Scarcity and Unlimited Wants
Humans have many different types of wants and needs. Economics looks
only at man's material wants and needs. These are satisfied by
consuming (using) either goods (physical items such as food) or
services (non-physical items such as heating).
There are three reasons why wants and needs are virtually unlimited
1. Goods eventually wear out and need to be replaced.
2. New or improved products become available.
3. People get fed up with what they already own.
Commodities (goods and services) are produced by using resources. The
resources shown in Table 1.1 are sometimes called factors of
Table 1.1 Different types of resource
All natural resources
The physical and mental work of people
All man-made tools and machines
All managers and organisers
Types of Commodity
A free good is available without the use of resources. There is zero
, for example air. An economic good is a commodity in
Expenditure on producer or capital goods is called investment.
The Economic Problem
The economic problem refers to the scarcity of commodities. There is
only a limited amount of resources available to produce the unlimited
amount of goods and services we desire.
Society has to decide which commodities to make. For example, do we
make missiles or hospitals? We have to decide how to make those
commodities. Do we employ robot arms or workers? Who is going to use
the goods that are eventually made? Do we build a sports hall in Wigan
The opportunity cost principle states the cost of one good in terms of
the next best alternative. For example, a gardener decides to grow
carrots on his allotment. The opportunity cost of his carrot harvest
is the alternative crop that might have been grown instead (eg
potatoes). Further examples are given in Table 1.2.
Table 1.2 Examples of opportunity cost decisions
Should I buy a record or a revision book?
Should we build a music block or tennis courts?
Should we increase police pay or pensions?
An economic system is the way a society sets about allocating
(deciding) which goods to produce and in which quantities. Different
countries have different methods of tackling the economic problem.
There are three main types of economy.
A market or capitalist economy is where resources are allocated by
prices without government intervention. The USA and Hong Kong are new
examples of market economies where firms decide the type and quantity
of goods to be made in response to consumers. An increase in the price
of one good encourages producers to switch resources into the
production of that commodity. Consumers decide the type and quantity
of goods to be bought. A decrease in the price of one good encourages
consumers to switch to buying that commodity. People on high incomes
are able to buy more goods and services than are the less well off.
In a command-planned or socialist economy the government owns most
resources and decides on the type and quantity of a good to be made.
The USSR and North Korea are examples of command economies. The
government sets output targets for each district and factory and
allocates the necessary resources. Incomes are often more evenly
spread out than in other types of economy.
In a mixed economy privately owned firms generally produce goods while
the government organises the manufacture of essential goods and
services such as education and health care. The United Kingdom is an
example of a mixed economy.
Method of Calculation
The study of population statistics is called demography. Since 1801 a
population census (survey) of the UK has been held every ten years to
count the number of people in the country.
A census is carried out because the government needs to plan ahead.
The figures can be used to estimate the number of roads, schools,
hospitals etc likely to be needed in the future.
The crude birth rate is the number of births per thousand of the
population in a year. The birth rate has fallen from 28.6 in 1900 to
12.8 in 1988. This dramatic fall has been caused by:
· Improved birth control. Contraceptives are now more available and
· Women choosing to continue working, or waiting before raising
The death rate is the number of deaths per thousand of the population
in a year. The death rate has fallen from 18.4 in 1900 to 11.7 in
1988. This fall has been caused by:
· Improved housing, diet and sanitation.
· Improved health care through medical discoveries and introduction of
the National Health Service.
Migration happens when people either permanently leave a country (emigration)
or enter it (immigration). Net migration is the difference between the
number of people emigrating and immigrating.
People usually want to leave countries (voluntary emigration) for two
1. Push factors which include high unemployment, low living standards
or poor climate in their own country.
2. Pull factors which include good job prospects and high living
standards in a new country.
Population Structure by Sex and Age
Population pyramids can be used to show the sex and age structure of a
particular country. Developed countries tend to have an even sex and
age structure while less developed ones have over half their
population aged under 16.
An ageing population occurs when the average age per person is rising.
Population Structure by Area
There is an uneven spread of population about the country because:
· Some areas are remote, hilly or uninhabitable.
· Farming areas employ few people.
· Industry is concentrated in towns.
80 per cent of the UK population live in England, largely in the
south-east and midlands. 80 percent of people live in urban (built-up)
areas. 20 cities have a population of more than 250 000. The seven UK
conurbations (several towns joined together) house a third of the
population but they occupy only 3 per cent of the land area. Move away
from living in the inner cities.
T R Malthus
Writing at the end of the eighteenth century, Malthus argued that:
· Population rises in a geometric way, ie 1,2,4,8,16.
· The food supply rises arithmetically, ie 1,2,3,4,5.
Only way, famine and plague would prevent absolute poverty.
Malthus did not take into account the spread of birth-control
techniques which reduced the rate of population growth. Malthus also
overlooked the effects of future farming inventions, and the
development of foreign trade which dramatically increased the food
· Optimum(best) population occurs when productivity (output per
person) is highest.
· An under-populated country can increase productivity by increasing
· An over-populated country can increase productivity by reducing its
Specialisation happens when one individual, region or country
concentrates in making one good.
Division of Labour
The division of labour is a particular type of specialisation where
the production of a good is broken up into many separate tasks each
performed by one person. An early economist, Adam Smith, suggested
that without any help one worker could produce only ten pins in one
day. However, in a pin factory where each worker performs only one
task, ten workers using the division of labour principle, could
produce a daily total of 48 000 pins. Output per person (productivity)
rose from 10 to 4800 when the division of labour principle was used.
Advantages of the Division of Labour
The division of labour raises output, thereby reducing costs per unit,
for the following reasons:
· Workers become more practised at the task
· Workers are able to be trained more precisely for the task
· Specialisation enables more efficient organisation of production
with a series of distinct tasks
Disadvantages of the Division of Labour
Eventually the division of labour may reduce productivity and increase
unit costs for the following reasons:
· Continually repeating a task may become boring.
· Workers begin to take less pride in their work.
· If one machine breaks down then the entire factory stops.
· Some workers receive a very narrow training and may not be able to
find alternative jobs.
· Mass-produced goods lack variety.
Limits to the Division of Labour
· Mass production requires mass demand.
· The transport system must be good enough to reach a large number of
consumers (mass market)
· Barter is the direct exchange of goods for other goods. Each worker
creates only part of the finished goods, therefore the division of
labour cannot be used in a barter society.
The introduction of conveyor belts at the turn of the century allowed
mass production (very large output). Automation refers to intensive
use of machinery in production.
Costs of Production and Revenue
A firm organises the manufacture of a good or service. An industry is
made up of all those firms producing the same commodity. The amount
spent on producing a given amount of a good is called total cost, TC,
and is found by adding together variable and fixed costs.
Variable costs, VC, depend on how many goods are being made (output).
If just one more unit is made then total variable costs rise. Variable
costs include the following:
· Weekly wages paid to the shop floor workers.
· The cost of buying raw materials and components.
· The cost of electricity and gas.
Fixed costs, FC, are totally independent of output. Fixed costs have
to be paid out even if the factory stops production. Fix costs include
· monthly salaries paid to managers;
· rent paid for the use of premises;
· rates paid to the council;
· any interest paid on loans;
· insurance payments in case of accidents
· money put aside to replace work-out machines and vehicles sometime
in the future (depreciation).
Average cost, AC or unit is the cost of producing one item and is
calculated by dividing total costs by total output.
Marginal cost, MC is the cost of producing one extra unit and is
calculated by dividing the change, , in total costs by the change in
· Total revenue, TR, is the money the firm gets back from selling
goods and is found by multiplying the number sold, Q, by the selling
· Average revenue, AR, is the amount received from selling one item
and equals the selling price of the good.
· Marginal Revenue, MR.
TC = VC + FC
VC = TC - FC
FC = TC - VC
AC = TC/Q
TR = P x Q
AR = TR/Q
MC = TC/Q
MR = DTR/DQ
The private cost to a motorist of driving from Cornwall to Scotland is
the cost of petrol and oil and the wear and tear on his car. However,
other people have to put up with the externalities of the journey, for
instance the noise, smell, pollution and traffic congestion the
motorise helps to cause along the way.
If we add on to private cost an amount of money to compensate for the
inconvenience caused, the overall figure will be the social cost of
Private costs + Externalities = Social cost
(Cost to individual) + (Cost to other people) = (Cost to everyone)
Economies of Scale
These occur when mass producing a good results in lower average cost.
Economies of scale occur within an firm (internal) or within an
Internal Economies of Scale
These are economies made within a firm as a result of mass production.
As the firm produces more and more goods, so average cost begin to
fall because of:
· Technical economies made in the actual production of the good. For
example, large firms can use expensive machinery, intensively.
· Managerial economies made in the administration of a large firm by
splitting up management jobs and employing specialist accountants,
· Financial economies made by borrowing money at lower rates of
interest than smaller firms.
· Marketing economies made by spreading the high cost of advertising
on television and in national newspapers, across a large level of
· Commercial economies made when buying supplies in bulk and therefore
gaining a larger discount.
· Research and development economies made when developing new and
External Economies of Scale
These are economies made outside the firm as a result of its location
and occur when:
· A local skilled labour force is available.
· Specialist local back-up forms can supply parts or services.
· An area has a good transport network.
· An area has an excellent reputation for producing a particular good.
For example, Sheffield is associated with steel.
Internal Diseconomies of Scale
These occur when the firm has become too large and inefficient. As the
firm increases production, eventually average costs begin to rise
· The disadvantages of the division of labour take effect
· Management becomes out of touch with the shop floor and some
machinery becomes over-manned.
· Decisions are not taken quickly and there is too much form filling.
· Lack of communication in a large firm means than management tasks
sometimes get done twice.
· Poor labour relations may develop in large companies.
External Diseconomies of Scale
These occur when too many firms have located in one area. Unit costs
begin to rise because:
· Local labour becomes scarce and firms now have to offer higher wages
to attract new workers.
· Land and factories become scarce and rents begin to rise.
· Local roads become congested and so transport costs begin to rise.
This occurs when two firms join together to form one new company.
Integration can be voluntary (a merger) or forced (a takeover). The
figure below shows the three main types of integration.
Types of integration
Motives for Integration
· Integration increases the size of the firm. Larger firms can achieve
more internal economies of sale.
· One firm may need fewer workers, managers and premises (rationalisation).
· Large domestic firms are then more able to compete against large
· Integration allows firms to increase the range of products they
manufacture (diversification. Diversified firms no longer have 'all
their eggs in one basket'.
· Reduce competition by removing rivals.
Survival of the Small Firm
Small firms are able to compete with large firms because:
· Some products cannot be mass produced, eg contact lenses.
· Some products have only a limited demand, eg horse shows.
· Some products require little capital, eg window cleaning.
· Small firms receive grants and subsidies from the government.
Market structure refers to the number of firms in an industry. In
perfect competition there are a large number of small firms in the
industry, each producing identical products. Very few markets are
perfectly competitive but one example is wheat.
In a monopoly one firm supplies 25 per cent or more of a market. The
Ford Motor Company is an example of a monopoly firm. A pure monopoly
is a special type of monopoly where one firm supplies the entire
market. British Rail is an example of a UK pure monopolist.
Private- and Public-sector Firm
The Private Sector
The economy can be divided into the private and public sectors. The
private sector is made up of members of the general public and firms
owned by the general public. These firms include sole traders,
partnerships, limited companies (owned by private shareholders) and
Public Limited Companies (Plcs) (also owned by private shareholders).
The Public Sector
The Public Sector is made up of the central government in London,
various local councils, and firms owned by the government (nationalised
industries) such as the Post Office.
Types of Private-sector Firm
Table 5.1 summarises the main types of firm owned by members of the
Table 5.1 Private-sector firms
With sole trader
Requires little capital. Incentive to work hard. Regular customers
known. Owner Cab make quick business decisions.
Unlimited liability. Difficult to find capital. Long hours worked.
Holidays or illness cause problems.
Firm of doctors
2 to 20
Shared equally between partners
Each partner contributes capital. Each partner specialises. Regular
Unlimited liability. One partner's mistake affects all partners.
Partners may disagree.
Private limited company (Ltd)
Small family business
1 or more
Directors elected by shareholders
Limited liability. Shareholders contribute capital. Protected from
Still limited capital for expansion. Limited economies of scale.
Public limited company (plc)
2 or more
Directors elected by shareholders
Limited liability. Large amount of capital can be raised. Economies of
Unwanted takeover possible. Can be remote from customers. Potential
diseconomies of scale.
Oxford and Swindon
2 or more
Profits returned to customers. Democratic.
Committee may lack business experience.
The owners are liable or responsible for the debts of a company.
· Unlimited liability means the owner may have to sell some or all of
his personal possessions to help pay off the company's debts.
· Limited liability means that the owner loses only the money he has
put into the company and no more. He does not have to sell personal
Establishing a Limited Company
Limited companies have their own legal identity. They can sue people
and other companies and be sued themselves. Anyone wanting to
establish a limited company must issue:
· A memorandum of association stating the name, aims and address of
the company and the amount of capital to be raised.
· Articles of association stating the internal organisation of the
The Registrar of Companies then issues a certificate of incorporation
which permits the company to trade.
The limited company then prepares a prospectus describing the history
and prospects of the firm and inviting individuals to buy their
shares. Only a public limited company can advertise its prospectus.
Each share allows one vote and pays one dividend (profit payment).
Each year the shareholders elect a chairman and a board of directors
who control the everyday running of the firm.
Types of Public-sector Firm
Each nationalised industry (or public corporation) has its own Act of
Parliament and its own government minister. Firms owned by the
government aim to operate in the public interest and do not
necessarily try to make maximum profits.
Public Limited Companies and Public Corporations
These are compared in Table 5.2
Table 5.2 Differences between public limited companies and public
Public limited company
Chairman elected by shareholders
Chairman selected by the government
Raised by issuing shares
Raised by issuing stocks
Go to the shareholders
Go to the government
Make a large profit
Serve the public interest
The Thatcher administration followed a course of selling state-owned
firms such as British Telecom back to the private sector. This is
Arguments for Privatisation
· Firms operate more efficiently in the private sector because they
are trying to maximise profits.
· Money can be raised to increase government services or to pay for
· Ordinary people become shareholders and take a greater interest in
economic matters ('peoples's capitalism').
Arguments Against Privatisation
· Public monopolies simply become private monopolies.
· Socially necessary but unprofitable services may not now be
· Nationalised industries are already owned indirectly by the general
A multinational corporation is a very large firm with a head office in
one country and several branches operating overseas.
Advantages of Multinationals
· Investment by multinationals creates jobs for the host country.
· The multinational will introduce new production techniques and
· New or better goods may now become available in the host country.
Disadvantages of Multinationals
· Profits are returned to the overseas head office.
· The multinational may operate against the interest of the host
· The multinational may force its overseas branches to buy supplies
from the head office.
Factors Influencing Location
Sometimes firms have to decide where to build a new factory. It is
important to consider the different costs of different locations.
Businessmen take into account the natural and acquired advantages of a
· An area may have a water source for waste disposal or cooling.
· An area may be flat or isolated and attract dangerous or unpleasant
· An area may have the right climate for the production of a good.
· Weight-losing industries use bulky raw materials to produce a
compact finished product and tend to locate near the source of raw
An area may have developed a number of advantages as the result of
firms locating in the region. These are called external economies of
Weight-gaining industries use compact raw materials to produce a bulky
finished product and tend to locate near the major market for the
A footloose industry gains no particular advantage from any one
location usually because transport costs are the same for each site.
Industrial inertia occurs when a firm continues to expand on its
existing site even though there are cheaper alternatives.
Structure of UK Industry
Regional Structure of UK Industry
The localisation of industry occurs when there is a concentration of
producers of a particular product in one area. See Table 6.1
Table 6.1 Structure of UKindustry by region
Type of industry
Traditional heavy industry concentrated around Tyneside and Teeside
Yorks and Humber
Iron and steel; textiles and clothing; coal; fishing
Diverse industry but specialises in hosiery, footwear and clothing
Agriculture and food processing; footwear and tourism; micro
Financial and commercial centre; technological and light engineering
Agriculture and food processing; tourism; aerospace; tobacco
Mechanical and electrical engineering; vehicles; iron and steel;
Heavy engineering; cotton; clothing; glass; chemicals; vehicles
Coal, iron and steel in S. Wales. Agriculture; light engineering
North Sea oil; agriculture; shipbuilding; tourism
Recent Changes in the Structure of UK Industry
· Declining industries. Since 1973 manufacturing output has been
falling by 2 per cent each year. The shipbuilding, textile and motor
vehicle industries have suffered particularly.
· Expanding industries. The energy crisis and discovery of North Sea
oil has increased the output of the mining industry, dramatically.
However, the collapse of oil prices in 1986 may see a reversal of this
trend. Service industries including banking, communications and
insurance have expanded rapidly.
The regional problem refers to the uneven spread of living standards
between different regions of the UK. Areas with below-average income
per person and high unemployment are depressed regions. They usually
have a large concentration of declining industries and are remote from
the major markets. New firms prefer to locate in the expanding South
The gap between the prosperous South East and the rest of the country
is growing. New firms are attracted to the South East by the extensive
motorway and air links and the availability of workers familiar with
the new technologies. For example, computer-based, high-technology
firms have located along the M4 motorway corridor west of London.
Government Regional Policy
Footloose firms can be attracted to depressed regions by government
grants. The government offers:
· Urban development loan.
· Regional selective assistance. Firms locating in intermediate
development areas may receive a grant towards machinery and training
· Enterprise Zones. These are small areas situated mainly in
inner-city areas where rate and rent allowances are provided by the
Desire refers to people's willingness to own a good. Demand is the
amount of a good that consumers are willing and able to buy at a given
Utility is the satisfaction people get from consuming (using) a good
or a service. Utility varies from person to person. Some people get
more satisfaction from eating chips than others. Even the same person
can gain greater satisfaction by eating chips when hungry than when he
has lost his appetite.
Factors Influencing Demand
The amount of a good demanded depends on:
· the price of the good;
· the income of consumers;
· the demand for alternative goods which could be used (substitutes);
· the demand for goods used at the same time (complements);
· whether people like the good (consumer taste).
The demand curve labelled DD in the figure below shows the amount of a
good one or more consumers are willing and able to buy at different
Movements Along and Shifts in Demand Curves
A change in price never shifts the demand curve for that good. In the
figure below an increase in price results in a movement up the demand
curve. The fall in the quantity demanded from Q1 to Q2 is sometimes
called a contraction in demand.
A demand curve shifts only if there is a change in income, in taste or
in the demand for substitutes or complements. In the diagram below a
decrease in demand has shifted the demand curve to the left. The new
demand curve is D1 D1.
Factors Influencing Supply
Supply is the amount of a good producers are willing and able to sell
at a given price. Supply depends on:
· the price of the good;
· the cost of making the good;
· the supply of alternative goods the producer could make with the
same resources (competitive supply);
· the supply of goods actually produced at the same time (joint supply);
· unexpected events that affect supply.
The supply curve labelled SS in the figure below shows the amount of a
good one or more producers are prepared to sell at different prices.
Movements Along and Shifts in Supply Curves
A change in price never shifts the supply curve for that good. In the
diagram below an increase in price results in a movement up the supply
curve. The increase in quantity supplied from Q1 to Q2 is sometimes
called an expansion in supply.
A supply curve shifts only if there is:
· a change in costs;
· a change in the number of goods in competitive or joint supply; or
· some unforeseen event which affects production.
In the diagram below an increase in supply shifts the supply curve to
At prices above the equilibrium (P*) there is excess supply while at
prices below the equilibrium (P*) there is excess demand. The effect
of excess supply is to force the price down, while excess demand
creates shortages and forces the price up. The price where the amount
consumers want to buy equals the amount producers are prepared to sell
is the equilibrium market price. All these situations are shown in the
Equilibrium market price
Indirect Taxes and Subsidies
In the figure below an indirect tax has been added to SS. This has the
effect of shifting the supply curve up vertically by the amount of the
tax. Note in the diagram below that price does not increase by the
full amount of the tax. This suggests that part of the tax is paid by
In this figure a subsidy has been given to the firm. This has the
effect of making firms willing to supply more at each price and so
shifts the supply curve downwards. The shift is equivalent to the
value of the subsidy. Note that price falls by less than the full
amount of the subsidy. This suggests that the firm keeps part of the
Price Elasticity of Demand
Price elasticity of demand measures the responsiveness of demand to a
given change in price and is found using the equation:
PED = Percentage change in quantity demanded/Percentage change in
PED = P/Q x Q/P
where P = the original price
Q = the original quantity
and = 'the change in'
See Table 7.1
Table 7.1 Features of price elasticity of demand
Greater than 1
Less than 1
A rise in price means
A larger fall in demand
A smaller fall in demand
Slope of demand curve
Number of substitutes
Type of good
Price of good
Price Elasticity of Supply
Price elasticity of supply (PES) measures the responsiveness of supply
to a given change in price.
PES = Percentage change in quantity supplied/Percentage change in
or PES = P/Q x Q/P
See Table 7.2
Table 7.2 Features of elasticity of supply
Greater than 1
Less than 1
A rise in price means
A larger rise in supply
A smaller rise in supply
Slope of supply curve
The good is produced
The time period is
The firm has
Income Elasticity of Demand
Income elasticity of demand (YED) measures the responsiveness of
demand to a given change in income:
YED = Percentage change in quantity demanded/Percentage change in
If YED is negative then the good is inferior. People use an increase
in income to buy less of this good and more of a superior substitute.
If YED is positive then the good is normal. Consumers use an increase
in income to buy more of the good.
Cross Elasticity of Demand
Cross elasticity of demand (XED) measures the responsiveness of demand
for one good (z) to a given change in the price of a second good (w):
XED = Percentage change in quantity demanded of good z/Percentage
change in the price of good w
If XED is positive then the two goods are substitutes. If XED is
negative then the two goods are complements.
Types of Income
Income is the amount of money received by a household over a period of
time. This income may come from employment, self-employment,
dividends, rent or a variety of other sources.
Distribution of Income
Income distribution is the way in which total income is shared out
between households. Not everyone receives the same amount of money
each year because of wage differences and the uneven ownership of
Methods of Payment
Workers sell their labour to employers in return for:
· Salaries.Usually salaries are paid monthly to non-manual workers
such as managers irrespective of the number of hours worked.
· Wages. Wages are weekly payments for work done and are paid by:
1. Piece rate or piece work: an amount for every item made.
2. Time rate: an amount for every hour worked.
The gross wage is made up of basic wages plus overtime and bonus
payments. Deducting income tax and national insurance contributions
leaves net wages or take-home pay.
Money and Real Wages
Money wages refers to pay without any adjustment for inflation. Real
Wages are the amount of goods and services money wages can buy; this
is given by the equation:
Real wages = Money wages/Retail price index x 100
The wage for a job is determined by the supply and demand for labour
in that particular occupation. A job where labour is in high demand
but in short supply will pay higher wages.
Demand for Workers
The demand for labour is found (derived) from the demand for the
finished good. There will be an increased demand for workers if:
· There is an increased demand for the finished good.
· Workers increase their productivity.
Supply of Workers
There will be a limited supply of workers if the job:
· Requires special qualifications, skills, training or ability/
· Is unpleasant, dirty or boring.
· Is stressful or carries great responsibility.
· Involves antisocial hours.
Wage drift occurs when the earnings of some workers rise above the
average for the industry. Workers doing the same job within the same
industry may be paid differently because:
· Workers in cities are sometimes paid more to meet the higher cost of
· In spite of equal-opportunities legislation women tend to earn less
because their careers are interrupted by family commitments, or they
suffer from sex discrimination.
· Older workers tend to earn more because they are paid a bonus to
reward their experience.
· Some workers are paid more for working harder.
· Some workers receive overtime, bonuses, etc.
Types of Wealth
Wealth is the value of all the assets (items) owned by a household at
a particular moment in time.
Wealth Distribution means the way the ownership of assets is shared
out between households. Wealth is much more unevenly distributed in
the UK than incomes.
Table 8.1 suggests that while the top 1 per cent and 10 per cent now
own a smaller share of total wealth than in 1971, half the population
still own only 4 per cent of all assets.
Table 8.1 Wealth trends
Share of total wealth
Most wealthy 1%
Most wealthy 10%
Most wealthy 50%
Features of Trade Unions
Types of Trade Union
A trade union is an organisation which represents workers. There are
four main types:
1. Craft unions representing skilled workers from one occupation. For
example, SOGAT 82 (printers) and the AUEW (engineering).
2. General unionsrepresenting mainly unskilled workers from many
occupations. For example the TGWU (Transport and General Workers'
3. Industrial unionsrepresenting mainly workers in one industry. For
example, the NUM (miners' union)
4. Professional or white-collar unions representing skilled workers in
mainly service industries. For example, the NUT (teachers' union).
Functions of Trade Unions
Trade unions aim to:
· Improve the pay of workers.
· Improve working conditions and secure longer holidays.
· Protect members' jobs.
· Provide local, social and welfare facilities.
· Influence government policy by sponsoring Members of Parliament and
contributing money to political parties.
Organisation of Trade Unions
Each trade union has its own internal organisation. Generally:
· Small groups of workers elect a local spokesman (shop steward).
· Every area has a branch which sends delegates (representatives) to a
yearly national conference.
· Conference passes resolutions (policies) and elects a national
executive. Only the national executive can call an official strike.
· The entire membership elects a general secretary. The general
secretary acts as the union's spokesman and manages everyday affairs,
usually until he reaches retirement age.
The Trades Union Congress
The Trades Union Congress (TUC) is made up of over 90 unions
representing more than 9 million members. An annual conference decides
overall union policy and elects the General Council. The General
Secretary of the TUC is the trades union spokesman in any negotiations
with the government or employers' organisations. The TUC has no power
to initiate or halt an individual union's industrial action.
In the nineteenth century workers used to negotiate their own pay and
conditions with their employers. Collective bargaining occurs when
workers allow the union to negotiate on their behalf. Negotiations can
be with an individual employer or an employers' association.
Types of Dispute
Disputes can arise over pay, working conditions, redundancies or
restrictive practices which include:
· A closed shop when a union insists that all workers in a place or
work are members.
· Demarcation when a union insists that only their members do certain
· Blacking goods when the union refuses to handle goods produced by a
firm in dispute with a union.
· Over-manning when the union insists on a large number of workers for
If negotiations break down employers may lose output while workers may
lose some pay. More often than not a compromise is found. However,
sometimes one party resorts to industrial action. Unions can:
· Work to rule and do the bare minimum of work.
· Impose an overtime ban and refuse extra work.
· Strike and refuse to work altogether.
· Mount a picket line outside their place of work and ask other trade
unionists not to enter.
Employers can operate a lockout and refuse workers entry or they can
dismiss striking workers to breach of contract.
Recent legislation has severely weakened trade union power as follows:
· An employer can now sue a union for lost profits if industrial
action is taken without an initial secret ballot of workers.
· Industrial action can be taken only against the original employer
and not against his suppliers or buyers.
· Mass picketing is unlawful. Only a handful of strikers are allowed
to man a picket line, peacefully.
Arbitration is when employers and the unions agree to an independent
referee to try to find common ground.
· Since 1974 an independent Advisory Conciliation and Arbitration
Service (ACAS) has been available to help solve disputes.
· In the 1980s and 1990s there have been an increasing number of
single-union agreements where employers negotiate with only one union.
Pendulum arbitration is used to settle a dispute where an independent
referee chooses one side or the other.
Circular Flow of Income
Real and Money Flows
The figure below divides the economy into two sections or sectors made
up of households and firms.
Circular flow of income
There are two types of flow (an amount per time period) between these
1. A real flow. Households own factor services which they hire out to
firms. Factor services are then used to manufacture goods and
2. A money flow. Households receive payments for their services (income)
and use this money to buy the output of firms (consumption).
Leakages or Withdrawals From the Circular Flow
Not all income will flow from households to firms directly. The
circular flow below shows that some part of household income will be:
· Put aside for future spending, ie saved.
· Paid to the government in taxes.
· Spent on foreign made goods imported into the country.
Injections Into the Circular Flow
These flows out of the circular flow of income will be counterbalanced
by flows back in. These flows are known as injections. These may take
the form of:
· Other firms, ie investment expenditure.
· The government, ie government expenditure.
· Foreigners, ie export expenditure.
The diagram shows the impact of these injections on the circular flow:
The Multiplier Effect
When there is an increase in the level of injections a part of it will
be received by a household as extra income. The households will
probably act so that part of this extra income is then spent and part
This extra consumer spending then gives rise to a series of further
incomes and expenditures. The overall increase in spending is much
higher than the initial injection. This effect is known as the
multiplier effect. The greater the proportion of the extra income that
is spent (the Marginal Propensity to Consume), the bigger the
multiplier effect will be.
National Income Accounts
The relationships explained in the sections above form the basis of
national income accounting. The aim of national income accounting is
to place a money value on this year's output. There are three methods
The income method adds together the total value of all incomes that
have been earned in the relevant time period. These may include income
from employment, income from self employment, profits, surpluses of
public (government) corporations and rent. Note that only incomes
earned from supplying a factor service are counted. Transfer payments
The government adds up all the money spent in buying this year's
output. This will be the total of Consumption, investment, government
expenditure and net exports (exports - imports). This ignores:
· Indirect taxes and subsidies included in the selling price.
· Spending on second-hand goods.
The economy is broken up into twelve different sectors (eg
manufacturing). The money spent on making the goods (inputs) is taken
away from the money received from the sale of the goods (outputs) to
give each sector's value added. Taking final output or adding up each
sector's value added gives national income.
Unpaid output such as the work of housewives is not recorded.
Standard of Living
Measurement of the Standard of Living
The value of this year's national income is a useful measure of how
well-off a country is in material terms. However, inflation increases
the money value of national income but does not provide us with any
more goods to consume. Real national income is found by applying the
Real national income = Money national income/Retail price index x 100.
The standard of living refers to the amount of goods and services
consumed by households in one year and is found by applying the
Standard of living = Real national income/Population
A high standard of living means households consume a large number of
goods and services.
A second method of calculating living standards is to count the
percentage of people owning consumer durables such as cars,
televisions, etc. An increase in ownership indicates an improved
standard of living.
A third method of calculating living standards is by noting how long
an average person has to work to earn enough money to buy certain
goods. If people have to work less time to buy goods, then there has
been an increase in the standard of living.
Interpretation of the Standard of Living
An increase in the standard of living may not mean a better life-style
for the majority if:
· Only a small minority of wealthy people consume the extra goods.
· Increased output of certain goods results in more noise, congestion
· Leisure time is reduced to achieve the production increase.
· There is an increase in the amount of stress and anxiety in society.
Features of Money
Functions of Money
Money is something which people generally accept in exchange for a
good or a service. Money performs four main functions:
· a medium of exchange for buying goods and services;
· a unit of account for placing a value on goods and services;
· a store of value when saving;
· a standard for deferred payment when calculating loans.
Properties or Characteristics of Money
Any item which is going to serve as money must be:
· acceptable to people as payment;
· scarce and in controlled supply
· stable and able to keep its value
· divisiblewithout any loss of value
· portable and not too heavy to carry.
Origins of Money
The earliest method of exchange was barter in which goods were
exchanged directly for other goods. Problems arose when either someone
did not want what was being offered in exchange for the other good, or
if no agreement
could be reached over how much one good was worth in terms of the
Valuable metals such as gold and silver began acting as a medium of
exchange. Governments then decided to melt down these metals into
By the seventeenth century people were leaving gold with the local
goldsmith for safe keeping. Receipts of £1 and £5 were issued which
could then be converted back into gold at any time. Soon these
receipts were recognised as being 'as good as gold' and were readily
taken in exchange for goods. Goldsmiths became the first specialist
bankers and their receipts began to circulate as banknotes.
Only the Bank of England can now issue banknotes in England and Wales.
However, notes are not usually used to buy expensive items such as
cars. The buyer is more likely to write out a cheque, which instructs
his bank to transfer money from his account into the account of the
seller. Hence bank deposits act as money.
Banks are authorised institutions and perform four functions. They
accept deposits, make loans, arrange payment of bills and provide a
number of customer services. The four main high street or clearing
banks in the UK are Barclays, Lloyds, Midland and National
Types of Bank Account
Banks provide different types of account for different needs.
Customers can open:
· A current account which provides a cheque book but usually pays no
interest. Current accounts are mainly used to pay bills.
· A deposit account which does pay interest but money can only be
taken out by visiting the bank. Deposit accounts are mainly used for
short term saving.
· An investment or savings account which pays a higher rate of
interest but written notice of withdrawal must be given. Accounts of
this type are used mainly for long-term saving.
Types of Bank Loan
· An overdraft is when the bank allows a customer to take out more
money than is in his account. Overdrafts are up to an agreed limit,
and must be paid off whenever the bank asks. Interest is charged daily
on any outstanding balance.
· A loan account is when a customer borrows a fixed sum of money to be
repaid in monthly instalments over a number of years. A fixed rate of
interest is charged.
Methods of Payment
· Cheques when the bank is ordered to pay money to someone else. The
people involved in writing a cheque are:
1. The person writing out the cheque (drawer).
2. The bank ordered to pay the money (drawee)
3. The person receiving the money (payee).
A cheque card is issued to trusted customers which guarantees payment
by the bank of any cheque up to the sum of £50, though some will now
go up to £100.
· Standing orders when a fixed sum is paid out on set dates.
· Direct debits when a variable sum is paid out on set dates.
· Credit cards when customers have a special card (eg Visa or Access)
which can be used to buy goods. Cardholders receive a statement every
month and no interest is charged if the account is settled in full.
Interest is changed monthly on any outstanding balance.
Banks have cash points; exchange foreign currency and issue
travellers' cheques; provide night safes and store valuables; execute
(carry out) wills and trusts; and factor (collect) debts.
Commercial Bank Balance Sheet
A balance sheet shows the present position of a company. One for a
commercial bank is shown here.
The balance sheet of a commercial bank
(a) Current a/c
(e) Cash in tills
(b) Deposit a/c
(f) Money at the Bank of England
(c) Savings a/c
(g) Money at call and short notice
(h) 91-day bills
(i) Government securities with less than 1 year to maturity
(d) Total liabilities
(l) Total assets
In the balance sheet the liabilities column shows the origin of the
money held by the bank. Items (a) to (c) show the amount of money held
in each type of account. Item (d) states the total value of the
deposits held by the bank.
The assets column shows what the bank has done with the money. Note
that only a small percentage of total liabilities is kept as cash in
tills (item (e)). Item (f) is the bank's own current account for
settling debts. Item (g) is money lent out to discount houses for a
few days. Items (i) and (j) are IOUs issued mainly by the government.
Items (e) to (I) are the bank's liquid or reserve assets and can
easily be turned into cash.
Items (j) and (k) are illiquid (not easily turned into cash) but
highly profitable. By definition, the amount of total assets (item (l)
must equal total liabilities.
Some customers leave money in the bank earning interest. A bank can
use these idle deposits to make loans to people who then buy goods.
Shopkeepers receive extra money which they redeposit with the bank.
Some of this redeposited money is left to earn interest and can be
re-lent. The bank has therefore created money. If all customers were
to try to cash their deposits at once, their would not be sufficient
cash. The amount of money the bank can create therefore depends on the
ratio of cash to liabilities that they hold. The higher this cash
ratio the less money the bank can re-lend or create.
The money supply is the total amount of assets in circulation which
are acceptable in exchange for goods. In modern economies people
accept either notes and coins or an increase in their current account
as payment. Hence the money supply is made up of cash and bank
deposits. There are five main measures of the money supply known as M0
Control of the Money supply
The Bank of England is responsible for controlling the money supply
and this involves limiting the amount of cash, and bank deposits in
As the Bank of England actually issues notes and coins, it can easily
control the amount of cash in the money supply.
However, the major part of the money supply is not created by the Bank
of England. Commercial banks decide the amount of bank deposits in
circulation using the equation:
D = 1x A
where D = total deposits
A = liquid assets
and = the percentage of deposits held in liquid form.
The Bank of England can:
· Place a limit on the amount of deposits a bank can have.
· Force up interest rates to discourage customers from taking out
· Reduce the amount of liquid assets held by a bank selling bills to
the public. The public then write out cheques to the government and
money leaves the bank.
The Bank of England
The Bank of England is the central bank of the United Kingdom. It was
established in 1694 and nationalised in 1946.
Functions of the Bank of England
· The Bank of England is the sole issuer of notes and coins through
the Royal Mint.
· The Bank of England is the government's banker.
· The Bank of England is the banker for commercial banks.
· The Bank of England has close links with foreign central banks and
· The Bank of England holds the UK gold and foreign currency reserves
in the exchange equalisation account which it uses to help stabilise
· Since the election of the Labour government in 1997, the Bank of
England has been given operational independence. This means that they
set interest rates through a Monetary Policy Committee that meets
monthly. This takes the setting of interest rates out of the hands of
politicians. The Bank of England set them at a level appropriate to
meet the governments inflation targets.
The Money Market
The money market arranges large-scale short-term loans (up to three
months) and is mainly used by commercial banks and discount houses.
The Stock Exchange
The Londonstock exchange is the centre of the capital market and
provides large-scale long-term loans for companies and the government.
New Share Issues
Firms can raise money for expansion by reinvesting profits or
arranging a loan through a bank. However, a company wanting to raise
millions of pounds' worth of capital may consider going public, ie
becoming a public limited company. The firm prepares a prospectus
stating the history and aims of the company and inviting the public to
A public limited company can raise further capital through a rights
issue when shareholders are invited to buy new shares at a discount on
the current stock market price.
An alternative method of raising money is to issue debentures. A
debenture is a loan to a company paying a fixed rate of interest.
Second-hand debentures can be bought and sold on the stock exchange.
Table 12.1 Types of share
Order of dividend payment
Ordinary or equities
Depends on size of profits
1 per share
Fixed but no profit means no dividend
Fixed but lost dividends made up
Organisation of the Stock Exchange
In 1986 the stock exchange underwent a radical change in organisation
(the 'big bang'):
· Market makers buy and sell shares.
· Brokers or dealers represent the client but may be part of the same
firm as the market maker.
· Market makers and brokers are linked by a new computer system, SEAQS
(Stock Exchange Automated Quotation System).
· The stock exchange has been enlarged to include a number of high
street banks and foreign financial institutions.
· The Stock Exchange Council (a committee of elected dealers) is
directly responsible for policing the market. The council itself is
under the supervision of the Securities and Investment Board.
Changes in Share Prices
An increase in the demand for a share will raise its price. This may
be the result of a possible takeover bid, increased profits or because
the economy is booming.
A speculator buys or sells shares hoping to make a quick profit. There
are three sorts:
1. A bull buys shares now expecting share prices to rise.
2. A bear sells shares now expecting share prices to fall.
3. A stag buys new share issues expecting their price to rise.
Functions of the Stock Exchange
· An organised market for the purchase and sale of second-hand shares.
· The stock exchange gives people confidence to buy new shares issued
by companies since they know there is an organised market for their
· The stock exchange allows institutions collecting money for small
investors such as trade unions, insurance and pension funds to make
large purchases of shares in UK companies.
Other Financial Institutions
A number of specialist institutions lend for special purposes:
· Building societies assist house buyers by collecting money from many
small savers and lending large long-term loans.
· Merchant banksspecialise in lending directly to firms, and in giving
advice to companies involved in takeover deals.
· Finance housesspecialise in leasing and hire purchase agreements.
· Pension fundscollect contributions which are then used to buy stocks
· Unit trusts allow small investors to buy a spread of shares in
different companies. The money raised from selling units is used to
buy stocks and shares in a large number of companies. Units can only
be bought and sold from the trust.
· Insurance companies collect premiums from policy holders. Some of
this money is used to buy stocks and shares.
There is an increasing trend for financial institutions to extend the
scope of their business. As a result of the Building Societies Act
(1986) they are now able to offer a wide range of financial services.
However, many Building Societies have converted to Plcs as they feel
that they are unable to compete fully if they retain their mutual
status. This process was started with the conversion of the Abbey
National to a Plc. These conversions have resulted in substantial
windfall payments during the 1990s and helped contribute to the
recovery in retail sales in the middle of the 1990s.
Sources of Government Income
The government needs money to pay for public expenditure . Revenue can
be raised through taxation, national insurance contributions,
borrowing, charging for services or by selling off state-owned assets.
Aims of Taxation
· To raise money to pay for government spending.
· To discourage people from buying harmful goods such as cigarettes.
· To influence the level of total demand in the economy.
· To redistribute income from the rich to the poor.
Principles of Taxation
· A tax should be certain so that everyone knows the amount, method
and time of tax payment.
· A tax should be convenient so that tax collection is at a time and
in a form suitable to the payer.
· A tax should be economical with the cost of collection representing
only a small part of the revenue raised.
· A tax should be equitable (fair) so that wealthy people pay more
than poor people.
· A tax should not act as a disincentive and stop people from working.
· A tax should be flexible so that the government can use tax changes
to help control the level of demand in the economy.
Main Types of Taxation
· Income tax. Everyone is given a tax-free personal allowance (amount)
above which additional earnings are taxed at an increasing rate.
· Value added tax (VAT) is a tax on spending. 17.5 per cent is added
onto the selling price of most non-essential goods and services.
· Duties are taxes on the sale of luxury goods. A fixed amount is
added to the selling price.
· Council Tax is a local tax on property. All properties are valued
and the amount of council tax paid depends on the value band which the
property falls into.
· Corporation tax is a tax on company profits.
· Petroleum revenue tax is a tax on oil taken from the North Sea.
· Inheritance tax is a tax on the transfer of money and property.
Method of Collection
· Direct taxes are paid straight to the Inland Revenue.They are
therefore taxes on income.
· Indirect taxes are first collected by the seller and then passes on
to Customs and Excise. These taxes are therefore taxes on expenditure.
Some taxes are fairer than others. A tax can be:
· Progressive, where the percentage of income taken in tax rises as
income rises. Income tax in an example of progressive taxation.
· Regressive, where the percentage of income taken in tax falls as
income rises. Rates are an example of regressive taxation.
· Proportional, where the percentage of income taken in tax stays the
same as income rises. VAT is an example of proportional taxation.
Calculation of the Budget
The Chancellor of the Exchequer is the minister of finance in charge
of the Treasury. The Chancellor announces how much the government is
going to spend over the next twelve months, sometime in November.
The government states how it is going to raise the money to pay for
its expenditure at the same time in the Budget.
Table 13.1 Advantages and disadvantages of various taxes.
* Convenient (PAYE)
* Large revenue raiser
* Disincentive to work
* Disincentive to save
* Reduces demand
* Discourages consumption
* Regressive therefore unfair
* Disincentive to invest
* Disincentive to invest
Types of Budget
· A reflationary or deficit budget where government spending is
greater than government income. Reflationary budgets increase total
demand within the economy.
· A deflationary or surplus budget where government income exceeds
expenditure and total demand is falling within the economy.
· A neutral budget where government income and spending are the same
and total demand in the economy remains constant.
Public Sector Net Cash Requirement
If the government spends more than its received income it will have to
borrow the difference. The amount the government needs to borrow in a
given time period is called the public sector net cash requirement
(PSNCR). The PSBR is met by:
· Selling National Savings certificates and Premium Bonds.
· Selling Treasury bills which are IOUs which will be bought back in
ninety-one days; time.
· Selling securities, which are IOUs paying interest yearly which will
be bought back sometime in the future. Securities are sometimes called
gilts, stocks or bonds.
The total amount owed by the government to UK citizens and foreigners
at a particular moment in time is called the national debt. The money
raised may have been spent on capital goods which increase our ability
to produce goods. Interest has to be paid on the debt. A large
national debt is a problem if:
· Interest has to be paid to overseas citizens, so that the balance of
· Taxes have to be increased to meet interest payments
Structure of Public Expenditure
Public expenditure is spending by central government, local
government, and nationalised industries. For every pound of public
spending in 1996:
· Central government spends 74p
· Local authorities spend 25p
· Public Corporations spend 1p
Table 14.1 The main government spending departments
Name of department
Pensions & welfare benefits
National Health Service
Navy, Army and Air Force
Education and Science
Schools; universities; the arts
Roads; housing; local authorities
Courts; police; prisons; fire service
Training schemes; job centres
Agriculture, Fisheries and Food
Trade and Industry
Regional and Industrial policy
Electricity; gas; oil; atomic energy
Public and Merit Goods
A public good is an item which cannot be withheld from one consumer
without withholding the good from all customers. Non payers cannot be
excluded. Since public goods, such as street lighting, can be used
free of charge, they will not be supplied by private-sector firms.
Public goods are therefore supplied by central and local government.
A merit good is a useful item, such as education, which some people
are unwilling to buy. Merit goods are supplied by the public
authorities either free or for a minimal charge so as to enlarge
Aims of Government Spending
· To provide public goods and services.
· To encourage the consumption of merit goods.
· To relieve poverty.
· To influence the level of total demand in the economy.
Macroeconomics is concerned with the study of the whole economy.
Problems arise when the economy suffers from high unemployment,
inflation, or a balance of payments deficit. Therefore the government
sets itself certain macroeconomic objectives:
· Low unemployment
· Low inflation
· A balance of payments surplus
· Economic growth
Booms in the Economy
A boom is when output and employment in the economy are rising. This
is the peak of the trade cycle.
· A boom increases spending on imports, causing balance of payments
· Once high levels of employment have been reached, output cannot be
increased any further and the boom causes inflation.
Slumps in the Economy
A slump is when output and employment in the economy are falling. This
is the bottom of the trade cycle. However:
· A slump reduces spending on imports, thus improving the balance of
· Reduced total spending lowers inflationary pressure.
The trade or business cycle refers to regular movements in the economy
between booms and slumps.
Government Macroeconomic Policies
Table 14.2 shows some of the policies the government can use to try to
get full employment, stable prices etc.
Table 14.2 Macroeconomic policies
Changes in government expenditure and taxation
Changes in the money supply and interest rates
Prices and incomes
Legal or voluntary limits on price and wage increases
Measures to help depressed areas
Government planning of industry
Quotas, tariffs, exchange controls or free trade
Encouraging a depreciation or appreciation of sterling
Structure of the Working Population
The UKpopulation divides into two sections:
· The working population is made up of people who are of working age
and available to work. It does not include people in full-time
education. All those people actually employed or self-employed make up
the labour force.
· Dependants make up the rest of the population.
There has been a radical change in the structure of occupational
employment. Before the industrial revolution over 80 per cent of the
labour force were employed in agricultural production. Now the figure
is less than 3 per cent. As recently as 1951, over half the labour
force were employed in manufacturing. Since then there has been a
period of rapid decline, particularly in the heavy-engineering sector.
The complexity of modern society has increased the number of
administrators. This trend has been accelerated by the spread of
Measurement of Unemployment
When calculating the level of unemployment the government only counts
those people who register as unemployed and claim benefit. A large
number of people seeking work either do not register or do not claim
benefit and are now excluded from official figures. The benefit count
that was used for the headline figure for unemployment was superceded
in 1998 by a figure based on the Labour Force Survey.
The unemployment rate is the percentage of the labour force officially
jobless. Full employment occurs when the number of notified job
vacancies exceeds the number of registered unemployed.
Costs of Unemployment
The opportunity cost of each unemployed person is their foregone
output. Since average annual output per worker is £12,000,
unemployment of 3.3 million costs the UK £40 billion a year in lost
Increased Benefit Payments
Each extra person who becomes unemployed stops paying tax ( perhaps
£4000) and starts receiving benefit (upwards of £5000). The government
therefore has to raise a minimum of £27 billion to finance
unemployment benefits for 3 million unemployed. As the figure falls
the government pays out less unemployment benefits and receives more
in tax. The savings to the exchequer from this will be considerable.
Lost Tax Revenue
Growing unemployment means less direct and indirect tax revenue. When
people lose their jobs they will stop paying income tax, and their
spending will fall considerably reducing government receipts from VAT
and other indirect taxes.
Human Costs of Unemployment
The long-term and youth unemployed feel increasingly isolated and
removed (alienated) from society. There will also be increased NHS
costs as people's health often suffers when they are unemployed, and
there will be increased costs to society in terms of crime.
Types, Causes, and Remedies for Unemployment
Table 15.1 summarises the main causes and remedies for different types
The Thatcher and Major administrations (1979 - 1997) believed that the
current high level of unemployment cannot be reduced by more
government spending. The government argues that extra spending only
increases inflation and UK imports. The government does offer a number
of employment and training schemes summarised in table 15.2. The
Labour government elected in 1997 has introduced the New Deal for the
unemployed to try to get people back to work by giving them the skills
and experience they require. This is targeted particularly at the
young and long-term unemployed.
Unemployment is a flow and not a stock. There are always inflows onto
the unemployment register, and there are outflows off the register as
people get jobs or join training schemes.
If all inflows rise and all outflows except training fall then overall
unemployment will rise. Young people, women, the over-fifties and
ethnic minorities tend to be the hardest hit. Inner cities and
manufacturing areas also tend to have above-average unemployment. The
average length of time workers remain unemploymed is a critical
measure of the seriousness of the unemployment figures. If the average
length of unemployment is short then the economy will be healthier and
people will not lose their skills from long periods without work.
Unemployment rose sharply from 1979 - 1983 and reached a peak of over
3 million. From then on it fell very slowly, until the late 1980s when
the impact of the Lawson Boom was to create large numbers of jobs. The
impact of the subsequent recession (1989-1992) was to increase
unemployment once more, but recovery in the 1990s has reduced the
figure once again. For more detail see the data section of Biz/ed.
Table 15.1 Causes and remedies of unemployment
Workers temporarily between jobs
Delays in applying interviewing and accepting jobs
Improve job information, eg computerised job centres
Workers have the wrong skills in the wrong place
Declining industries and the immobility of labour
Subsidies and improve the mobility of labour
All firms need fewer workers
Low total demand in the economy
Increased government spending or lower taxes
Firms replace workers with machines
Automation and information technology
Overseas firms replace UK producers
High-priced/low-quality UK goods
Tariffs quotas or sterling depreciation
High unemployment in one area
Local concentration of declining industries
Regional aid, eg relocation grants
Unemployment for part of the year
Seasonal variation in demand
Workers choose to remain unemployed
More money 'on the dole' than from working
Remove the low-paid from the liability to pay income tax
Table 15.2 Employment and training schemes that have been used in the
1980s and 1990s
Interviews and training for the long-term unemployed
Local projects for the long-term unemployed
New Workers Scheme
A subsidy to employers taking on youth unemployed
Job Search Scheme
Return fare and allowances for job interviews
Job Release Scheme
Older workers retire early with an allowance and are replaced by an
Job Splitting Scheme
A subsidy to employers who encourage job sharing
Youth Training Scheme
Two-year work experience and training for school leavers
Job Training Scheme
Retraining scheme for unemployed adults
Measurement of Inflation
Definition of Inflation
Inflation refers to the continual increase in prices. The value or
purchasing power of money refers to the amount of goods or services
one pound can buy. Inflation means the value of money is falling
because prices keep rising.
Calculating the Retail Price Index
The retail price index (RPI) is a monthly survey carried out by the
government which measures price changes. The following procedure is
· A basket of goods and services consumed by the average family is
listed. For example, food, clothing and transport are included in the
· The price of items in the basket in the base (first) year is noted.
· Each item in the basket is given a number value (weighted) to
reflect its importance to the average family. For example, food has a
higher weighting than transport.
· The price of goods in the basket is recorded every month compared
with base year as a percentage (price relative) using the equation:
Price relative = Current price/Base price x 100
· The price relative of each item is then multiplied by its weighting.
· The new RPI is found using the equation:
RPI = Total weightings x Price relative/Total weightings
The value of the RPI in the base year is always 100. After twelve
months the price of good items in the basket may have risen by 25 per
cent and that of housing by 20 per cent while the cost of transport is
unchanged. Table 16.1 shows how the RPI for year two might then be
The RPI = Total weightings x Price relative/Total weightings = 12
100/100 = 121
Table 16.1 Calculation of the retail price index
Weightings x price relative
The rate of inflation is the percentage change in the RPI over the
last twelve months and is calculated using the equation:
Rate of inflation = (Current RPI - Last RPI)/Last RPI x 100
At the beginning of year two the rate of inflation is:
(121 - 100)/100 x 100 = 21 per cent
See the economics section of Biz/ed for a worksheet on calculating and
interpreting index numbers.
Problems in Using the Retail Price Index
· Which items should be included in or excluded from the basket of
· Different families have different tastes hence different weightings.
How is an average family found?
· Not all regions in the country experience identical price changes.
· For a while new products ( eg mobile phones) may not be included in
Effects of Inflation
Advantages of Inflation
Not everyone suffers from inflation. Some parts of society actually
· The government finds that people earn more and so pay more income
· Firms are able to increase prices and profits before they pay out
· Debtors (borrowers) gain because they have use of money now, when
its purchasing power is greater.
Disadvantages of Inflation
· People on fixed incomes are unable to buy so many goods.
· Creditors (savers) lose because the loan will have reduced
purchasing power when it is repaid.
· UK goods may become more expensive than foreign-made products so the
balance of payments suffers.
· Industrial disputes may occur if workers are unable to secure wage
increases to restore their standard of living.
Causes of Inflation
Cost-push Inflation occurs when a firm passes on an increase in
production costs to the consumer. The inflationary effect of increased
costs can be the result of:
· Increased wages, leading to
1. a wage-price spiral, which occurs when price increases spark off a
series of wage demands which lead to further price increases and so
2. a wage-wage spiral, which occurs when one group of workers receive
a wage increase which sparks off a series of wage demands from other
· Increased import prices which can be the result of:
1. a rise in world prices for imported raw materials;
2. a depreciation of sterling
· Increased indirect taxation
Demand-pull inflation occurs when there is 'too much money chasing too
few goods' because the demand for current output exceeds supply.
The figure below shows increased demand and increased prices as
consumers compete to buy up goods still available.
A major source of inflationary pressure is the government which can
print money to buy goods. The monetarist view of inflation can be
stated in the equation:
MV = PT
where M = the money supply,
V = the number of times each pound changes hands (the velocity of
P - the average price of goods, and
T = the number of goods bought (transactions).
Monetarists believe that the values of V and T are fixed so that any
increase in M, the money supply, must raise P, the level of prices, ie
Remedies of Inflation
· Introduce a prices and incomes policy to free price and wage
· Encourage an appreciation of sterling.
· Reduce indirect taxation.
· Reduce government spending.
· Increase income tax to reduce consumer spending.
· Reduce peoples's ability to borrow money by increasing interest
rates and tightening credit regulations.
· Control the supply of money.
Reasons for Trade
International trade is the exchange of goods and services between
countries. An import is the UK purchase of a good or service made
overseas. An export is the sale of a UK-made good or service overseas.
A nation trades because it lacks the raw materials, climate,
specialist labour, capital or technology needed to manufacture a
particular good. Trade allows a greater variety of goods and services.
Principle of Comparative Advantage
The principle of comparative advantage states that countries will
benefit by concentrating on the production of those goods in which
they have a relative advantage.
For instance, France has the climate and the expertise to produce
better wine than Brazil. Brazil is better able to produce coffee than
France. Each country benefits by specialising in the good it is most
suited to making.
France then creates a surplus of wine which it can trade for surplus
Advantages of Protectionism
Protectionism occurs when one country reduces the level of its imports
· Infant industries. If sunrise firms producing new-technology goods
(eg computers) are to survive against established foreign producers
then temporary tariffs or quotas may be needed.
· Unfair competition. Foreign firms may receive subsidies or other
government benefits. They may be dumping (selling goods abroad at
below cost price to capture a market).
· Balance of payments. Reducing imports improves the balance of trade.
· Strategic industries. To protect the manufacture of essential goods.
· Declining industries. To protect declining industries from creating
further structural unemployment.
Disadvantages of Protectionism
· Prevents countries enjoying the full benefits of international
specialisation and trade.
· Invites retaliation from foreign governments.
· Protects inefficient home industries from foreign competition.
Consumers pay more for inferior produce.
Tariffs (import duties) are surcharges on the price of imports. The
diagram below uses a supply-and-demand graph to illustrate the effect
of a tariff.
Note that the tariff
· raises the price of the import;
· reduces the demand for imports;
· encourages demand for home-produced substitutes;
· raises revenue for the government.
Quotas restrict the actual quantity of an import allowed into a
country. Note that a quota:
· raises the price of imports;
· reduces the volume of imports;
· encourages demand for domestically made substitutes.
Other Protection Techniques
· Administrative practices can discriminate against imports through
customs delays or setting specifications met by domestic, but not
· Exchange controls(currency restrictions) prevent domestic residents
from acquiring sufficient foreign currency to pay for imports.
The European Community (EU)
The European Community was established by the Treaty of Rome (1957)
and is also called the European Union (EU). The fifteen members of the
EU (Belgium, Denmark, France, Greece, Irish Republic, Italy,
Luxembourg, Netherlands, Portugal, Spain, West Germany and the United
Kingdom ........) form a customs union which aims for eventual
economic and political unity. The EU has:
· free movement of capital and labour within member countries;
· free trade between member countries;
· common tariffs against non-members;
· a Common Agricultural Policy (CAP) which guarantees minimum prices
for farmers' output;
· standardised trade and customs procedures, eg metric measurements;
· some members who are part of the European Monetary System (EMS)
which aims to maintain exchange rate stability by concerted government
intervention. In January 1999 many of the members will adopt a single
european currency - the EURO. Britain has elected to stay outside this
until at least after the next election - 2002.
The International Monetary Fund (IMF)
Established in 1944 at Bretton Woods, the main aim of the IMF is to
stabilise exchange rates and to lend money to countries needing
foreign currency. Over 140 member countries pay a sum of their own
currency into a pool. The amount paid in depends on the size of their
economy. Each country can then borrow foreign currency from the pool
according to their contribution to settle temporary
balance-of-payments problems. Countries can draw up to 25 per cent of
their quota before the IMF begins to set conditions on the loan. In
1967 the IMF created a new international currency called special
drawing rights (SDRs) which governments use to settle debts with other
The International Bank for Reconstruction and Development (IBRD)
Known as the World Bank. IBRD lends money to developing countries for
capital projects such as power stations or roads. Loans are for about
thirty years and carry a low rate of interest.
The World Trade Organisation (WTO)
The World Trade Organisation was set up in 1995 and succeeded the
General Agreement on Tariffs and Trade (GATT). The aim of the WTO is
to help trade flow smoothly, freely, fairly and predictably. It;
· administrates trade agreements
· acts as a forum for trade negotiations
· settles trade disputes
· reviews national trade policies
· assists developing countries in trade policy issues
The Organisation for Economic Co-operation and Development (OECD)
The OECD is made up of member countries who send a representative to a
council. This offers an opportunity to discuss common policies to help
stabilise exchange rates and encourage growth. The OECD also publishes
surveys of individual economies.
The Organisation of Petroleum Exporting Countries (OPEC)
This is an international group of many of the largest oil-producing
nations which tries to limit world production and so maintain the
price of oil. In 1985 the price of a barrel of oil stood at over $30.
By mid-1986 members had exceeded set production levels and the price
of oil had fallen below $10 for the first time in a decade. Since then
it has recovered, but never to the previous levels.
Components of the Balance of Payments
Definition of the Balance of Payments
The balance of payments is a record of one country's trade dealings
with the rest of the world. Any transaction involving UK and foreign
citizens is calculated in sterling (UK pounds).
Dealings which result in money entering the country are credit (plus)
items while transactions which lead to money leaving the country are
debit (minus) items.
The balance of payments can be split up into two sections:
1. the current account which deal with international trade in goods
2. transactions in assets and liabilities which deals with overseas
flows of money from international investments and loans;
The current account consists of international dealings in goods (visible
trade) and services (invisible trade).
Invisible trade includes payments for overseas embassies and military
bases: interest, profit and dividends from overseas investment;
earnings from tourism and transportation.
Table 18.1 The UK current account 1985
By referring to Table 18.1 you can see that in 1985:
· The UK bought £80 140 million worth of goods made overseas.
· The UK sold £78 072 million worth of goods overseas.
· The difference between visible exports and imports is knows and the
balance of trade or visible balance. The amounted to -£2 068 million.
· The UK bought £75 007 million worth of foreign-produced services.
· The UK sold £80 027 million worth of services overseas.
· The difference between invisible exports and imports is called the
invisible balance. This amounted to £5 020 million.
Adding the balance of trade and balance on invisibles together gives
the balance on the current account. A deficit on the current account
means that more goods and services have been imported into the UK than
have been sold abroad. A surplus on the current account means more
goods and services have been exported than imported.
Transactions in Assets and Liabilities
The transactions in assets and liabilities section of the balance of
payments shows all movements of money in and out of the country for
investment. This may be direct investment - investment in productive
capacity, or portfolio investment - investment in shares or other
assets. Changes in assets will be outflows from the UK, as UK
investors invest money overseas. These flows will be debits to the UK
Balance of Payments. Changes in liabilities will be credits to the UK
Balance of Payments as overseas investors invest money into the UK
Balance of Payments Problems
Correcting a Balance of Payments Deficit
Strictly speaking, the balance of payments always balances because of
official financing. However, a balance of payments deficit means a
persistent and large negative balance for official financing. This can
be the result of excessive purchases of foreign goods and services or
excessive UK investment overseas. In the short term, a balance of
payments deficit can be corrected by:
· continued borrowing of foreign currency;
· increasing interest rates to attract overseas investors;
· imposing exchange controls;
· imposing tariffs and import quotas.
In the long run, the government can correct a balance of payments
deficit by reducing demand in the economy for all goods including
imports. Reducing UK inflation rates or encouraging a sterling
depreciation will also help.
Correcting a Balance of Payments Surplus
An unwanted balance of payments surplus can be the result of excessive
foreign investment in the UK. This will place a future strain on the
invisible balance. A reduction in interest rates or restrictive
exchange controls will correct the surplus.
An exchange rate is the price of one currency in terms of another. For
the UK, the dollar exchange rate means the number of dollars ($) one
pound (£) can buy. The exchange rate is determined by the supply and
demand for sterling (pounds) and is $2 per pound in the diagram below:
Demand for Sterling
Americans want to exchange dollars for pounds for two reasons:
1. to buy British goods and services;
2. to lend or invest in the UK.
The diagram above shows the number of pounds demanded at each and
every exchange rate. This is the D curve.
Supply of Sterling
Britons want to exchange pounds for dollars for two reasons:
1. to buy American goods and services;
2. to lend or invest in the USA.
In the diagram above S shows the number of pounds supplied by Britons
at each exchange rate.
Changes in the Exchange Rate
A fall in the value of sterling (depreciation) means one pound now
buys fewer dollars. Sterlingdepreciates if Americans
demand fewer pounds (shown in the diagram below) or if UK citizens
offer more pounds. UK exports become cheaper and UK imports become
dearer. Hence, a sterling depreciation improves the balance of
A rise in the value of sterling (appreciation) means one pound now
buys more dollars. UK exports become dearer and UK imports become
cheaper. Hence a sterling appreciation worsens the balance of
Features of Economic Growth
Economic growth refers to an increase in a country's ability to
produce goods and services. The advantage of economic growth is that
an increase in real national income allows more goods for consumption.
A developing country or less developed country (LDC) is one which is
not yet fully industrialised and tends to have the following features:
· Agriculture is more important than manufacturing.
· There is limited specialisation and exchange.
· There are not enough savings to finance investment.
· Population is expanding too rapidly for available resources.
· A low standard of living.
A developed country is more fully industrialised and has a high
standard of living.
Barriers to Economic Growth
A country can increase production if it increases the amount of
resources used or makes better use of existing factors. Economic
growth is more difficult if:
· A country lacks the infastructure (underlying capital) to produce
goods more efficiently. There are three types of infastructure:
1. basicincluding electricity, road and telephone networks;
2. socialincluding schools, hospitals and housing;
3. industrialincluding factories and offices.
· A country lacks the machines or skilled labour needed to manufacture
modern goods or services.
· A country lacks the technical knowledge.
· Workers are not prepared to accept specialisation and the division
· Population growth is too rapid.
· A country has too large a foreign debt.
Disadvantages of Economic Growth
· Increased noise, congestion and pollution.
· Towns and cities may become overcrowded.
· Extra machines can be produced only by using resources currently
involved in making consumer goods.
· A traditional way of life may be lost.
· People may experience increased anxiety and stress.
North v. South
The Brandt Commission
The Brandt Report divided the world into rich (North) and poor (South)
sectors and found that in developing countries more than 800 million
are destitute and 17 million die needlessly before they are five years
old. We in the North have 25 per cent of the world's population but
consume 80 per cent of all the goods made.
Recommendations of the Brandt Commission
Brandt suggested that the North should help the South by transferring
resources and starting a global famine relief programme. The
development role of the World Bank should be strengthened. Nations
should pay an income tax, and a tax should be put on the sale of
Many people cannot afford to buy their own homes. Renting is when a
tenant pays money to a landlord (owner) for the use of a house.
The landlord is responsible for repairs to the building. The tenant is
not allowed to make alterations to the building without the landlord's
A tenant has security of tenure, ie he cannot be forced out of the
house by a landlord. If a tenant thinks his rent is too high then he
can go to a rent tribunal where a government rent officer will decide
a fair rent. The tenant and the landlord have to accept the decision
of the rent officer.
Houses can be rented from private landlords but there is a great
shortage of rented accommodation. Local authorities provide council
housing but there is still not enough to go round. People wanting a
council house are put on a waiting list. Priority is given to families
in need. Tenants now have the right to buy their council houses from
the local authority.
Houses cost thousands of pounds. Most people buying a house take out a
special loan (mortgage) from a bank or a building society which they
repay usually over twenty-five years. There are two main types of
1. An ordinary (repayment) mortgage is where the loan is repaid with
interest in monthly instalments over twenty-five years.
2. An endowment mortgage is more expensive than an ordinary mortgage.
Every month a premium is paid to an insurance company, and interest is
paid on the loan to a building society. After twenty-five years the
insurance company pays out enough money to pay for the house and the
owner keeps any money left over.
Home ownership is encouraged by the government which reduces the cost
of monthly repayments by giving tax relief (a reduced tax bill).
People buying their own home have a good choice of property. If house
prices go up, they may be able to sell at a profit.
The shortage of rented property makes if difficult for tenants to move
house. Home owners are faced with various 'hidden' costs when moving.
They have to pay for:
· An estate agent who keeps a list of houses for sale in an area and
arranges for potential buyers to see them. The seller pays commission
if the agent finds a buyer.
· A surveyor who checks the house to see if it is well built and in
· A solicitor who checks the seller actually owns the house and draws
up a contract between the buyer and the seller.
· A removal firm which transports belongings to the new house.
· Stamp duty which is a tax on the purchase of a house.
The cost of moving can add up to several thousand pounds.
There are two types of cost involved in running a car:
1. Fixed or standing costs which must be paid even if the car is not
used. These include the interest lost by not having the money used to
buy the car in the bank, depreciation, insurance and car tax.
2. Variable or running costs for petrol and servicing.
A car is convenient but costs hundreds of pounds a year to run and
maintain. Public transport by bus, rail or underground offers a
cheaper alternative. An increase in the number of private motorists
using public transport would reduce pollution because there would be
fewer cars on the road.
Insurance is a system where in return for a previous payment a company
will give money to repair accidental damage. Insurance is based on the
pooling of risks. Thousands of policyholders pay a small sum of money
(premium) into a central pool. The pool is then large enough to meet
the expenses of the small number of people who actually suffer an
accident. Insurance companies use the principle of indemnity which
means that the insured is returned to the same financial position as
before the accident. The policyholder is given enough money to repair
the damage and no more.
Companies use data (information) to calculate a particular risk and
the premium to charge.
Main Types of Insurance
· Liability insurance.
· Household insurance covers damage to the building and the contents.
· Motor insurancecovers damage to your car, to other people and their
property. There are three main types of car insurance:
1. Third party. You are the first party; the insurance company is the
second party; anyone else is a third party. You are covered for damage
to other people and their property, only.
2. Third party, fire and theft. As for (1) plus you are covered for
damage to your own car through fire or theft, only.
3. Comprehensive. You are covered for any damage to your own car,
other people and their property.
· Life assurance which covers dependants and provides for retirement.
There are three main types of life assurance:
1. Term. Money is paid to dependants if death occurs within a stated
period, eg twenty-five years.
2. Whole life. Money is paid to dependants upon your death.
3. Endowment. Money is paid at death or after a stated period.
Whichever is the sooner.
· National insurance. Workers pay 5 per cent or more of their wages
into a pool. If they are ill or unemployed they receive benefits
(money). Once they are over 65 they receive a pension.
Leisure is free time when someone is not doing paid work, or at school
or looking after the house. The average worker spends 45 hours each
week on employment and travel. The average worker has 2.6 hours of
free time each weekday and 10.2 hours of free time per weekend day.
The principle of opportunity cost is used to value leisure time. For
example, the cost of going to the cinema is the cost of the ticket
plus any lost overtime payments that could have been earned from
Retailing and Advertising
Types of Retail Outlet
A retail outlet is a shop. There are several types:
· A unit or corner shop is local, convenient, friendly, open long
hours and offers credit to known customers but is also expensive and
has little choice.
· A multiple or chain store is several shops using the same name.
Chain stores are cheap and offer a large choice but they are not
always local or friendly places to shop.
· A department store is several shops under one roof. They are
luxurious, stock all types of goods and offer personal service but
they are found only in city centres and can be expensive.
· Supermarkets have goods on shelves (open display) and customers help
themselves (self service). Payment is made at tills.
· Hypermarkets are huge supermarkets found on the outskirts of large
towns. They have their own car parks.
Advertising is the publicising of goods and services. Advertising
creates a brand image whereby consumers buy more of a good because
they believe it is better than substitutes.
There are two types of advertising:
1. Informative which gives details about the use, price quality, etc.
of a product.
2. Persuasive which gives opinions about a product.
Many laws have been passed to protect the consumer when he buys a
good. Here are a few:
1. Trades Descriptions Act. Goods must be marked with their country of
origin. A good on special offer must have been on sale at a higher
price for at least twenty-eight days in the last six months.
2. Weights and Measures Act. The weight of a good must be shown on a
packet. It is an offence to sell under weight goods.
3. Saleof Goods Act. Goods sold must match their description. Goods
sold must be undamaged. Goods sold must live up to their description.
For example, a waterproof coat must be waterproof.
4. Goods Act. If you are sold faulty goods you are allowed your money
back or a replacement. Proof of purchase must be given.
The Consumers' Association is an independent watchdog which
investigates products and applies pressure on the government on behalf
of the ordinary shopper. The Association publishes a monthly magazine
called Which? Giving impartial information about products.
Making a Budget
Budgeting means making your expenditure less than your income. You
draw up a budget plan by:
· Making a list of all the money you receive each month (income).
· Making a list of all the money you spend each month (expenditure).
If your expenditure is greater than your income you will have to buy
Credit involves buying a good now and paying for it later. The annual
rate of interest for borrowing money on credit can be as high as 18
per cent. This means that for every pound borrowed you must pay back
18 pence in interest each year.
With hire purchase the customer pays a deposit and then makes monthly
repayments including interest. The customer does not get a discount
(money off) when using hire purchase but the good can be returned with
nothing more to pay once half the repayments have been made. The
customer does not own the good until the last payment has been made.