Microeconomic Decision

Makers
Money and Banking
Functions of money

 Medium of Exchange: accepted as means of payment.

 Unit of account: for placing a value on goods/services

 Store of value: can save money since it keeps its value.

 The Standard for Deferred Payment: borrowers can borrow

money and pay it back later

Characteristics of money

 Acceptability: Anything can be used as money as long as it’s

generally accepted

 Durability: Good money must be hard-wearing

 Portability: It should be easy to carry around

 Divisibility: Must be able to divide it into smaller values

 Scarcity: Should be limited in supply to create value

Commercial Banks

 Accepting deposits of money and savings

 Helping customers make and receive payments

 Making personal and commercial loans

 Buying and selling shares for customers

 Providing insurance

 Operating pension funds

 Providing financial and tax planning advice

 Exchanging foreign currencies

Central Banks

 Printing notes & minting coins that are legal tender

 Destroying torn notes & worn-out coins

 Setting interest rates

 Lender of last resort: if a bank needs cash in a hurry, they can

borrow from the central bank

 Supervising monetary policy: heads of the central bank hold

meetings with officials from other banks to determine interest rates

and the quantity of money in the economy

 Banker for commercial banks & the government:

o Government accounts & spending are carried out with the

central bank

o Helps government to borrow money.

o The total amount the government owes is the national debt.

 Manage international financial system: governments of

different nations lending each other money.

Households
Influences on Spending, Saving and Borrowing

 Disposable income: amount of income left to spend or save after

direct taxes have been deducted.

 Spending: enables a person to buy goods/services to satisfy their

needs/wants

 Saving: involves delaying consumption

o As interest rates rise, people may save more.

  Borrowing: allows a person to increase their spending, enabling

them to buy goods they cannot afford now

 People with low disposable incomes may spend less in total than

people with high incomes

 But will tend to spend all or most of their income meeting their basic

needs

Spendi Savin Borrowin

Increase in…
ng g g
Real income ↑ ↑ ↑
Direct tax ↓ ↓ ↕
Wealth ↑ ↓ ↑
Interest rates ↓ ↑ ↓
Availability of saving
↓ ↑ ↓
scheme
Availability of credit ↑ ↓ ↑
Consumer confidence ↑ ↓ ↑

Workers
 Entry: Young employees will receive low earnings due to a lack of

work skills and experience; they can become an apprentice or join a

management training scheme to become more skilled

 Skilled workers: the more skilled a worker is, the more

opportunities he has for increasing his earnings; bonuses will be

given a higher rate of overtime paid.

 End-of-career employees: if workers keep updating their skills,

they will continue to have opportunities to increase wages; however,

when they stop this, their demand will fall & income will diminish,

finally reaching a stop when retired

Factors that influence the choice of occupational

 Level of Challenge

 Career Prospects

 Level of Danger involved

 Length of training required

 Level of education required

 Recognition in the job

 Personal satisfaction gained from the job

 Level of experience required

Why firms change demand for labour

 Changes in consumer demand for products

 Changes in the productivity of labour

 Changes in price and productivity of capital

 Changes in non-wage employment costs

Why labour supply might change

 Changes in net advantages of an occupation

 Changes in provision and quality of education and training

 Demographic changes

Factors that Cause Occupational Wage Differentials

 Different abilities and qualifications

 ‘Dirty jobs’ and unsociable hours

 Job satisfaction

 Lack of information about jobs and wages

 Labour immobility

 Fringe benefits
Factors that cause wage differentials in the same job

 Regional differences in supply and demand of labour

 Length of service

 Local pay agreements

 Non-monetary agreements

 Discrimination

Specialisation

 Division of labour: The production process is broken up into a

series of different tasks

 Specialization: workers concentrate on a few tasks and then

exchange their product for other goods/services

Advantages for Individual Disadvantages for Individual

Employees can make the best
use of their talents/skills and Doing the same job or repetitive tasks
increase them by repeating is tedious and stressful
tasks.
Employees can produce more Individuals must rely on others to
output and reduce business produce goods and services they
costs want but cannot produce themselves
Many repetitive tasks can now be
More productive employees can
done by machines, leading to the
earn higher wages
unemployment of low-skilled workers.

Trade Unions
 An organization of workers formed to promote & protect the interest

of its members concerning wages, benefits & working conditions

Functions

 Negotiating wages & benefits with employers

 Defending employee rights and jobs

 Improving working conditions

  Improving pay and other benefits, including holiday entitlement,

sick pay and pensions

 Encouraging firms to increase worker participation in business

decision-making

 Developing skills of union members by providing training and

education courses

 Supporting members taking industrial action

Types of Trade Unions

 General Unions: represent workers across many different

occupations

 Industrial Unions: represent workers of the same industry

 Craft Unions: represent workers with the same skill across

different industries

 Non-manual unions/Professional unions: represent workers in

non-industrial and professional occupations

Collective Bargaining

 Process of negotiating wages and other working conditions between

trade unions and employers

 A trade union will be in a strong bargaining position to negotiate

higher wages and better conditions if:

o It represents most or all of the workers in a firm

o Union members provide goods/services that consumers need,

which have few alternatives

Industrial Action
  Industrial action is taken when collective bargaining fails to result in

an agreement

 Taking industrial action can help a union force employers to agree

to their demands

 Industrial actions:

o Overtime ban: workers refuse to work more than their

normal hours

o Work to rule: workers deliberately slow down production by

complying with every rule & regulation

o Go slow: workers deliberately work slowly

o Strike: workers protest outside their workplace to stop

deliveries/non-unionized workers from entering

Impact of Trade Unions

Possible Advantages Possible Disadvantages

Could help to bring about minimum It might cause lack of flexibility in
working standards working practices
This could be major problem as
Could help keep pay higher
fashions change very quickly
Could help maintain This could lead to some firms
Employment/enhanced job security going out of business
Could lead to improvement in
Workers made redundant
health and safety
Workers will need to pay union
membership fees.

Firms
Classification of Firms

 Primary Sector - Extracting raw materials from the earth (fishing,

mining, farming and more)

  Secondary Sector - Manufacturing Goods (Construction, Refining and

more)

 Tertiary Sector - Service Sector (Retail Shops, Lawyers and more)

Public and Private Sector

 Private Sector firms are owned and run by private individuals and

owners. The main objective of this sector is to earn profit.

 The government owns Public Sector firms, and their main aim is to

provide services.

Size of Firms

 Number of employees: less than 50 are classified as small

 Amount of capital employed: large firms invest a lot in fixed

assets such as machinery & equipment

 Market share: relative size of firms compared by percentage share

of total market supply/revenue

 Organization: large firms may be divided into many departments

& be spread over many locations

Small Firms

Advantages Disadvantages
The size of the market is Markets cannot raise enough capital to
small expand their business
Consumers like tailored
goods/services
Governments provide help
Types of Economies and Diseconomies of Scale

Economy of Scale Diseconomy of Scale

Cost savings due to increased Rising costs because a firm has
scale of production become too large
 Economy of Scale Diseconomy of Scale
Management: larger firms must
Financial: larger firms often have manage so many different
access to cheaper sources of departments in different locations,
finance making communication/ decision-
making difficult
Marketing/Selling: fixed costs
such as advertising and Labour: demotivated workers lead
transportation are spread across a to a decrease in productivity due to
larger number of products, boring, repetitive tasks
lowering per-unit cost
Excess Agglomeration: A
Technical: larger firms invest in company takes over or merges with
specialized production equipment too many other firms producing
and highly skilled workers; they different products, making it hard
develop new products for business owners and managers
to co-ordinate all activities
Risk-bearing: the ability to
spread risk over many investors &
reduce market risks by selling a
range of products in different
locations
Purchasing: when raw materials
are bought in bulk, suppliers may
provide bulk discounts, lowering
per unit cost of production
Integration

 Growth often involves integration with other firms

 Takeover: a company acquires ownership & control of another a

company by purchasing its shares

 Merger: two or more firms agree to form an entirely new company

& issue new shares

Types of Integration

 Horizontal integration: occurs between firms at the same stage

of production producing similar products

  Vertical integration: occurs between firms at different stages of

production

o Forward: taking over the firm at a later stage of production

o Backwards: integration is the opposite

 Lateral integration or conglomerate merger: occurs between

firms that are involved in totally unrelated business activities.

Firms and Production

Demand for “Factors of Production”

 Demand for goods & services by consumers: higher demand =

more labour/capital firms will need

 Price of labour & capital: higher cost = less labour & capital

demanded

o Firms may also decide to substitute labour for more capital

and vice versa

 Productivity of labour & capital: more output/revenue labour &

capital helps to produce, more profit will generate over & above the

cost of employing them

 Capital-intensive Production: where the use and cost of capital

are higher than other factors of production

 Labour-intensive Production: where the cost of labour is higher

than other factors of production

 Labour-intensive production method primarily involves labour,

whereas capital-intensive methods primarily involve machinery

Productivity & Production

 Productivity: the ratio of output to input

  Labour Productivity:

������ ��� ������=Total OutputNumber of Lab

ourOutput per Labour=Number of LabourTotal Output

 Capital Productivity:

����� ��� �������=Total Output ValueValue of

CapitalValue per Capital=Value of CapitalTotal Output Value

 Productivity refers to the efficiency of a business, whereas

production refers to output only.

Firms’ Costs, Revenue and Objectives

 Fixed Costs: Costs that have to be paid regardless of the output,

e.g. interest on loans

 Variable Costs: Costs that change with the output. The higher the

output, The higher the variable costs

 Breakeven: where total revenue = total cost

 Total Revenue: the total receipts a seller can obtain from selling

goods or services to buyers

 Average Revenue: the revenue generated per unit of output sold

Average Fixed Cost=����������/

������Average Fixed Cost=FixedCosts/Output

Average Variable Cost=�������� �����/

������Average Variable Cost=Variable Costs/Output

Total Variable Cost=�������� �����������

Total Variable Cost=Variable Costs×Output

Total Cost=����� �������� ����+�����

����� ����Total Cost=Total Variable Cost+Total Fixe

d Cost

Average cost=(����� ����)/������Average cost

=(Total Cost)/Output

Total Revenue=����� ��� ������������

����Total Revenue=Price Per Unit×Quantity Sold

Profit or Loss=����� �������−����� ����P

rofit or Loss=Total Revenue−Total Cost

Objectives of firms

 Survival

 Social welfare

 Profit maximisation

 growth

Market Structure
Competitive Markets

 Businesses will charge the same price, a minimum price they can

charge without going out of business

  Price will be equivalent to the lowest average cost of producing

goods

 The average cost of production would be the same as the average

revenue for selling

 No firm would risk charging more than the market price

 A business would be a price taker; the market price

Monopoly Markets

 Firms with monopolistic powers control all of the market shares

 Able to influence the price; price makers

 Can restrict competition with artificial barriers to entry & other

pricing strategies

 One firm controls the entire market supply

 May use predatory pricing to force competing firms out

 Other firms deterred from competing due to a lack of capital

Advantages of Monopolies

 It avoids duplication & wastage of resources

 Economics of scale: benefits can be passed to consumers

 High profits can be used for research & development

 Monopolies may use price discrimination, which benefits the

economically weaker sections of the society

 Monopolies can afford to invest in the latest technology &

machinery to be efficient & avoid competition

Disadvantages of Monopolies

 May supply less & charge higher prices

  May offer less consumer choice and lower quality products than if

they had to compete with other firms

 They may have higher production costs because they are poorly

managed

 Restrict competition using barriers to entry

Barriers to entry

Natural Artificial
Cost savings from large- Predatory pricing strategies to force
scale production smaller firms out
Preventing suppliers from selling
Lots of capital equipment
materials & components to other firms by
that other firms can’t afford
threatening to switch to rival suppliers
Large customer base built Forcing retailers to stock & sell only their
up over years product
Developed advanced
products or processes that
are protected by patents

The Basic Economic Problem

The Nature of the Economic Problem
 There are too few resources to make all the goods and services that

consumers need and want.

 Unlimited wants and limited resources

 The scarcity of resources is the basic economic problem

Economic and Free Goods

 Economic goods: A good or service that requires resources to

produce and has a degree of scarcity and, therefore, an opportunity

cost.

 Free goods: A good or service that is not scarce and is available in

abundance. For example, the air we breathe.

The Factors of Production

 Consumers are people or firms who need and want goods and

services

 Resources or factors of production are used to make goods and

services

LLCE

 Land: natural resources used in production (e.g. land)

 Labour: human resources used in the production of goods/services

(e.g. workers)

 Capital: the manufactured resources that are used to produce

goods/services (e.g. tractor)

 Enterprise: the skills and willingness of a business person to take

the risks required to organize productive activities

  Entrepreneurs organize and combine resources in firms to produce

goods and services

 Durable consumer goods last a long while (e.g., furniture) non-

durable consumer goods (e.g., food) do not

 Capital goods and semi-finished goods or components are used in

production

Rewards for Factors of Production

 Land - Rent

 Labour - Wages

 Capital - Interest

 Enterprise - Profits

Mobility of Factors

 Refers to the degree of mobility while changing from one production

area to another.

Geographical Mobility Occupational Mobility

Refers to the willingness and the ability
Refers to the ease with which a
of a person to relocate from one area
person can change between
to another due to employment
jobs.
purposes.
Reasons why many workers are not This would vary depending on
willing to relocate - Family Ties and the cost, training period and
Related Commitments, Cost of Living the educational professions.
Changes in the Quantity or the Quality of Factors of

Production

 Cost (Labour Costs, Raw materials costs)

 Government Policies (Taxes, Subsidies)

 New Technology
  Migration of Labour

 Improved Education and Healthcare

 Weather Conditions (Agricultural Products)

Opportunity Cost
 Opportunity cost is the cost of the next best alternative while

choosing the uses of a resource.

 Choosing one use will always mean giving up the opportunity to use

resources in another way, & the loss of the next best goods &

services they might have produced instead.

 The problem of resource allocation is choosing how best to use

limited resources to satisfy as many needs and wants as possible

and maximize economic welfare.

 Economics aims to find the most efficient resource allocation

 Example 1: A person invests $10,000 in a stock

o He could have earned interest by leaving 10,000 dollars in a

bank account instead

o The opportunity cost of the decision to invest in stock is the

value of the potential interest

 Example 2: A city decides to build a hospital on vacant land; it

owns

o Could have built a school or sports centre

o Opportunity cost is the value of the benefits forgone of the

next best thing which could have been done

Production Possibility Curves (PPC)

Diagrams
  Opportunity cost can be shown using a production possibility curve

(PPC)

 It shows the maximum combinations of two goods and services that

an economy can produce in each time period with its limited

resources

 Each combination is a choice

 An economy shouldn’t have any unemployment of factors of

resources to be on the PPC

 A point within the curve signifies like X, represents inefficiency

 A point outside the curve, like Y, represents combinations that

cannot be produced due to the lack of resources

Movement in PPC and Shift of PPC

Movement in PPC Shift in PPC

Movement along the PPC is The shift of PPC occurs when the PPC line
when the resources utilized is moved. This may be due to better
are moved from one product availability of resources (due to the
to another. For example, the Discovery of new materials, Better
movement from Point A to Technology and more), which causes an
Point B is shown in the above outward shift of the PPC or a decrement
 Movement in PPC Shift in PPC
in resources (due to natural disasters,
war and more) which causes an inward
diagram.
shift of the PPC. An example is given
below.

The Allocation of Resources

Microeconomics and Macroeconomics
Microeconomics
  It is the study of particular markets and segments of the economy. It

looks at issues such as consumer behaviour, individual labour

markets, and the theory of firms.

 It involves supply and demand in individual markets, Individual

consumer behaviour, and individual labour markets

 Example - A consumer considering his options while buying a

product

Macroeconomics

 Study of the whole economy. It looks at ‘aggregate’ variables, such

as aggregate demand, national output and inflation.

 Involves decisions made by the government regarding, for example,

policies

 Example - Governments deciding on the tax rates

The Role of Markets in Allocating

Resources
The Market System

 A market economy is an economic system in which economic

decisions and the pricing of goods and services are guided

by the interactions of supply and demand- the market

mechanism.

Key Resources Allocation Decisions

The basic economic problem of scarcity creates three key questions

 What to produce?

 How to produce?

 For whom to produce?

Introduction to the Price Mechanism

 It aids the resource allocation decision-making process. The decision

is made at the equilibrium point where supply and demand meet.

Features of Price Mechanism

 Private Economic Agents can allocate resources without any

intervention from the government.

 Goods and Services are allocated based on price (Higher Price

means more supply, and lower price means more demand)

 Allocation of Factors of Production is based on financial returns

 Competition creates choices and opportunities for firms, private

individuals and consumers.

Demand
Demand refers to the willingness and ability of customers to buy a good

or service at a given price level.

The higher price of a good = fewer

people demand that good; hence, demand is inversely related to the price

Price∝1DemandPrice∝Demand1

 Factors that affect demand

 o Price

o Advertising

o Government Policies

o Consumer tastes/preferences

o Consumer Income

o Prices of substitute/ complementary goods

o Interest rates (price of borrowing money)

o Consumer population (population increase = demand

increase)

o Weather

 The individual demand is the demand of one individual or firm

 The market demand represents the aggregate of all individual

demands

Movement along the

Shift of the Curve
Curve
A Change in the price of
the good or service will Changes in Non-Price factors cause the
cause movement along the demand curve to shift. These factors
curve. The movement can include tastes, prices of substitute goods,
be either contraction or consumer incomes and many more.
extension.
 Movement along the
Shift of the Curve
Curve

Contraction is caused
when the demand falls due
to a price increase; This
causes the point to go
An increase in demand causes the demand
upwards. Extention is
curve to shift rightwards, and a decrease in
caused when the demand
demand shifts the curve towards the left.
increases because of a
price decrease; This
causes the point to go
downwards.

Supply
 Supply refers to the ability and willingness of suppliers to provide

goods and services at a given price.

 The higher price of good =

higher quantity supplied; hence, quantity is directly proportional to

the price

Price∝Quantity suppliedPrice∝Quantity supplied

 Factors that affect supply

o Cost of factors of production

o Prices of other goods/services

o Global factors

o Technology advances

o Business optimism/expectations

 The individual supply is the supply of an individual producer

 The market supply is the aggregate of the supply of all firms in

the market.

Price Determination
Market Equilibrium

 When supply & demand are equal, the economy is said to be at an

equilibrium.
  At this point, the allocation of goods is at its most efficient because

the amount of goods being supplied is the same as the amount of

goods being demanded & everyone is satisfied

Market Disequilibrium

Excess Supply Excess Demand

If the price is set too high, excess When the price is set below the
supply will be created within the equilibrium price. Creates demand
economy, and there will be that exceeds production due to the
allocative inefficiency low price.
Price Changes

Causes of Price Changes

 A change in supply

 A change in demand
Consequences of Price Changes

 An inward shift of the supply curve will increase prices and vice

versa

 An inward shift of the demand curve will decrease prices and vice

versa

Price Elasticity of Demand (PED)

 Definition: The responsiveness of demand to a change in price

Inelastic Demand Elastic Demand

PED lower than 1 PED greater than 1
The necessity of the product is high The necessity of the product is
– it is either essential or habitual relatively low
A change in price has little effect Demand would respond quickly
on the change in demand and more drastically

���=% �ℎ���� �� �������� ��������

% �ℎ���� �� �����PED=% change in price% chang

e in quantity demanded

 When demand is price inelastic:

o An increase in price would raise revenue

 When demand is price elastic:

o A decrease in price would raise revenue

  Factors that affect PED:

o The number of substitutes

o The period of time

o The proportion of income spent on the commodity

o The necessity of the product

Special Situation with PED

Perfectly Price Perfectly Price

Unitary Price Elastic
Inelastic Elastic
Changes in price Any changes in the The percentage change in
do not affect the price will lead to the price is proportional to the
quantity quantity demanded percentage change in
demanded being zero quantity demanded

Price Elasticity of Supply (PES)

 Definition: The responsiveness of quantity supplied to a change in

price

Inelastic Supply Elastic Supply

It has a PES of less than 1 It has a PES of more than 1
A large price change will A large price change will have
have little effect on the amount a large effect on the amount
supplied supplied
���=% �ℎ���� �� �������� ��������

% �ℎ���� �� �����PES=% change in price% chang

e in quantity supplied

 Factors that affect PES:

o Time

o Availability of resources

o Supply available to meet demand

o Spare production capacity available

o Factor substitution available

Market Economic System

 Market Economic System is the economic system that relies on the

market forces of demand and supply to allocate market resources

with minimal involvement of the government.

 This system is run by private firms and individuals

 They produce a wide variety of goods and services if it is profitable

to do so, but only for those consumers who are willing and able to

pay for them

 Market failures can cause scarce resources to be allocated to uses

that are wasteful, inefficient or even harmful to people and the

environment

Advantages Disadvantages
Wide variety of goods/services Serious market failure
The profit motive encourages the
Only profitable goods are
development of new and more efficient
provided
products & processes.
Quick response to changes in Firms will only supply products
 Advantages Disadvantages
to consumers with the ability
consumers’ tastes and demand
to pay
Resources will only be
No taxes on incomes and wealth or
provided if it is profitable to do
goods and services
so
Harmful goods may be readily
available to buy.

Market Failure
 Market failure occurs when the market mechanism fails to allocate

scarce resources efficiently, so social costs are greater than social

benefits.

 Social Costs = Private Costs + External Costs

 Social Benefits = Private Benefits + External Benefits

 Private Costs are the production and consumption costs of a firm,

individual or the government

 Private Benefits are the benefits of the production and consumption

to the firm, individual or government.

 External Costs are the negative side-effects on third parties for

which the consumer doesn’t pay.

 External benefits are the positive side-effects enjoyed by third

parties.

Consequences of Market Economic System

 Only goods and services that are profitable to make will be

produced

 Public goods and services such as street lighting won’t be provided

as the private sector can't earn profits from them

  Resources are only employed if profitable – people may be left

unemployed without an income

 Harmful goods may be produced and sold freely

 Producers may ignore environmental impacts

 Monopolies dominate the supply of products and charge high prices

Mixed Economic System

 It has a private sector & a public sector

 A government can try to correct market failures in a mixed-

economic system

 It can allocate scarce resources to provide goods and services that

people need

 Can introduce laws and regulations to control harmful activities

Maximum Prices

 This is a price control method that involves the government setting

the price below the equilibrium point to make things more

affordable.

Minimum Prices

 The government sets the price above the equilibrium to encourage

the supply of certain goods.

 This involves the National Minimum Wage (NMW) as well.

Government Intervention

 Produce merit goods such as education for the needy

 It can provide public goods such as street lighting

 The public sector can employ people, and welfare benefits can be

given to the needy

  Laws to make goods illegal or high taxes to reduce consumption

 Laws and regulations would protect the natural environment

 Monopolies can be broken up or regulated to keep prices low

 Educating consumers about the private costs of consuming demerit

goods

Privatisation and Nationalisation

 Privatisation transfers all assets from the public to the private

sector.

 Nationalisation is the purchase of all assets by the government

yggggggggggggA