Group activities

1 a craft or industrialised union

b white collar union
c general union
d industrial union e industrial union f craft union

2 a A union representing firefighters. They provide an essential service. People can do

without flowers for a period of time.
b A union representing skilled workers. It is more difficult to replace skilled than unskilled
workers.
c A union striking during a period of low unemployment. In such a situation, it would be
difficult to replace the workers on strike.

Individual activities

1 a The university lecturers were advancing the comparability argument – comparing their
pay with that of a head teacher and that of a doctor. b University lecturers are in a
white-collar union.

Four-part question

a A trade union is an association of workers designed to protect them from, for example,
redundancy and to improve their wages and working conditions.

b Trade union membership may decline if government legislation reduces the power of trade
unions to take industrial action. Banning strikes, for example, may reduce the bargaining
power a trade union has in negotiating on behalf of their members. This may make it less
worthwhile to join a trade union. Trade union membership may also fall if there is a rise in
unemployment. There would be fewer people in a position to join a trade union and some of
those still in employment may be afraid of joining a trade union in case employers would
make members redundant before non-members.

c A trade union will be stronger if it has a high number of members. This will increase the
funds available to the trade union to pursue its objectives. If the trade union has not only a
high number of members but also a high proportion of the number of workers employed, it
will make it more difficult to replace striking workers with new workers. It will also increase
the strength of its claim to represent the interests of the workers. A high level of economic
activity strengthens a trade union. This is because there will be a high level of employment.
Employers will want to recruit more workers and to retain existing workers. This is likely to
make employers more willing to increase wages and working conditions. Government
legislation may favour trade unions. If laws give trade unions the right to strike and take
other industrial action, the trade unions will be in a more powerful position to pursue their
aims. Trade unions that represent skilled workers tend to be in a stronger position than those
representing unskilled workers. This is because it will be more difficult to replace skilled
workers with other workers or machinery. Trade unions representing workers in essential
services, such as the fire service, may also be in a stronger position than a trade union
representing, for instance, people working in florist shops. This is not only because cut
flowers are a luxury that people can do without but also because people working in florists
tend to get together less frequently than firefighters.

d Trade unions may benefit workers. They can negotiate on behalf of their members for
improved pay, good pensions and better working conditions. Bargaining as a group gives
greater strength than bargaining on an individual basis. The trade union officials may bring
expertise to the bargaining process and can concentrate on negotiating for shorter working
hours, for instance. Trade unions can provide their members with information about their
rights and protect them against unfair redundancy. They may also run educational courses
for members and provide some university scholarships. They can provide legal advice and
represent members at employment tribunals. They can also help prevent some workers from
being discriminated against. In addition, trade unions may help workers by persuading the
government to introduce policy measures that benefit them, including introducing or
increasing a national minimum wage and reducing the maximum number of hours that
workers have to work each week. There may, however, be cases where trade unions do not
benefit workers. There is a risk that trade unions may push the wage rate too high, which
may result in redundancies. If unions call workers out on strikes, the workers will lose pay
from the employers. They may not receive any strike pay from the trade union and the
strikes may not be successful. Industrial action may cause some firms to go out of business
and this can also result in workers losing their jobs. Workers pay membership fees to belong
to a trade union. If the trade union is weak or does not have a good relationship with the
employers, this may not be money well spent. Trade unions negotiate for the same pay for
groups of workers on the same level and some individual workers may think they should
have higher pay than their fellow workers.
13.1 The Market Economic System

Resources move automatically according to price changes

Remember the Price Mechanism: the way decisions by

households and firms interact to decide the allocation of
resources.
Basically the interaction between Demand and Supply.

The goal in a market economy is equilibrium price.

When Demand and Supply meet at the same price

If there is excess demand leads to a shortage so we need

to increase the price

Excess supply (due to decrease in demand) leads to a

surplus and we need to lower the price

Draw the diagrams in 13.1

Individual Activity 1

1. Draw 2 diagrams:
one showing the demand and supply curves for the
price of onions.
page 69 fig 10.4
Monsoons in India destroyed onion crops leading to a
decrease in supply- also known as a shortage.
When you have shortage we need to raise the price to
get back to equilibrium.
 One showing the demand and supply curve for the
price of tomatoes.
an increase in demand for tomatoes, due to an increase in
incomes, leads to a shortage so price must increase to
reach the new equilibrium

Shortage: comes from a decrease in supply or an increase

in demand- rise in price

Surplus> comes from an increase in supply or a decrease

in demand- we need to lower the price

b. The market responded to both situations by raising the

price.

The importance of competition and incentives

one of the benefits of a market economy is choice.

Consumers are sovereign.
A choice creates competition which puts pressure on firms
to make good quality products at a lower price.
Firms compete for consumers to survive. The more
successful a firm is in keeping its costs low and the more it
targets the desires of consumers, the more efficient it is
said to be.

Firms have the incentive to create a competitive product

because of profit.
A market economy is an economy based on the private
sector

Market economic system has rewards: “carrots” (profits)

and punishments “sticks” (going out of business)

The rewards are profits and the punishment is going out of

business.

It’s important for entrepreneurs to respond to consumer

demand, innovate and expand.

In labour markets, workers can enjoy higher wage if they

have the right skills and are efficient. Workers who lack
skills and lack occupational and geographical mobility will
have low incomes.

Individual Activity 2

a. Higher wages
b.
Decrease in Supply (curve shifts to the left) and an
increase in Wages (so instead of writing P, you write a
W). A decrease in supply always means shortage.
 page 155 Fig 18.6

Private and Public sectors:

Private Sector: covers business organizations which are

owned by shareholders and individuals.
Their goal is profit. They are more efficient and have a
better quality price than public goods and services.

State Owned Enterprises (SOE’s): organizations owned

by the government which sell products or services.
Public Sector: the part of the economy controlled by the
government.
Their goal is welfare of the people. Their prices are
affordable and they make sure everyone (including the
poor) can afford basic necessities: healthcare, education,
food.

13.2 Advantages of a Market Economic System

What Is a Market Economy? Private sector

The assumption behind a market economy is that supply and demand are
the best determinants for an economy's growth and health. These market
forces (price mechanism) influence what goods should be produced, how
many goods should be produced, and at what price the goods should be sold.
These factors determine other economic decisions, such as how many
individuals companies should employ. The advantages of a market economy
include increased efficiency, productivity, and innovation.

1. A market economy should be very responsive to

changes in consumer demand. Consumers are
sovereign-they determine what is produced.
 2. Resources should change automatically and quickly to
reflect changes in consumer demand. This is for 3
reasons:
a. The price mechanism (the system by which the
market forces of demand and supply determine
price) in a market economic system provides
information on which products are increasing in
demand.

EXAMPLES of the price mechanism:

1. excess demand leads to a shortage so we
need to raise the price to go back to
equilibrium (goal of price mechanism)
2. excess supply leads to a surplus so we
need to lower the price to go back to
equilibrium.
GOAL: to have price = quantity demanded or
supplied= equilibrium price

b. a market economy provides an incentive for

resources to move in response to consumer
demand as it leads to profit. Benefits firms,
workers, capital and land.
c. a market economy punishes those firms,
workers, capital and land who do not respond to
changes in consumer demand -leading to loss of
jobs and closing of firms.
3. A Market Economy gives consumers a choice, they can
decide what to buy and which firms to buy from. Firms can
decide what to produce (responding to consumer demand)
and workers can decide who to work for.

4. Costs and prices may be low. Firms will want to set

competitive prices so they can earn more profit. They will
do this by using resources to make costs of production as
low as possible. This is an example of efficiency and
reward.

5. Quality may be high. Market forces can promote the

improvement of methods of production and a rise in quality
of the products it makes. Consumer demand puts
competitive pressure on firms to provide high quality.
Tha Market Economy is all about good price quality ratio

13.3 The disadvantages of a market economy

There is a risk that the market forces of demand and supply

may not work well. In fact market failure may occur:
Market Failure: market forces (demand and supply
interaction) resulting in an inefficient allocation of resources.

1. Consumers and private sector firms may only take into

account the costs and benefits to themselves. These
are called Private Costs and Benefits. They do not
take into account the costs and benefits of others.
EXAMPLE: Some people may smoke even if it annoys
and endangers the health of those around them. This
is called an External Cost.
2. Lack of competition leading to a possible monopoly:
leading to high prices and low quality.
 3. Unable to respond to consumer demand because of
lack of workers with the right skills or geographical
immobility.
4. Firms will not make products unless they can charge
for them. Some products like military defence, which
most people want, will not be provided by a private
sector because of free -riders: someone who
consumes a good or service without paying for it.
5. Advertising can distort consumer choice persuading
people to buy products they do not want. Consumers
and producers may also lack information and make
inefficient choices
6. Uneven distribution of income with some people very
rich and some people very poor. The sick and disabled
may find it difficult to earn incomes.
7. Differences in Income will increase over time. People
earning higher incomes can save. Poor people are
unable to save. Children of the rich have more
opportunities than children of the poor.

Group Activity 2

a Those people whose labour skills are in high demand are

well paid. Entrepreneurs, who produce what consumers
want, can make high profits. Those with high incomes can
save and earn income from their savings.

b The sick, disabled and old will find it hard to earn an

income.
13. 4 Allocative Efficiency

allocative efficiency: when resources are allocated to

produce the right products and the right quantities.
When supply matches consumer demand

diagram a: equilibrium price and allocative efficiency

diagram b: shortage, under-production

diagram c: surplus, over- production

Market forces, by changing price, should eliminate shortage

and surpluses.
With a shortage we need to raise the price
With a surplus we need to lower the price

When there is lack of efficiency there is the threat of

punishment in a market economy and therefore a firm can
go out of business.

Individual Activity 3

a. A fall in demand would be likely to lower the price.

b. The evidence is that resources moved out of the crisps

industry, in response to a decrease in demand.
13. 5 Productive Efficiency

productive efficiency: when products are produced at the

lowest possible cost and making full use of resources.

Fig 13.3 shows letter B as productively inefficient

Letter A is productively efficient

Any of the 4 factors of production not being used

efficiently leads to point B: Example: workers lying idle on
the job, broken machinery (capital), empty factory space not
being used. Agricultural land not being used (land)

13.6 Dynamic Efficiency

Dynamic Efficiency arises when resources are used

efficiently, over a period of time as a result of investment
and innovation.
Money spent on Research and Development allows firms to
innovate products and gain higher margins.

Group Activity 3

a. Bata responded to consumer demand by also making

purse
b. Higher profits mean they can increase their supply to
respond to an increase in demand. Consumers also
benefit from the company offering innovative products
 (dynamic efficiency) . Example: Covid vaccine. Thanks
to high profits, pharmaceutical companies now have
innovative products like the Covid vaccine.
13.7 Examples of the different economic systems

To a certain extent all economies are mixed economies.

This is because there is some government intervention in
all economies and some private sector production.

Examples of a more market economy: USA. Public sector

exists but most land and capital are privately owned.
Sweden is an example of a country where public and
private sectors are equal in size.
North Korea is a planned economy with little land privatelt
owned

Change in economic systems

Economies can change over time

Example: Eastern Europe and Russia changed from

communism to mixed economies in the 1990’s with SOE’s
being privatised

Privatisation : sale of public sector assets to private sector

Four Part Question

a. Private sector has individuals and shareholders

deciding how to allocate resources. Public sector has
 the government who decides how to allocate
resources
The goal of private sector is profit. The goal of the public
sector is public sector

b. Consumers are said to be sovereign in a market

economic system as they determine what is produced.
They signal their choices by means of the price mechanism.
If they want to buy more of a product, they will bid up its
price which will encourage firms to allocate more resources
to its production. If they want to buy less of a product, the
price they are willing to pay will fall. The reduction in price
will result in fewer resources being allocated to its
production.

c. Profit plays a key role in a market economic system.

Profit is the incentive firms have to respond to the signals
that consumers send via price changes. The opportunity to
earn a profit encourages firms to produce the products
consumers are willing and able to buy, using the most
efficient methods of production. If consumers demand
more of a product, its price will be bid up. More revenue will
be earned by making the product, which may increase their
profit. If firms can cut the costs of production by, for
instance, introducing new, more productive capital
equipment, their profit will again rise. Those firms that are
the most efficient will gain the highest profits. They will
have the finance to expand, while those firms that are
inefficient and cannot make a profit may go out of business.

d. Prices may be low in a market economic system. This is

because there may be a high level of competition in such a
system and because profit plays a key role. If there are a
high number of firms competing for the custom of
consumers, they will have to keep their prices low. To make
a profit when prices are low, costs will have to be lower.
This means that firms will have to use the most efficient
methods of production, which keep cost per unit low and so
enable them to charge low prices. A market economic
system, however, does not mean that all prices will be low.
Indeed, if a market economic system is working efficiently,
the prices of products that are in high demand will be high
relative to those products that are less popular. This
difference in price will encourage more resources to be
devoted to those products that are most in demand. The
prices of the popular products may still be lower than might
exist in other types of economic systems if there is a quick
and full response to changes in market conditions.

There is, however, no guarantee that a market economic

system will always work efficiently. There may not be a high
level of competition in all markets. If one firm dominates a
market, it will have more power than consumers. It will be
able to raise the price it charges because consumers will
not be able to switch to substitutes. There are a number of
other reasons why inefficiency may occur in a market
economic system, causing prices to be high. For instance,
firms may want to respond to an increase in consumer
demand by producing more. If, however, they have difficulty
recruiting more workers due to the occupational and/or
geographical immobility of labour, they may not be able to
adjust their supply by much. Inelastic supply will mean an
increase in demand that will result in a higher rise in price
than would have been the case with elastic supply. A
market economic system has the potential to keep prices
low if there is, for instance, a high level of competition and
mobility of factors of production. In practice, this does not
always occur in all markets.
Group activities

1 a Three of the top five were in the public sector – the civil service, public sector healthcare
(the NHS) and public sector broadcasting (the BBC).

b Two possible reasons for a graduate to wish to work in public healthcare sector are that
he or she may think the job may provide a high level of job satisfaction and job security.

2 a Three possible reasons why a person may want to be a pilot are the high pay offered,
the high status attached to the profession and the good occupational pensions.

b There are a number of reasons to account for a person’s failure in becoming a pilot. These
include a lack of qualifications, poor health and a lack of vacancies.

3 a The wages of air cabin crew in India are likely to have increased, as demand for their
services has risen.

b Pilots are paid more than cabin crew as their supply is lower, relative to demand. This is
because more qualifications and skills are required to become a pilot, and airlines can
possibly reduce the number of cabin crew but not the number of pilots. This gives stronger
bargaining power to the pilots than cabin crew.

4 a Workers who are discriminated against may be paid less than other workers because
they are offered lower wages, may be given less training and may not be promoted.

b Paying higher wages to older and younger workers may increase their motivation, reduce
labour turnover and persuade employers to train them to get a better return. All of these
effects would increase labour productivity and reduce labour costs per unit.

5 a and c – in both cases, a rise in wages is likely to result in a greater percentage

contraction in demand for labour. In the case of a, some workers would be replaced by
machines. In the case of c, a rise in wages would raise costs and hence prices, by a
relatively large amount. This, in turn, would reduce demand for the product and the number
of workers significantly.

6 a, c, d, e and b.

Individual activities

1 a $80 000 is one quarter of $320 000. So, pilots in Brazil were paid $80 000.

b The shortage of pilots in China would be expected to push up the wages of pilots in Brazil.
This is because some Brazilian pilots may go to China, creating a shortage in Brazil.
2 a Demand is high.
b Supply is low.

c Workers have strong bargaining power.

d Workers are skilled.

3
a i Piece rates are a method of paying workers on the basis of their output.
ii A national minimum wage is a floor, that is wage rate, set by the government, below which
wages cannot be legally reduced.

b Factory workers in the garment industry may receive lower pay than construction workers
because they are in higher supply relative to demand, have less bargaining power and are
less favoured by government policy

4 a Among the possible reasons accounting for a smaller proportion of working women in
Chile than in other Latin American countries may be: lower pay for women workers in Chile,
discrimination against women workers in Chile, social attitudes against working women and
less availability of childcare.

b The passage notes that female workers earned nearly a fifth less than men. It also
mentions that the government introduced a new labour code to curb unfavourable treatment
of female workers.

Four-part question
a Wages in a free market are determined by the interaction of demand for and supply of
labour. If,
for example, there is a decrease in the supply of train drivers, their wage would increase.

b By specialising in cooking one type of food, a chef would gain experience in cooking this
type of food.
This may make the chef very skilled, which may increase the wage she or he may be able to
gain.
A chef may also have a particular interest in cooking, for example, Thai food. If the chef can
specialise, she or he can spend the working day doing what she or he enjoys.

c An increase in demand for restaurant meals is likely to encourage restaurant owners to

expand. To
sell more meals, they are likely to demand the services of more chefs. The diagram below
shows that an increase in demand for chefs would be likely to result in a rise in their wage
rate from W to W1. This higher payment would be expected to cause the quantity of their
labour supplied to rise to Q1
d It would be expected that an increase in the wage rate paid to
chefs would encourage more people to become chefs. The
wage rate paid is a key influence on what job people choose to
do. A higher wage can allow people to enjoy a better standard
of living. Their purchasing power would increase. They would
be able to buy more goods and services. They may be able to
afford better healthcare and better education for their children.
It is also possible that if the wage rate per hour increases, chefs
may be able to work fewer hours while being able to buy the
same quantity and quality of products and enjoy more leisure
time. There are, however, a number of reasons why a higher
wage rate may not always lead to more people wanting to be
chefs. The wage rate may be higher, but overtime payments
and any bonuses might have been cut.

Non-wage factors may also discourage people from becoming

chefs. Working conditions may have declined. For example,
kitchens may have become less safe as ovens may not have
been maintained to a good standard and kitchens may have
become more crowded. Fringe benefits may have been
removed with, for instance, chefs and their families no longer
being entitled to free meals in the restaurants they work in.
Promotion chances may have been reduced, the length of
holidays cut and the restaurant owners may no longer offer a
pension scheme. People may also be discouraged from
becoming chefs if the period of training and the qualifications
required increase. They may also not want to work as a chef if
they would have less say in the menus or if the vacancies are
in restaurants some distance from their homes.
Mixed Market Economy

Mixed Market Economy: an economy in which both the private and

public sectors play an important role.

With state intervention we have the following benefits: page 112

1. Government takes into account all social costs and benefits. It is

important there are more benefits than costs. Private sector only
considers private costs and benefits.
2. Encourages consumption of certain services and products by
granting subsidies: Merit Goods (external benefits).
3. Discourages consumption of harmful products: Demerit Goods.
4. Produces products that cannot be charged for directly: Public
Goods, like defence.
5. Prevents private sector from overcharging for goods- prevent
monopolies.
6. Government seeks to employ available labour making maximum
use of its resources: mobility of labour.
7. The government will plan ahead to a greater extent than private
sector to devote more resources to capital goods preventing short
termism.
8. Government can help vulnerable groups with redistribution of
income, taxing the rich and helping the poor.

15.2 Maximum and Minimum Pricing

A Maximum price is set below the equilibrium price by the government

so poor people can afford to buy basic goods and services. This
encourages consumption.
The problem with this pricing however is that it can lead to a shortage. In
this case the government has to do rationing and a lottery so people do
not consume too much of the product.

To encourage production the government set a Minimum Price, above

the equilibrium price so producers are encouraged to produce basic
necessities. This situation can lead to a surplus- in which case the
government buys any remaining goods.
Minimum pricing is especially important for setting a National Minimum
Wage for labour- so people can earn enough money to live.

15.3 Government measures to address Market Failure

Subsidies are given for Merit Goods and encouraging consumption

Fig 15.3 Shows a subsidy for a product with inelastic demand. In this
case the consumer benefits more from the subsidy.
Consumer box: PSP1X
Producer box: P1XYP2

Fig 15.4 Shows a subsidy in the case of elastic demand. In this case the
producer benefits more from the subsidy.
Consumer box: PSXP1
Producer box: P1XYP2

The impact of tax with price elasticity.

The government will earn more revenue if it taxes goods with inelastic
demand. Remember we learned in Chapter 11 that Price and Revenue
go in the same direction with inelastic demand and the opposite direction
with elastic demand. So if you want to make more money with an
inelastic product you need to raise the price.
As we know the government imposes indirect taxes on Demerit goods to
discourage their consumption. There is a paradox here: the government
makes more money by taxing these Demerit goods because they are
inelastic (addictive products) but at the same time they are not happy
that people are consuming the Demerit goods because they have
external costs. Therefore the extra revenue coming in would go to
increase in healthcare.
Individual Activity 2

a. external costs of air travel are noise pollution and air pollution

b. imposing a tax can increase the price of air travel . Air travel is an elastic
product, therefore an increase in price will lower demand

c. a new airport will allow business like restaurants and retail shops to open.
This will also provide jobs to local people.

Competition Policy

The government will try and prevent monopolies from forming through the
following ways: Remember monopolies are negative: they set high price and
low quality for products and services.
1. Prevention of firms merging together (two or more firms become one) if
the interest is not for the consumer: example they merge to get rid of
competition so they can charge high prices.
2. The government can remove barriers of entry and exit. Example: it costs
a lot of money to start certain industries like car production, because of
the high costs of machinery (entry barrier). The government can offer
subsidies to new companies entering the market.
3. the government can regulate monopolies and prohibit non competitive
practices: Limit Pricing: setting a price low enough to discourage other
firms from entering the market. Predatory Pricing: a firm charging a
price below their rivals, so they drive them out of the market.
Environmental Policies page 116

Government may place rules on how much a firm can

pollute. If firms exceed the limit they pay a fine.

Another policy, which has become more popular in recent

years, is tradable permits:
Government allows firms to pollute to a certain limit. If
firms pollute less than their limit they can sell the rest of
their permit to a “dirtier” firm. So the “cleaner” firms save
money.

Activity 3

a. An energy-intensive sector is an industry that uses a high amount of

energy per unit produced.
 b. An emissions trading scheme may reduce pollution by rewarding firms
that cause little pollution and punishing those that generate a high
amount of pollution. Permits are issued or sold to firms allowing them
to pollute up to a given level. Those that pollute less can sell their
leftover allowance to other firms. This should enable them to charge
lower prices, gain more market share and reduce the pollution the
industry creates.

Regulation
Regulation includes rules and laws that place restrictions on the
activities of firms. The government may regulate a target audience
for the product, the quality of products and mode of staff
management of firms:
Examples:
-firms cannot sell cigarettes to children
- products may need to follow certain standards (no toxic materials)
- workers need to be allowed holidays
- shops cannot stay open all day and need to respect opening and
closing hours

Regulations are backed by law and should be easily understood.

Regulations work if people agree to it and the government needs to
make sure people are following the rules. Sometimes it can be costly for
the government to follow up on offenders: it might cost time and money
to have police checking if people are riding motorcycles with helmets.
Nationalization and Privatisation page 117 and 118

1. Define: Nationalisation and Public Corporation

2. List the advantages (5) and disadvantages (3) of a State

Owned Enterprise

3. What are 2 advantages of the private sector buying a state

owned enterprise?

4. What are 3 criticisms about the Private Sector taking over a

State Owned Enterprise?

5. Do Individual Activity 4
Direct Provision
Most governments produce at least some goods and
services that they think are essential:
housing
education
healthcare

These are provided free of cost or are subsidised.

Besides being essential services, these are Merit Goods

Merit Goods have external benefits and are

underconsumed.
To stimulate consumption:
-governments may pay private sector to produce them
- information about their benefits may be distributed
- consumption may be compulsory

The private sector may not have incentive to produce some

products: these are public goods: goods that are consumed
without paying. Governments need to provide these and pay for
them through taxation.

Remember the characteristics of public goods:

non-rival, non-excludable, zero cost to extra users,
non-rejectable.
Unfairness

Governments also intervene with Equity- that is fairness.

Income distribution can be very uneven if it is solely

distributed by market forces: some people will be very rich
while others very poor. In fact the private sector caters to
people who can afford to buy them. This means they will not
produce products needed by the poor.

The government ensures that everyone in the country has

access to basic necessities including housing, education
and healthcare.
Government can assist the poor and provide essential
products free to consumers.
In a number of countries, state education and healthcare is
free, not just because they are merit goods but also to
make them accessible to the poor. State services are
provided for through taxation.

The difference between income and wealth can also be

socially divisive and result in some workers being less
productive. The elderly and sick may not be able to work.
Inequality can lead to social unrest and poor people may be
less educated and eat less healthy leading to being less
productive.
Governments can create a redistribution of income to
prevent social division: taxing the rich and financing the
poor.

Effectiveness of Government Intervention

Government intervention can reduce market failure, but

sometimes government failure can occur:
- it may overestimate private benefits
- it may not calculate the efficient quantity of public
goods to supply

Government can take time to make decisions and those

decisions may be influenced by political factors, and in
some cases, corruption.
for example: the government may not raise petrol tax in
order to get votes from the people

Government intervention may also reduce economic

efficiency by reducing incentives. If the government gives
high unemployment benefits, people may not want to work.
Firms may be discouraged from their activity if the
government has a high corporation tax.
Development of effectiveness of government
intervention

A case study: building an airport:

public sector or private sector?
advantages and disadvantages

1 advantage of the private sector is they would build the

airport in a short time, with high quality and low price-
driven by profit incentive.
There is a risk that the private sector is a monopoly and
might not keep costs low and charge high price- they will
only consider private costs and benefits

Only public sector considers social costs and benefits. So

when the government carries out a CBA" Cost Benefit
Analysis, it makes sure that the social benefits are equal to
or greater than social costs. otherwise the project is not
approved.

If social costs are high it may consider using its resources

for education for example
Regarding building an airport, the arrival of MNC’s
-Multinational Companies- can provide external benefits
by offering work to local workers and more tax revenue
Group activities

a The government will benefit in terms of high

corporation tax revenue. There will also be a
probable reduction in the amount of
unemployment benefit paid by the government.
This is because profitable firms are likely to
expand and take on more workers.

b Private sector firms may be more efficient than

state-owned enterprises, as the market provides
both a ‘carrot’ and a ‘stick’ for them to produce at
a low cost and to make the products desired by
consumers. If firms are efficient, they are
rewarded with high profits and if they are not,
they are punished by going bankrupt.

Four Part Question

a. A minimum price is a price floor. To have any effect, a minimum

price has to be set above the equilibrium price. The price can be
above the legally enforced minimum but cannot be below. An
example of a minimum price is a minimum wage where employers
have to pay a wage at least equal to this.

b. A maximum price set above the equilibrium level will have no

effect. This is because producers could still charge the equilibrium
and comply with the law. A maximum price set below the
equilibrium, which it is where it is normally set, will result in a lower
price.. A shortage can occur when demand exceeds supply

c. A government could encourage consumption of a merit good by

providing more information to people about the benefits they can gain
from consuming it. For example, a number of governments run
campaigns to overcome the information failure that exists about the
benefits of eating fruit and vegetables.
A government could also subsidise production of the merit good. This
would lower its price, which would increase people’s ability and probably
their willingness to buy the product. A third way is for the government to
use regulation. It could make consumption compulsory. For instance, a
number of governments make it illegal for parents not to send their
children to school. This measure is sometimes combined with a subsidy
that reduces the price to a low level or even to zero price.

d Consumers may benefit more from a market economic system than a

mixed economic system. Consumers are said to be sovereign in a
market economic system. In theory, at least, they decide what is
produced and signal their choices to producers through the price
mechanism. If they want more of a product, they will bid up its price,
which will encourage producers to supply more of it. Consumers may
also benefit from low prices and high quality if competition results in
efficiency. To attract consumers, producers may have to keep prices low
and to innovate. Due to the risk of market failure, however, consumers
may benefit more from a mixed economic system. A government can
finance the production of public goods. In a market economic system,
consumers would not be able to buy public goods. This is because
private sector firms would have no incentive to produce them. They
cannot prevent those not willing to pay for them from enjoying them.
Consumers’ choices will be affected by measures to encourage the
consumption of merit goods and to discourage demerit goods. Some
may dislike, for instance, taxes on high-fat foods and may argue that
they know better than the government what is good for them. In the long
run, however, these measures may change the pattern of consumer
demand. Competition is not guaranteed to be present in a market.
Consumers may benefit from the government in a mixed economy
intervening to prevent private sector monopolies charging high prices. It
may do this by regulating private sector monopolies or nationalising
them. State-owned enterprises may be more likely to base their
production decisions on social rather than private costs and benefits. If
this is the case, consumers may benefit from, for instance, less pollution.
A government may also implement policies to promote factor mobility. If
labour, in particular, becomes more geographically and occupationally
mobile, producers will be able to respond to changes in consumer
demand to a greater extent. Poor consumers may benefit more from a
mixed economic system than a pure market economic system. This is
because they lack purchasing power and so will have little ability to
influence and receive what is produced. In a mixed economic system,
some essential products may be heavily subsidised and they may
receive benefits to increase their purchasing power. Of course, there is
the possibility that products produced by state-owned enterprises may
be of a low quality if the lack of competition and government funding
reduces pressure on the enterprise to be efficient. The government may
also fail to estimate external costs and benefits accurately and so may
over-tax or over-subsidise. Which type of economic system will benefit
consumers most will be influenced by whether market forces or market
forces combined with government intervention works more efficiently
Four part question answer section 3 test
a Total cost is the full cost of producing a given output. It includes both fixed
and variable costs. In contrast, average total cost is total cost divided by
output. It is sometimes known as average total cost.

b There are a number of reasons why so many firms exist in the car repair
industry. People will not travel far to have their car repaired and in a given
area, demand for the service may be somewhat limited. The service is not a
standardised one. A variety of cars with different problems are likely to be
taken to a car repairer. This means that it would not be advantageous to be
large. Indeed, a car repair firm would benefit from being flexible. Small firms
can build up a relationship with their customers, getting to know their cars and
their requirements. It is also relatively easy to set up a small car repair firm.
Not much capital equipment is required and the premises may be small. The
owner of a car repair firm may also want it to stay relatively small so that
she/he can keep control of the firm.

c Many car manufacturing companies are large because they can take
significant advantage of economies of scale. Technical economies of scale are
important in the manufacturing industry. Large car companies use large-scale
equipment to mass produce cars. They are likely to experience research and
development economies as they can operate research and development
departments that develop new car designs and new features. They can also
benefit from buying, selling, managerial and financial economies of scale.
They can buy tyres, for instance, in bulk. As important customers, they are
likely to be charged a discounted price. Transporting a high number of cars
out to car dealers can be relatively cheap per car as the delivery vehicles can
carry a number of vehicles. A large car manufacturer, employing a relatively
large labour force, can take advantage of managerial economies of scale by
allowing its labour force to specialise. Some of its workers can be
accountants, some can be paint sprayers and some can be human resource
managers.
A large car manufacturer can reap financial economies of scale. Banks may
be more willing to lend to a car company they have heard of and which has
considerable collateral than a small, unknown car manufacturer. As a large
company is likely to borrow a large amount of money, it may be charged a
relatively low rate of interest. This is because the administrative costs of
processing and managing a large loan per dollar lent are lower than those
involved with a small loan. A large firm may also find it easier to sell its shares
as again it is likely to be better known.

d There are both potential benefits and costs for a car manufacturer from both
merging with another car manufacturer and with a firm selling cars. The
merger with the car manufacturer might, in practice, prove to be more
beneficial. A merger with another car manufacturer may reduce average costs
if the new, merged firm can take greater advantage of economies of scale. A
larger firm should be able to make use of larger, more technologically
advanced equipment and exploit division of labour to a greater extent. It will
also have greater buying power, may be able to gain more loans on more
favourable terms from banks and may face greater demand for its shares.
One reason why people may want to buy shares from a new, larger merged
car manufacturer is because they may expect it will make more profit. This is
because a horizontal merger, such as that between two car manufacturers,
will increase the firm’s market share. Having more market power can enable a
firm to widen the gap between the cost per unit and the price it charges.
A horizontal merger can also reduce average costs as a result of
rationalisation. The new firm may be able to reduce costs by cutting out any
unnecessary duplication. There is a risk, however, that the merger between
two car manufacturers may increase average costs. This may occur if the new
firm is too large and so experiences diseconomies of scale such as problems
of managing the new firm. These problems are more likely to arise if the two
firms were located some distance apart, although advances in information and
communications technology are reducing this problem. There is initially likely
to be some extra costs involved in seeking to harmonise, for instance, wage
rates and accounting systems in the two firms. Management problems may be
more serious in the case of a vertical merger forwards, such as that between a
car manufacturer and a car dealership. This is because of the different nature
of the firms and the different skills required in running them. There may also
be a problem if the size of the two firms does not match. For example, if the
car manufacturing part does not produce enough cars for the car dealership,
there will be a waste of resources in the car dealing part. There would,
nevertheless, be some advantages that could be gained from such a merger.
One is that it will guarantee a market outlet for the cars. The car manufacturer
will know that the cars it produces will get into car showrooms. It will be able to
control how its cars are sold, seeking to ensure that they are well presented
and that the sales staff are fully informed about the advantages. Having the
direct link to the sale of the product should also mean that it will receive
feedback from its customers. It could use this information in the design of new
models. The merged firm is also likely to use its control of car dealers to stop
them selling rival firms’ cars.
Four Part Question ch 21
a. Investment: spending on capital goods.
b. Car production is capital intensive so the
productivity of workers can be low while the
production (output) can b e high thanks to the
machines.

c. Because machines are more efficient: they do not

get tired and sick and there is not human error.
Lower average cost of production thanks to a higher
output with combining machines per worker. Making
a car with just human labour would be very
expensive. We can still have productivity even when
the labour goes on strike.
d. Think of 4 reasons why an industry becoming
capital intensive would cause unemployment and 4
reasons why it wouldn’t.
Why it would cause unemployment:
1. This depends a lot on the industry: Example
online banking. We do not need humans to
manage accounts.
2. Vending machines and self checkout at
supermarkets do not need humans.
3. Retail shopping online like Amazon and Ebay :
no human has to sell you these items however
this can increase employment for truck drivers.
4. Drone taxis: self driving taxis can cause drivers
to lose their jobs.
Why it would not cause unemployment:
1. Many machines need human workers to operate
them.
2. As mentioned purchasing online can provide people
work with delivery service and processing orders.
3. Computer hardware and software that provide
advances in technology are developed by humans.
4. Air travel is an example of a capital intensive
industry that requires humans to make it available:
plane hostess, pilot, luggage management.
Four-part question

a The opportunity cost of saving is spending now. A decision to

save, for example, $20 dollars means that $20 cannot be spent
now.

b Young workers may save less than the middle-aged workers

because they may earn less. Wages tend to rise as workers
approach middle-age. Having more income increases people’s
ability to save, they can afford to purchase the products needed
for a reasonable standard of living and have income left to
save. Young workers may be less concerned to save for their
old age as it may seem a long way off. In contrast, middle-aged
workers may be concerned to build up a good pension.

c Households may borrow less if there is an increase in the

rate of interest. A higher interest rate will raise the cost of the
loan, making it less affordable. It may also make banks more
reluctant to lend to some people as there may be greater
concern about their ability to repay it. A reduction in confidence
in their future economic prospects may also make people less
willing to borrow. If they think there is a risk that they may lose
their jobs in the future or experience a cut in their wages, they
may be concerned that they would not be able to repay any
loan taken out, for instance, to buy a better home. There may
also be changes in the attitude to borrowing. For instance, past
experience of running into difficulties repaying loans may make
households less willing to take out future loans.

d An increase in income usually increases the total amount

that people spend. As people’s disposable income rises, they
are able to afford to purchase more goods and services. Having
more goods and services usually increases people’s living
standards. Higher income also tends to be associated with
greater wealth. As people get richer, they can afford to buy
more consumer durables and acquire assets such as houses
and shares. Having more wealth can give people greater
confidence, which can increase their willingness to spend. It
also increases banks’ willingness to lend to them and so
increases their spending capacity. An increase in income does
not, however, necessarily mean an increase in disposable
income. If the amount of income tax increases in proportion
with gross income, people’s spending power may be
unchanged. An increase in income may be associated with an
increase in the total amount spent but a fall in the proportion of
disposable income spent. When people are poor, they have to
spend all of their income just to survive. As people get richer,
they enjoy a good material standard of living with, for instance,
high-quality clothes and housing, but may still be able to save a
proportion of their income. There may be other changes
happening in the economy that may have more of an impact, at
any one time, than an increase in income. An increase in
income may be accompanied by a fall in spending if, for
instance, there is a rise in the rate of interest or financial
institutions are offering more and better quality saving
schemes. There may also be a change in the age distribution of
the population. A higher proportion of older people may, for
instance, reduce spending.
Group activities

1 a secondary b tertiary c primary d tertiary e tertiary or quaternary

f tertiary

2 b and c would tend to favour small firms. a, d, e and f would all be

likely to encourage the emergence of large firms in the industry.

3 a technical economies b research and development economies c

managerial economies d buying economies e selling economies f
financial economies

Individual activities

1 a External growth.
b One influence is the size of the market. A firm selling a product in
an expanding market has the potential to grow in size. Another
influence is the age of a firm. A new firm is likely to be of relatively
small size.

2 a To take greater advantage of economies of scale and to gain a

greater market share.

b If the merger enables the new firms to take greater advantage of

economies of scale and work more efficiently, bank customers may
be able to enjoy lower bank charges and improved banking services
such as internet banking.

3 a A mining company could exploit, for example, technical

economies of scale. Large capital equipment can be used in the
industry as the greater the amount of coal mined, the more viable
the employment of the equipment becomes. It can also take
advantage of financial economies of scale. A large mining company
is likely to be able to borrow more easily and more cheaply than a
small firm.

b Firms in the mining industry may be able to take advantage of a

skilled labour force and specialist suppliers of capital equipment.
New mining firms can hire workers trained by other firms in the
industry. Subsidiary industries will set up, if the mining industry is
large enough to supply them with goods and services including
capital equipment.

Four-part question

a A state-owned enterprise is a business owned by the government.

b There are a number of reasons why a firm may decide to stay

small. Some owners may choose to keep their firms small in order
to retain control. Other owners may want their firms to expand, but
may realise they lack the necessary finance. Banks may be
reluctant to lend to small firms at low rates of interest and small
firms are unlikely to issue shares. If the market for a product that a
firm is producing is small, the firm will not be able to grow. A small
firm may be making a specialised product with a limited demand or
may be serving a small, local market.

c A financial economy of scale is the benefit a firm can gain from

growing in size in the form of being able to raise finance more easily
and cheaply. A large firm may find it easier to obtain a loan from a
commercial bank at a low rate of interest. As a firm grows in size, it
is also more likely to be able to find buyers of new shares issued to
expand the business. Another internal economy of scale is
managerial. As the firm grows in size, it may become large enough
to employ, for example, IT support staff, an accountant and a web
designer. A small firm would not have the volume of output to
generate enough work to employ these people on a permanent
basis and they would not be able to afford their wages. It would
have to pay outside agencies for these services. These agencies
may charge a relatively high price and may be less in touch with the
firm’s needs.

d The merger between two book publishing firms may bring a

number of benefits for consumers. The new larger firm may be able
to take greater advantage of internal economies of scale. A few
publishing firms still print their own books. Most, however,
outsource the printing to printing firms. A new larger firm may be
able to either use more advanced printing equipment itself, or, more
likely, to negotiate a contract that uses the latest technology. A
larger publishing firm may be able to gain loans at a lower interest
rate, purchase paper at a lower price and may be able to employ
more specialised staff, including, for example, an editor
concentrating on economics books. Technical, financial, buying and
managerial economies of scale will lower costs of production. This
may result in the new firm charging lower prices, which would
clearly benefit consumers. Consumers may also benefit from an
improvement in the quality of the firm’s books brought about by
using more advanced capital equipment and experts and by having
more finance to spend more on research and development. In
addition, consumers may benefit from greater choice if the larger
firm takes advantage of riskbearing economies of scale and
produces a wider range of books written by a greater number of
authors. There is a risk, however, that consumers will experience a
reduction in choice. The new firm may decide to concentrate on a
narrower range of books and writers. Consumers will have one less
publisher to buy from and there may be some titles they will no
longer be able to buy. Having fewer publishers will reduce
competition in the market, which may also disadvantage consumers
as prices may rise and quality may fall. The new firm may not feel
the same pressure to keep costs down and quality up, as
consumers may now find it more difficult to find a publisher
producing a similar book. Prices may also rise and quality fall if the
new firm becomes too big and as a result experiences
diseconomies of scale. Its managers may find it more difficult to
control a larger firm. There may be a greater risk of
miscommunication occurring because there is likely to be more staff
working in more departments. There may also be worse industrial
relations if workers find it difficult to adjust to the requirements of
the new firm or if the new firm engaged in rationalisation and
sacked some of their colleagues. Whether the merger will benefit
consumers will depend largely on whether the new firm experiences
internal economies of scale or internal diseconomies of scale and
how a reduction in competition affects the new firm’s efficiency.
21.2 Demand for Factors of Production

What Factors of production are employed

The type of factors of production employed is influenced

by the type of product produced:
-car industry is capital intensive
-beauty salons labour intensive
It is also influenced by the productivity of the factors and
their cost.

combining factors of production:

a fall in price of substitutes may result in shifting factors
of production.
Example: a fall in the price of capital goods may mean
replacing labour with capital equipment.
with compliments: a fall in the price of one will increase
the employment of all factors of production. Example:
fall in the price of an aircraft will increase employment of
cabin crew and pilots.
Altering Factors of Production

If a firm wants to change the quantity of resources

employed by it, it will find it easier to do this with some
factors than others.
1. In the short run there is likely to be at least one
fixed factor of production. This means the quantity
cannot be altered quickly. Example: the size of an
office or factory. It will take time to expand
2. In the short run it might be easy to alter the
quantity of labor by changing the amount of
overtime available. Raw materials and capital
equipment can also be altered depending on the
contracts for them and availability.

Combining the Factors of Production

It is important to achieve the right combination of the

factors of production. Example: It does not make sense
to have 10 hairdryers and 2 hairdressers in a salon.
Firms combine labour, machines and land to reach the
highest level of output. Table 21.1 shows the right
combination of labour and capital for highest output.
Factors influencing demand for capital goods**

Key factor influencing Demand for capital goods:

1. A rise in the price of capital goods will cause a

contraction in their demand, whereas an increase in
the price of another factor of production , like labour,
may increase the demand for capital goods. Note:
labour is a substitute for capital. An increase in the
price of a complement however will decrease the
demand for capital goods.
2. If profit levels are high, firms will have both the
ability and incentive to buy capital goods.
3. A cut in corporation tax (tax that firms pay on their
profit) will allow firms to invest in capital goods.
4. Rising real disposable income will increase
consumption and encourage firms to invest in
capital goods for an increase in output.
5. A cut in interest rates would also tend to raise
consumption and encourage firms to expand their
capacity.
6. Confidence about future sales
7. Advances in technology will increase productivity of
capital goods.
Demand for Land

Productivity is a key factor influencing demand for land:

1. Agricultural land-the most fertile will be in highest
demand and receive the highest rent (or if by owner
has the highest value).
2. City Centres are also good targets for attracting
more customers.
3. Competition pushes up the rent at favourable sites.

KEY term (p 11) Productivity: the output per factor of

production in an hour

One natural resource experiencing an increase in

demand is water. Water is used for domestic,
agricultural, industrial and energy production purposes.
As countries become richer they have bigger
demand on water supplies.

Individual Activity 2

a. As economies and living standards develop people

have money to buy dishwashers, washing machines
and even luxury products like swimming pools.
Factors of Production and Sectors of Production

As economies develop they evolve from primary to

secondary and tertiary sectors. In certain situations
countries like India can move from primary directly to
tertiary sector. This all depends on resources available.
Different industries use different factors of production.
Example: the Chemical industry is capital intensive.

Ind Act 3
a. piece work model: people are paid based on how
much output is produced
b. i. How is output affected working from home?
Perhaps workers are distant from each other so
they might work inefficiently since they can’t
communicate. Maybe people could be more
efficient since they do not have to travel and save
time on that and are also more relaxed and less
stressed.
ii. How can smart working affect cost of production?
It can lower cost of production because the firm
saves money on energy costs and rent.
21.2 Labour Intensive or Capital Intensive

1. Labour intensive means there are more workers

than machines in an industry.
Reasons for Labour intensive sectors:
- There is a large supply of labour in a country
making labour cheap.
- Some producers are too small to take
advantage of capital equipment.
- The producer may be an artisan and offer their
customers better quality hand-made products
along with the option of custom design. This
proves to be worth more than manufactured
goods. Artisan made has higher prices than
manufactured goods: Artisan Italian shoes
-example Fiorentini Baker- made with good
materials is more expensive than manufactured
shoes (industrial made with machinery) from
Bata shoes (a brand that manufactures shoes).
- Workers can be more flexible in terms of what
they do and the size of the labour force can be
adjusted by small amount.
- Firms may switch from capital intensive to
labour intensive if the price of capital increases
and costs more than labour. NOTE: every
decision made that is economic has an
opportunity cost.
Firms who have capital-intensive production: Reasons
for this to happen:
- advances in technology tend to make goods more
affordable and more productive: machines produce
faster than humans. Because of technology,
Education for example is becoming capital intensive
with online degrees.
- Manufacturing can produce products at a lower
average cost and also be free from human error.
- capital goods do not engage in industrial action.
- machines do not get tired or sick, however they
need to be maintained: old machines may be
replaced with new ones.
Chapter 14

We learned from Ch 13:

There is a risk that the market forces of demand and supply

may not work well. In fact market failure may occur. We will
take the following notes from Ch 13 and elaborate them in
Ch 14.

14.1 The Nature of Market Failure

Definition: Market Failure: market forces (demand and

supply interaction) resulting in an inefficient allocation of
resources.

Market Failure occurs when market forces fail to produce

the products that consumers demand, in the right quantities
at the lowest possible cost.
Market failure means inefficiency (remember a Market
economy survives on efficiency- allocative, productivity,
dynamic)
14. 2 Failure to take into account all costs and benefits

1. Consumers and private sector firms may only take into

account the costs and benefits to themselves. These
are called Private Costs and Benefits. They do not
take into account the costs and benefits of others.
EXAMPLE: Some people may smoke even if it annoys
and endangers the health of those around them. This
is called an External Cost: a cost to third parties not
involved in production or consumption
Key TERMS
Private Costs: costs borne by those directly
consuming or producing the product. Examples: A
factory (firm) has the private cost of paying their
workers. A consumer has the private cost of buying the
product.
External Costs: costs imposed on those who are not
involved in the consumption and production of the
product. EXAMPLE: Somebody lives near a factory
producing pollution, gets sick and has to go to the
hospital- this costs the person and government money.
These people are third parties to consumption and
production.
Third party: those not directly involved in producing or
consuming a product.
Social Costs: The TOTAL costs to society of an
economic activity. Basically they are Private Costs +
External Costs
 Draw Fig 14.1
This figure shows an over-production of a product
because external costs are not being calculated.
Curve SS shows only Private costs to the firm
Curve SxSx shows total costs to society (private costs
plus external costs). Which raises the price level
The allocative efficient output is Qx
The government taxes products and factories that
harm the environment and health.
Example: for the consumer-The government taxes
cigarettes and alcohol and other harmful products.
For the firm- the government taxes how much
pollution they create- because people living near the
factory can breathe the pollution and get sick causing
costs to society.

Private Benefits- benefits received by those directly

producing or consuming the product. Example: a
student benefits from attending university.
External Benefits - benefits enjoyed by those not
involved in the consumption and production activities
of others directly.
Social benefits= Private benefits + External Benefits,
the total benefits to society.
Example: students attending university and get a good
education to get a good job as doctor and now they
make good money- This is a private benefit
University education benefits society because now the
economy has skilled labour and doctors, lawyers and other
professionals- these are External benefits.
This makes living standards higher- these are called
External Benefits: you have better products and services
thanks to educated people.
Since external benefits are not considered, the government
gives subsidies (gives money) to increase education.
Fig 14.2 shows Under -production. DRAW
This diagram shows the demand for degree courses
DD shows the private benefits
DxDx shows all the benefits to society.
If left to market forces the quantity would be at Q, but since
the government gives subsidies we can get to Qx.
Immagine in the diagram that the gap between DD and
DxDx is filled with a subsidy.

Conclusion
Whenever there is a gap between the total effects on those
directly consuming and producing products, markets will fail
to allocate resources efficiently:
-Therefore with over-production the government fills the
gap with taxes. (external costs)
-with under-production the government fills the gap with
subsidies. (external benefits)
Therefore, the government steps in and corrects market
failure.
Socially Optimum Output: the level of output where social
costs equal social benefit and society’s welfare is
maximised.
Social Costs = Social Benefits (the goal)

Social Costs> Social Benefits = diagram like 14.1 showing

over-production-----this means we need to tax the products

Social Benefits > Social Costs = diagram 14.2 showing

under-production-----this means we need to give a subsidy
to the product

An example of where social costs exceed social benefits in

most countries is the use of road space by private cars.
Rather than use the train to travel on a long trip: Example
Bologna to Paris, people take their private car.
With this choice there are many external costs:
-use of gasoline
-pollution
- car accidents
- wear and tear on the vehicle (consuming the car will
make the car have less of a life time- leads to waste)

To correct these external costs, many governments, like in

Singapore and the UK, started using road pricing
schemes: people are charged money to use the road.

Individual Activity 1
a. materials to build the factory and the cost of labour
b. external costs are costs that do not involve those who

produce or consume the product.

people can breathe the pollution and get sick: now they go to
the hospital which costs money (both the government and the
patient)
another example is the pollution damages natural life like
animals and the river
and this destroys the ecosystem. bad ecosystems can ruin
and economy

14.3 Information Failure

Workers need to be well informed before taking a job

or they risk taking a job they are not skilled for or in a
location that requires commuting- can lead to stress
and inefficiency.

Advertising can distort consumer choice persuading

people to buy products they do not want. Consumers
and producers may also lack information and make
inefficient choices. Remember wasting money is
market failure in your own home.
Firms can have lack of information about where to buy
the cheapest raw materials and spend too much on
their product, leading to inefficiency.
Example of information failure for a producer: A
firm makes cotton t-shirts. They buy their raw materials
from a supplier who sells cotton fabric for 14
euro/meter. Meanwhile there is another supplier the
firm does not know about who can sell them cotton
fabric for 7 euro/meter.
Therefore the firm increases their cost of production
and this is market failure.

14.4 Merit Goods

SUBSIDY- money given by the government to a firm to

increase and encourage production

Merit Goods: Products which the government

considers consumers do not fully appreciate how
beneficial they are and so which will be
under-consumed if left to market forces. Such goods
generate positive externalities. (external benefits)

Examples:
Healthcare: some people may not recognize the
importance of regular medical check-ups and visiting
the doctor. They do not realize the benefits to others
of their fitness.
This good healthcare is a benefit to all people so we
have healthy workers that do not stay home sick and
also it prevents giving diseases to other workers.

First diagram shows market failure due to under

consumption (people do not consume the product or
service)

The second diagram shows market correction with the

government granting a subsidy (supply increases,
Demand and Supply are in equilibrium)

Group Activity 1
a. to create a skilled labour force for everyone, to create
equity so even poor people can go to school
b. people do not realize the benefits of education. Also if
governments do not provide subsidies only families who
can pay for school will go.

Demerit Goods
Products which the government considers consumers
do not fully appreciate how harmful they are and so
which will be over-consumed if left to market forces.
Such goods generate negative externalities (external
costs)

Demerit goods over-consumed and hence

over-produced. To tackle this problem, a government
could raise their price by imposing a tax on them.
 Group Act 2
a. Alcohol has negative externalities because people
drinking it can harm others by creating a traffic
accident, or being aggressive and fighting with
other people.

b. The government can impose taxes on alcohol so

it’s more expensive to buy and it can make
legislation for high cost tickets/fines for driving
under the influence or one can also go to jail.

14.6 Public and Private Goods

Firms will not make products unless they can charge

for them. Some products like military defense, which
most people want, will not be provided by a private
sector because of free -riders: someone who
consumes a good or service without paying for it.

public good: a product which is non-rival and

non-excludable and hence needs to be financed by
taxation.
If left to market forces public goods would not be
produced because the private sector is interested in
profit. So we need the mixed market economy and
intervention of the government to provide public goods
like military defense and things like a flood defense
system in a coastal town.

remember the objective of the public sector is public welfare

4 characteristics of Public goods:

1. non-excludability : no one is excluded from using the
public good (even if they do not pay taxes)- these are
called free-riders. example: street lights, military
defence
2. Non-rivalry: consumption of the product by one
person does not reduce another person’s ability to
consume it. Example: walking on the street everyone
can enjoy the street lights.
3. non-rejectable: it is not possible for people to reject
the services of the police for example.
4. Zero cost to other users: the cost of supplying a
public good to more than one person is often zero.
Example: defending more than one person in a
country does cost extra money.

private good: a product which is both rival and

excludable

Most products, including merit goods and demerit

goods, are private goods. These products are both
rival and excludable:
Education and healthcare are private good (merit
good) because if a place at school or a hospital bed is
occupied by one person, no one else can occupy it.
 So even though Merit goods are subsidised by the
government they still have this aspect of rivalry and
excludability so are private goods.

14.7 Abuse of Monopoly Power

Lack of competition leading to a possible monopoly:

leading to high prices and low quality.

If one firm dominates the market they may not be

allocatively, productively and dynamically efficient
since there are no competitors:
remember competition creates efficiency and helps
firms respond to consumer demand better.
Monopolies create products that have high prices and
low quality since there is no competition.

Market failure can also occur when there is more than

one firm producing the product - they can get together
and create the effect of a monopoly by keeping the
price high with price fixing.

The government corrects the market failure of monopolies

existing by lowering barriers to entry and making price fixing
illegal. They may also stop firms from merging (when two
firms join together) only if the merge goes against the
interest of the consumer.
Immobility of Resources

Unable to respond to consumer demand because of

lack of workers with the right skills or geographical
immobility.
The government can take measures to promote
occupational mobility of labour by improving education
and provide training.
Geographical mobility of workers can be made making
it easier for workers to rent or buy houses in an area
where demand for labour is high. Government can
provide financial help to workers seeking to move to
these locations.

Short Termism

When market forces may not result in sufficient

resources being devoted to capital goods. Short
termism is when an economy produces a high quantity
of consumer goods without considering the future so
the increase in living standards is temporary.
 the government intervenes by stimulating the private
sector investment by for example cutting taxes on
firms and undertaking some investment itself.

Group activities

1 a. The merit good and equity arguments.

b. Education is likely to be under-consumed, if left to market forces

as people underestimate its value to themselves. Also, while
making their consumption decisions, they do not take into account
the associated benefits to others.

Individual activities

1
a . Among the private costs are the costs of buying the land and
the building materials and the wages of the workers.

b. Pollution is an external cost, as it harms those who are not

directly involved in the production and consumption of the products
involved. For example, those living near the factories may suffer
from poor health as a result of carbon dioxide emissions from the
factories.

Individual Activity 2

a. To respond to consumer demand and earn more profit

b. competition gives choice so consumers can choose the higher quality
at the best and lowest price

14.8 Immobility of Resources

Remember on page 96 we studied Allocative
Efficiency and the problems with shortages and
surpluses. Allocative Efficiency means
equilibrium price: Demand and Supply meet at
the same price.
Immobility of Resources interferes with
Allocative Efficiency: this happens when
consumer demand increases for a product or
service and there are not resources available
that are occupationally or geographically
mobile.
Examples: If there is an increase in consumer
demand for financial services and there are not
workers that are occupationally and
geographically mobile then we have a shortage
and inefficiency. So we need workers who can
fulfill consumer demand with their mobility.
If we previously had a demand for the steel
industry - it is very hard for steel workers to
move to the financial sector. We need training
and education or geographical mobility to fulfill
the new demand.

How does the government correct Market

Failure with Immobility of Resources?
By improving education and provide training in
the new skills needed. The government can also
provide investment to make it easier for firms to
use land and buildings. Geographical mobility of
workers can be encouraged to buy or rent
housing where demand for labour is high.

14.9 Short-Termism
There is a risk that market forces may not result
in sufficient resources being devoted to capital
goods.
Look at page 21 : the PPC curve is important in
evaluating the allocation of resources toward
both capital goods and consumer goods.
If all your resources go to consumer goods you
will not be able to produce more as you need to
invest in new capital goods to produce more
consumer goods.
This is called making money in the short run.
You are not looking at the future.
The government solves this problem but
stimulating investment into the private sector’s
ability to buy new capital goods- they cut taxes
and may also provide a subsidy.
a. An external cost is a harmful effect on third
parties, that is on people not directly
involved in consuming and producing a
product. For example, people living near a
steel factory may suffer from the pollution
the factory creates.

b. A merit good is one that the government

considers is more beneficial to consumers
than they realise and it generates external
benefits. The social benefit of a merit good
exceeds the private benefits. As a result, a
merit good is underconsumed and
underproduced if left to market forces. In
contrast a demerit good is one that the
government thinks is more harmful to
consumers than they appreciate and it
causes external costs. It is overconsumed
and so overproduced if left to market forces.
c. Social benefit includes private and
external benefits. The social benefit of
education exceeds the private benefits of
education because education has external
benefits. The private benefits of education
include the development of skills, increased
earning potential and an increased range of
interests. As well as the benefits to those
being educated, others may gain. The
external benefits include increased output
and better quality output due to higher
labour productivity. More and better
products can be consumed. There may also
be increased tax revenue arising from higher
incomes. This extra tax revenue may be
spent on, for example, healthcare, which can
be enjoyed by third parties. A more educated
country may also be a more civilised and
compassionate society.

d. The rainforests, in the Amazon region of

Brazil, are being cleared at a relatively rapid
rate. The firms that are engaged in logging
in the forests are only taking into account
private costs and benefits. In the case of a
logging firm, private costs will include, for
example, the cost of transporting the wood
and the cost of labour. The private benefit a
logging firm receives from selling the wood
is the revenue it earns. The company will
continue cutting down trees, as long as the
revenue received by it exceeds its costs.
External costs caused by the logging firms
may include damage to wildlife habitats,
loss of plant species that could be used to
develop medicines, global warming and
interference with the lifestyle of local tribes.
External benefits may include reduced
transport costs for tourism firms in the area
due to construction of roads by logging
firms and tax revenue. While making its
decisions on the number of trees to be cut
down, a logging company will not take these
external costs and benefits into account.
The decision as to whether trees should
continue to be cut down in the Brazilian
rainforests should be based on the
relationship between social cost and social
benefit. If the social cost exceeds the social
benefit, no more trees should be cut down.