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Microeconomic decision makers

3.1 Money and banking

Money: any commodity used as medium of exchange when purchasing goods/services

Forms – cash, bank deposits & central bank reserves

Functions

  1. Medium of exchange – widely accepted as a means of payment for most goods/services
  2. Measure of value – more efficient to express price of goods/services
  3. Store of value – ppl can save money coz it keeps its value, so it can be used in the future
  4. Standard of deferred payment – enable ppl buy goods on credit

Characteristics   DAD SUP

Durability, Acceptability, Divisibility, Scarcity, Uniformity, Portability

Long time ago…

Bartering: act of swapping items in exchange for other items through a process of bargaining & negotiation

Problems

  1. Need double coincidence of wants – inefficient
  2. Low divisibility & portability

Types of banks

Banks Functions
Commercial banks (Primary)

  1. Accept deposits eg sight & time deposits
  2. Provide advances eg overdrafts & mortgages
  3. Credit creation – make money to ↑ money supply – ↑ purchasing power, ↑consumption & investment for firms

(Secondary)

  1. Collect & clear cheques on behalf of client
  2. Offer additional financial service eg foreign exchange dealings
  3. Online banking eg Amazon

But

Banks may charge in high interest rates to ↑its profit – makes borrower more difficult to repay & might have debt
Central banks
  1. Sole of issuer of banknotes & coins – print banknotes & coins
  2. Gov’s bank eg accept deposits, provide advances, manage gov debt

→ stabilise external value of nation’s currency

  1. Banker’s bank – oversee crash reserves of commercial banks

→ manage claim made by banks against each other

→ enable commercial bank ↑ efficiency

  1. Lender of last resort – require commercial banks to keep certain % of their cash balance as deposits with central banks

→ build public confidence in country’s banking system

→ protect jobs

→ ensure commercial banks X collapse

3.2  Households

Influence on spending

  1. Disposable income (income after compulsory deduction eg tax) & wealth
  • ↑ income/wealth ↑ purchasing power ↑ spending
  1. Interest rates – ↑interest rate, ↓ borrowing, ↑ saving, ↓ spending
  1. Inflation & Confidence

– inflation → ppl expect high employment / feel confident about future, ↑ spending

  1. Needs/wants for products – to satisfy needs eg food or wants eg luxury goods
  1. Factors affecting pattern of spending eg time of year – Christmas

Influence on saving

  1. Save to purchase goods/services later eg children’s education / retirement
  2. Provide income from interest paid on savings
  3. Precautionary reason eg accident

Influence on borrowing

  1. Purchase expensive goods/services eg property, land
  2. Fund education, large projects eg firm expansion
  3. Start up new business

Firms adv

  • Improve products by spending on R&D
  • Spend on advertising to increase demand
  • Invest capital to improve efficiency to increase profit

3.3  Workers

Wages factors: financial rewards that workers receive in return for their labour services

Wages Time-based payment
Salary Based on fixed annual amount
Overtime Payment for work in excess of standard, contracted hrs
Commission Payment based on % of sales worker makes
Bonus Extra payment for exceptional performance
Piece rate Fixed amount paid per item produced/sold
Profit-related pay Additional payment to workers, based on amount of profits made by firm
Share options Workers receive shares in firm

↑ motivation ↑ profit
Fringe benefits Additional benefits eg pensions

Non-wages factor

  1. Job satisfaction eg ppl enjoy challenging occupation
  2. Type of work – safe or dangerous environment
  3. Working hours
  4. Size of firm
  5. Career prospects – clear career progression eg teacher
  6. Fringe benefits eg pension, health insurance
  7. No. / length of holidays
  8. Location of job

Wage determination – determined by market force eg doctors → high demand, low supply → high pay

Demand of labour: no. of workers that firms are willing & able to hire at given wage rate

Factors affecting demand of labour

  1. Level of total demand – boom → ↑production ↑labour
  2. Productivity of labour
  3. Cost of labour

Supply for labour: ppl willing & able to work at different wage rates

Factors affecting supply of labour

  1. Availability & level of welfare benefits
  2. Changing social attitudes
  3. Geographical mobility
  4. Occupational mobility

Backward-bending supply of labour curve

  • ↑ no of hours worked, ↑ wage rate
  • But, when a person get to a very high position and his salary ↑ highly, the no of hours he works may ↓
  • CEOs and executive managers at the top of the management tend to have backward-bending labour supply curves
  • Relative bargaining power – ↑bargaining power ↑ wagesFactors affecting bargaining power
    1. Trade unions
    2. Age & experience
    3. Level of education

    Gov policy – Nation minimum wages (NMW): lowest amount a firm can pay its workers set by gov

    Reasons of differences in earnings

    1. Skilled vs unskilled

    – (skilled) high level of education, ↑productivity, low supply compared to unskilled ppl → harder to employ

    1. Primary vs secondary vs tertiary sector
    2. Male vs female – (female) part-time coz take care of family, discrimination
    3. Private vs public sector (public) less wages, more secure, have pension

    Specialisation of labour: workers being expert in a particular process / profession

Adv Dis
  1. ↑productivity
  2. ↑ quality
  3. Workers more skillful, ↑ earning potential
  1. Repetitive, boring
  2. Deskilled in other areas → less flexible
  3. Overspecialisation

3.4  Trade unions

Types

  1. General unions – skilled & unskilled workers with different jobs in different industries
  2. Industrial unions – ppl from same industry
  3. ‘White collar unions’ – ppl with different professional occupation
  4. Craft unions – skilled workers perform similar tasks in different industries

Roles

  1. Negotiating improvements in non-wages benefits of workers eg pension
  2. Improving working conditions eg better safety measures
  3. Developing skills of workers → provide training
  4. Provide financial & legal support to workers who’s made redundant / unfairly disciplined
  5. Bargaining with employers for ↑ wages & conditions
Adv Dis
  • Achieve higher wages, workers afford eg better healthcare, motivate workers, improve skills of workers
  • Improve working conditions increase labour productivity increase competitiveness, increase econ growth
  • Increase communication between workers & employers, reduce conflict, make negotiations more effective
  • A union have more power than 1 worker – take industrial action to support working condition improvement
  • Increase firms’ cop, reduce profits, reduce wages, reduce output
  • Increase industrial action, reduce productivity, disrupt economy, reduce investor confidence
  • Restrict ability of firms to change output, reduce responsiveness
  • Workers pay fee to be a member – reduce spending power
  • Union might bring workers on strike, reduce wages, reduce living standard

Collective bargaining: process of trade union representatives negotiating on behalf of their worker with employer representatives for better pay & condition 

Industrial action: measure taken by group of workers as a result of major disagreements with employers

Types Definition Impact
Strike Stop working
  • X output
Sit-in Present but don’t work
  • Workers X paid
Work-to-rule Work to fulfil min. requirement
  • ↓ productivity
Go-slow Work slowly

3.5  Firms

Measurements of size of firm

  1. of employees
  2. Market share – measures firm’s sales revenues as a proportion of industry’s sales revenue
  3. Market capitalization of firm
  4. Sales revenue of firm

Explain influences on size of firm

  • Size of market – increase demand, increase size
  • Availability of capital – increase profit for expansion

Private sector   Aim: earn profit

Sole trader Business owned & controlled by a person
Partnership
  • Owned by 2-20ppl with share ownership
  • Easy to set up
Private limited company
  • Owned by shareholders
  • More complex set up → require legal doc.
  • Unable to buy/sell shares with agreement with other shareholders
Public limited company
  • A company whose shares are traded on a stock exchange
  • These shares can be bought & sold by public
  • The company has limited liability
  • Owned by shareholders
Co-operative
  • Working tgt to share profits according to amount that consumers had spent
  • The owners of a co-operative are the members. This gives them voting rights but each member only has one vote

Public sector – owned by gov  Aim: provide services

Small firms

Adv Dis
  • To compete with larger firms by providing goods that can’t be bought in larger firms
  • May located in a remote area and be the only firm that sell goods
  • Provide personal shopping experience for customers, more contact with consumers – meet specific needs
  • Adapt quickly to changing consumer tastes
  • Better communication with workforce coz simple structure of firm
  • Limited start-up capital → hard to raise finance to establish business
  • Limited finance available → hard to expand business
  • ↑ risk of business failure
  • ↑ cop → unable to exploit benefits of large-scale production, lower price of goods
  • (Dis of sole trader)

Sole trader (sole proprietor)

  • Owner runs & controls business
  • Held responsible for its success or failure
  • Set up with little capital – obtain for personal savings / borrowing
Adv Dis
  • Respond to changes in demand quickly coz one person makes all the decisions
  • Easy to set up coz less paperwork needed
  • Provide a personal service get to know customers personally
  • Profit incentive owner will get all the profits
  • Sole trader has total control of deciding e.g. hours of work, holidays
  • May have good relationships with staff coz less industrial disputes
  • Limited start-up capital → difficult to secure funds beyond personal saving
  • ↑ workload & stress → lack of labour

 

 

 

Primary sector: extractive industry where raw materials are collected eg agriculture

Secondary sector:  manufacturing or construction sector where raw materials are turned into goods eg car production

Tertiary sector: service sector of the economy eg education

Causes of growth of firms

Internal growth – when firms expand using own resources by increasing no. of branches in more countries → ↑ market share

External growth – when expansion involves another firm

  • Mergers – 2+ firms join together to form one firm
  • Takeovers – a firm take over by another firm, can be hostile (doesn’t agree) or agreeable
  • Franchising – an individual or firm buy licence to trade using another firms name

Types of merger

Horizontal merger – firms in same industry join together eg 2 banks

Adv Dis
  • ↑ market share – reduce competition
  • Gain skilled employees from each other
  • Operate with fewer employee coz no need to hire two departments
  • → ↓ cop
  • Take adv of econ of scale eg bulk-buying – reduce average costs, reduce cop and increase profit
  • Allow firm rationalise to cut out duplication – reduce cop
  • Duplication of resources
  • Firm experience disecon of scale eg communication problem – increase average cost
  • Increase market share, reduce competition, make demand price-inelastic, increase price

 

 

 

Vertical mergers – firms in different industries join together eg tea company take over tea plantation

  1. Backward vertical merger – firm from tertiary sector joins secondary / primary
Adv Dis
  • Firm in secondary sector has control over quality of raw materials supplied – ensure adequate supply of raw material
  • Price of raw material decrease coz manufacturer doesn’t have to pay another firm for raw materials
  • Cost of running farm in primary sector increase total cost coz increase in factors of production
  • Transport cost increase coz raw material delivered by external firm

 2. Forward vertical merger – firm from primary sector joins secondary / tertiary

  • Allow firms to control sale of product
  • Conglomerate merger – firm from unrelated areas of business join eg India company Tata which produces motor vehicles & tea

Increase range of products produced

Adv Dis
Take adv of econ of scale Too diverse

Economies and diseconomies of scale

Economies of scale – ↑ output ↓ costs of production

Internal econ of scale – ↑size ↑cost saving

Bulk-buying Bought in ↑quantities ↓cost
Technical Purchase equipment
Financial Ability to borrow money
Managerial Employ specialist manager
Risk-bearing Produce range of products & operate in many locations
Research & development (R&D) Fund R&D
Marketing ↑advertising budgets

External econ of scale – arise from external factors

Being near to related firms easy to access & ↓ transportation cost
Availability of skilled labour easy to employ labour, ↓ costs for firms
Reputation of area many ppl go there
Access to transportation networks easy to trade

Diseconomies of scale – ↑size ↑cop

Why?

Internal

Communication problems
  • firm too large/diverse, ↓ control & communicate, slower decision making & responding to changes in market conditions
  • ineffective management as management becomes more complex
Demerge
Employ more labours or build new factories ↑cop
Workers in large firms don’t feel part of firm ↓motivation & productivity

External

  • Traffic congestion
  • ↑ competition for resources / ↑ price of labour

3.6  Firms and production

Derived demand: demand of fop depends on demand of goods/services

Derived demand depends on cost, quantity, productivity

Labour-intensive production: an industry which has a high proportion of labour compared with proportion of other fop used

Cause of increase

  • Improve education, workers more skilled, produce higher output per hour
  • Adv tech
  • Better working condition – content workers be productive
  • High wages – motivate workers
  • Derived demand – demand of fop depends on demand of goods, increase demand increase workers employed
  • Production method – if production is labour intensive, increase demand
Adv Dis
  • Labour cheap coz increase supply decrease wages
  • Employees can be creative and use their own initiative
  • Labour is usually readily available
  • No need expensive equipment
  • Expensive & takes time to recruit, select & train employees
  • Employees require specalised skills which can take time to learn
  • Quality of work can vary depending

Capital-intensive production: an industry which has a high proportion of capital compared with proportion of other fop used

Adv Dis
  • Advances in technology
  • Increased productivity
  • Greater output
  • Improved quality
  • Lower cost per unit
  • Cost of equipment
  • Cost of making workers redundant
  • Increased training costs
  • More skilled workers required
  • May be reduced morale

What to choose?

Factors – size of market, firm’s objective, cost of labour vs capital

Production: total output per period of time

Productivity: output produced per factor eg per worker, per period of time

3.7  Firms’ costs, revenue and objectives

Cost of production: payments made by firms in production process

Types Graph Definition/formula
Fixed cost (FC)
  • Cost that firm pay no matter how much it sell
  • Eg salaries
Variable cost (VC)
  • cop charges when output level changes
  • Eg Wages
Total cost (TC)
Average fixed cost (AFC)
Average variable cost (AVC)
Average total cost (ATC)

Revenue: income earned by business

Types Formula
Total revenue (TR) Price × quantity
Average revenue (AR)

Objectives of firms

  1. Profit maximisation
  • Seek earning as much profit as possible
  • Profit = TR-TC
  • Profit maximisation is greatest difference between TR & TC
  • Profit used for reinvestment or pay high individuals
  •   2.Sales maximisation -↑market share
  •   3.Growth maximisation – ↑revenue & market share
  •   4.Social/environmental concern – better treatment to workers, better public perceive

3.8  Market structure

Perfect Competitive markets

Characteristics

  1. Many firms
  2. Price takers – set price according to market price
  3. Sell homogeneous products (same goods)
  4. Produce differentiated products (eg different brands)
  5. High level of competition
  6. Many buyers & sellers
  7. Free entry & exit
  8. Perfect information

Monopoly markets

Characteristics

  1. Single supplier – increase price
  2. Price maker – increase price
  3. Imperfect knowledge – to protect trade secret
  4. High barriers to entry – limit competition
Adv Dis
  1. Take adv from econ of scale, lower average cop eg bulk-buying, decrease price
  2. Have financial resources from profits to innovate – increase quality
  3. Eliminate wasteful competition eg wraps
  4. Compete internationally, reduce price
  5. High barriers to entry & exit – protect any profits it makes, encourage to produce high quality products
  1. Inefficient allocation of resources, increase price, reduce supply due to dis econ of scale eg communication problems, increase cop and price, reduce quality
  2. Lack of competition , inelastic demand increase price, price maker reduce supply, less innovation, reduce quality and choice
  3. Imperfect knowledge – irrational consumer choice

Exam questions