GCE A level Economics - Global Economy

Name 5 strategies to promote growth and development:

Aid, debt cancellation, investment (humans, agriculture, manufacturing and tourism), inward/outward looking strategies, interventionist approaches, free market approaches, microfinance and fair trade.

What kinds of aid are there?

Emergency aid, Tied aid (condition attached), bilateral aid (one country gives to another) and multilateral aid (countries give to an organisation).

Name 5 benefits of aid.

Decrease absolute poverty
- Fill saving gap
- Provide funds for infrastructure (allows for industrialisation)
- Improves human capital
- Aid may contribute to increases in globalisation and trade
- The reduction of world inequality

Name 5 disadvantages of aid

Results in dependency culture
- May not benefit intended recipients (due to corruption)
- There is no clear evidence that aids contributes to the reduction of absolute poverty or to growth and development
- Right wing economists argue aid distorts market forces and leaves inefficient allocation of resources
- Left-wing economists argue aid is a form of economic imperialism whereby political influence is desired
- Aid derived from concessional loans include interest which has an opportunity cost

Why is debt cancellation called for?

Countries such as Gambia struggle to service the debt, making repayments representing a disproportionate amount of public expenditure.

Name 5 arguments for the cancellation of debt.

Developing countries would have more foreign currency to buy from developed countries
- If money released from debt cancellation is spent on capital goods then potential economic growth
- Help reduces absolute poverty as less money spent servicing debts
- Reduce the savings and foreign exchange gap
- May help conserve the environment (e.g debt for nature swaps)

Name 5 arguments against the cancellation of debt

Debt cancellation programmes take longer than aid
- Unless conditions are attached, there's no guarantee that the countries will persue sound macroeconomic policies
- Corruption might misplace financial benefits
- Shareholders in banks in dev. countries may bear the burden of debt cancellation
- May be less effective than policies to reduce protectionism in developed countries

What is seen as the most effective investment in human capital? Evidence suggests that investment in primary education in developing country yields higher return than other types of education (promotes literacy)

Why might a country benefit from investment in agriculture?

- Because they have a comparative advantage and thus resources are allocated more efficiently
- Can benefit financially from selling goods with a high income elasticity of demand

Why is it seen that investment in manufacturing will aid growth/development?

The structural/dual sector mode (Lewis model) is based on the view that development requires a move away from traditional agriculture (subsistence farming) to more productive manufacturing.

Name the 5 key features of the Lewis model

Describes the transfer of surplus labour from low productivity agriculture sector to high productivity industrial sector
- Because of excess worker supply, marginal productivity (MP) of agricultural workers may be close to zero (diminishing returns)
- With MP zero, opportunity cost of transferring workers from agricultural to industrial sector would be zero
- Industrialisation associated with investment (transnational firms?) which will increase productivity and profitability, which when invested will further increase growth
- Share of profits as a percentage of GDP will increase as will the savings ratio, providing more funds for investment and continued economic growth.

List 3 criticisms of the Lewis model

- Profits made in the industrial sector might not be invested locally, especially if they are transnational firms
- Reinvestment may not take the form of capital equipment
- Empirical evidence suggests the assumption of surplus labour in the agricultural sector and full employment in the industrial sector is invalid, e.g. favelas (slums) in South America

Name 5 advantages of the tourism to a developing country

likely to attract investment by transnational hotel chains which will in turn increase GDP by the multiplier
- Jobs will be created direct and through the multiplier
- Increased GDP and investment will mean more tax revenue = better public services
- Can help preserve national heritage of a country (Egypt)
- Foreign investment may lead to better infrastructure (new roads?)

Name 5 drawbacks of tourism to a developing country

- May mean an increase on imports and BOP will be affected by TNCs repatriating shareholders
- Tourism is income elastic - tough times in a recession
- Employment may only be seasonal and low paid (TNCs may bring in own managers)
- Tourism can be subject to fashion (Spain has seen a loss of custom from Europeans)
- Externalities (increase in waste, pollution)

What are inward and outward-looking strategies?

Strategies adopted by countries to work towards diversification and industrialisation.

Name 2 inward-looking strategies

Import substitution (replace imports with domestically produced manufactured goods) and protectionism.

What is the desired effect of inward-looking strategies?

To enable a country to diversify in a controlled way until its domestic base is strong. This will be most effective where the country's domestic market is large enough to allow for economies of scale.
When achieved the industry will be strong enough to cope with foreign competition.
What are the 2 main drawbacks of inward-looking strategies?
- Comparative advantage is distorted and so resources will be allocated inefficiently
- the lack of foreign competition may result in inefficiency
Name 4 types of outward-looking strategies
- Free trade
- Deregulation of capital markets
- Promotion of foreign direct investment
- Devaluation of exchange
What were post WW2 government interventionist practices characterised by?
- Import substitution policies
- Nationalisation
- Fixed lower prices for farmers to sell to state cont. boards
- Price subsidies on necessities
- Over-valued exchange rate (aimed at keeping down the cost of imports)
What negative effects did the post WW2 government strategies lead to?
- Low economic growth
- Resource and allocative inefficiency because of no profit motive
- Government failure
- Corruption by civil servants
- Increasing fiscal deficits (from subsidies and nationalised ind.)
- Increasing BOP (over valued currency)
What are the key components of free market approaches?
- Free market analysis (assumes markets are efficient and the best way to allocate markets)
- Public choice theory (politicians, civil servants and governments use their power for their own self interest)
What will a free market be characterised by?
- Trade liberalisation
- Market liberalisation
- Supply side policies
- Structural adjustment programmes


Why have modern governments seen the need to intervene in a market-friendly way?
- Asymmetric information
- Externalities
- Absence of property rights
- Investment decisions
What are the four key features of microfinance?
- offers poor families small loans (microcredit)
- differs to development lending in that it insists of repayment
- interest charged to cover costs
- focus on groups where the only alternative is the high interest informal sector
Who are the main customers of microfinance?
- women (over 97% of clients)
- self-employed, often household-based entrepeneurs
- small farmers in rural areas
- small shopkeepers, street vendors and service providers in urban areas
What do fair trade schemes aim to do?
'address the injustice of low prices' by guaranteeing that producers receive a fair price. This is done by paying an above-market price, provided certain labour and productions standards are met.

Name 4 benefits of fair-trade schemes
- Producers receive a higher price
- Extra money to spend on education, health, conversion to organic farming and other development programmes
- Smaller price fluctuations allowing producers to be shielded from market forces
- Extra money can be used to increase product quality
- Producers are enabled to diversify into other products
What criticisms of fair trade schemes are there?
- Distorts market forces: lower prices should be a signal to switch to growing other crops
- Certification based on normative views on how to organise labour
- coffee fair trade only avail. to co-ops of small producers
- no incentive to improve quality
- only 10% of premium trickles to producer
- may create a dependency trap for producers

What is globilisation? Globilisation refers to a variety of ways in which countries are becoming more and more closely integrated, economically, culturally and politically.

What is globalisation characterised by?
- An increase in trade as a proportion of world GDP
- Increased movements of financial capital between countries
- Increased international specialisation and division of labour
- a growing importance of transnational companies (TNC) and foreign direct investment
Give 5 reasons for recent modern globalisation
- Fall in transport and logistical costs
- Decline in the cost and increase in the efficiency of communications
- Lowering of trade barriers since WW2
- thanks to WTO negotiating reductions in tariffs
- Collapse of communism and opening of China opens up new countries (good for TNCs)
What are the benefits of globalisation?
- enables law of comparative advantage allowing an increase in world output and living standards
- for consumers a wider variety of goods at a lower price
- for producers, lower production costs, markets and economies of scale
What are the disadvantages of globalisation?
- promoted exploitation of workers, children, farmers and the environment
- external costs (global warming due to 'food miles', less legislation in developing countries)
- Increase inequality as the rich can take advantage of internet
- Liberalisation and integration of financial markets may lead to increased global instability
How can international trade be measured?
Exports as a proportion of world GDP.
What does the law of comparative advantage state?
If a country has an absolute advantage in the production of all goods, it can still benefit from specialisation and trade if it specialises in the production of goods in which it has a comparative advantage. The main prerequisite is that there is a difference in the opportunity cost of producing the products.
Where does the terms of trade have to be in order for trade to be beneficial?
Between the opportunity cost ratios.
How does one measure the terms of trade?
index of export prices
------------------------------- X 100
index of import prices


What are 3 criticisms of the law of comparative advantage?
- Free trade doesn't have to be fair trade (monopsony power can be exerted on develop. countries)
- The law is based on unrealistic assumption. such as constant production costs, zero transport costs and no barriers to trade.
- The law does not take into account the future of certain products (a country may be more efficient at producing petrol engines but if the demand for it is going to shoot down in the future then it will be a poor strategy to gear a country up for producing it)
Name 5 arguments for protectionism
- to protect infant industries (too small for econ. of scale)
- to protecti geriatric industries (firms need time to restructure)
- ensures employment
- prevents dumping
- correct BOP deficit on current account
- restrict imports from countries without adequate H&S+env regs
- Strategic reasons (less depedant in war?)
- Raise tax revenue via tariffs
- In retaliation to other countries
What are the 4 main types of protection/ import barriers?
Tariffs, quotas, subsidies (to domestic producers), administrative regulations and by artifically holding down a fixed exchange rate to be more competitive (China accused)
What are tariffs and how do they affect the market?
They are taxes on imported goods (custom duties).
When imposed they -
- increase P
- reduce consumers' surplus
- rise domestic output, increase producer surplus
- reduce imports
- create a deadweight, net welfare loss
What do quotas do?
Place a physical restriction on the amount of goods that can be imported. They have a similar effect to tariffs by increasing prices of imported goods and increasing the revenues of domestic produces, but do not give extra tax revenue.
What do subsidies to domestic producers do?
They are grants given to domestic producers that artificially lower their production costs, enabling their goods to be more competitive domestically and internationally.


How do administrative regulations act as a barrier to trade?
Via labelling, H&S regs, environmental standards and country of origin documentations such regulations increase the costs of foreign producers.
Name 4 arguments against protectionism.
- inefficient resource allocation (trade barriers distrt comparative advantage and reduce specialisation, reducing world output + so living standards)
- higher prices and less chocie for consumers
- less incentive for domestic producers to become more efficient
- can be hard to remove considering the effect on domestic producers and their dependancy on trade barriers
What does the World Trade Organisation do?
Liberalises trade by lowering trade barriers, settles disputes between member countries and provides a system of trade rules. It does this by providing the government with a forum for negotiating trade agreements.
Name 2 of WTOs set of principles
- Most-favoured-nation principle implying that countries shouldn't favour between trading partners (tariffs should be reduced to all countries not just one)
- National treatment whereby imported and locally produced products must be treated equally once the foreign goods have entered the market.
How can the WTO's work be seen as less successful?
- Reducing barriers to trade in services hasn't gone so well
- Non-tariff barriers such as administrative regulations have offset some of the gains from tariff reduction
Explain and describe the 4 kinds of trading blocs?
- Free trade areas (trade barriers removed between member countries)
- Customs unions (Free trade between member states and a common external tariff. Eg. EU)
- Common markets (custom unions with the added bonus of being able to freely move around factors of products eg. labour)
- Monetary unions (custom unions that adopt a common currency eg. the Euro)
Explain and describe the consequences of trading blocs.
- Trade creation (removal of trade barriers= inc. specilisation)
- Trade diversion (member countries can buy goods from other member countries rather than countries outside bloc)
What is the current account composed of?
- The trade in goods balance (val. of goods export. - val. of goods import.)
- Trade in services balance (val. of services export. - val. of goods import.)
- Income balance (income flows into country from non-re sidents minus income flows out of country from residents to non-residents)
- Current transfers (food aid, UK's contribution to the EU's Common Agricultural Policy)
What is included within the capital and financial account?
Transactions associated with changes of ownership of the UK's foreign financial assets and liabilities including foreign direct investment (FDI), shares, bonds, changes in foreighn exchange reserves and short-term capital flows ('hot money').
Why has the UK had a large deficit on the current account in recent years?
- high value of sterling '96-'08
- continuous economic '92-'08
- relatively low productibity of the UK's workers resulting in higher average costs
- relocation of manufacturing to countries with lower labour costs
- 'Chindia effect', the industrialisation of China and India has led to a flood of cheap imports into the UK
What is an exchange rate?
The price of one currency in terms of another.
List 5 causes of changes in the exchange rate
- Relative inflation rates
- Relative interest rates
- The state of the economy
- BOP on the current account
- Political stability
- Speculation
What are the direct effects of a change in the UK exchange rate?
- Price of exports from the UK cheapen
- more internationally competitive
- Price of imports into the UK increase
- Decrease BOP deficit
What is the Marshall-Lerner condition
For there to be an improvement in the current account, the Marshall- Lerner condition must be fulfilled (i.e. the sum of the price elasticities of demand for imports and exports must be greater than 1).
Why does the J curve effect occur in regards to exchange rates?
There could be a time lag before the full effects of a depreciation of currency work through the economy so that in the SR the sum of PED would be less than 1 but greater than 1 in the LR.
What happens to BOP in order to form the J curve?
The current account deteriorates since demand for imports is price inelastic in the SR because of contracts, stocks and adaptation to price changes.
In the LR, BOP improves as demand ofr imports and exports may become more elastic, and if the Marshall-Lerner condition is fulfilled, the current account will improve.
What are the 5 convergence criteria of the European Monetary Union (EMU)?
- Fiscal deficit below 3% of GDP
- Public sector net debt (national debt) less than 60% of GDP
- Inflation rate within 2% of the three lowest interest rates in EU
- Long-term interest rates within 2% of three lowest interest rates
- Exchange rates kept within 'normal' fluctuation margins of European's exchange rate mech.
What are the 5 tests set out by the chancellor to determine whether the UK should join the Euro?
- Are the business cycles of the UK and European economies converging so the European Central Bank's interest rates suit
- Are economies flex. enough to cope if there's external shocks to the world economy
- Will joining Euro...
...encourage FDI?
...be good for financial services
...promote higher economic growth, stability and a long-term increase in employment?
Name 4 main advantages of a monetary union
- No transaction costs (comiss.)
- Price transparency (to compare)
- Firms can benefit from economies of scale as trade conditions are eased
- Encouragement to TNCs to invest in Euro zone countries (little evidence)
Name 5 main disadvantages of a monetary unions
- Loss of independent monetary policy (can't set own interest rates)
- ECB aims to keep inflation below 2%, more stringent and deflationary than BOE's
- Loss of exchange rate flexibility against other Euro adopters
- Transition costs
- Meeting requirements of the growth and stability pact may result in slower economic growth
Define 'international competitiveness'
The extent to which a firm can sell its goods and services in domestic and international markets at a price and quality that is attractive in those markets.
How might international competitiveness be measured?
- Relative unit labour costs
- Relative productivity measures
- Composite indices
...such as the global competitiveness index
...contains 12 pillars of competitiveness



Name 5 factors that influence international competitiveness?
- Real exchange rate
- Wage & Non-wage costs
- Labour productivity
- Education and training
- Human capital
- Quantity of capital equipment per workers
- R+D
- Infrastructure
- Labour market flexibility
What is the real exchange rate?
The nominal exchange rate adjusted for changes in price levels between economies
= nominal exchange rate x foreign price level / domestic price level
Name 5 non-wage costs can influence international competitiveness
- NI contributions from employers
- Health & safety regs
- Environmental regs
- Employment protection and anti-discrimination laws
- Pension scheme contributions
What is the main way in which a government can promote international competitiveness?
Supply side policy.
They could potentially promote investment in capital equipment or a focus of quality and design (via subsidies perhaps?).
What is the World Bank's definition of poverty?
Where people have incomes below the minimum level to meet basic needs such as food, shelter, clothing, access to clean water, sanitation facilities, education and information. The World Bank has set international poverty lines at $1 and $2 (PPP). In 2008 the lower level was set at $1.25 at 2005 GDP (PPP).
What is relative poverty?
A subjective measure whereby people live below a certain income threshold in a particular country.
How is the human poverty index (HPI) calculated?

1.      % people who are not expected to reach 40
2. % people who are illiterate
3. % children who are illiterate and % population who do not have access to safe water and health care

What is the HPI-2 and how is it calculated?
A measure of poverty more relevant to developed countries.
Elements include...
1. Probability at birth of not surviving to age 60 (x100)
2. Adults lacking functional literacy skills
3. Population below income poverty line (50% of median adjusted household dispoosable income)
4. Rate of long-term unemployment (lasting 12 months or more)
Name 5 factors that influence inequality
- education and training
- wage rate
- inheritance
- ownership of assets. e.g. houses and shares
- pension rights
- unemployment
- social benefits
- the tax system
What is the Lorenz curve and how does it represent poverty?
It measures the degree of inequality by plotting the cumulative percentage of the population against the cumulative percentage of total income.
What is the Gini coefficient?
It is a measure of the degree of inequality and so income distribution in a country. It will have a measure between 0 and 1, with 0 showing abs. equality and 1 abs. inequality.
Measure by G=A/B
Name four consequences of inequality
- The very poor will not have the collateral needed to start businesses
- Absolute poverty remains high
- Those on low incomes will have low marginal propensity to save, limiting investment
- High income earners may spend a lot on imported goods or transfer earnings abroad
- social issues may increase (crime)
What is economic development?
A normative concept dependant on value judgements referring to changes in living standards and welfare over time.
How might one measure economic development?
The Human Development Index (HDI).

How is the HDI formulated?
- GDP per head (PPP)
- Health (measured in terms of life expectancy)
- Education (measured in terms of the school enrolment ratio and life expectancy)
How can one criticise the HDI?
Ignores indicators such as...
- % access to clean water
- % employed in agriculture
- energy consumption per person
- mobile phones per thousand
Name 5 problems with primary product dependency?
- subject to price fluctuations
- revenues and foreign exchange earnings entirely subject on price as inelastic demand
- difficulty of planning investment and output (due to price fluctuations)
- natural disasters
- protectionism by developed countries
- low income elasticity of demand products
- uncertain yields (poor harvest, or not finding as much copper as expected)
What does the Prebisch-Singer hypothesis state?
That countries that export commodities would be able to import less and less for a given level of exports. Terms of trade for primary commodity exporters had a tendency to decline due to manufactured good's greater income elasticity of demand, making their prices rise more rapidly relative to primary product prices.
Name 3 ways in which the Prebisch-Singer hypothesis can be criticised
- Some countries have developed on the basis of primary products (e.g. Botswana: diamonds)
- If a developing country has a comparative advantage then resources will be used more efficiently when specialising
- Primary product prices rose sharply until mid. 2008 whilst manufactured products were falling
- YED for some primary products is very great such as for diamonds gold
- Outlook for some countries can be very good such as Bolivia's ownership of over half of known reserves of lithium (for batteries)
How does the savings gap work?
Low incomes mean low savings which means low investment which results in low capital accumulation. Low capital accumulation then ends up continuing the cycle with low incomes earnt.
Why might there be a foreign exchange gap?
- Due to dependence on export earnings from primary products
- Due to dependence on imports of capital goods and other manufactured goods
- Servicing debt
- Capital flight
What is capital flight and how is it at detriment to a country's economy?
When individuals or companies decide to place cash deposits in foreign banks or buy shares or other assets in foreign countries.
This could mean a greater saving gap and foreign currency gap. This will lead to economic growth being restricted.
It will also mean a reduction in the tax base as the country loses tax payable on these assets.
Why has debt become a problem?
- Risky decisions to borrow are often made at times of low interest rates or at times of a strong economy
- increases in oil prices
- fall in the value of exchange rates, increasing the burden of foreign debt
- loans taken out to finance expenditure which do not aid the payback of the loan at all
How should the significance of a countries debt be assessed?
By its ability to serve the debts, not the absolute size of it.
What is corruption?
The use of power for personal gain. This might take the form of extortion, bribery and the diversion of resources to the governing elite.
What is government failure?
Where government intervention results in a net welfare loss.
What did Thomas Malthus say?:
That at the end of the 18th century, famine was inevitable as population grow geometrically where as food production grows arithmetically.
How relevant is Malthus today?
Even though his views were mainly proved wrong by the lack of famine in 19th century Britain, some cite they are relevant for developing countries today. Malawi and Mozambique are subject to this whereby population growth outstrips GDP, resulting in falling GDP per capita.
Why might their be a lack of human capital?
- Low school enrolment
- AIDS means that school fees can not be afforded by some parents as they do not work, many teachers stop teaching due to aids and the training of workers may be disrupted by AIDS, putting TNCs off.
How does a lack of human capital affect a country?
- Mainly slower rates of economic growth due to productivity of the workforce being low
What is the infrastructure?
Infrastructure includes a whole range of structures that are required for a smoothly running economy. This includes transport, telecommunications, energy supply, water supply and waste disposal.
What macroeconomic objectives are there?
Balance of payments
Inflation
Growth - sustainable
Fiscal balance
Unemployment - small
Redistribution of income
What is aggregate demand made up of?
CGI + (x-m)
Consumption, government spending, investment + net exports
What does aggregate demand show?
The relationship between GDP demanded and the price level
What may cause a shift in AD?
Change in -
Asset prices
Interest rates
FDI
Speculation about the economy
Exchange rate
Government spending changes
Tax rates
What does the short run aggregate supply curve show (SRAS)?
The relationship between the total quantity of final goods and services supplied (real output) and the price level, holding everything else constant.
What might cause the SRAS curve to shift?
Changes in wage costs
New legislation (health and safety leg may increase bus's costs)
Changes in the prices of raw material and components
Changes in taxation on firms
Changes in


What does the long run aggregate supply curve show?
The relationship between the total quantity of final goods and services supplied (real output) and the price level, where there is full employment.
What is the difference between neo-classical and Keynesian aggregate supply curves?
Keynesian economics holds that the economy can be at long-run equilibrium at less than full employment. The neoclassical models holds that the economy can only be in equilibrium at full employment, thus resulting in the vertical line.
What may cause a shift in LRAS?
Increase in capital stock
Increase in human capital
Greater access to raw materials
Technological change
The size of the labour force
What is the difference between monetary policy and fiscal policy?
Monetary policy refers to the use of interest rates, money supply and exchange rates where as fiscal policy refers to the use of taxation and government expenditure in order to influence the level of economic activity in a country.
What methods of monetary policy are there?
Changes in interest rates
Inflation targets
Quantitative easing
What kind of fiscal policy methods are there?
Automatic stabilisers
Discretionary fiscal policy
What are automatic stabilisers?
Government expenditures of revenues from taxes that change automatically in line with changes in GDP and the state of the economy.
Give 2 examples of automatic stabilisers.
Progressive taxation
Welfare payments such as unemployment pay and various means-tested benefits (e.g. pension credits for those on low income)
What is discretionary fiscal policy?
Deliberate changes in taxes and public expenditure designed to achieved a government's macroeconomic objectives.
E.g. public expenditure on infrastructure (roads and bridges in the USA), green technoogy and targeted subsidies to distressed industries (e.g. motor industry) and tax cuts.
What are supply side policies?
Policies aimed at increasing aggregate supply often targeting either labour, product or capital markers.
What are 3 supply side policies aimed at the labour market?
Increasing human capital
Decreasing employment benefits
Decreasing trade union power
'Back to work' schemes to increase the size of the labour market
Reduction in income tax rates
Reduction in employment protection legislation (makes employing workers more attractives for firms)
Name 3 supply-side policies aimed at the product market?
Take emphasis away from public sector - privatisation, deregulation and contracting out
Trade liberalisation
Promotion of new/small firms
Name 2 supply-side policies aimed at the capital market
Deregulation of the financial markets
Reduction in corporation tax/ capital gains
Name 5 criticisms of supply-side policies
Increased inequality
Time lags
The incentive effects of tax cuts may be over-estimated
Ineffectiveness
Adverse affects of deregulation (collapse of banking system due to excessive risks?)
What 2 problems face policy makers in their decisions?
Inaccurate information
Risks and uncertainties
What are the four elements of public finance?
Public expenditure
Taxation
Public sector net borrowing
Public sector net debt


How is public expenditure categorised?
Current expenditure - day to day expenditure on goods and services, e.g. salaries of teachers, drugs for the NHS
Capital expenditure - relates to expenditure on long-term investment projects such as new hospitals and roads
Transfer payments - payments made by the state to individuals in the form of benefits which there is no production in return

What is 'crowding out'?
Can refer to either resource crowding out or financial crowding out whereby actions by the public sector decrease availability or increase prices in the private sector.
Resource crowding out occurs when the economy is operating at full employment an an increase in public expenditure results in insufficient resources being available for the private sector.
Financial crowding out occurs when increased public expenditure or tax cuts are financed by increased public sector borrowing, so increasing demand for loanable funds and driving up interest rates.
Give 5 determinants of the size and pattern of government expenditure
Debt interest
Political party in power
GDP
Size and age distribution of economy (aging population = more pensions)
Redistribution of income and need for it as regards to poverty
Discretionary fiscal policy
What is the different between direct and indirect taxation?
Direct taxes are levied on income and wealth whereas indirect taxes are those levied on expenditure (e.g. VAT)
What three kinds of tax are there?
Progessive - proportion of income paid in tax rises as income increases
Proportional - the proportion of income paid in tax remains constant as income increases
Regressive - the proportion of income paid in tax falls as income increases
Name 4 implications of a change in taxation
Increase in taxes represent leakage from circular flow and so a downward multiplier effect on GDP
Increase in indirect tax on product will means leftward shift in the supply curve
Indirect taxes wold increase prices above marginal cost, resulting in allocative inefficiency, unless external costs are associated with the production of the product
Increase in indirect taxes cause cause further via wage-price spiral
Explain four effects of a change in income tax
Income distribution (progressive so less equitable?)
Incentives to work
Tax revenues (laffer curve - optimum % to maximise cash revenue)
Level of economic activity (changes amount of disposable income)
Explain five effects of a change in indirect taxes
Income distribution (VAT shown to be regressive, makes i.d less even)
Incentives to work (possible that peeps work harder to maintain standard of living)
Tax revenues (increase in indirect taxes would increase revenues assuming goods are price inelastic)
Rate of inflation
Economic activity (rise in vat a leakage from circular flow of income, downward multiplier)
Explain five effects of a change in indirect taxes
Income distribution (VAT shown to be regressive, makes i.d less even)
Incentives to work (possible that peeps work harder to maintain standard of living)
Tax revenues (increase in indirect taxes would increase revenues assuming goods are price inelastic)
Rate of inflation
Economic activity (rise in vat a leakage from circular flow of income, downward multiplier)
What problems can national debt cause?
Opportunity cost
Crowding out
Danger of inflation
Why is public sector net borrowing (PSNB) important?
- Net borrowing could be inflationary because aggregate demand would be increasing
- PNSB must not exceed 3% GDP to meet criteria for euro entry
- Taxes as a %GDP give indication of the size of the state sector relative to the whole economy
What is public sector net borrowing / fiscal borrowing?
The difference between public expenditure (current and capital) and tax revenue

Business Economics

	BUSINESS ECONOMICS Edexcel A Level Unit 3 Conglomerate merger				A merger between two firms producing unrelated products.
	Demerger		When a firm splits into two or more independent businesses.

	Horizontal merger/integration		A merger between two firms in the same industry at the same stage of production.
	Merger, amalgamation, integration or takeover.				The joining together of two or more firms under common ownership.

	Vertical merger or integration				A merger between two firms at different production stages in the same industry.
	Why do firms grow?		To increase market share, benefit from greater profits, increase sales, increase economies of scale or gain power.

	How can firms grow?		Either horizontally or vertically (through either forward, backward or conglomerate).
	Name eight ways why some firms remain small?				Legal barriers (need permits maybe), Overt barriers (imposed by other established businesses) Sunk costs (unrecoverable costs on market exit) Because they are in a Niche-market Lack of expertise Optimum efficiency has been achieved Benefits of staying small (financial support) Lack of motivation (owner wants to live a leisured life, less stress) Avoid attention from potential buyers

	Why do some firms break up?				Some firms grow too large and experience diseconomies of scale, because of this increase in average costs firms can choose to demerge (breakup). This leaves a smaller number of firms who can maximise economies of scale and concentrate on their specialist area.
	What are total fixed costs?		Costs that do not vary with output and can only apply when one factor of production (land, labour, capital and entrepreneurship) is fixed. This can only occur in the long run.

	What are variable costs			Costs that vary with output which can occur both in the short and long run.
	Where does productive efficiency occur?				At the bottom of the average cost curve. It is the lowest unit costs where the firm is producing as much as possible using the fewest amount of inputs.

	Where does allocative efficiency occur?		When a firm produces a mix of goods using scarce resources in a way that meets the demands of consumers.
	How much will firms charge for the goods if they are performing at allocative efficiency?				The prices equal to the marginal costs of manufacturing the good.

	What is the formula for average fixed cost?				Fixed costs / Output
	What is the formula for average variable costs?		Variable costs / Output

	What is the formula for marginal cost?				Change in total cost / Change in output
	Where does the marginal cost curve always go through?		The minimum point of the average variable cost and average total cost curves.

	What are economies of scale?		The benefits brought to a business from an increase in size.
	Name the 5 main internal economies of scale.				- Financial economies (banks more willing to lend) - Risk-bearing economies (wider customer base and products) - Marketing economies (as firm increases product range, can advertise brand in every advert) - Managerial (can afford to increase productivity through specialists) - Increased dimensions (double size = double costs = 8x volume)

	How may external economies of scale help a business?		A firm may be able to benefit from innovations provided by other firms or may be able to share administrative facilities with other businesses. This would reduce LRAC for all concerned businesses.
	What are disconomies of scale?				Adverse effects brought to a business by increases in size.

	What diseconomies of scale can occur and how may they have come around?		Managerial or communication problems. These may have happened due to internal growth or through mergers, where management lacks the resources or experience necessary to maintain managerial focus or control.
	What is and how do you calculate total revenue?				The turnover of a firm. Price X Quantity = TR

	What is and how do you calculate average revenue (AR)?				The revenue a firm receives per unit of output. Total revenue / Quantity
	How do you work out marginal revenue?		You find the change in total revenue of selling one more unit of output. It is the price of a product.

	Why is AR and MR downward sloping?				To reflect the downward-sloping demand curve and the need for firms to lower prices to increase sales.
	Where does profit maximisation occur?		At the output level where super-normal profits are at their greatest (or where losses are at their lowest). Marginal cost must also be rising and equal to marginal revenue.

	What will a firm aiming to revenue maximise do?		Make as much revenue as possible. This means selling goods until the last unit sold adds nothing to the revenue as it will know the next unit sold will reduce revenue.
	What are the two main pricing strategies designed to gain market share?				- Predatory pricing (pricing low enough to drive firms out by reducing profitability) - Limit pricing (pricing low enough to limit profits, which discourages new market entrants)

	Does predatory and limit pricing benefit the consumer?		In the short term, yes, as prices as lower. In the long run however the loss of constestability will mean the firm can raise prices and reduce consumer surplus.
	What can non-price competition include?				- Advertising - Branding - After care/ customer service /warranties - Product development and innovation - Product placement (where the product is sold, nicer retail outlet?)

	What can conflict with the rational profit maximisation motives of a firm?		Managers and owners. They may decide to maximise their own welfare or personal ego, perhaps by trying to overtake rivals or taking significant risks.
	How may managers let themselves off the hook whilst not doing what is best for the business?		They can profit satisfice; that is not to see profit as a goal but a goal that must be fulfilled at a minimum level in order for other objectives to be followed (e.g. improving one's golf game).

	What is the concentration ratio?				The market share controlled by the 'n' largest firms.
	What are the characteristics of perfect competition?		Many, small firms selling homogenous products. Each firm has perfect knowledge (or at least access to rival firms' price and output decisions). There are no barriers to entry or exit and each firm is a price taker (takes the price set by the market).

	Why can't firms in a perfectly competitive market achieve supernormal profits in the long run?				Because rival firms will see that supernormal profits are being made (perfect knowledge) and enter the industry (no barriers to entry). This is known as long run equilibrium.
	What are the main characteristics of monopolistic competition?		There are many small firms all selling slightly differentiated goods, with imperfect knowledge (though know when supernormal profits are being made), with low barriers to entry/exit and some price setting power.

	Why can't a firm a monopolistically competitive firm maintain supernormal profits in the long run?				Due to the low barriers of entry and exit, new firms after detecting supernormal profits can enter the market.
	What are the main characteristics of an oligopolistic firm?		It is one of few large firms in a market selling similar but branded goods. They have imperfect knowledge, high barriers to exit/entry (sunk costs) and large price setting capabilities.

	On what do oligopolistic firms tend to compete on?		Anything non-price related do to the unnecessary revenue lost of entering into a price war. Therefore they make use advertising, branding, product quality, innovation, packaging, free gifts or loyalty cards to persuade customers to buy their goods.
	What factors promote collusion within oligopolistic firms?				The similarity of the costs, the few number of firms, high barriers to entry (keeps number of firms small and protects existing firms from new entrants if supernormal profits are being made) and low levels of regulation.

	Why might firms fail to collude succesfully?		They may get landed with a significant fine or a lack of trust may lead to a firm being incentivised to lower their prices below what is agreed.
	What are the characteristics of a monopoly?				One firm selling a unique product, with imperfect knowledge (opaque pricing and output strategies) with large price setting capabilities.

	What is the most allocatively efficient point for a firm to operate on?				P = MC
	Why do monopolies act with neither productive or allocative efficiency?		Because there is no or very little competition, there is no motivation to do so as profits can simply be increased with price.

	What do monopolists seek to do?		Maximise profits by operating on the elastic part of the demand curve and so diminish consumer surplus (the price above what customers were willing to pay above what they do pay).
	Name 4 potential disadvantages of monopoly power.				- High barriers to entry and supernormal profits means the monopolistic firm can afford to be lazy and unwilling to innovate, especially as they do not produce at the most productively efficient point of output. - Can mean high prices and lower output for domestic consumers. - Resources may be wasted by cross-subsidisation (firms financing losses with profits from other sectors). - Setting prices above marginal cost may lead to a misallocation of resources.

	Name 4 potential advantages of monopoly power?				- Supernormal profits mean there is enough capital to innovate and work on efficiency - Employment can be more stable due to large capital reserves - Firms have financial power to match large overseas competitors and so can work positively on BOP. - Cross subsidisation can mean a greater range of goods or services availible to the consumer that give external benefit (provision of rural, unprofitable bus routes?).
	What is price discrimination?		When a firm sells the same product to two different markets with differing elasticities at different prices.

	What does price discrimination allow firms to do?		Increase profits and reduce consumer surplus (that is the amount above what they pay than they were willing to pay).
	What three conditions must a firm fulfill to embark on price discrimination?				- Have high barriers to entry and a degree of monopoly power - Identify at least two separate markets with differing elasticities - Keep these markets separate at a cost that is lower than the gain in profits (to prevent resale between markets).

	What is first-degree price discrimination?		A primarily theoretical method of price discrimination whereby the seller must know the absolute maximum price that every consumer is willing to pay, effectively eroding all consumer surplus.
	What is the best real life example of first-degree price discrimination?				Auctions/Ebay, as consumers can bid for as high as they are willing to pay.

	What is second-degree price discrimination?		A type of price discrimination based on the amount or volume sold, for example bulk buying.
	What is third-degree price discrimination?				Price discrimination based on regional, age or time differences.

	What is an example of third-degree price discrimination?				Charging different prices for adult and child train tickets or charging differently for peak and off peak gas, electricity or phone services.
	What is a natural monopoly?		Where an industry can only support one firm and so typically has very high sunk costs and requires large levels of output to exploit economies of scale.

	What is an example of where natural monopolies occur?				In the supply of water, gas and electricity; there are high start up and infrastructure costs which would outweigh any economic or social benefit derived from setting up the competing firm.
	What is a contestable market?		Where a market has low sunk costs and so low barriers to entry and exit. New firms can easily enter the market when they see supernormal profits can made.

	What is a monopsony?		A market in where there are many sellers but there is only one buyer.
	Give some examples of monopsony.				The NHS, the MoD or large supermarkets such as M&S (not a pure monopsony).

	When does the Competition Commission conduct inquiries into mergers?				If a merger will result in a market share greater than 25% or a combined turnover of £70m or more.
	What is the Competition Commission's job?		To stop anti-competitive practices and so anything that 'prevents, restricts or distorts competition'.

	Why were regulators put in place in the UK?				Because of the privatisation of state-owned monopolies, electricity and water firms were appointed a regulator instead of competition to set prices and maintain quality.
	What does RPI - X do?		RPI - X takes the retail price index and subtracts the factor 'x' determined by the regulator. 'X' represents the efficiency gains that the regulator has determined can reasonably be achieved by the firm in question.

	What does RPI + K do?		RPI + K uses RPI but allows the addition of the 'K' factor, which accounts for any necessary capital spending that a firm has agreed with the regulator is necessary.
	What are the benefits of RPI + K?				It allows the firm to profit from any efficiency gains that it makes, motivating it towards being productively efficient. In addition, as 'X' and 'K' are fixed for 5 years they can plan ahead and not be penalised for any further (maybe unsustainable) efficiency gains.

	How does the method of rate of return work?		This primitive regulatory method, used in the USA before price capping was devised allows a firm to make a certain level of profit based on their capital, whilst the rest is taxed at 100%.
	What is the problem with the rate of the return method?				Firms are not rewarded for efficiency gains and instead penalised for extra profit. They are also encouraged to over state their capital in order to increase the rate of return of investment and increase profits.

What are performance targets?

Where a regulator sets performance targets which are monitored and can lead to fines if not fulfilled. These can be anything from improvements in the quality of service or reductions in customer complaints.