Theme 2 - The Wider Economic Environment Flashcards
What are the 2 types of economies of scale?
Internal and External economies of scale
Define both types of economies of scale
Internal - Occurs when a firm grows and average cost of production decreases
External - Occurs within the industry
What are all the economies of scale
- Risk-Bearing
- Managerial
- Financial
- Technological
- Marketing
- Purchasing
Define financial economies of scale
When a firm grows, it is seen as less risk to banks so can acquire loans easier and at lower interest
Describe purchasing economies of scale
As output increases, firms can bulk-buy raw materials so cost per unit decreases
Give one way diseconomies of scale can occur
As a firm grows, employees may feel devalued and therefore demotivated to work productively
How do large firms have control over markets
They can set prices and discourage new firms from entering the market
When does a firm have a competitive advantage?
When its goods/services are deemed better quality than its competitors by customers
Why would firms ensure their employees are well looked after?
To boost employees’ motivation, which in turn increases productivity and output
What is inorganic growth?
This is when a business expands by merging and acquiring other firms.
What is organic growth?
This is when a business grows by increasing output, expanding their customer base and developing new products.
What are the disadvantages of organic growth compared to inorganic growth?
It takes time to grow this way, and in this time other firms may gain a competitive advantage over the market, which may become a problem for shareholders.
Define vertical integration
This occurs when a firm merges with or acquires another firm in the same industry but different step in the supply chain.
Which vertical integration is closer to the producer: forwards or backwards?
Backwards vertical integration
Define horizontal integration
Occurs when a firm marges with or acquires another firm in the same industry and same stage of production.
How is horizontal integration beneficial for firms?
It gives them a competitive edge over the market as their market share increases, leading to increased output
What is conglomerate integration?
The joining of two firms with no common connection (i.e. two different industries)
Recall the definition of R&D
Research & Development is investment in research with the intention of improving goods, introducing new ones and improving methods of production
How can R&D increase market power?
It differentiates products from their competitors, making them more unique and thus helps increase brand loyalty
Why does the state often provide funding for R&D?
The positive externalities of R&D are not always fully understood, so the state intervenes to ensure more investment in R&D
Draw a graph showing the product life cycle and describe each stage
R&D, Introduction, Growth, Maturity, Decline
How have price comparison sites been beneficial to consumers?
They have helped reduce information gaps by increasing the quantity of knowledge consumers have about a good or service
What is viral marketing?
A form of marketing whereby the good/service is promoted on social media, where it can be shared with friends
What is micro-marketing?
This is where advertising is focused on a small group of consumers, rather than the market as a whole
What is the long tail theory?
The long tail theory suggests consumers get a wider choice when it comes to online retailing
Give two ways online stores have an advantage over their brick-and-mortar counterparts
- Online businesses are not restricted to physical space, so can target customers worldwide
- Online stores have lower costs, so can charge lower prices and therefore gain a larger portion of the market share
What does the acronym USP stand for?
Unique Selling Point
Why can most small firms NOT benefit from economies of scale?
Since they are small firms, they do not produce enough output to lower their average costs.
How could small firms act as monopolists?
They can create a local, more personal service and a niche market.
Draw and locate the ‘economies of scale’ and ‘diseconomies of
scale’ on the economies of scale graph
Graph should look like a U shape with economies of scale as the first half and diseconomies of scale as the second half
Define and give the formula for Price Elasticity of Demand
PED is the responsiveness of quantity demanded given a change in price
PED= Δ%QD / Δ%P
Does a PED graph with a slight downward slanting line to the right represent a PED elastic or inelastic good?
PED elastic good
What does PED = 1 represent?
A unitary elastic good, whereby the change in price is equal to the change in quantity demanded
Draw the graph for a perfectly inelastic good
Should be a straight vertical line
If price increased by 22% and quantity demanded decreased by 30%, is the good PED elastic or inelastic?
-30 / 22 = -1.36
Therefore a PED elastic good
Name the 6 factors influencing elasticity of demand
- Necessity
- Substitutes
- Habitual consumption
- Proportion of income spent
- Durability
- Peak/off-peak demand
How does the number of substitutes affect the elasticity of demand for the good?
The more substitutes there are, the more PED elastic the good is
Would peak demand for a good make it PED elastic or inelastic?
PED inelastic
If good ‘A’ is PED elastic and the price of the good increases, what happens to revenue?
The fall in quantity demanded is proportionally larger than the increase in price, so overall revenue falls
Describe the concept of price skimming
A short-term pricing strategy that usually occurs when a new product is released, whereby a high price is set before new firms enter the market and increase competition
How does predatory pricing differ from price penetration?
Predatory pricing aims to push incumbents out of the market, whereas price penetration aims to boost customer loyalty
List the 3 factors that determine the most appropriate pricing strategy
- Number of USPs
- Price elasticity of demand
- Stage in the product life cycle
If good ‘A’ has a high PED, will firms give it a high or low price, and why?
A low price because the good is dependent on price so if the good was expensive, firms’ profit margins would be at risk
Give the formula for income elasticity of demand
YED = Δ%QD / Δ%Y
Define inferior goods and give their YED value
Goods that experience an increase in demand as income falls.
YED less than 0
Name the type of good with a YED greater than 1
Normal luxury goods
During an economic recession, what type of goods are firms more likely to produce, and why?
Inferior goods, because recessions usually accompany a reduction in income, so inferior goods will experience an increase in demand
Define productivity
The output per unit of input per unit of time
What are the implications of higher productivity for firms and the overall economy?
Lower average costs of production → lower prices → increase in demand → lower unemployment → higher GDP growth
How can a firm’s credit history determine how productive it can be?
Good credit scores increase the loans given to firms, which they can invest in R&D and become more productive through technological advancements
What is capital-intensive production?
This occurs when firms have access to cheap credit, whereby capital is cheaper to purchase than labour
Give the formula for capacity utilisation
(Actual level of output / Maximum possible output) x 100
Why would a firm possibly be operating under maximum capacity?
A reduction in demand from consumers means there is no need to be producing extra units of output
How could operating at full capacity affect the quality of goods produced?
Operating at full capacity implies a rushed process where employees are demotivated, thereby diminishing the quality of goods
Give one benefit of under-utilised capacity
Firms have the flexibility to change its level of output according to changes in the economic cycle (e.g. an economic boom means firms are able to produce extra units of output without exhausting its capital)
If a firm entered a new market, how would it affect its capacity utilisation?
It would improve capacity utilisation, as more labour and capital is required to produce the extra output now that the firm has entered a new market
What is lean production?
The process of minimising waste during the different stages of production
Describe the difference between quality control and quality assurance
Quality control ensures the products meet the minimum standards, whereas quality assurance encourages collaboration between design, production and marketing
How can small, continuous improvements (kaizen) reduce average costs of production?
Constantly making small ‘tweaks’ in a firm reduces the need for major capital investments
Describe JIT management of stock
Just In Time ensures stock arrives as and when it is needed, based on consumer demand, thereby reducing costs of storage
Give two disadvantages of JIT
- The firm is dependent on the supplier for stock in a short timeframe
- The firm won’t be able to handle huge, unexpected surges in consumer demand
What is lead time?
The time between a decision being made and then carried out
Describe globalisation
The integration of the world’s economies in a single market, whereby tariffs and quotas are eliminated
How has transport contributed to an increase in globalisation?
It’s now easier and more efficient to transport goods to and from different countries, thereby encouraging more trade
Name the international institution that regulates global trade
World Trade Organisation (WTO)
What are MNCs?
Multinational Corporations - corporations that manage the production of goods/services in multiple countries
Describe containerisation
The distribution of goods in standard sized containers
Name the two countries that have arguably grown the most due to globalisation
India and China
What is GDP per capita
The GDP of an economy divided by its population (capita)
Give 2 limitations of using GDP to measure the health of an economy
- Does not give any indication to the distribution of income and wealth
- Cannot track the performance of the hidden markets
List the 3 components of the HDI index
- Education
- Life expectancy
- Standard of living
How does population growth in developed countries compare to that in developing countries
Much slower population growth in developed economies
Which type of economy usually has a stronger agricultural sector?
Developing economies
Which countries form the BRICS economies?
Brazil
Russia
India
China
South Africa
How would you find the ‘median’ income of an economy?
This is the middle value of all incomes
What is specialisation?
Occurs when each worker completes a specific task in the production process, which can increase productivity and therefore reduce average costs of production
Describe the disadvantages of specialisation
- Employee motivation is compromised as a result
- Structural unemployment, due to a mismatch between skills required and provided
Define comparative advantage
Occurs when one country can produce a good/service at a lower opportunity cost than a different country
Define absolute advantage
This is when one country can produce more units of a good/service than a different country with the same factor inputs
What are free trade areas?
Comprise of different countries that agree to trade with each other with no protectionist barriers
How do customs unions differ from free trade areas?
A customs union comprises of a free trade area and a common external tariff, meaning it has a common trade policy with countries outside the customs union
What 2 features are added to a customs union to make it a common market?
The free movement of labour and capital
Give an example of a monetary union
The Eurozone
List the 4 requirements in order to become a member of the Eurozone
- Budget deficits must not exceed 3% of GDP
- Gross National Debt has to be below 6% of GDP
- Inflation has to be below 1.5% of the three lowest
inflation countries - The average government bond yield has to be below
2% of the yield of the countries with the lowest interest rates
How can firms benefit from economies of scale when in a trading bloc?
By entering a trading bloc, firms now have access to a broader market, which increases their output which they can benefit from lower average costs
How would costs between borders be reduced by entering a trade bloc?
By eliminating protectionists measures such as tariffs, there is no need for firms to pay high taxes, which could results in lower prices
Which is an outflow of money: imports or exports?
Imports
What are exports?
Goods and services that are sold to foreign countries and are positive on the balance of payments scale
Do the UK specialise in goods (visibles) or services (invisibles)?
Services (invisibles)
How do cheap imports affect unemployment in the domestic economy?
Cheap imports harm domestic firms as they lose their competitive advantage, therefore they produce less units of output, meaning they require less workers, hence the
unemployment rate increases
How do cheap imports affect the domestic inflation rate?
Cheap imports promote competition, so firms find ways to reduce costs and lower prices, which lowers the overall rate of inflation
When does exchange rate depreciation occur?
When the value of one currency falls relative to another currency in a floating exchange rate system
How is the exchange rate determined in a floating system?
Determined by the forces of Supply and Demand
How is the exchange rate determined in a fixed system?
Determined by what the government wants to value the currency at
Draw a graph showing what happens to the exchange rate when demand for one currency increases in a floating system
Should be a normal supply and demand graph with a shift to the right from D1 to D2
How would a depreciation of the pound (£) help domestic firms?
It makes exports cheaper, which boosts demand for them and therefore helps UK firms grow
How would a depreciation of the pound (£) damage domestic firms?
If UK firms import raw materials from other countries, a depreciation increases the cost of these materials, which would be passed onto consumers in the form of higher prices
What is the effective exchange rate?
Shows the strength of one currency compared to a basket of others, whereby the weight of different currencies is determined by how much trade occurs between the two countries
What is the economic cycle?
Refers to stages of economic prosperity and decline
Which stages of the economic cycle are inflationary?
Booms and recoveries
Which stages of the economic cycle are accompanied by government spending?
Recessions and Slumps
What stage of the economic cycle would tax revenue be the highest, and why?
Booms
Aggregate demand is high, firms produce more units of output so pay more corporation tax, and consumers earn higher wages so pay more income tax
When do consumers and firms have the lowest levels of confidence?
During economic slumps
Name the 3 injections and 3 withdrawals to the circular flow of income
Injections: exports, investment, government spending
Withdrawals: imports, savings, taxes
When does the economy reach a state of equilibrium?
When the rate of withdrawals = the rate of injections
What is the equation for income?
Income = Output = Expenditure
List the components of aggregate demand
Consumer Spending
Investment
Government Spending
Exports - Imports
Which is the largest component of aggregate demand?
Consumer spending
Define disposable income
Income left over for consumers to spend once taxes have been deducted
How do low interest rates encourage more consumer spending?
Low interest rates make it cheaper to borrow money and discourage saving.
They also lower the cost of variable rate mortgages, increasing disposable income
What are the only two things consumers can do with income?
Save it or spend it
How do business confidence and capital investment correlate?
As confidence increases, so does capital investment
Is fiscal policy demand-side or supply-side?
Demand-side
However you can have fiscal supply-side policies
When would the government initiate contractionary fiscal policy?
During economic booms, in order to ease inflationary pressures and prevent any periods of economic instability
How would the exchange rate affect the current account deficit?
A depreciation of the pound (£) makes imports expensive and exports cheap, thus narrowing the deficit and boosting economic growth
How could the government intervene to reduce the current account deficit?
By adopting protectionist measures, whereby tariffs against imports increase and British firms are subsidised to improve their competitiveness
List 4 factors affecting aggregate supply
- Cost of employment
- Cost of raw materials
- Government regulation
- Migration
Which way would the SRAS curve shift given an increase in taxes?
Shift to the left (i.e. a decrease in supply)
Which way would the SRAS curve shift given a decrease in the cost of raw materials?
Shift to the right (i.e. an increase in supply)
Define inflation
A persistent increase in the general price level of goods/services over a period of time
How does deflation differ from disinflation?
Deflation is a fall in the general price level, whereas disinflation is a fall in the rate of inflation
What is the target inflation rate in the UK?
2% (+/- 1%)
Briefly describe the Consumer Price Index
A survey is used to find a weighted basket of goods. The prices of these goods are measured and updated annually
How does the Retail Price Index differ from the CPI?
The RPI includes housing costs, and therefore generally has a higher value than the CPI
Describe the difference between nominal values and real values
Real values take into account the rate of inflation
What type of inflation is caused by exchange rate depreciation?
Demand-pull inflation
When does cost push inflation occur?
During a inward shift of aggregate supply, whereby firms face higher costs
What type of inflation occurs when workers demand higher wages?
Cost-push inflation
How does inflation benefit those in debt?
The value of debt erodes over time with inflation, so consumers don’t have to pay back as much
How would inflation be a burden on firms?
Workers would see their real income erode when accounting for inflation, therefore they would demand higher wages which increases costs for firms
How does someone unemployed differ from someone economically inactive?
Unemployed are those who are able to work and actively seeking a job, whereas those economically inactive choose to remain out of a job
How does the Claimant Count work?
This counts the number of people claiming unemployment-related benefits
What is the main disadvantage of using the Claimant Count?
Many of those unemployed don’t claim benefits, as they have partners on high salaries
What 2 things does the Labour Force Survey ask?
- If the subject has been out of work for 4 weeks
- Whether or not the subject can start work within 2 weeks
Briefly describe structural unemployment
Occurs when there is a mismatch between skills provided and skills required
When does cyclical unemployment occur?
When there is a lack of demand in an industry or the economy
What are the 4 main macroeconomic objectives
- Economic growth
- Low unemployment
- Low inflation
- Balance of payments equilibrium
What rate of unemployment does the government aim for?
3%
What is a budget deficit?
This occurs when expenditures exceed tax revenues
Describe the difference between government debt and the budget deficit
Government debt is an accumulation of budget deficits
What is discretionary fiscal policy?
This is when the government increases their spending and manipulates taxes in order to influence aggregate demand
What do governments spend the most money on?
Pensions and welfare payments
What is the biggest source of tax revenue?
Income tax
What type of fiscal policies does the government implement when inflation is high
Deflationary fiscal policies
Give 2 features of expansionary fiscal policy
Increase in expenditures and reduction in taxes
Describe crowding out
Occurs when an increase in government spending reduces the resources available for the private sector to use
Will fiscal policies have an immediate impact on the economy?
No, there is a time lag
What 3 things does monetary policy involve?
- Interest rates
- Money supply
- Exchange rates
How often do the MPC meet?
8 times a year
What is the base rate?
The interest rate set by a central bank to loan money to commercial banks
Do low interest rates encourage saving or borrowing
Low interest rates encourage borrowing
What is the positive wealth effect?
This occurs when people spend more because they feel richer
Briefly describe how quantitative easing works
The central bank digitally creates new money, which it then uses to buy corporate and bank bonds, so that banks are more willing to loan money to consumers to stimulate more demand in the economy
Why might changing the base rate have no effect on the economy?
Banks may not choose to pass this base rate onto consumers in the form of higher interest rates
What is the aim of supply side policies?
To improve the long-run productive potential of the economy
How are training and education beneficial to firms?
They improve the productivity of the workforce
Give 1 benefit of privatisation
Firms now have a profit-motive, and so will find ways to cut costs and improve productivity, which in turn increases output
Are supply side policies better at reducing structural or cyclical unemployment?
Structural unemployment
How will an increase in interest rates affect exchange rates?
It attracts more hot money, thus appreciating the currency against one with a lower interest rate
What is the Marshall-Lerner condition?
This states that a devaluation in a currency only leads to an improvement in the balance of payments if the sum of export and import elasticities is equal to or greater than 1
What is likely to happen to aggregate demand given an exchange rate appreciation?
Exports become expensive, so AD is most likely to fall
What does the Phillips curve show?
The inverse relationship between inflation rates and the rate of unemployment
Explain why inflation rises as unemployment falls
As the economy grows, workers have more bargaining power as firms need more of them, so workers demand higher wages which increases the prices of goods and thus the overall inflation rate
What is a positive output gap?
Occurs when the actual level of output exceeds the potential level of output
Why does economic growth lead to a current account deficit?
British consumers have a high propensity to import, which eventually exceeds the level of exports during times of economic prosperity
What is a command economy?
This is when the government allocates all the scarce resources in an economy
What is a mixed economy?
Combines the features of both a command economy and free market economy
