY POLLUTION
Income inequality
o If growth is prioritized over development, then investment has a high place in it
for this to occur there needs to be savings by a high income sector and this
requires unequal distribution of income
Sustainable development
o since this may cause environmental degradation it is not sustainable for future
generations
o If LDCs want to be sustainable it will be much slower
Solutions:
Government provision of basic sanitation and clean water
extension of property rights
prohiition of polluting activities
Pollution taxes
Tradable permits
Finding environmental actions that actually promote growth
Education of farmers and communities
Family planning CHINA
Removal of subsidies that encourage the use of fossil fuels

78

63. Globalization Good or bad?

GLOBALIZATION
Definition: Increased openness of economies to international trade, financial flows, and direct
foreign investment.
Broader definition: is a process by which the economies of the world become increasingly integrated,
leading to a global economy and, increasingly global economic policy making, for example, through
international agencies like the WTO.
Advantages of globalization:

The possibility of reducing global poverty by rich countries through cultural, social, scientific
and technical exchanges, and through conventional trade and finance.
The faster diffusion of productive ideas may help LDCs catch up more quickly.
Absorbing new knowledge is one of the foundations of present MDCs
Counties like China and India have been using globalization as a means to accelerate their
growth thereby reducing some international inequalities, and as well as reducing absolute poverty
in their own countries.

Disadvantages of globalization:

The real possibility that poor counties are locked into a pattern of dependency, and that the
dualism of LDC will be made worse.
The share of international investment received by the poorest countries has been steadily falling
rather than rising.
Can be a threat to LDCs cultural identities.
Much of the African world missing out on investment and have declining per capita incomes as
well as worsening regional inequalities (Africa only gets about 1% of the worlds FDI, but this has
increased over the last few years)
Also, some analysts argue the interdependence of countries through globalization has led to the
first truly world economic slowdown (2008-12) as every country and region has been effected.

Globalization and its effects on development

Assumption that basic education and health, absorption of productive ideas, sound institutions are
sufficient incentives and are all that is needed for development to take place, and globalisation can
help with these.
But many MDCs still practice protectionist policies. Example: North America, Europe and Japan,
in the very goods that LDCs could be competitive in such as agricultural goods and textiles.
The UN estimates that protectionism by rich countries costs the developing world $100 billion a
year.
Need for LDCs to create their own MNCs in the long run. The question is whether this will
happen. But 6 of the worlds largest companies (by market capitalization) are now Chinese.
Example: ICBC, Petro China, China Mobile.

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64. Economic Growth vs. development

PPC
economic growth with or without development
Production Possibility Curve refers to the boundaries that are attainable and unattainable levels of
production.

economic development is an increase in Real GDP per capita plus an improvement in the standard of living.
it is one of the five major macroeconomic objectives.
In graph 1 (left), there is economic growth as the PPC is shifting outwards. However, the PPC shifts
outwards only on luxury goods and services (generic term, use an actual good/service provided by the
data response), which indicates that there isnt an improvement in the standard of living. In graph 2, we
see that there is economic growth as the PPC is shifting outwards as well, this time in favor of
necessity goods (again generic) such as healthcare/etc/etc. this indicates an improvement in standard
of living and BAM ECONOMIC DEVELOPMENT

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65. Inward or outward development strategies

Inward Intentions (ISI= Import Substitution Industrialism):

Create employment. Local firms lose out to multinational corporations in many ways from
management skills to professional workforce, amount of investment into operations & scale of
productions.
o import barriers such as tariffs & quotas were erected, making it more costly for
consumers to purchase imported goods than locally made ones.
o By supporting home-made substitute goods, producers will over time reap supernormal
profit. They will be able to grow further thus creating more job opportunities. At same
time, this is hopefully can eradicate poverty
Improve BOP deficit. It could be imports are growing, exports are falling or both.
o By operating behind governments protection, it is hoped that local producers will be able
to produce locally. These products can be exported, thus boosting exports.
o As consumers substitute away from foreign goods, imports will fall. BOP deficit will be
narrowed
To build strong base for EP (export promotion). Barriers will stay as they are until local firms are
able to compete in terms of size & have acquired the know-how techniques to be productively
efficient.
o Good examples will be the East Asian economies such as Taiwan, Hong Kong, South
Korea & Singapore which once operate behind protection.
Now they are able to produce at competitive costs to the whole world. This is
the strongest argument use by economists to defend the need of ISI
Evaluation of ISI:
Productively inefficient. In theory, local firms will eventually be more cost efficient once the
industry reached maturity.
o Not the case These firms realised that they have their own captive markets & yet
being insulated from competition.
o So whats the need to improve? As a result, they will never strive to be cost-efficient.
Also in many cases, the products are of ill-quality & yet expensive. Consumer surplus
falls
Never removed. Local producers will tend to slack knowing that once they become more-able,
protections will be removed & there is no guarantee that they are able to compete internationally
& earn as much profit as now.
o Furthermore, removal of protections is very politically unpopular & may cause
resentment. Ruling government may lose its mandate
Capital-intensive.
o Even if there were improvements made in terms of cost efficiency, very often it is done at
the expense of another. As infant industry grows, they may begin to capitalise &
substituting manpower with machineries, giving rise to large scale unemployment
BOP deficit. Poor developing countries do not have the sufficient means to grow by themselves.
To develop a strong local industrial base, other than human capital they also need capital goods
such as specialise machineries which must be imported from abroad. This represents an outflow in
current account. Hence, improvement of BOP deficit is questionnable
Outward Development Strategies:
Benefits
Creates employment. Many of these factories are located in urban areas & they are labourintensive providing jobs for people including the rural people.

81

o reduces the level of absolute poverty

Influence AD. An export-oriented economy will expect an increase in its exports over imports,
thus creating net exports. This shall move the AD curve rightward resulting in an increase in real
GDP.
o Through the multiplier effect, national income & employment will further increase
Financing capital goods. An increase in exports over imports can improve its terms of trade. Terms
of trade means ratio of export prices to import prices. In other word, the country need to export
lesser to finance the same amount of imported goods e.g. machineries. Also there will be lesser
danger that the economy will run into foreign exchange & foreign debt problems
Learn from rivals. By competing with multinational companies, local firms will be able to
improve its competitiveness. There will be more efforts put into R&D.
o Also they can learn the unique features of rivals product & perhaps make a large
improvement over their existing ones to enlarge market share
Problems
Dependency. Its level of success depends a lot on the pace of economic growth in rich Western
countries. If say, US is hit by a recession, then third world countries could be the worst affected.
Level of exports will slump. Unemployment will escalate & the demultiplier effect will feed into
the whole system

(2) Rich countries erect protectionism. It is unlikely that Western manufacturing sectors are able to
compete with low cost Asian economies. Whats more in manufacturing sector which is labour
intensive. More often than not, labours form a large portion of total costs. That is also one of the
major arguments as to why major Western economies are shifting their comparative advantage to
services sector, except Germany. Others which still have manufacturing industry as their core
economic activity began to erect unfair protectionism

(3) Environmental degradation. Developing countries are often accused by Western economies as
the major contributors to global warming, especially China. This is true. Rich Western economies
have already reached the desired level of income. As such living in a cleaner environment is now
their priority. Meanwhile, for poor but booming countries they have to sacrifice environment at the
expense of economic growth & development. Besides, industrialists in developing economies are
not that well educated. As such their level of environmental awareness is very low

(4) Fall in export prices. This is assuming if all developing countries are trying to export their way
out simultaneously. Due to flooding of manufactured goods into the world market, its prices will
be forced to plunge, putting exporters in disadvantage

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QUANT
**dont forget 2 DP!!!!!!
**dont forget +/- signs for growth!!
Multiplier
Higher MPC (marginal propensity to consume) = greater multiplier
MPC = change in consumption/change in income
Leakages = Marginal propensity to save + propensity to buy imports + taxes:
(changes in savings + changes in taxes + change in imports)/change in income
Multiplier (k) = 1/(1-MPC)
or
1/(changes in savings + changes in taxes + change in imports)

ELASTICITY
PED = % change in QD / % change in price

- less than 1 = inelastic

- greater than one = elastic
+ = giffen or veblen good

Income elasticity = % change in quantity / % change in income

+ less than 1 = inelastic
+ more than 1 = elastic
- = inferior good
X elasticity = % change in quantity A / % change in price B
- complements
+ substitutes
THEORY OF THE FIRM (costs)
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1. Calculate total, average and marginal product from a set of data and/or diagrams.
HOW TO: Total product is the output of workers as the number of workers increases.
Average product is the output per worker = TP/# of workers
Marginal product is the output of the last worker = Change in total product / change
in the number of workers.
2. Calculate total fixed costs, total variable costs, total costs, average fixed costs, average
variable costs, average total costs and marginal costs from a set of data and/or diagrams.
HOW TO: TFC is constant as output increases. It is the firms total cost when output = 0.
TVC increases as output increase, at first at a decreasing rate (due to increasing returns),
and then at an increasing rate (due to diminishing marginal returns).
TC = TVC + TFC. If you know the firms fixed costs and its variable costs, TC can
easily be calculated.
AFC = TFC / Q of output. AFC falls as output increases as the firm spreads its
overhead. Graphically, it is the distance between AVC and ATC.
AVC = TVC / Quantity of output. AVC falls at first due to increasing returns and then
increases due to diminishing returns. MC and AVC should intersect at the lowest point of
AVC
ATC = AFC + AVC, or TC / Quantity of output. ATC lies ABOVE the AVC curve
(since it includes the average fixed costs), and will intersect MC at its lowest pont.
MC = the change in TC / the change in output. It is the cost of the last unit produced.
MC sloped down when a firms workers experience increasing returns and upwards once
the firm experiences diminishing marginal returns.
Revenues:
1. Calculate total revenue, average revenue and marginal revenue from a set of data
and/or diagrams.
HOW TO: Total revenue (TR) = price X quantity.
Average revenue (AR) is simply the price of the good. The demand curve can be labelled
D=AR=P to help you remember this.
Marginal revenue (MR) = the change in total revenue divided by the change in
quantity. This is the change in total revenue resulting from the last unit sold. For a PC
firm, MR is constant and equal to the market price (since the firm is a price taker and can

84

sell additional units for the same price.) But for an imperfectly competitive firm, MR is
lower than price beyond the first unit of output, since the firm must lower its price to sell
additional units of output. MR fall twice as steeply as the D=AR=P curve in an imperfect
competitor diagram.
Profit:
1. Calculate different profit levels from a set of data and/or diagrams.
HOW TO: Economic profit is usually found by the following equation. Profit = (PATC)Q. Find the per-unit profit (P-ATC) and multiply it by the quantity of output (Q).
If you are given total revenue (TR) and total cost (TC) data, than economic profit = TRTC.
If ATC>P or if TC>TR, then the firms profit is negative, and it is earning losses.
Perfect Competition:
1. Calculate the short run shutdown price and the breakeven price from a set of data
HOW TO: A firm should shut down if the price in the market is lower than the firms
minimum average variable cost. At this point, the firms total losses are greater than its
total fixed costs, so it will LOSE LESS by shutting down!
A firm will break even when the price in the market equals the firms minimum ATC, or
if the TR = TC (see above). Economic profits = 0.
Monopoly:
1. Calculate from a set of data and/or diagrams the revenue maximizing level of output.
HOW TO: Total revenue is maximized when MR=0. If you have a table you can
calculate the change in TR at each level of output, and when this equals zero, the firm
would be maximizing its total revenues. Anything beyond this level of output, MR will be
negative and the firms revenues will begin to fall.

GDP
EXPLANATIONS
Problems w/ Measuring GDP
Exclusion of parallel market activity
o problem especially in developing countries where a large portion of the
economy may come from parallel market activity
Example: 30% of Indias economy is estimated to come from
parallel market activity

85

Doesnt show income inequality

o Use GINI coefficient instead Singapore (0.478 in 2012)
o important because one may opt to live in a country with more income
equality.
Doesnt take into account population
o countries with higher population would have higher GDP
o Example: nominal GDP of Italy about 61.3 million and Chile about 17.2
million (July 2013)
o use GDP per capita
Doesnt show negative externalities
o important as it might be better to live in a different due to negative
externality
For example, it may be better to live in Sweden than Indonesia as
67% of men over 15 smokes, while it is only 17% in Sweden in
2012.
to indicate negative externalities on GDP = GDP - welfare loss

GDP
Expenditure approach or aggregate demand: AD= C+I+G+(x-m)
Income approach: using total income earned by households in a country. Different types
of income: rent, wages, interest and profit.
Output approach: output of primary sector + secondary sector + tertiary sector
real GDP in year 1 = (nominal GDP / price index) x 100
real = (nominal x 100) / price index
output growth = [(real GDP in year 2 - real GDP in year 1) / real GDP in year 1] x 100
= [(real 2 - real 1) / real 1] x 100
= [($1028 - 1000) / 1000] x 100
= +2.80%
real GDP per capita = (year 1 real GDP / population in year 1)
= real / population
= $1000/100
= $10

INFLATION / UNEMPLOYMENT
Problems w/ Measuring CPI

86

International Comparisons cant be made because different goods and services are
in the basket. Also the consumption and the methods of calculation differ.
o basket of USA include housing, apparel, medical care, transportation
o Example: Philippines basket has 479 items while the UKs basket has
around 700
Regional/Cultural factors consumer groups who buy different things from the
typical household due to culture.
o Example: Rice in Asia, Bread in Europe (same as ^ D: )
Doesnt take into account changes in consumption pattern due to introduction of
new products
o a fixed basket of goods and services cant take into account new products
introduced into the market, and the old products that become less popular
o example: the british government introduced ebooks into the 2013 basket of
goods and services in order to suit the consumption patterns

Core Rate of Inflation

goods w/ highly volatile prices
^caused by wide swings in supply/demand
when ^ goods are included in CPI give misleading impressions of rate of
inflation
therefore, construct core rate doesnt include food/energy products w/ highly
volatile prices
basically gives more accurate information on rate of inflation
CPI (Consumer Price Index)
cost of base/current year items = quantity x unit price
*quantity in base year = quantity in current year
= 30.00 x $5.00
= $150.00
spending in base/current year = total sum of costs of base/current year items
*aka total cost of buying all item in year __
*of standard items (grocery bag necessity goods e.g. shelter, clothes, electricity, gas,
food)
= $150.00 + 240.00 + 90.00
= $480.00
CPI = (cost of current year prices / cost of base year prices) x 100
= (current/base) x 100
= ($530.00 / 480.00) x 100
= 110.40
*means that what we could have bought in the base year for 100, we can now buy for
110.40
*CPI of base year = always 100

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Price changes = [(current CPI - base CPI) / base CPI] x 100

= [(110.40-100.00)/100] x 100
= +10.40%
Notes

change in base year does NOT change percent change in prices between years
conditions when each price index # = cost of living index
o grocery bag = necessity goods, = regular buying list
quality increases = utility increases
If quality changes however, you should not be using the CPI as you are no longer
measuring the same thing as thus rendering your numbers inaccurate

Core rate of inflation

CRI = (cost of current year prices / cost of base year prices) x 100
= (current/base) x 100
= ($530.00 / 480.00) x 100
= 110.40
*DOES NOT INCLUDE GOODS/SERVICES WITH HIGHLY VOLATILE PRICES
Changes is Spending
Others
unemployment rate = (# unemployed / labor force) x 100
labor force participation rate = (# in labor force / adult population) x 100

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Definitions
SUPPLY AND DEMAND
Economics
The study of how people and societies use their scarce resources to satisfy unlimited
wants
Normative StatementAn expression of opinion that cannot be verified by observation or statistical fact.
E.g.
Positive Statement An expression that can be verified by observation and/or fact
E.g. Real GDP: Denmark > Nigeria
Short Run the time period when at least one factor of production is fixed
Long Run the time period when all factors of production are variable
Abundance
Occurs when a person can obtain as much of something as they want. It is the opposite of
scarcity.
Scarcity exists when human wants exceed amount of available resources can produce.
Production Possibility Curve/Frontier (PPC/PPF) Refers to the boundary between attainable and unattainable levels of production
Shortage is an excess demand over supply of a good or service at EQ price
Opportunity Cost The cost of any economic activity measured in terms of the best alternative that is
foregone

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When the best alternative is chosen from a range of alternatives, the second best choice is
the opportunity cost
E.g. buying bananas instead of apples
Capital
One of the four FOPs
Refers to man-made items that help produce other items
Payment: interest
E.g. machines, robots and factories

Capital Goods
One of the four FOPs
Produced by people that help produce other items
E.g. machines, robots and factories
Human Capital Investment in the FOP of labor
Aimed to increase productivity, well-being and job satisfaction
Occurs through investment in education or the training of people
Labor One of the four FOPs
Refers to human resources involved in productive contributions to the economy
Land One of the four FOPs
Refers to all natural resources
Ceteris Paribus
The assumption that all other variables are kept constant, except the variables under study
Consumption
The process of using up goods and services
Economic Problem
One of relative scarcity of resources relative to unlimited human wants
Factors of Production (FOPs)
Refers to the scarce resources land, labor, capital and enterprise used to produce
economic goods and services
Demand
The relationship between the quantity demanded of a good or service and its price
Theory of Demandstates that the quantity demanded and price are inversely related, other things being
equal.
Demand Curve

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Shows the relationship between the quantity demanded of a good or service and its price,
holding all else constant
Supply Curve graph showing quantity supplied and price of a good or service, holding everything else
constant.
Demand Schedule
Lists the quantities of a good or service and its price, holding all else constant
Supply Schedule is a list of quantity supplied at different prices, holding everything constant.

Quantity Demandedis the amount of a good or service that consumers plan to buy at each price in a given
period of time.
Quantity Suppliedis the amount of a good or service that producers plan to sell at each price in a given
period of time.
Unit Elastic Demandis an elasticity of demand of 1. The quantity demanded and price change in equal
proportions.
Long-Run Supply Curve Describes the response of the quantity supplied to a change in price
After all technology adjustments have been made
Equilibrium
Situation where the market clears
Where demand equals supply at a given price
Veblen Goods Goods that have snob value and are bought to display wealth
Their demand curve slopes upwards from left to right, as the higher the price, the greater
the quantity demanded
E.g. Mona Lisa
Giffen Good Goods where the income effect of a price change of ingerior goods is greater than
substition effect. when PED is positive
E.g. Instant Noodles
Normal GoodA good or service for which demand increases when income increases.
E.g. Cars
Indirect Tax 91

Tax imposed by the govt directly on spending

Includes both fixed and ad valorem taxes
Example: 12% sales tax in PH
Subsidy government payment to producers of goods and services
Ex: 20 billion subsidy in USA for agriculture

Laffer Curve Graphical representation of the relationship between tax rates and total revenues raised by
taxation. The curve illustrates that higher tax rates will generate a lower tax revenue for
govt, but the supply side incentive of lower tax rates will incentivize entrepreneurs to
earn more, and also create jobs for others who will also pay more tax to the treasury.
Complementary Goods or Service
Exists when the change in the price of one good or service
Results in the opposite change in quantity demanded of another good or service
E.g. cars and gas
Substitutes goods and services that may be used in place of another
Ex: PS3 and Xbox
Elasticity
Measure of the responsiveness of one variable to a change in another variable
Cross Price Elasticity of Demand (CPED/XED)
A measure of the responsiveness of the quantity demanded of a good or service to a
change in price in a related good or service
CPED = (% change in QD of Good A / % change in P of Good B) x100
Income Elasticity of Demand (YED) The responsiveness of the quantity demanded of a good or service to a change in income.
YED = (% change in QD / % change in Y) x 100
Price Elasticity of Demand (PED) The responsiveness of quantity demanded of a good or service to a change in its price
PED = (% change in QD / % change in P) x 100
Price Elasticity of Supply (PES) The responsiveness of the quantity supplied of a good or service to a change in its price
PES = (% change in QS / % change in P) x 100
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Perfectly Elastic Demand Demand with an elasticity of infinity

(horizontal line)
Perfectly Elastic Supply Supply with an elasticity of infinity
(horizontal line)
Perfectly Inelastic Demand Demand with an elasticity of 0
(vertical line)
Perfectly Inelastic Supply Supply with an elasticity of 0
(vertical line)
Market Economic System A system where individuals, rather than governments, own the factors of production and
decide what, how and when to produce.
Capitalism
An economic system in which the productive resources are owned by
individuals/corporations
Mixed Economy An economic system in which the economic decisions regarding the allocation of scarce
resources is partly determined by the private sector and partly by the government.
Eg: USA
Command Economy
Economic system in which the government controls all or the majority of FOPs, makes
decisions about the allocation of scarce resources and the distribution of income
E.g. North Korea
Free Goodis any good or service that is abundant.
E.g. Oxygen
Inferior Good Good where quantity consumed decreases as income increases.
Example: cup noodles
Free RiderSomeone who consumes a good or service without paying for it.

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MARKET FAILURE
Market Failure Occurs where markets do not work at all or do not work well. It refers to the failure of the
price mechanism to achieve an optimum allocation of resources.
E.g. USA: Amtrak - monopoly train company - productively & allocatively inefficient
Merit Good Good or service that is socially desirable
It has positive externalities and is often underprovided and underconsumed in a free
market
E.g. vaccinations: prevents the spread of disease
Demerit Good
Good or service that is socially undesirable. Usually over consumed and over produced.
Opposite of a merit good
E.g. cigarettes: second hand smoke
Public Good A good or service that is non-excludable and non-rivalous
E.g. park benches
Externality
The effect of production or consumption that is not taken into account by producers or
consumers
That affects the utility or costs of other producers or consumers
E.g.
Positive Externalities Non-market activity that positively affect other people
E.g. PH: (Education) rED (Renovate to Educate) adult literacy rate, employment,
income

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Negative Externality Market activity that negatively affects other people. It is a form of market failure. It
normally comes from demerit goods.
E.g. Pollution from cars
Social Costs Costs of a good or service that are not borne by the producer but by society as a whole.
They include the cost of negative externalities.
E.g.
Marginal Social Benefit (MSB) The total value of benefit from one additional unit of consumption. It includes benefits to
the buyer + indirect benefits to society.
Marginal Social Cost (MSC) The total cost of producing one additional unit of output.
Includes costs borne by the producer plus any indirect costs borne by society.
Ad Valorem Tax
An indirect tax on a good or service imposed by there government
Where the amount of the tax depends on the value of the good or service
E.g. PH: 12 % sales tax
Specific Tax is a tax set at a fixed amount per unit on a good or service.
Ex: 45 pence per unit of Alcohol in UK
Maximum Price / Price Ceiling Price imposed BELOW the market equilibrium price. It is designed to help consumers by
making the price cheaper.
Ex: PH: Mackerel Scad 120PHP/kg
Minimum Price / Price Floor Price imposed ABOVE the market equilibrium price
Designed to assist producers.
Ex: UK: 45 pence per unit of alcohol
Parallel Market
Refers to the unofficial economic activity in a country
It cannot be precisely measured because the value of the activities is not officially
recorded in a countrys accounts
E.g. Greece- if parallel market is included, GDP would increase by 2% (2014)
E.g. UK if parallel market (drugs & prostitution) is included, GDP would increase by 10
billion GBP (2014)
THEORY OF THE FIRM
Microeconomics The study of the behaviour of households and firms and how the prices of goods and
services are determined.

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Returns to Scale refers to increases in output that result from increasing all inputs by same percentage
Constant Returns of Scale
Exists when the percent change in a firms output equals the percent change in its inputs
Increasing Returns to Scale Occurs when output increases more than proportionally to the increase in inputs
Decreasing Returns to Scale
Occurs when an increase in a firms inputs results in a less than proportional increase in
output
Diminishing/Marginal Returns
Occurs at a point when a continual increase in a variable FOP applied to a fixed FOP
results in a less than proportional increase in output
Law of Diminishing or Marginal Returns States that at some point, continual increase in a variable FOP applied to a fixed FOP will
result in a less than proportional increase in output
Diseconomies of Scale
Exists when an increase in output leads to an increase in the LR average costs
E.g. Amazon- organize shipping by size, rather than destination
Economies of Scale
Occurs when increasing the scale of production leads to a lower cost per unit of output
E.g. Walmart receive a bulk-buying discount
Accounting Profit
The difference between total revenues and total explicit costs
AC = TR TC
(if TR > TC +AC) & (if TR=TC breakeven) & (if TR < TC AC)
Total Cost (TC) is the sum of the costs of all the inputs used in production.
TC = TFC + TVC.
Fixed Costs (FC)
Refers to the costs that do not vary with output in the short run
In the long run, all costs are variable
Total Fixed Costs (TFC) is the cost of all the fixed inputs.
Average Fixed Cost (AFC)
Total fixed costs divided by the number of units produced
AFC = TFC / Q
Marginal Cost (MC) The change in total cost for the last unit increase in the variable input.

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Average Total Cost (ATC)

Total costs divided by the number of units produced
ATC = TC / Q
Total Variable Costs (TVC) is the cost of all variable inputs.
Variable Cost (VC) Cost that varies with the output level
Average Variable Costs (AVC)
Total variable costs divided by the number of units produced
AVC = TVC / Q
Total Revenue (TR) is the price of goods or services multiplier by quantity sold.
TR = P x Q.
Marginal Revenue (MR) The change in total revenue resulting from selling one more unit.
Long-Run Average Cost (LRAC) Curve
The cheapest way to produce goods and services
It is derived by joining the minimum points of the various SRAC curves
Variable Inputs Inputs whose quantity can be varied in the short run
Economic Profit (Supernormal)
Extra profit a firm earns
Over the combination of accounting and normal profit
Normal Profitrefers to the opportunity cost of capital
Shut Down Point when a firm is just covering its total variable costs.
Consumer Surplus
The difference between the amount a consumer is willing to pay and the amount that is
actually paid
Producer Surplus The difference between a producers total revenue and the opportunity cost of production
Market Structure -

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Primarily classified by the degree of competition that exists in the market. Structures
range from perfect competition through to monopoly.
Monopoly is a type of market structure where a single supplier that supplies the whole
industry.
Characteristics: high barriers to entry or exit, high concentration, high product
differentiation
Monopoly: Meralco in PH
Imperfect Competition The many market structures that fall between the two extremes of perfect competition
and monopoly
E.g. PH - monopolistic competition of coffee shops - Coffee Bean, Starbucks, Seattles
best
Duopoly
Market structure where there are only two sellers in a market
Interdependence plays a major role in price determination
E.g. Boeing and Airbus
Oligopoly Type of market structure in which a small number of producers compete with each other
Characteristics: imperfect information, high concentration, high barriers to enter or exit,
some product differentiation
E.g. USA: cell service providers: AT&T, Verizon and T-Mobile
Monopolistic Competition is a type of market structure in which large number of firms
compete with similar items.
Characteristics: imperfect information, low concentration, low barriers to entry or exit,
low product differentiation
Example: fast food industry in US
Perfect Competition Market structure in which the decisions of buyers and sellers have no effect on the market
price
Consumer sovereignty is maximized
Characteristics: Perfect information, no concentration, no barriers to enter or exit, no
product differentiation
Probably does not exist in real life, but a close example isE.g. PH: fake DVD industry in Greenhills Shopping Mall/ fish in Tsukiji Fish market
Contestable Markets
Refers to markets where entry and exit is free,
Thereby allowing greater competition in an industry
Competition
Rivalry among buyers and sellers of the inputs and outputs of the FOPs
Concentration Ratio

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The percentage of all sales contributed by a small number of the largest firms in an
industry
Barriers to Entry
A form of protectionism
Often imposed by governments to protect their domestic industries.
Obstacles placed to make it difficult for firms to enter an industry and
Provide competition to existing suppliers of a good or service.
E.g. US Postal Service- legistlation - government imposed law saying USPS is the only
one allowed to deliver mail
Product Differentiation Refers to real and/or perceived slight differences in a good or service
Monopoly Power exists where producer sovereignty is maximized.
Collusive Oligopoly
When oligopolies set prices to prevent a price war from occurring
E.g.
Cartel
When a group of producers begin a collusive agreement
To limit output and control supply
In order to raise prices and profits
Results in increased producer sovereignty
E.g. OPEC- Organization of Petroleum Exporting Countries
Collusion
Situation where a group of individuals/firms join together, either officially or unofficially,
to exercise greater producer sovereignty
E.g. International Tea Producers Forum (6 major tea producing nations cartel)
Ex: Recently found that Panasonic and Samsung were holding back supply of cathode
ray tubes for TVs between 1996 to 2006
Non-price Competition generally refers to the branding and advertising of products/services to increase sales,
market share and profits by firms, without having to engage in price competition.
E.g. Blackberry Superbowl Ad Campaign - $4 million (2013)
Kinked Demand Curve Pricing model in an oligopolistic market structure that shows that rivals follow one firms
decision to decrease price, but do not follow an increase in price, of a good or service.
Allocative Efficiency
Occurs when no resources are wasted;
When no one can be made better off without making another worse off
Occurs when P < MC
E.g.

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Productive Efficiency (aka Technical Efficiency)Exists when a firm is producing output with the minimum amount of inputs
The incentive for a firm to achieve this is the profit motive
MACRO
Macroeconomics study of the whole economy and its aggregates.
Macroeconomic Equilibrium occurs where the quantity of Real GDP demanded and supplied meet. It is where AD =
SRAS.
Macroeconomic Objectives refers to the five key macroeconomic issues that are of concern to governments:
economic growth, economic development, full employment, price stability, and external
equilibrium.

Gross Domestic Product (GDP) The value of a countrys total output of goods and services before depreciation
AD = C + I + G + (x - m)
National Income = W + I + R + P
National Output = Output of Primary + Secondary + Tertiary Sector
E.g. Madagascar $10.05 billion (2012)
Real GDP is the nominal value of output of final goods and services adjusted with inflation using
GDP implicit price deflator.
Ex:
GDP per Capita The gross domestic product divided by the population
GDP per Capita = GDP / population
E.g. Ghana 3300 USD (2012)
GDP Implicit Price Deflator An index that measures the changes in prices of all goods and services produced in an
economy
Purchasing Power Parity (PPP) Exists where money has equal value across countries
Double Counting
Exists when expenditure is counted on both intermediate and final goods and services
It is avoided in the preparation of national accounts
E.g. Brazil largest producer of sugar, counted in GDP as sugar and bakery goods
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Human Development Index (HDI) (a UN measure) measures the average achievement of a country in three dimensions of
human development - life expectancy at birth, adult literacy rate and purchasing power
through GDP per capita (PPP USD). The maximum level is 1.
E.g. Norway 0.955 (2012)
E.g. Burundi 0.355 (2012)
Aggregate Demand (AD)
Refers to the relationship between the aggregate quantity of goods and services
demanded or Real GDP and price level the GDP deflator holding everything else
constant
AD = C + I + G + (x m)
Aggregate Demand Shock
Is any shock, such as 9/11 or war, which causes the AD curve to shift left or right
E.g.
Aggregate Supply Curve
The relationship between the planned rates of total production for the whole economy
and the price level
Aggregate Supply
The sum total of planned production for an economy
AS = Output of Primary + Secondary + Tertiary Sectors
Short Run Aggregate Supply (SRAS) is the relationship between Real GDP and the price level, holding everything else
constant.
Short Run Aggregate Supply (SRAS) is a CURVE showing relationship between Real GDP and the price level, holding
everything else constant.
Aggregate Supply Shock
Is any shock, such as 9/11 or a dramatic change in weather, which causes the AS curve to
shift left or right
E.g. Typhoon Haiyan
Supply Side Policies refer to government policies designed to increase output. Examples include tax reductions
and concessions.
Ex:
External Shock
Relates to an unexpected shift in the AD and/or AS
Long-Run Aggregate Supply (LRAS)
The relationship between Real GDP and the price level at full employment- at its natural
rate.

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Inflation Sustained increase in the general price level

Measured by the consumer price index (CPI)
E.g. PH - 7.6% (2014)
Cost-Push Inflation
Refers a sustained increase in the general price level
Resulting from an increased cost in the inputs of the FOPs
E.g. UK- increased minimum wage to 6.50GBP per hour --> 1.9% inflation
Demand-Pull Inflation
Refers to a sustained increase in the general price level
Resulting from an increase in aggregate demand
E.g.
Stagflation refers to the combination of very high rates of inflation and very high rates of
unemployment.
Accelerator
Refers to when a percent change in demand results in a larger percent change in
investment
Multiplier is the change in equilibrium Real GDP divided by change in autonomous expenditure,
causes Real GDP to change.
K = how much the AD shifts left or right in response to a change in income or spending.
Ex: US: Military Defense Spending (known by research to be) 3.6
Business Cycle
Refers to the fluctuations in economic activity over a period of time
Usually measured by Real GDP and other macroeconomic variables
Recession is a decline in Real GDP in two or more successive quarters.
EX: Greece
Creeping Inflation
Sustained low rate of increase in the general price level (1-3%)
Considered good for the economy
E.g. Germany- 1.7%
Deflation
Sustained decrease in the general price level
Often accompanied by a decrease in total output and an increase in unemployment
E.g.
Above Full Employment Equilibrium

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Exists when macroeconomic equilibrium occurs at a level of Real GDP above long-run
aggregate supply (LRAS).
E.g.
Unemploymentis the number of adult workers who are not employed but are seeking jobs. The figure
includes frictional, seasonal and structural unemployment.
E.g. UK: 6.9% (Feb 2014)
Seasonal Unemployment refers to unemployment caused by seasonality in demand or supply of a good or service.
Ex: ski instructors who dont have a job during summer
Structural Unemploymentrefers to the type of unemployment that results from a fundamental change in the
structure of the economy.
Example: 525 miners being laid off when mines closed in Kentucky (2013)
Classical Unemployment (Real Wage)
One of the two types of unnatural/disequilibrium unemployment
Caused when labor unions or minimum wage legislation holds real wage above the
equilibrium level
Not allowing the market to clear
E.g. Greece: lowered minimum wage 683.76 EUR/month
Cyclical Unemployment (Keynesian, Demand Deficient)
One of the two types of unnatural/disequilibrium unemployment
Unemployment resulting from a downturn in the business cycle that results in recession
Occurs when total demand is insufficient to create full employment
Demand-Deficient Unemployment (Cyclical, Keynesian)
One of the two types of unnatural/disequilibrium unemployment
Occurs as a result of a fall in the aggregate demand of goods and services
Leads to a decline in the demand for labor
Frictional Unemploymentrefers to unemployment caused by new entrants into the market, technological change
and geographic movement of workers.
E.g. banker who quit his job in HSBC and is looking for a job elsewhere.
Full Employmentexists when the labour market clears allowing for structural, seasonal and frictional
unemployment. Also known as the natural rate of unemployment. It is one of the five
major macroeconomic objectives.
Close E.g.: Thailand: unemployment rate = 0.6 (2012)
Fiscal Policy

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Refers to the governments policy on taxation (direct and indirect), government

expenditure and transfer payments, and their effect on aggregate demand and aggregate
supply
E.g. US: 20 billion subsidy on agriculture
E.g. India: 28 billion subsidy on infrastructure (2013)
Monetary Policy
refers to changes in the money supply and interest rates to affect aggregate demand and
aggregate supply. In most countries, these policy decisions are made by the Central Bank.
Ex: Thailand cut OCR by 2%
Keynesian Theory Advocates government intervention due to the inherently unstable nature of the economy.
It favors Fiscal Policy measures to correct macroeconomic problems in the economy.
Laissez-Faire A viewpoint that advocates non-government intervention in an economy.

Infrastructure The basic physical systems of a countrys or communitys population, including roads,
utilities, water and sewage. These systems are considered essential for enabling
productivity in an economy. Developing infrastructure often requires large initial
investment, but the economies of scale tend to be significant.
Economic Development
Occurs in a country where there is an increase in Real GDP per capita
Plus an improvement in the standard of living
One of the five major macroeconomic objectives
Sustainable Economic Development refers to the use of the factors of production by the current generation that result in the
resources being available for future generations.
E.g. Iceland: 100% of energy produced by renewable resources
Economic Growth
Increase in a countrys real GDP per capita
One of the five major macroeconomic objectives
External Equilibrium
Concerned with the balance of payments on the current account of a country
Whether its in balance, surplus or deficit
The attainment of balance over a period of time is an indication that a country can pay its
way in the world
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Persistent deficits obviously indicates that a country is living beyond its means
It is one of the five major macroeconomic objectives
Less Developed Country (LDC)
Refers to countries with a low standard of living, such that many people do not have the
basic necessities of life such as adequate food, water, clothing, health and education.
E.g. Guinea - HDI: 0.355 (2012)
Most Developed Country (MDC) refers to a country where its people have the basic necessities of life, plus the majority of
people have money for luxuries. A country that has a high level of economic development
- Real GDP per capital plus a high standard of living.
Eg: Canada - HDI: 0.911 (2012)

TRADE
Absolute Advantage
Exists when one country can produce a good or service with less resources or FOPs than
another country
E.g. Saudi Arabia over the UK for oil
Comparative Advantage
Exists when a country can produce a good or service at a lower opportunity cost than
another country
E.g. USA- 700 million gallons of wine/ year, Italy- 4 billion gallons of wine/ year. Italy
can produce more wine (output) in the same amount of time (input) than the USA
Appreciation
Increase in the value of a domestic currency in terms of other currencies
Occurs as a result of market forces in a free float exchange rate system
E.g.
Depreciation Reduction in the value of a domestic currency in terms of other currencies
Occurs as a result of market forces in a free float exchange rate system
E.g.
Capital Flight
The movement of domestic financial capital across international boundaries
Usually caused by domestic problems, such as war or insurgency, and

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Results in problems of capital deepening, particularly for LEDCs, leading to increased

international debt
E.g. Russia capital outflow of 25.8 billion USD (2013)
Infant Industry Argument The argument for governments to protect newly established industries from foreign
competition, to enable them to grow domestically and internationally
Balance of Payments (BoP)
An account of a countrys transactions with the rest of the world
Dumping
When the price of a countrys exports is below the true cost of production
E.g. Bra wars
Protectionism The restriction of international free trade by governments
Measures include quotas, tariffs, embargoes and import duties
E.g. Ghana: 59% tariff on electricity (2013)
Embargo
Total ban on trade. Form of protectionism. May be imposed by a domestic government or
from outside the country
E.g. Embargo on Cuba by the US
Quotasare restrictions on the quantity of a good or service that a firm is permitted to sell or that a
country is permitted to import.
E.g. 34 international movies in China
Tariffsare taxes imposed by the government of an importing country. They are a major form of
protectionism, particularly of agricultural protectionism by the USA, EU and Japan
against agricultural imports from LDCs.
E.g. up to 747% on rice in Japan
Voluntary Export Restraint (VER) A self imposed restriction by an exporting country on the volume of its exports
E.g.
Imports The purchase of goods and services from another country
Exports
Goods and services sold by one country to another
Dirty/Managed Float
Exists when a government intervenes in the managed float of its currency
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Creating an artificial price or value of a currency

Generally unsustainable in the LR
E.g. China 6.1CNY to 1USD
Free Floatis one where the price of one currency against another is determined by market forces on
the foreign exchange market.
E.g. Philippines - 1 USD is 44.44 PHP

Fixed Exchange Rates

Exists with the price of one currency against another is fixed on the foreign exchange
market
E.g. $1 Hong Kong is $0.13 US
E.g. 1 Cuban CUC to 1USD
Pegged Currency Exists where the price of one currency is fixed to another
E.g.

Foreign Direct Investments (FDI) Refers to the investment by overseas firms in another country. Majority is undertaken by
MNCs.
E.g. India: Tesco and Vodaphone cleared to invest over 1.5 billion USD (2014)
Free TradeRefers to the movement of goods and services without protectionist barriers
J-Curve Effect The way and the time frame in which the trade balance may initially worsen before
improving, after a depreciation in the exchange rate
The J-Curve above shows that a deficit may be reached before a surplus.
Marshall-Lerner Condition States that if the PEDx + PEDm > 1, then a depreciation of the exchange rate will
improve the balance of payments. If the PEDx + PEDm = 1, then the BOP will remain
unchanged. If the PEDx + PEDm <1, then a depreciation will worsen the BOP.
DEVELOPMENT
Development
Process that improves the lives, or standard of living, of all people in a country.
Includes both tangible and intangible factors
E.g.
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Standard of Living covers range of tangible and intangible goods & services and benefits that people enjoy in
a society.
Includes health care, education, free speech, employment, and freedom from oppression.
Poverty Those members of society who cannot enjoy the basic necessities of life
There are two types of poverty: absolute and relative
E.g. USA: family of 4 considered in poverty when income < 23550 USD
Absolute Poverty
Exists when only the minimum level of basic needs such as food, shelter, and clothing
can be met.
E.g. UN 1.5 billion people live under $1 a day (regarded as^)
Relative Poverty exists where a proportion of the population in a country cannot enjoy the standard of
living normal to their society.
Will always exist where there is a substantial degree of income and asset inequality
within a society
E.g.

Lorenz Curve
Measures the inequality within a population
The Lorenz curve above shows that Finland is more income equal than South Africa
because it is closer to the line of perfect equality.
Aid
Money and/or goods and services provided to a country
From private investment and/or Overseas Development Assistance
It can be tied where the donor country imposes certain conditions or untied
E.g. UK - 60 million GBP to PH for Typhoon Yolanda (2013)
Foreign Aid
refers to assistance to a country from private sources or public bodies from outside a
country. For LDCs, it is a major source of financing BOP current account deficits.
E.g. ADB
Crowding Out
The likelihood that an increase in government expenditure will result in an increase in
interest rates
Thereby crowding out private investment because firms borrowing costs are higher
E.g.: ObamaCare and Medicaid in US crowding out private health insurance

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Globalization The process of breaking down barriers between countries

Resulting in greater integration and interdependence
E.g.
Globalized Economy The movement - through globalization - to a borderless economy
Multinational Companies/Corporations (MNC) Companies that have production units in more than one foreign country (also known as
TNCs).
Ex: Coca Cola/ Nestle
E.g. Gap: over 135000 workers worldwide

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