Externalities – costs or benefits that affect third parties (e.g., pollution, vaccination).
Public goods – non‑rival and non‑excludable (e.g., street lighting).
Information asymmetry – one party has more/better information (e.g., used‑car market).
Government tools:
Taxes & subsidies (internalise externalities).
Regulation & standards (e.g., emission limits).
Provision of public goods.
2.4 Economic Systems
System
Key Features
Typical Advantages
Typical Disadvantages
Market economy
Resources allocated by price mechanism; private ownership.
Efficient allocation, innovation.
Potential inequality, market failures.
Mixed economy
Market forces plus government intervention.
Combines efficiency with equity.
Risk of over‑regulation, fiscal burden.
Command economy
Central planning, state ownership.
Can achieve rapid mobilisation of resources.
Often inefficient, lack of incentives.
3. Micro‑economic Decision‑Makers
3.1 Households
Primary consumers of goods & services.
Determinants of consumption:
Income (current & future expectations).
Prices of goods and substitutes.
Tastes & preferences (culture, advertising).
Expectations of future price changes.
Age – younger households tend to spend more on durable goods, older households on health care.
3.2 Money & Banking
Functions of Money – medium of exchange, unit of account, store of value, standard of deferred payment.
Central Bank – issues currency, sets policy interest rates, controls money supply.
Commercial Banks – accept deposits, provide loans, create money through fractional‑reserve banking.
Interest rates influence:
Household saving & borrowing decisions.
Business investment (link to productivity – see Section 4).
3.3 Workers (Labour Market)
Labour is a factor of production; demand for labour is derived demand – it depends on the demand for the product the labour helps to produce.
Wage determination influenced by:
Productivity of workers.
Supply of labour (population, skill levels).
Minimum wage legislation, trade unions.
Higher productivity → higher wages (ceteris paribus) and lower unit labour cost.
4. Firms and Production – Production vs. Productivity
4.1 What is Production?
Production is the total quantity of goods or services that a firm creates in a given period. It is measured in physical units (e.g., tonnes of wheat, number of shirts, megawatt‑hours of electricity). Production is a total‑quantity concept – it tells us how much has been produced, not how efficiently it was produced.
4.2 What is Productivity?
Productivity measures the efficiency with which inputs are turned into output. It is a rate concept – it tells us how much output per unit of input. Higher productivity means the same amount of input yields more output, or the same output can be produced with fewer inputs.
4.3 Production Function & Key Curves
Figure 2: Production function – TP curve with AP and MP. The MP curve cuts the AP curve at the point where AP is highest (law of diminishing marginal returns).
4.4 Key Formulas (Syllabus‑required)
Total Product (TP) – total output produced from a given amount of input.
Average Product (AP) – output per unit of a particular input.
$$AP = \frac{TP}{\text{Quantity of Input}}$$
Marginal Product (MP) – additional output generated by one more unit of input.
$$MP = \frac{\Delta TP}{\Delta \text{Input}}$$
Labour Productivity – output per worker or per hour of labour.
$$\text{Labour Productivity} = \frac{TP}{\text{Labour Hours}}$$
Capital Productivity – output per unit of capital equipment.
$$\text{Capital Productivity} = \frac{TP}{\text{Capital Stock}}$$
4.5 Labour‑Intensive vs. Capital‑Intensive Production
Requires investment in new machinery to expand output
Productivity Influences
Training, work organisation, motivation
Technology, automation, maintenance
4.6 Influences on Production & Productivity
Investment in capital – new machines or better technology raise capital productivity.
Training and skill development – improves labour productivity.
Management techniques – division of labour, workflow redesign, lean production.
Scale of operation – economies of scale lower average cost; diseconomies raise it.
External factors – input price changes, government regulation, raw‑material availability.
4.7 Effects of Investment on Productivity (Illustrative Example)
When a firm purchases a modern machine, the same amount of labour can produce more output. This raises capital productivity and usually also labour productivity because workers can work faster or more safely.
4.8 Economies & Diseconomies of Scale (Brief)
Economies of scale – as output expands, average cost falls because fixed costs are spread over more units.
Diseconomies of scale – if a firm becomes too large, coordination problems raise average cost.
4.9 Comparison of Production and Productivity
Aspect
Production
Productivity
Definition
Total quantity of output produced.
Output per unit of input (measure of efficiency).
Measurement
Physical units (units, tonnes, litres, etc.).
Ratio (e.g., units per worker, units per hour).
Focus
Scale of operation.
Effectiveness of resource use.
Implication for Costs
Higher production usually raises total cost.
Higher productivity lowers average cost, raising profitability.
Typical Indicator
Total Product (TP).
Average Product (AP) or Marginal Product (MP).
4.10 Why the Distinction Matters for Firms
Decision‑making: Managers must choose between expanding output (increase production) and improving processes (raise productivity).
Cost control: Higher productivity reduces average costs, enhancing competitiveness.
Growth strategies: Sustainable growth relies on both larger output volumes and continuous productivity gains.
Performance evaluation: Productivity provides a clearer picture of managerial efficiency than raw production figures.
5. Government & the Macro‑economy (Links to Production)
5.1 Aggregate Demand & Supply (simplified)
Aggregate Demand (AD) – total spending on a country’s output (C + I + G + (X‑M)).
Aggregate Supply (AS) – total output firms are willing to produce at each price level.
Shifts in AD (e.g., fiscal stimulus) can raise short‑run production; shifts in AS (e.g., improved productivity) raise long‑run potential output.
5.2 Fiscal Policy
Government spending ↑ or tax cuts → increase AD → may boost short‑run production.
Higher taxes or reduced spending → opposite effect.
Long‑run impact depends on whether the spending improves productivity (e.g., infrastructure investment).
5.3 Monetary Policy
Central bank lowers interest rates → cheaper borrowing → encourages investment in capital → raises productivity and potential output.
Since |PED| > 1, demand is elastic – total revenue falls when price falls.
Practice Question (AO2/AO3)
Explain how a rise in the minimum wage could affect (a) the productivity of low‑skill workers and (b) the overall cost structure of a labour‑intensive firm. Include at least two economic concepts in your answer.
9. Key Take‑aways
Production = total output; productivity = output per unit of input.
Higher production does not automatically mean higher productivity.
Improving productivity lowers average costs, raises profitability and supports long‑run economic growth.
Derived demand links product markets to factor markets; wages and input prices respond to changes in productivity.
Government policies (fiscal, monetary, regulatory) and global trade can influence both production levels and productivity growth.
For exam success, be able to:
Define key terms and write the relevant formulas.
Interpret the TP, AP and MP curves.
Analyse how changes in investment, technology or policy affect productivity and costs.
Apply concepts to real‑world examples (e.g., automation in manufacturing, minimum‑wage debates).
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