The Basic Economic Problem

The basic economic problem arises when there are unlimited wants but limited resources.

Opportunity cost = The next best alternative forgone when making a decision

The Three Economic Agents Are

Households, Firms & Government

Primary Sector
All economic activity involving extraction of raw materials
Secondary Sector
All economic activity dealing with converting raw materials into manufactured goods
Tertiary Sector
Provides services and intangible goods to consumers
Quaternary Sector
The knowledge-based part of the economy (ICT, computing)

Consumer goods
Luxuries eg. Clothes, Mobile phones
Capital goods
Goods used for production / generate more income eg. tractors, sewing machines

Factors of Production
Resources that are required for the production of any goods or services.

4 types of resources:
Land (natural resources)
Labour (workforce of the economy in terms of mental and physical effort)
Capital (man-made equipment used to aid in production) (computers, coffee machines)
Enterprise (individual/firm that successfully manages the other 3 FOP to take risks and make
profit) (BMW, Elon Musk)

Rewards for FOP

Land - rent
Labour - wages
Capital - interest
Enterprise - profit

Mobility of FOP
- Land can be used for various purposes (grow certain crops or used for housing)
 - Capital machinery can be used for different purposes (same machinery in a Coca Cola
factory can be used in a Sprite Factory)
- Entrepreneurs/labourers can be mobile

Production Possibility Curve

Production Possibility Curve

A graph showing the maximum possible output of two goods the economy can possibly
produce given the available resources and the available technology.

Assumptions:
1. Resources are used to produce one or both goods
2. The quantity of resources are fixed
3. Technology and production techniques are fixed
4. Resources are used in a technically efficient manner

Efficient points of production are

A,B,C,D

Inefficient point of production is

E

Infeasible point of production is

F
Constant opportunity cost / linear graph: You lose the same and gain the same amount of
goods (corn & wheat) as it requires similar resources
Increasing opportunity cost / curved graph: It does not remain the same
The law of increasing opportunity cost: An increase in the production of one good will lead to
a greater forgone production of another good.

Law Of Demand & Supply

Law of Demand: More goods are purchased at a low price (inverse relationship between goods
demanded and price)
Law of Supply: Producers willing to sell more at a higher price (direct relationship between
goods demanded and price)

If the price is too low, there will be shortages.

If the price is too high, there will be a surplus for the seller (low demand).
Demand / Supply Curve Shift
a. Increase in Demand (Outward Shift):
● When consumers want to buy more of a product at each price level.
● Factors causing an increase in demand:
● Increase in consumer income: More income means people can afford to buy
more goods and services.
● Change in consumer tastes: If a product becomes more popular, its demand
increases.
● Price of related goods: If the price of a substitute increases, demand for the
original product may rise.
● Expectations: If consumers expect future prices to increase, they may buy more
now.
b. Decrease in Demand (Inward Shift):
● When consumers want to buy less of a product at each price level.
● Factors causing a decrease in demand:
● Decrease in consumer income: Less income means people can afford to buy
fewer goods and services.
● Change in consumer tastes: If a product falls out of favor, its demand decreases.
● Price of related goods: If the price of a complement increases, demand for the
original product may fall.
● Expectations: If consumers expect future prices to decrease, they may buy less
now.
a. Increase in Supply (Outward Shift):
● When producers are willing to supply more of a product at each price level.
● Factors causing an increase in supply:
● Technological advancements: New technology can make production more
efficient.
● Lower production costs: Reduced costs, like cheaper raw materials, can lead to
increased supply.
● Government subsidies: Financial incentives can encourage producers to increase
output.
● Favourable weather conditions: In agriculture, good weather can lead to higher
crop yields.
b. Decrease in Supply (Inward Shift)
● When producers are willing to supply less of a product at each price level.
● Factors causing a decrease in supply:
● Natural disasters: Events like hurricanes or droughts can disrupt production.
● Increase in production costs: Higher costs, such as increased labor or energy
expenses, reduce supply.
● Government regulations: Restrictions can limit production or increase costs.
● Technological setbacks: If machinery breaks down, it can reduce production
capacity.

Price Elasticity of Demand

The PED of a product refers to the responsiveness of the quantity demanded in relation to
changes in its price.
PED Formula

Elastic demand is where the quantity demanded changes with price, inelastic demand is where
the quantity demanded does not change at all.
 Price Elasticity Of Demand

Type Description Coefficient Graph Example

Relatively The increase in Consumer

Elastic price leads to 1<e< ∞ goods e.g
bigger % clothing
decrease in
quantity
demanded

Perfectly Elastic A small increase Goods with

in price leads to e= ∞ perfect
zero demand substitutes

Unitary Elastic An increase in e=1

price leads to an
equal % fall in
quantity
demanded

Relatively The increase in 0<e<1 Essential goods

Inelastic price leads to a e.g fuel / food
smaller %
decrease in
quantity
demanded

Perfectly An increase in e=0 Life saving drug

Inelastic price has no / vaccines
effect on
quantity
demanded

Revenue = Price x Quantity

Revenue is what I get overall, profit is what I earn

If demand is inelastic, the higher the price, the higher the total revenue
If demand is elastic, the lower the price, the higher the total revenue
Price Elasticity of Supply
PES measures the responsiveness of Qs to a change in the price of the good.

PES Formula
 Price Elasticity Of Supply

Type Description Coefficient Graph Example

Relatively The fall in price Goods that can

Elastic leads to bigger 1<e< ∞ be manufactured
% decrease in easily e.g. pens
quantity
supplied

Perfectly Elastic A fall in price

leads to a e= ∞
complete halt in
production

Unitary Elastic A fall in price e=1

leads to an
equal % fall in
quantity
supplied

Relatively The fall in price 0<e<1 Goods that are

Inelastic leads to a difficult to
smaller % produce e.g.
decrease in Boeing 777s
quantity
supplied

Perfectly A change in e=0 One of a kind

Inelastic price has no goods e.g.
effect on Paintings (by
quantity dead artists)
supplied
Economic Systems

Free Market System------------Mixed Economic System-----------Centrally Planned System

Market Economy
- Government intervention at a minimum
- Private sector owns the means of production
- Allocation of resources are determined by private sector
- Allocation of resources are decided through price mechanism - law of supply and
demand
- Profit orientated
- Almost all FOP owned by private individuals and firms
- No barriers to entry
- Highly competitive to obtain highest profit
- Decentralised decision making, no single body allocates resources

Mixed Economy
- combination of free market and planned system
- Private sector owned by firms and individuals
- Public sector owned and controlled by government
- Japan, Italy and Spain

Planned Economy
- State owned means of FOP
- Government decides the allocation of resources
- Equal distribution of goods and services
- Production of standardised goods of lower quality
- Planned for the long term growth of the economy

Pros and Cons of Market Economy

Advantages
- Efficient
Market pays attention to consumers’ wants and needs, stimulates innovation and is more
responsive, G&S produced is equal to demand
- Freedom of Choice
consumer utility is maximised
- Incentives
Motivated by unlimited wealth, incentives to work hard which boosts the economy
- Innovation
To obtain a competitive edge in a competitive market, they have the initiative to undergo
r&d
Disadvantages
- Income and Wealth Inequality
The rich have much more freedom and choice, poorer members of society may be
neglected. Owners of highly valued resources will receive higher income
- Environmental Issues
Due to self interests and profit motive, consumers and firms may not consider the impact
of their activities on the environment
- Social Hardship
public goods like street lighting and public phones may not be provided, relief for poverty
may only be done through charities
- Wasteful Competition
competitive pressures means firms use up unnecessary resources to gain advantages,
production of homogeneous products
- Production Of Demerit Goods
Producers will produce harmful demerit goods such as liquor and cigarettes if there is
demand

Pros and Cons of Planned Economy

Advantages
- Low Inflation
Prices are kept at a fixed level
- Attainment Of Full Employment
Unemployment is avoided through the government’s careful allocation of labour
- Distribution Of Income
Even distribution of income as planner set a minimum standard of living (subsidising
essential goods)
- Social Justice (Socially Optimum)
Production is geared towards maximising welfare, everyone receives equal treatment
and the same opportunity to receive housing, healthcare

Disadvantages
- Lack Of Competition
Businesses are structured as state monopolies, resulting in lack of competition
- Lack Of Choice
Products tend to be specialised, leading to lack of variety for consumers
- Inefficiency
 Lack profit incentive to use the most cost-efficient means of production. Low levels of
innovation leads to wastage of resources
- Misallocation Of Resources
Planning authority may misjudge preferences and needs of consumers, may lead to
underproduction or overproduction of certain goods

Answering Exam Questions

Use a supply and demand diagram to describe why the demand for air travel has increased. (8)

Sketch a diagram with supply and demand curve shifts - 4 points

2 factors of supply - 2 points
2 factors of demand - 2 points

Market Failure
an inefficient distribution of goods and services in the free market. In market failure, the
individual incentives for rational behaviour do not lead to rational outcomes for the group.

Private Cost + External Cost = Social Cost

Private Benefit + External Benefit = Social Benefit

Free market fails to allocate resources efficiently in the following situations

1. When healthcare and education are underproduced.
2. Street lighting and public roads are underprovided.
3. Tobacco, alcohol and gambling are over provided.
4. Extraction of oil and construction of buildings will have a negative impact on the
environment.
5. Monopoly abuse occurs, electricity in Malaysia is only produced by one company.

Mixed Economy
Government intervention includes max/min prices, taxes and subsidies

Tax takes care of overproduced demerit goods

Subsidies takes care of under-produced merit goods

Governments will set a ceiling price / maximum price to make goods affordable (covid-19
test kits)
Problems: shortage (excess demand)
A minimum wage is a form of minimum price
Problems: surplus (excess supply)

Direct tax = tax on income (given directly to government)

Indirect tax = tax on spending (suppliers choose how much of the burden they want to carry eg.
50% tax is burdened by consumers.

Privatisation: transfer of ownership assets from public sector to private sector

Nationalisation: purchase of privately owned assets by the government

Types of privatisation
1. Sale of nationalised industries (BBC)
2. Contracting out (Family Mart in Hospital)
Pros: More innovative, save taxpayers money, more efficient
Cons: lack of monitoring,
3. Sale of land and property
Cons: Unemployment (maximise profits and lay off workers)

[Link]

Money and Banking

Macroeconomics aims of a government
1. Price stability
2. Full employment
3. Economic growth
4. Satisfactory balance of payment

These aims are achieved by the central bank with

Money supply & rate of interest

Functions Of Central Bank

1. Sole issuer of currency notes
2. Government’s bank
3. Banker’s bank
4. Custodian of foreign exchange reserves
5. Lender of last resort
6. Conducts monetary policy (manipulation of interest rates)
 Central Bank Vs Commercial Bank

Central Bank Commercial Bank

Number There is only one central There are multiple

bank in a country commercial banks in a
country

Status Central bank is an apex Commercial banks are units

institution of the monetary in the banking system which
market work under the control of the
central bank

Aim Control and supervise To earn profit

monetary policy and banking
system

Ownership Owned by the government May be owned by

government or by private
parties

Dealing Does not deal directly with Deals directly with the public
the public

Issuing of currency Has monopoly over issuing of Not authorised to issue

currency currency

Credit Controls availability of credit Creates credit in the

in the economy economy

Characteristics of money
1. Durability - withstand physical wear
2. Portability - easy to carry around
3. Divisibility - $1 = 4 quarters
4. Uniformity - must look the same
5. Acceptability - must be accepted by everyone as money

Households

Factors influencing spending

● Wealth
● Consumer confidence (future income, jobs)
● Disposable income (income - tax)
 ● Interest rates (if interest rates on savings are high, this discourages consumers to
spend)
Factors influencing saving
● Income
● Consumer confidence
● availability of saving schemes
● interest rates
● disposable income
Factors influencing borrowing
● interest rates (when they are high, people are reluctant)
● Wealth (banks tend to lend more money to high income individuals)
● Consumer confidence (there will be inflation soon, borrow and buy now)
● Ways of borrowing (if there are many ways like overdraft, bank loans etc then there will
be more borrowing.)

Current Expenditure: Money spent on goods which are consumed within a year, eg. clothes
and food.

Capital Expenditure: Money spent on fixed assets, an item which lasts more than 12 months,
e.g cars, houses and furniture.

Too much spending = inflation

Too little spending = deflation

High and growing levels of debt will hinder the long term economic growth of a country.

Workers
Wage factors affecting an individual’s choice of occupation:

Explanations Examples

Wages A fixed regular payment, Part-time workers, waiter

made hourly, daily or weekly earning RM 10 per hour

Salary Paid monthly at a fixed rate, Full-time workers, teacher

regardless of the work done earning RM 3000 per month

Piece Rate A fixed amount paid per item Factory worker earning RM 5
sold or produced for every shoe that is made

Commission A percentage given of the Salesperson getting 1% of

value when a product is sold commission for every car sold

Bonus An additional sum of money Salesperson gets a bonus for

paid during the year, usually selling the most phones
performance-based

Profit-related Pay Additional payment given Managing director earns 3%

based on amount of profit of profit from firm’s
earned by a firm highest-earning year

Share Options Workers receive shares in Genting group offer share

firms as an incentive to work options for free, employees
harder so that the firm is will be much more motivated
profitable to work

Perks Additional benefits, which High ranking positions within

have a monetary value a company come with a
company car, health
insurance and pensions
 Non-wage factors affecting an individual’s choice of occupation:

Explanation Examples

Level of challenge Whether a job requires Individuals might choose to

thinking and innovation or just teach law instead of being a
pure repetition clerk in a law firm

Career Prospects Available opportunities and Individuals might avoid a firm

progression within a firm which offers no chance of
promotion in a certain role

Level of Danger Involved How dangerous and An individual might choose to

life-risking a job is be a safety instructor instead
of being an active military
personnel

Length of Training Required The amount of training that is A doctor might not be eligible
required for a job, usually to work as a surgeon without
skilled and high earning jobs more years of training

Level of Education Required The amount of education An individual with only

needed for a job (degrees, secondary school level
postgraduate levels) education may only be
eligible to work in a factory

Recognition in the Job The amount of recognition An individual has left the
and praise a worker gets to company due to a lack of
be motivated and remain in a recognition and respect from
certain job colleagues and bosses

Personal Satisfaction Gained How happy and satisfied a A policeman is happy to work
worker feels working, for low pay as he feels
voluntary employment might satisfied and proud for
be carried out where a worker serving the country
works for no pay.

Level of Experience Required The amount of previous An individual is only eligible

experience within a certain to work as a judge after at
field needed for a job least 10 years experience as
a lawyer

Wages are determined by the interaction of the demand for labour (firms) and the supply of
labour (households)

High wages = DL>SL

Low wages = SL>DL
Labour market graph
Equilibrium wage rate
Changes in demand and supply of labour in an industry will change the equilibrium wage rate

Demand for labour would depend upon:

- The level of aggregate demand in an economy (during a boom period, recession)
- The productivity of labour (output per worker over a period of time, demand increases if
productivity increases)
- The cost of labour (demand falls when there is a cheaper alternative, often compared
with technology or machinery)
Worker’s productivity = product output / no of hours
Firm’s productivity = total product / no of workers

Supply of labour in an economy:

The supply of labour refers to everyone in an economy who is of working age and is both willing
and able to work at different wage rates.
 Individual supply of labour
Individuals who earn a sizable enough wage will value leisure
and time more. Example, a surgeon is satisfied with 30k per
month, that is offered at W1, he doesn’t have to work as much
hours as before to reach the target.

Labour force participation rate

The labour force participation rate is influenced by:
- The number of full time and part-time workers in the labour force
- The number of women in the labour force
- The age distribution of the labour force (too many old people in Japan)
- The official retirement age of a country
- Availability and level of welfare benefits (attractive welfare benefits discourage people
from working)
- Changing of social attitudes (more and more women are delaying childbirth to join the
workforce, fewer couples want children which affects the birthrate)

Geographical mobility
Refers to the willingness and ability of an individual to relocate to another place to work.
- Family ties and related commitments (people may want to remain close to their families,
not wanting to transfer their children to other schools)
- Costs of living (may not want to relocate in

Occupational mobility
This refers to the extent and ability of a person to switch jobs.
It would be easier for an ex-banker to be an economics teacher than to be a civil engineer, this
would require more training.

Relative Bargaining Power

The ability of workers to negotiate and bargain with their employers for higher wages
- Trade union (a larger and more united trade union will have higher bargaining power with
employers e.g. teachers union)
 - Age and experience (workers with a greater degree of experience or age will be more
successful in negotiating higher wages)
- Level of education (a person’s education level affects their earnings and ability to
negotiate)

Government Policy: minimum wage

A national minimum wage is the lowest legal amount any firm can pay its workers set by the
government.

NMW in 2 countries
Democratic Republic of Congo: 65 USD per month
Ukraine: 220 USD per month

Advantages of NMW:
- Workers receive a fair wage and are not exploited by employers
- Unemployed people will have an incentive to work
- Low-income earners will have more money to spend, increasing consumption in an
economy
- Improve quality of life

Disadvantages of NMW:
- Workers who have already earn more than the NMW might request for higher pay to
maintain the difference between them and lower positions, thus increasing the labour
cost in a firm.
 - Leads to unemployment because it lowers the demand for labour, firms will look to
purchase machinery and equipment as it is cheaper in the long run.

Ways a government can influence the supply of labour:

1. Encourage positive net inward migration of labour (permits)
2. Tax-free or subsidised child care
3. High NMW
4. Increase national retirement age
5. Provide bursaries for education (sum of money that does have to be repaid)

Wage Difference

Difference between primary (production), secondary (manufacturing) and tertiary

(service) sector workers:
- A low value product will lead to low wages (fishing)
- Primary sector usually requires the least skilled workers
- More training and education needed, more wage paid
- Students prepared to take out loans for education as a high earning job in the future is
guaranteed

Difference between men and women workers:

- More women in part-time jobs than men (so lower wages on average)
- Women take career breaks to have children (miss out on promotional opportunities)
- Women accept low pay or part time jobs as hours are flexible and fits with childcare
arrangements (usually women are not the main breadwinners)
- Women may face discrimination at work (affecting personal satisfaction gained at work)

Difference between private and public sector workers:

- Usually private sector workers earn more
- Public sector jobs are more secure and often include pensions
- Private sector firms and individuals strive for profit maximisation (profit related pay)
- Private sector jobs unsecure and vulnerable to recessions or financial crises (often no
pension)

Trade Unions

Employers want to
 - Maximise profits
- Minimise costs
- Maximise sales

Employees want to
- Maximise wage
- Work in a safe/healthy environment
- Maximise non-wage benefits
- Have job security at work

Why trade union memberships may be reduced:

- Improved working conditions
- Improved wages
- High unemployment
- Fear of losing jobs
- Government measures against unemployment, have reduced the ability of trade unions
- Changes in pattern of employment (gig economy, self employment)
- Dissatisfaction over trade unions (high fees, different political views)

Firms

Primary: all economic activity involving extraction of raw materials

Secondary: all economic activity dealing with producing finished goods
Tertiary: provides services and intangible goods to consumers

Public: firms owned and run by the government

Private: firms owned and run by private individuals

Economies of Scale
Cost saving benefits of large scale operations, which reduce the average costs of production.

Internal Economies of Scale

Cost savings that arise from within the business as it grows

- Bulk buying (cost of raw materials or components fall when bought in large quantities)
- Financial economies of scale (credible firms have cheaper loans)
- Managerial economies of scale (large firms have the resources to employ qualified
and skilled employees, productivity increases and cuts costs)
 - Risk-bearing economies of scale (conglomerates vary their businesses to diversify the
risks, e.g produce TVs and Chips)
- Research and development (R&D) EOS (large firms can fund R&D to allow them to be
market leaders in innovation)
- Marketing economies of scale (large firms have large advertising budgets to be
promoted effectively)

External Economies of Scale

Benefits that arise due to the location of the firm

- Proximity to related firms (A garment manufacturer benefits from nearby firms

producing zippers and buttons)
- Availability of skilled labour (Tiruppur has a pool of skilled garment workers)
- Reputation of geographic location (easier to attract workers e.g. Silicon Valley and
Wall Street)
- Access to transportation networks (more appealing to workers and for transportation)

Diseconomies of scale
Total average costs of production increases when a firms becomes to large

- Necessary to employ more employees (adds to the total cost)

- Communication issues (too many branches to control efficiently)
- Distant relationship between workers and owners
- Business may become too diverse in areas of less expertise (reduced control
causes costs to increase)

Risk Bearing EOS

Large firms like conglomerates are able to produce a range of products and operate globally,
which allows them to diversify the risks. Never put all your eggs in one basket, in case a product
is failing, the firm has plenty more ventures to back it up. For example, Uniqlo is experiencing
financial loss in Malaysia but its thriving businesses overseas balance it out. Another example is
the low sales of Sony phones but their products in other ranges such as the PS5 are incredibly
successful.

Firms and Production

The demand for the factors of production(land,labour,capital,enterprise):

Derived demand = the demand for the goods and services that the factors of production
produce
Other factors which affect the demand for factors of production are:
- Cost of the factor of production (the higher the cost of land or labour the lower the
demand)
- The quantity of factors of production (the higher the availability, the lower the cost)
- The productivity of factors of production (better-quality resources fetch a higher cost due
to high productivity e.g. surgeons and pilots are in high demand.

Labour intensive and capital intensive production

Labour-intensive
production requires a larger amount of human resources compared to technological resources

- Can be very expensive (fee-paying schools charge customers high prices)

- Labour-intensive production tends to produce individual or custom-made products
(custom-made wedding dresses)
- Professional football is very labour intensive

Capital-intensive
Happens when a firm spends more on capital costs than any other factors of production

- High initial cost but huge cost savings in the form of technological economies of scale
- Firms that are capital intensive do so to increase productivity and output by mass
producing their products
- Unit costs of production are low

Firm’s costs, revenue and objectives

Cost of production: a firm’s expenditure in the process of producing goods and services
Fixed costs: costs that is independent of the level of output (tables, coffee machines)
Variable costs: costs that change depending on a firm’s output (sugar)

Total costs = variable costs + fixed costs

Costs of production:
- Wages and salaries
- Rent paid to landowners
- Advertising expenses
- Purchases for raw material
- Utility bills for telephone and electric bills
- Dividend payments to shareholders
- Taxes paid to government
Revenue = Price*Quantity
Total profit = Total revenue - Total cost

Firm Objectives
- Survive / break even
- Profit
- Growth (EOS, job security)
- Market share
- Service to society

Market Structure
Competitive markets
- Many sellers
- Many buyers
- No barriers to entry

Monopolist markets
- One seller
- Many buyers
- barriers to entry (airline system)

Market structure: Market structure refers to the way that various industries are classified and
differentiated in accordance with their degree and nature of competition for products and
services

Price takers: firms in a perfectly competitive market have to prevail to the equilibrium price set
by the market

Pricing
Penetration pricing = setting a lower price for a new product to build a customer base

Predatory pricing = setting a price lower than the COP that other suppliers are forced to exit the
market (dumping) to set high barriers of entry.

Price leadership = a leading firm in an industry can set the price in the market

Price skimming = setting the price higher as you know you already have a customer base (PS5)
Role of Government
Government as a producer
- Merit goods (education)
- Public goods (street lights, military, drainage system)
- Welfare services (unemployment benefits, school aid)
- Infrastructure (roads)
Government as an employer
- Provides all levels of employment to a large population
- Employment directly or by contracting
- Support for agriculture and other prime industries that need public support
- Manage the macroeconomy (prices, growth)

Describe how a government can act as a producer of goods and services in a country.
A government acts as a producer of goods and services in an economy in a number of ways.
Nationalisation creates a situation of state control where a government may provide goods and
services especially when such provisions can be in the public's interest. For example, public
goods are provided in situations where it is unlikely to be provided by firms in the private sector.
Examples of public goods include street lights, parks and museums. Another instance where a
government is a producer of goods and services in an economy is when a government provides
merit goods as they are likely to be underproduced and under-consumed. The government
intervenes to ensure that they are available to the people. Examples of merit goods include
education and healthcare.
Government has to act as a producer because of nationalisation (not provided
elsewhere)

Another situation is when goods and services are under-consumed and

underproduced, it has to produce merit goods

Macroeconomic Aims of The Government

1. Economic Growth
When the annual national output of goods and services in a country increases
- Growth of Gross Domestic Product (monetary value of all goods and services
produced in a country over a period of time)
- If output falls over period of time (recession) leads to fall in tax revenue,
unemployment, low investments
 - If output falls throughout two consecutive quarters of a year then its a recession
- Boom-bust cycle
- Top 5 countries in GDP (US 23 trillion, China, Japan, Germany, India) Malaysia
300 billion
- PPC moves outwards when there is economic growth

2. Full Employment
- Unemployment is when people are willing to work but unable to find work
- Labour force = the people who should be working (population of working age is
not labour force)
- unemployment/labour force = unemployment rate

3. Price Stability
- Inflation is the sustained rise of general prices in a market
- Consumer Price Index to measure inflation
- Hyperinflation in Venezuela 2017 - 439%
- Inflation in Germany 2020 - 0.51%
- Hyperinflation in Zimbabwe 2020 - 557%
- Inflation is single digit, hyperinflation is double to triple digit

4. Balance of payments stability

- Financial record of a country’s transactions with the rest of the world for a given
period of time, usually annually.
- Government records credit items (UK tourists spending in Malaysia, all payments
received from other countries)
- Debit items are transactions made to other countries
- All transactions between Malaysia and the world are recorded on Balance Of
Payment slip
- Inflow < Outflow = deficit in BOP
- Inflow > Outflow = surplus in BOP
 problem aim

recession economic growth

unemployment full employment

inflation/deflation price stability

deficit/surplus in BOP satisfactory BOP

Other Aims Of Government:

Two other possible government objectives are to reduce poverty / reduce inequalities in
incomes and wealth:

To protect the natural environment and achieve a more sustainable growth

Conflicts Between Macroeconomic Aims

1. Full employment vs stable prices (inflation rises when everyone is able to demand and
afford)
2. Economic growth vs balance of payments stability (economic growth is higher spending,
therefore when consumption rises, expenditure on imports increases)
3. Full employment vs balance of payments stability (employed people tend to buy more
imports)
4. Economic growth vs stable prices (demand-pull inflation)

Monetary Policy
Money supply = the amount of money in the economy at a particular point in time, e.g. coins,
banknotes and bank deposits.

Interest rate = a percentage of the principal that is charged to a borrower by the lender

Deposit interest and borrowing interest

Hot money = funds that transfer between various financial institutions in an attempt to maximise
interest rates
During recession, the central bank will reduce interest to encourage spending and
discourage saving.

Inflation (AD>AS)
When interest rates are low (expansionary) AD goes up:
- Consumer spending increases
- Investments increase
- Government spending increases
- Hot money (park it where you get the highest interest) goes out, ringgit drops
- Ringgit drops (export rises, import drops)

Deflation (AD<AS)
When interest rates are high (contractionary) AD goes down:
- Consumer spending decreases
- Investments decrease
- Government spending decreases
- Inflow of hot money, ringgit value appreciates

Open Market Operation

- Selling treasury bill reduces money supply as a contractionary measure
(consumers/banks short term lending to government)
- Finances government spending
- Cash reserve ratio determined by central bank (money must be kept aside as reserves)
increase reserve ratio to lower money supply

1/Cash Reserve x Original Deposit = Money Supply

Quantitative Easing
Government buys private bonds and assets with digital currency.

Supply-Side Policy
Supply-side policy: long term measures to increase the productive capacity of the economy,
leading to outward shift of the ppc.

1. Education + Training = More Skilled Workers

2. Subsidies (rm 1.65 per litre for fisherman as compared to rm 2.05)
3. Privatisation
4. Trade Union Power (Reduce exploitation of workers)

Effects:
1. Lower price level
 2. Higher GDP (economic growth)
3. Improve in trade position as the country can export more
4. Fall in the level of unemployment
5. Satisfactory BOP

Disadvantages:
1. Government has to spend more (increase tax)
2. Long term to see impacts

Labour Market Reform (Incentivise Work):

- Reduce Trade Union Power
- Minimum Wage
- Reduce unemployment benefits

Encourage Investment:
- Research grants
- Subsidies
- Reduce corporate tax
- 5 year tax holiday in free trade zones (Bangi, Bayan Lepas)

Economic Growth
Measurement of GDP

Expenditure Method
GDP = C + I + G + (X-M)

Nominal GDP
Doesnt take inflation into account

Real GDP
Adjusted for inflation ( w/o inflation)

GDP per capita

GDP divided by population
Recession:
GDP falls in 2 successive quarters

Simon Kuznet Curve

Initially contributes to poor distribution of income.
Employment & Unemployment
Employment = unemployment / labour force x 100
Unemployment = capable and willing people of working age are unable to find a job

Measures the number of people out of work and claiming unemployment benefits = claimant
count

Labour force participation rate = labour force / working age population x 100

Types of unemployment
Structural
Results from industrial reorganisation usually caused by a mismatch between the skills that
workers in the economy can offer,
- Free Trade Zones (bring jobs to workers)

Seasonal
Occurs when jobs are only available at certain times (santa claus impersonators, sheep
shearer)
- Retraining

Cyclical
When the business cycle is at the peak, cyclical unemployment is low
- Harder to solve
- Conduct expansionary policies (fiscal, monetary, supply-side)
Frictional
When workers move from one job to another
- Provide job finding platforms

Consequences of unemployment
- Lose working skill
- Standards of living fall
- Loss of gdp
- Rising crime rate
- Rising divorce rate
- Loss of tax revenue
- Higher cost of unemployment benefits

Inflation And Deflation

Inflation is the sustained rise in the general price of goods and services over time.
Deflation is the sustained fall in the general price level of goods and services over time.
Demand-pull inflation
Inflation refers to a situation in which AD > AS persistently exceeds
i) C
ii) I
iii) G
Iv) x-m

Cost push inflation

i) increase in NMW
ii) indirect tax
iii) shortage of important resources (land)

Consumer Price Index (Calculate Inflation)

CPI = sum of weighted index / sum of weight

Weight is the importance of the item in terms of how much is spent on it.

Rate of inflation

CPI given year - CPI base year

--------------------------------------------- x 100
CPI base year

Consequences of inflation

Lower purchasing power - less you can buy with the same amount of money

Exports are less internationally competitive - price of exports are higher than usual, lower priced
foreign goods can rival it

Fixed income groups, lenders, savers lose - wage demands by labour trade unions, leads to
cosh push inflation

Menu costs - impacts the price charged by firms (updated regularly)

Causes of deflation
When AS > AD
 1. Productivity has risen
2. Advance in technology

Consequences of deflation
1. Lower prices will discourage production, leading to unemployment
2. Deflation can cause recession
3. Tax revenue of the government will fall
4. Borrowers lose because value of debt is worth more
5. Deflation will increase the real debt burden of the government

Living Standards
Standard of living = the social and economic wellbeing of individuals in a country at a particular
point in time.

Main indicators: GDP Per Capita & Human Development Index (HDI)

Real GDP per capita = has been adjusted with inflation levels

Human Development Index

The United Nation’s composite indicator of living standards in a country, comprising three
dimensions of human development, education, healthcare and income.

Healthcare - measures life expectancy at birth

Education - measures the mean years and expected years of schooling
Income Levels - measures national income (GDP)

HDI is used as various aspects are considered rather than a single one.

Limitations

Factors That Cause Income Differences In Income and Living

Standards

Productivity levels - differences in productivity levels cause differences in earnings

Role of governments - depends how a government redistributes income in an economy (market

economy vs mixed economy)
Size of population - densely populated cities tend to have higher rents due to limited space and
high demand, as well as congestion, pollution and higher living costs

Regional differences - there are regional income and wealth disparities within countries.

General price level - inflation increases the cost of living

Level of education - there is a positive correlation between educational attainments and

earnings

Level of freedom - living standards must include consideration of civil liberties, political rights,
religious freedom and economic rights.

Poverty
Poverty is a condition that exists when people lack adequate income and wealth to sustain a
basic standard of living.

Indicators
- Hunger and malnutrition
- Ill health and morality from illness
- Limited or lack of access to education and other basic services
- Homelessness and inadequate housing
- Unsafe environments
- Social discrimination and exclusion

Absolute Poverty
- Poor by a particular standard
- Less than 1.25 usd per day
- Spends most income on essential needs for survival (food, shelter)
- Living below the poverty line

Relative Poverty
- Lower standard of living compared to the average member of society

Causes of Poverty
- Unemployment
- Low wages (low gdp per capita)
- Illness
- Age (elderly are unable to sustain standard of living, child labour)
- Poor healthcare (hinders the ability of a country to develop)
 - Low literacy rates
- High population growth (lack of sex education)
- Poor infrastructure (neccessities for an efficeint functioning economy)
- Low foreign direct investment (lack of capital resources hinders growth)
- High public debt (low-income countries tend to borrow more to fund their public sector
expenditure)
- Reliance on primary sector output (low price and profit margins)
- Corruption and instability

Policies To Combat Poverty

1. Promoting economic growth (expansionary policies)

2. Improving education (positive correlation between the attainment of education and

potential earnings)

3. Providing more generous state benefits (financial assistance to meet basic needs)

4. Progressive taxing (reduce the gap between the rich and poor)

5. Increasing national minimum wage (alleviating poverty)

6. Targeting initiatives at the poor (Bantuan Rakyat 1 Malaysia,)

Population
Population refers to the total number of inhabitants in a country at a particular time.

Birth rate measures the number of live births per thousand of the population in a year.

Population growth refers to the rate of change in the size of a country’s population.

Fertility rate measures the average number of births per woman

Death rate measures the number of deaths per thousand of the population in a year

Net migration rate measures the difference immigration and emigration rates for a country
Immigration - emigration

Reasons for differences in growth and rate of populations

Birth rate
More economically developed countries have lower birth rates due to education and access to
contraception. The high costs of living and women choosing to pursue careers.

Death rate
Famine, poverty, poor housing and high infant mortality rates reduces life expectancy in LEDCs

Net Migration rate

Reasons to migrate are lower taxes, job opportunities or avoiding civil unrest.

Optimum population exists when the output of goods and services per head of population is
maximised.

Population Pyramid
Dependency ratio is a comparison of the number of people not in the workforce and number of
people in active paid employment.

Dependency ratio = dependent population / working population

The greater the ratio, the greater the tax burden on the working population

It increases when:
1. Higher birth rates
2. Higher compulsory school leaving age
3. Social changes (choosing to pursue higher education, early retirement)

Effects of population growth on the following:

Consumers
- The demand for goods and services will change according to the trend
- Elderly spends more on healthcare while younger people spend more on entertainment
and housing

Firms
- Rapid population growth will increase the supply of labour in the future
- Low birth rates and net emigration will decrease the supply of labour
- Most HIC have ageing populations (more than 30% of Japanese are over 60)

Government
- More tax revenue from the workforce
- Added pressure to provide public services and welfare benefits
- Governments have introduced compulsory pension saving schemes (EPF, employees
provident fund)
- Age of retirement raised

The Economy
- Pressure on scarce resources
- Inflationary pressures or increase in demand for imports

Natural Environment
- Non-renewable resources used up
- Pollution and traffic congestion

Development
GDP only accounts for economic growth.
Development involves three dimensions.
HDI

Difference In Economic Development Between

Countries
Economic development is an intangible concept that considers both quantitative and qualitative
variables in raising the standard of living within a country.

Factors accounting for differences in economic development:

Differences in income
- The higher the real gdp per capita, the greater the economic development
- Positive relationship between economic growth and development

Differences in productivity
- Low income countries are unable to access the latest technology and automated
production
- Some countries have plenty of resource endowments while others dont
- For LEDCs the main exports are cheap agricultural products
- Countries which are able to attract foreign direct investment will enjoy high levels of
productivity

Differences in population growth

- Rapid population growth reduces GDP per capita
- Competing pressures on earth’s scarce resources
International Specialization
Concentration on the provision of particular goods and services rather than other products.

Specialisation types:
1. Individuals (people may specialise in their career choices to be more skilled and efficient
at what they do)
2. Firms (specialise in the output of their products, e.g. KFC and chicken)
3. Regions (cities specialise in provision of a certain good, e.g. Silicon Valley or Milan)
4. Countries (international specialisation occurs when countries concentrate on the
production of certain goods and services due to cost advantages, perhaps due to their
abundance of resources, e.g. Thailand and rice)

Advantages of specialisation:
- Efficient use of scarce resources (increase GDP)
- Labour productivity
- Increased PPC
- Economies of scale, large quantities at lower average cost (keep inflation down)
- Improved competitiveness (competitive prices in the world market)

Disadvantages of overspecialisation
- Causes regional and structural unemployment (bad weather conditions wipe out an
entire agricultural-based economy)
- Lack of variety for consumers
- High labour turnover (workers leave the country as jobs are boring, costs a lot to re-train
and re-hire workers)
- Low labour mobility
- Higher labour costs (workers with highly specialised skills seek higher wages)

Overspecialisation = too much concentration on producing a limited number of goods and

services. This exposes the economic agent to a far higher degree of risk.

Multinational Companies
Globalization is a term used to describe the increases in worldwide trade and movement of
people and capital between countries. The same goods and services are sold across the
globe; workers are finding it easier to find work by going abroad for work; money is sent from
and to countries everywhere.

Some reasons how globalization has occurred are:

 ● Increasing number of free trade agreements– these are agreements between countries
that allows them to import and export goods and services with no tariffs or quotas.
● Improved and cheaper transport (water, land, air) and communications (internet)
infrastructure
● Developing and emerging countries such as China and India are becoming rapidly
industrialised and so can export large volumes of goods and services. This has caused
an increase in the output and opportunities in international trade, allowing for
globalisation
● Advances in technology such as e-commerce

Advantages of globalisation

● Allows businesses to start selling in new foreign markets, increasing sales and profits
● Can open factories and production units in other countries, possibly at a cheaper rate
(cheaper materials and labour can be available in other countries)
● Import products from other countries and sell it to customers in the domestic market- this
could be more profitable and producing and selling the good themselves
● Import materials and components for production from foreign countries at a cheaper rate.

Disadvantages of globalisation

● Increasing imports into country from foreign competitors- now that foreign firms can
compete in other countries, it puts up much competition for domestic firms. If these
domestic firms cannot compete with the foreign goods’ cheap prices and high
quality, they may be forced to close down operations.
● Increasing investment by multinationals in home country- this could further add to
competition in the domestic market (although small local firms can become suppliers to
the large multinational firms)
● Employees may leave domestic firms if they don’t pay as well as the foreign
multinationals

When looking at an economy’s point of view, globalisation brings consumers more choice
and lower prices and forces domestic firms to be more efficient (in order to remain
competitive). However, competition from foreign producers can force domestic firms to close
down and jobs will be lost.
Multinational businesses are firms with operations (production/service) in more than two
country. Also known as transnational businesses. Examples: Shell, McDonald’s, Nissan etc.

Advantages of MNCs
- Improve standards of living in the country
- Exploit economies of scale (lower prices passed on to consumers)
- Generate more profit (larger customer base)
- Spread risk (favourable conditions elsewhere e.g. turkey earthquake)
- Avoid trade restrictions (honda avoids import tax in eu, produces them in eu)
- Operate in countries with low corporation tax (hong kong, singapore)

Disadvantages of MNCs
- Criticised for unethical and cost-cutting practices especially by exploiting workers in
low-income countries (Nike sweatshop)
- Force local firms to shut down as they struggle to compete (Tesco vs mini-mart)
- Higher sales revenue than local country GDP (exploit government for subsidies, grants)
- No major consequences for mncs to pull out of low income countries (carrefour pulled
out of malaysia in 2010, leads to unemployment)

Trade protection refers to the use of trade barriers to restrain foreign trade, thereby limiting
overseas competition.
Examples
- A tariff is a tax on imports increasing foreign firms' production costs. (Leftward supply
shift)
- Import quotas sets a quantitative limit of the sale of foreign goods (Indonesia)
- Subsidies to help domestic firms compete with foreign firms
- Embargo is to ban trade with a certain country (USA with Cuba)
- Rules and regulations (bureaucratic rules e.g. food safety Taiwan)
- Voluntary export restraint (self-imposed limit of a good that they want to export)
- Smear Campaign (buy British last)

Reasons For
- To protect infant industries (China allows only 20 hollywood films per year) (proton)
- To protect sunset industries (declining)
- To protect strategic industries such as agriculture
- To protect foreign firms from dumping (prices set below fair market value / lower than
price set in its own country)
- Limit over specialisation
- Correct BOP imbalance (revenue from tariffs)
Foreign Exchange Rate
An exchange rate refers to the price of one currency measured in terms of other currencies.
Net import countries want appreciation vice versa

Demand for USD Supply for USD

Foreigners willing to buy US goods and US residents wanting to buy imports and
services foreign services

People wishing to invest in the US US residents wanting to invest abroad

Those wishing to take advantage of a future Those wishing to take advantage of a future
rise in the value of USD (speculators) rise in the value of another currency

Foreign government wishing to add USD in Governments wishing to replace USD in their
their reserves reserves with other assets

The US government wishes to raise the value The US government wishing to lower the
of the USD value of USD

Foreign governments wanting to devalue their Foreign governments wishing to raise the
currency value of their currencies

Fixed exchange rate

Where a currency is fixed against another
Revaluation (deliberately increased)
Devaluation (deliberately decreased)

Advantages
1. Reduces uncertainties in international trade and attracts foreign investment
2. Central bank has to artificially buy the currency to create demand so the value remains if
supply increases in the economy.
3. Promotes foreign investment as not prone to wild fluctuations
4. Good for countries with weak economies
5. Keeps inflation low and stable

Disadvantages
1. Hinder macro objective goals (increasing interest rate to keep value of the currency but
hinders economic growth)
2. Require high interest rates to keep the prices stable
3. Risk of overvaluation and undervaluation (cause inflation if too low, decrease exports if
too high)
Floating exchange rate
The value of a currency determined by the market forces of demand and supply
Appreciation (fall in supply, rise in demand)
Depreciation (rise in supply, loss in demand)
How to draw a graph,
1. Market for USD or intended currency
2. Other currency over your selected currency Y axis
3. Quantity of your currency X axis

Advantages
1. Self correcting because depreciation causes more exports
2. Frees up internal policies (govt is free to pursue internal objectives like full employment
and economic growth)
3. Dont need too much foreign reserves
4. Insulate a country from inflation elsewhere

Disadvantages
1. Uncertainty (lack of investment)
2. Speculation (encourage movement of hot money leading to wild fluctuations)
3. Lack of discipline (complacency as it is auto-correcting, allow domestic inflation to occur
until reaches crisis)

Forex rate fluctuation causes

- Prices and inflation (inflation decreases demand as export prices are more expensive)
- FDI, expansion of MNCs in other countries
- Speculation (Forex traders cause forex rate to go down if they sell, wrong speculation)
- Changes in demand for exports
- Changes in demand for imports
- Interest rates (when the interest rate is higher, foreign investment increases as
foreigners seek higher returns)
Consequences of forest rate fluctuations
1. Customers (greater purchasing power buying foreign goods when the exchange
rate increases, domestic goods purchasing power is caused by inflation not forex but
inflation causes depreciation due to fall in demand)
2. Exporters (during appreciation, goods are harder to sell)
3. Importers (during appreciation, cheaper to import raw materials, and finished
goods making it more expensive for consumers)
4. BOP (appreciation causes exports to fall, causing a trade deficit)
5. Employment (job losses in export-oriented industries)
6. Inflation (currency appreciation reduces general price levels from imports, keeping
prices stable)
7. Economic growth (low employment and low exports hinders economic growth)

Coping with strong exchange rates

- Cutting export prices to maintain competitiveness, domestic firms have to accept lower
profit margins
- Seeking alternative overseas suppliers of cheaper raw materials and components.
- Improving efficiency to keep labour costs low
- Focusing on non-price factors such as brand awareness
- Relocation productions overseas, where costs of production is lower and operations less
exposed to fluctuations (fixed exchange rate)

Balance Of Payments
Balance Of Payments = financial record of a country’s transactions with the rest of the world for
a given time period, usually a year

Credit = inflow
Debit = outflow

Current account of the balance of payments (the largest component of the BOP, records
all imports and exports of goods and services)
Is composed of 4 components
- Trade in services
- Trade in goods
- Primary profit
- Secondary profit
Exports and imports of goods and services

Trade in services (invisible/intangible goods)

Primary Income aka investment income
- Profits earned by companies based overseas
- Interests from loan and deposits in overseas banks
- Dividends earned from financial investments from overseas companies
- FDI from overseas companies
- Money sent home from foreign workers

Secondary Income
- Donations to charities abroad (Turkey Earthquake)
- Foreign aid
- Payments of pensions of people now based overseas
- Scholarships of students based in overseas universities

Causes of deficit
● Higher exchange rate: if the currency is overvalued, imports will be cheaper and
therefore there will be a higher quantity of imports. Exports will become uncompetitive
and therefore there will be a fall in the quantity of exports.
● Economic growth: if there is an increase in aggregate demand and national income
increases, people will have more disposable income to consume goods. If producers
cannot meet the domestic demand, consumers will have to imports goods from abroad.
Thus faster economic growth enables the possibility of a current account deficit
developing.
● Decline in competitiveness: if export industries are in decline and cannot compete with
foreign countries, the exports fall, ushering in a deficit. This is a major reason for many
countries today experiencing current account deficits.
● Inflation: this makes exports less competitive and imports more competitive (cheaper).
 ● Recession in other countries: if the country’s main trading partners experience
negative economic growth then they will buy less of the country’s exports, worsening the
current account.
● Borrowing money: if countries are borrowing money from other countries to finance
their expenditure and growth, current account deficits will develop.

Consequences of deficit
● Low growth: a deficit leads to lower aggregate demand and therefore slower growth.
Unemployment: deficit can lead to loss of jobs in domestic industries as demand for
exports is low and demand for imports is high.
● Lowers standard of living: in the long run, persistent trade deficits undermine the
standard of living as demand and income fall, especially if the net incomes and transfers
show a negative balance.
● Capital outflow: currency weakness can lead to investors losing confidence in the
economy and taking capital away.
● Loss of foreign currency reserves: countries may run short of vital foreign currency
reserves as more foreign currency is being spent on imports and foreign currency
revenues from exports is falling.
● Increased Borrowing: countries need to borrow money or attract foreign investment in
order to rectify their current account deficits. In addition, there is an opportunity cost of
debt repayment, as the government cannot use this money to stimulate economic
growth.
● Lower exchange rate: a fall in demand for exports and/or a rise in the demand for
imports reduces the exchange rate. While a lower exchange rate can mean exports
becoming more price-competitive, it also means that essential imports (such as oil and
foodstuffs) will become more expensive. This can lead to imported inflation.

How to correct a deficit

- Contractionary fiscal (increase tax to reduce demand for imports)
- Contractionary monetary (increase interest to attract FDI)
- Devaluation
- Protectionist measures (tariffs, import quotas)