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Faculty : Commerce and Administration Department : Economics Module : Microeconomics Module Code : ECN 111 Module Author : Gershon Sibinda Date of Publication : 12 January 2005

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Economics 1 ECN 111

Contents

MODULE 1 – Microeconomics Page

1. Introduction to Economics 6

2. Economic resources 16

3. The role of the market 23

4. Shifts in demand and supply curves 35

5. Elasticity 44

6. Output supply by firms 54

7. Market structures 61

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1. Study Guide Title: Microeconomics

2. Module structure: Qualification B. Com

Credits 12 credits

NQF Level 6

Type Core/fundamental/elective

Duration 10 weeks

Semester One

3. Module outcomes On completion of this module, you should be able to

• Explain the nature, scope and methodology of economics

• Describe the principles of microeconomics

• Define and explain different forms of economic systems.

• Explain and differentiate among different market structures

4. Module Introduction/Overview/Purpose Welcome to the first module of Economics 1. Studying Economics is not difficult;

however it requires a great deal of time and commitment from you and quite a lot

of patience and creativity from your lecturer. These notes are not meant to

replace the prescribed text book but to guide you through it. Economics cannot

be studied from notes only. The subject is too dynamic for this.

5. Prior Learning/ Learning in Place Basic numerical skills will be required as the study of this module entails some

calculations and graphical illustration. A background in matriculation mathematics

and, or basic statistics should be enough.

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6. Module Content Unit 1 Introduction to Economics

Unit 2 Economic Resources

Unit 3 The role of the market

Unit 4 Shifts in demand and supply

Unit 5 Elasticity

Unit 6 Output supply by firms

Unit 7 Market Structures

7. Module Assessment 7.1 The structure of the assessment is as follows:

• Two written tutorial work - 10% per written work (Total = 20%)

• One group assignment - 40 %

• One Test – 40%

• Examination

7.2 Assessment criteria In assessing submitted work, the following will carry more weight: originality,

knowledge, insight, application, analysis ability, comprehension, and

acknowledgement of your sources.

The examination at the end of this module is going to test whether you can meet

the set standard. What does this standard mean?

• Firstly, the questions will be based on the module. This means that the

questions will represent the whole module and that you must have

sufficient knowledge of everything that appears in it.

• Secondly, the questions will also be based on the learning outcomes set

in every study unit.

• Thirdly, your general knowledge regarding the economy is tested. This is

why it is so important that you read more than just the course material and

talk to people about economics.

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8. Moderation Two internal examiners and one moderator will be appointed for this module by

the Department of Economics. Once the internal examiners have assessed the

examinations, the moderator will undertake a similar exercise to finalise the

results

9. Prescribed Text book

• Mohr,P., Fourie, L & Associates (2004), Economics for South African

Students, Third Edition, Van Schaik. Pretoria

9.1 Recommended Readings. • Begg D, Fischer S & Dornbusch R (1997), Economics, McGraw-Hill,

London

• Smit et al (1996), Economics. A Southern African Perspective, Juta,

Kenwyn.

• Sloman, J. (1991) Economics. Prentice Hall. London

• Local news papers business portions (Sunday Times, City Press,

Sowetan, Mail & Guardian, and The Star.

• Financial Magazines – Financial Times, The Economist (Available in the

journal section of the library, enquire with librarian). Also listen to daily

news on market updates!

• The following web addresses will be relevant for assignments and

references:

www.resbank.co.za;www.dti.gov.za;www.absa.co.za,

www.treasury.gov.za, www.jse.co.za , www.omam.co.za and

many more.

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UNIT ONE 1. Unit Title: The Nature and scope of Economics

2. LLeeaarrnniinngg oouuttccoommeess

OOnn ccoommpplleettiioonn ooff tthhiiss ssttuuddyy uunniitt,, yyoouu sshhoouulldd bbee aabbllee ttoo

•• DDeeffiinnee eeccoonnoommiiccss aass aa ssuubbjjeecctt

•• DDiissccuussss tthhee ffuunnddaammeennttaall eeccoonnoommiicc pprroobblleemm

•• DDiissttiinngguuiisshh bbeettwweeeenn mmiiccrrooeeccoonnoommiiccss aanndd mmaaccrrooeeccoonnoommiiccss

•• DDiissttiinngguuiisshh bbeettwweeeenn ppoossiittiivvee aanndd nnoorrmmaattiivvee ssttaatteemmeennttss

•• EExxppllaaiinn tthhee ttoooollss ooff eeccoonnoommiicc aannaallyyssiiss

3. Introduction/Overview Most of you have probably wondered how the prices of the products in your local

store are determined. You have probably also wondered why you have to pay tax

and have also asked why our television sets are imported from Japan if we can

produce them ourselves in South Africa or your resident country. After studying

Economics you will be able to answer these questions. At this stage it should be

obvious that economics is about our daily activities. Your study of economics will

enable you to understand the financial reports in the newspapers.

This course follows a more formal and scientific approach to economics. The

nature and scope of economics are studied with special reference to economics

as a social science. We will also deal with the economic problems and the ways

in which solutions can be found for them.

3.1 Key Concepts Economics

Scarcity Needs

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Microeconomics Wants

Macroeconomics Allocation process

Positive statements Production process

Time series data Normative statements

Cross section data Distribution process

4. Learning in place As this is an introductory phase of your study of economics, basic numeric skills

are a prerequisite for this unit. A good grasp of definitions will also be required as

a lot of terminology is introduced.

5. Unit Content

5.1 Economics as a science The scientific fields of study are divided into two categories:

Natural sciences, such as, chemistry, physics, astronomy and zoology. These

involve the study of natural phenomena which we can observe and from which

we can draw conclusions. In the natural sciences we work with set law which

always hold. For example, it is possible mathematically determine the speed of a

car on a particular day.

Human sciences, such as theology, psychology, sociology and economics. In

these fields man is the central concept. In the human sciences, no set of laws

can be laid down for all people, because all individuals determine their own

behaviour. Economics can suggest the most effective behaviour but people

cannot be forced to follow the advice of economists.

Economics is that part of the human sciences which studies human actions (in other words a social science).

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Economics can be defined, as a human science which studies the principle,

which governs the effective utilisation of, limited means with numerous

alternative applications to satisfy multiple needs.

In economics the scientific investigation of human behaviour starts with the

problem of scarcity and the related choices. All other problems arise from the

problem of scarcity. Economics, therefore deals with the way in which man has to

satisfy his unlimited needs with limited resources.

5.2 Basic Economic ProblemThe economic problem is therefore the constant increase of man’s needs on

the one hand and on the other hand the limited means at man’s disposal. The

natural resources such as oil, agricultural land and fish are not available in

unlimited quantities. Another limitation is the ability to exploit the available natural

resources. For example, there might be natural resources in the desert, which

cannot be exploited because the terrain is inaccessible for vehicles, and

machines, which are required to exploit the resources.

Additional economic problems arise when decisions must be made on the

production of goods and services.

The following questions arise:

• How must the goods and services be produced?

Resources are scarce and there are various methods of production and therefore

it must be decided how and by whom production will take place. It must be

decided in which quantities means of production will be used and who will use

them. The furniture manufacturer, for example, periodically requires a certain

amount of wood to manufacture the number of furniture items, which keep him in

the market.

• Which and how many goods and services are produced?

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Scarce resources must be used in such a way that different needs can be

satisfied. The demand , or need, for the product must be taken into account as

must the resources which are available.

• How is the production of goods and services distributed among

members of the community?

The members of the community who make the biggest contribution to production

receive better benefits or income. They can therefore retain more of the goods

and services.

• Are the community resources fully utilised?

In the market economy we often find that not all resources are fully employed in

the production process. Prices are determined by supply and demand. In this

way a situation develops in the economy where not all available labour or capital

resources are employed. Fewer goods are produced and the prosperity of the

community decreases.

• Does the production capacity of the community always remain

the same or does it increase?

Scarce resources of the community are employed to produce the largest possible

quantity of goods and services. This production of goods and services is the

measure of the welfare of the community. Production can increase or decrease

over a period of time.

The problems discussed above can be summarised as three issues confronting

the economy, namely:

• The allocation process

• The production process

• The distribution process

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Alternatively, we could say economics deals with the choices that people have to

make, e.g. What to produce, How to produce, for Whom to produce.

Therefore, economics is concerned with the ordinary business of life. Economics

also studies the decisions of firms, government and other decision makers in the

society. For example, firms’ decisions to produce, government spending on

goods and services, government decision to increase taxation etc.

5.3 A distinction between Microeconomics and MacroeconomicsThe study of economics is usually divided into two parts viz.: Microeconomics

and Macroeconomics. In microeconomics the focus is on individual parts of the economy. “Micro” means small. In microeconomics the decisions or functioning of decision

makers such as individual consumers, households, firms, or other

organisations, are considered in isolation from the rest of the economy.

The individual elements of the economy are examined in detail. For example,

the study of the decisions of individual households, (what to do, what to buy etc.)

and of individual firms, (what goods to produce, how to produce them, what

prices to charge etc.).

Microeconomics also includes the study of the demand, supply and prices of

individual goods and services like petrol, jeans, houses etc.

Macroeconomics is concerned with the economy as a whole. “Macro” means

large. In macroeconomics we focus on the “big picture” of the economy. That is,

total or aggregate economic behaviour is studied.

For example, in macroeconomics we study, total production, total income and

spending, economic growth, aggregate unemployment, the general price level

and the balance of payments.

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Some examples:

Microeconomics VS Macroeconomics

• Price of a single product

• Production of jeans

• Market for individual goods

• A firms decision to export its

product

• Decisions of individual

consumers

• Overall prices of goods and

services (CPI)

• Total output of goods and

services

• The market for all goods and

services

• Total exports of all goods and

services to foreigners

• Combined decisions of all

consumers in the country

5.4 Positive and Normative Economics A positive statement is an objective statement or fact.

A normative statement involves an opinion or value judgement.

Examples of positive statements:

• The inflation rate in Zimbabwe is at 500%

• UNW and Potch University have merged to form Northwest University.

• The Governor of the South African Reserve Bank is Mr Tito Mboweni.

• The Tsunami devastated the Asian countries.

• As from 01 January 2002 the Euro is the official currency of the European

Union countries.

Examples of Normative statements:

• Government is not doing enough about poverty.

• Road accidents are caused by speeding drivers.

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• Economic policy should be aimed at reducing unemployment.

• President Mbeki is a very sweet fellow.

• South Africans are hospitable.

• Poverty is the direct result of the apartheid system.

Positive statements can be proved or disproved by comparing them with facts. Normative statements/issues can be debated but they can never be settled by

science or by an appeal to facts.

Therefore economics cannot be a value free science. Human behaviour can

never be analysed totally objectively and policy always involves judgement.

5.5 Economic Data Data (facts) interacts with models in two ways: -

i. Data help us quantify the relationship to which our theoretical models

draw attention.

ii. Data help us to test our models since economists must check their

theories against the relevant facts.

Economic data can be reorganised or presented in two ways in order to solve a

problem viz: -

Time series and Cross section. A Time series is a sequence of measurement of a variable at different points in time. It shows how a variable changes over time.

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Example,

Average price of bread in SA from 2002 to 2005 (in SA cents)

2002 2003 2004 2005 Brown bread 340 380 400 450 White bread 350 390 410 460 Whereas time series data record the way a variable changes over time, cross

section data record at a point in time the way an economic variable differs across different individuals or groups of individuals e.g.

Average price of bread amongst countries in 2005 (in SA cents) Brown bread White bread

SA 450 460 USA 730 750 UK 680 700 CANADA 732 755

6. Sources / References Study chapter 1 dealing with introduction to economics in your prescribed text

book.

Other relevant sources are the business times of local newspapers, and financial

magazines, this should help you get a feel of how economic issues are

addressed and how economic data is presented. The web sites listed above

should also be useful.

7. Learning Tasks/ Activities

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This is not to be formally submitted as an assignment; however you are welcome

to share your findings with me in class or office.

AACCTTIIVVIITTYY 11 IInn tthhee ttaabbllee bbeellooww,, iinnddiiccaattee wwhhiicchh aarree mmaaccrrooeeccoonnoommiicc iissssuueess,, wwhhiicchh aarree

mmiiccrrooeeccoonnoommiicc iissssuueess,, aanndd wwhhiicchh iissssuueess ccoouulldd bbee eeiitthheerr,, ddeeppeennddiinngg oonn tthhee

ssiittuuaattiioonn,, ggiivvee rreeaassoonn ffoorr yyoouurr aannsswweerr.. DDeessccrriippttiioonn MMiiccrrooeeccoonnoommiiccss MMaaccrrooeeccoonnoommiiccss BBootthh RReeaassoonn

IInnffllaattiioonn

LLooww wwaaggeess iinn

cceerrttaaiinn sseerrvviiccee

iinndduussttrryy

TThhee rraattee ooff

eexxcchhaannggee

bbeettwweeeenn tthhee SSAA

RRaanndd aanndd UUSS$$

WWhhyy tthhee pprriiccee ooff

ccaabbbbaaggee

fflluuccttuuaatteess mmoorree

tthhaann tthhee pprriiccee ooff

ccaarrss..

TThhee SSAA ggrroowwtthh

rraattee ooff tthhiiss yyeeaarr

ccoommppaarreedd wwiitthh

llaasstt yyeeaarr..

WWhhyy tthheerree aarree

ffeewweerr ffiirrmm tthhaatt

mmaannuuffaaccttuurree

pprroodduuccttss bbyy

hhaanndd

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AACCTTIIVVIITTYY 22 TThhiinnkk ooff tthhee ppoossiittiivvee aanndd nnoorrmmaattiivvee ssttaatteemmeennttss ooff yyoouurr oowwnn aanndd ssuuppppllyy rreeaassoonn

ffoorr yyoouurr ssttaatteemmeenntt..

8. Assessment 8.1 Assessment criteria Unit one introduces basic concepts of economic theory, and since this is the

case, you will be assessed on your knowledge of the concepts, ability to

differentiate between concepts and classification of data as it is given to you. All

this will be written work either in tests, assignments or examination.

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UNIT TWO 1. Unit Title: Factors of production and Economic resources

2. Learning Outcomes OOnn ccoommpplleettiioonn ooff tthhiiss ssttuuddyy uunniitt,, yyoouu sshhoouulldd bbee aabbllee ttoo::

•• DDiissttiinngguuiisshh bbeettwweeeenn tthhee pprroodduuccttiioonn ffaaccttoorrss

•• EExxppllaaiinn tthhee rreemmuunneerraattiioonn ooff eevveerryy ffaaccttoorr ooff pprroodduuccttiioonn

•• DDeeffiinnee aanndd ddrraaww tthhee pprroodduuccttiioonn ppoossssiibbiilliittyy ccuurrvvee ((PPPPFF))

•• DDeeffiinnee ooppppoorrttuunniittyy ccoosstt

•• DDiiffffeerreennttiiaattee bbeettwweeeenn eeccoonnoommiicc ssyysstteemmss

3. Introduction Production refers to the creation of goods and services with which needs can be

satisfied. During production, utilities (economic goods) are created and

consumers are prepared to pay a price for these. Economic resources refer to all

the natural human and manufactured resources that go into the production of

goods and services.

3.1 Key concepts FFaaccttoorrss ooff pprroodduuccttiioonn CCaappiittaall

CCaappiittaall ggooooddss LLaabboouurr

LLaanndd CCoonnssuummeerr ggooooddss

FFaaccttoorr iinnccoommeess EEnnttrreepprreenneeuurrsshhiipp

PPPPFF Market system

SSoocciiaalliisstt ssyysstteemm SSccaarrcciittyy

CCoommmmuunniisstt ssyysstteemm llaaww ooff iinnccrreeaassiinngg ccoossttss

LLaaww ooff ddiimmiinniisshhiinngg rreettuurrnnss cchhooiiccee

44.. LLeeaarrnniinngg iinn PPllaaccee

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UUnniitt oonnee iiss aa pprreerreeqquuiissiittee ffoorr lleeaarrnniinngg uunniitt ttwwoo ssiinnccee eeccoonnoommiicc ccoonncceeppttss aanndd

iilllluussttrraattiioonnss bbuuiilldd oonn oonnee aannootthheerr..

5. Unit content 5.1 Different kinds of Economic Resources.

• Land – this refers to all natural resources, which are used in the

production process. E.g., arable land, minerals, oil deposits and water.

• Capital - this refers to all manufactured aids to production. E.g.

machinery, equipment, storage transport etc.

• Labour – this refers to all physical and mental talents of people which are

usable in producing goods and services.

• Entrepreneurial ability – the entrepreneur takes the initiative in

combining the resources of land, capital and labour in the production of

goods and service. He does this with the hope of establishing a profitable

venture.

Capital goods differ from consumer goods in that consumer goods are used

directly to satisfy our wants, while capital goods facilitate the production of

consumable goods.

5.2 Remuneration of Economic Resources Resources are provided to business institutions in exchange for money income.

• Income received from supplying land is called rental.

• Income received form supplying capital is called interest or rental.

• Income received by those who supply labour is called wages (i.e.

salaries and various wage and salary supplements in the form of

bonuses, commission etc.)

• Income received by an entrepreneur is called profits

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Economic resources or factors of production have a fundamental characteristic in

common, viz. scarcity, i.e. they are scarce or limited in supply.

5.3 The Production Possibility Curve / Frontier The production possibility frontier shows for each level of the output of one good, the maximum amount of the other good that can be produced.

OR the frontier shows the maximum combinations of output that the economy

can produce using all available resources.

Example:

Consider an economy with four workers who can produce either food or guns.

The next table shows how much of each good can be produced. The answer

depends on how workers are allocated between the two industries.

Production possibilities

Food Guns Worker Output Worker Output

4 25 0 0

3 22 1 9

2 17 2 17

1 10 3 24

0 0 4 30

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The production possibility curve

The frontier displays a trade-off; more of one commodity implies less of the other.

Points above the frontier are unattainable with current resources. E.g. H. They

need more inputs than the economy has available.

Points inside the frontier show inefficient use of resources. E.g. point G. Opportunity cost of a good is the quantity of other goods which must be

sacrificed to obtain another unit of that good.

Output exhibits the following characteristics or laws:

• The law of increasing costs In terms of this law, the production cost per unit of output increases as the level

of output increases, all other things remaining the same (the ceteris paribus

assumption)

• The law of diminishing returns This can be defined as the increase that occurs in the marginal or additional

output when equal unit of a variable input, combined with fixed inputs, are added

consecutively the production process.

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Table 1: Increasing, constant and decreasing marginal returns (output)

Units of labour Total output

(bags of wheat)

Marginal output as a result of additional

units of labour while capital and land are

kept constant

0 0

1 5 5 – increasing marginal returns

2 11 6 – increasing marginal returns

3 18 7 – increasing marginal returns

4 25 7 – constant marginal returns

5 32 7 – constant marginal returns

6 38 6 – decreasing marginal returns

7 43 5 – decreasing marginal returns

8 47 4 – decreasing marginal returns

5.4 Introduction to Economic systems Economic systems are some of the mechanisms that are used to solve the

central economic questions e.g. what to produce, how to produce and for whom

to produce.

There are three forms of economic systems

i. Socialist system ii. Communist system iii. Capitalist system or Market system

A communist or command economy is a society where the government makes all the decisions about production and consumption.

A government planning office decides what will be produced, how it will be

produced and for whom it will be produced.

A socialist economic system is closely related to the command system. The only

difference is that in this case the level of government intervention is less

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intense e.g. government only controls scarce resources like electricity, water

etc. Government allows markets to take charge of demand and supply of some

goods and services.

Markets in which government does not intervene are called free markets.

Individuals in free markets pursue their own interests. The forces of demand and supply play a role in deciding what, how and for whom to produce.

6. Sources /Reference Study chapters 2 and 5, dealing with factors of production, production possibility

frontier and economic systems in your prescribed book.

7. Learning Task / Activity This is not to be formally submitted as an assignment; however you are welcome

to share your findings with me in class or office.

AACCTTIIVVIITTYY 11 AA ttyyppiiccaall pprroobblleemm tthhaatt aallll ggoovveerrnnmmeennttss ffaaccee iiss ttoo cchhoooossee bbeettwweeeenn mmiilliittaarryy

eexxppeennddiittuurree aanndd ssoocciiaall eexxppeennddiittuurree.. SSuuppppoossee ggoovveerrnnmmeenntt ooff aa ccoouunnttrryy XX,, ccaann

cchhoooossee ttoo uussee iittss pprroodduuccttiioonn ffaaccttoorrss ffoorr bbuuiillddiinngg hhoouusseess,, oorr ffoorr pprroodduucciinngg gguunnss..

CCoouunnttrryy XX oonnllyy hhaass llaabboouurr aass aa ffaaccttoorr ooff pprroodduuccttiioonn PPrroodduuccttiioonn

PPoossssiibbiilliittyy

NNuummbbeerr ooff hhoouusseess

bbuuiilltt

NNuummbbeerr ooff gguunnss

pprroodduucceedd

OOppppoorrttuunniittyy ccoosstt ooff

pprroodduucciinngg mmoorree

hhoouusseess iinn tteerrmmss ooff

gguunn pprroodduuccttiioonn

AA 00 11550000

BB 11000000 11440000

CC 22000000 11220000

DD 33000000 990000

EE 44000000 550000

FF 55000000 00

21

8. Assessment 8.1 Assessment criteria This unit involves definitions and illustration through graphs. Therefore

assessment will be based on exactly that, i.e. your knowledge of terminology,

ability to illustrate economic models in graphical illustrations and minor

calculations of opportunity cost. Mostly, this will be written work in tests,

assignments or examination.

22

UNIT THREE 1. Unit title: The role of the market

2. Learning Outcomes OOnn ccoommpplleettiioonn ooff tthhiiss ssttuuddyy uunniitt yyoouu sshhoouulldd bbee aabbllee ttoo

•• DDiissttiinngguuiisshh bbeettwweeeenn eeccoonnoommiicc ggooooddss aanndd ffrreeee ggooooddss

•• DDiiffffeerreennttiiaattee bbeettwweeeenn nneeeeddss aanndd wwaannttss

•• DDeeffiinnee aa mmaarrkkeett

•• DDeeffiinnee ddeemmaanndd aanndd ggiivvee ffaaccttoorrss aaffffeeccttiinngg qquuaannttiittyy ddeemmaannddeedd

•• SSttaattee tthhee llaaww ooff ddeemmaanndd aanndd ddrraaww aa ddeemmaanndd ccuurrvvee

•• SSttaattee tthhee llaaww ooff ssuuppppllyy aanndd ddrraaww aa ssuuppppllyy ccuurrvvee

•• GGiivvee ffaaccttoorrss aaffffeeccttiinngg qquuaannttiittyy ssuupppplliieedd

•• EExxppllaaiinn eeqquuiilliibbrriiuumm pprriiccee aanndd eeqquuiilliibbrriiuumm qquuaannttiittiieess

3. Introduction In this unit, we firstly need to distinguish free goods from economic goods. This is

important since the study of economic revolves around economic goods or goods

that command a price. Market theory deals with goods that are usually limited in

nature and thus command a certain price. The unit breakdown is as follows:

firstly we make a distinction between needs and wants, economic goods and free

goods, a market is then defined followed by definitions and illustrations of

demand and supply and the laws. The second part covers what impacts on

demand and supply and how these influence prices

3.1 Key concepts Need Market

Want Economic good

Demand Quantity demanded

Free good Supply

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Quantity supplied Equilibrium price

Equilibrium quantity

4. Learning in Place Ensure that you familiarise yourself with the terminology and illustrations in unit

two before moving on to this unit. Also the basic linear equations you learnt in

matric or elsewhere are going to be useful in this unit.

5. Unit Content 5.1 Free goods and Economics goods, Wants and Needs, and Markets

Free goods are goods that are free and the supply exceeds the demand for

them. These goods are available in unlimited quantities and do not have a price. Free goods have useful value but no exchange value since nobody will

accept these goods in exchange for something else. Examples: air around us,

water in the ocean.

Economic goods are goods that are manufactured in an economic system. The

supply of these goods is limited in relation to their demand and consumers must

pay for them. Economic goods have useful value and an exchange value.

Wants are human desires for goods and services. Human wants are unlimited;

we all want everything, e.g. biological, spiritual and material wants. Also, we all

want law and order, education, health etc.

Needs are necessities i.e. the things that are essential for survival e.g. food,

water, clothing, shelter etc. Needs unlike wants are not absolutely unlimited.

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5.2 A market A market is a set of mechanism or arrangement through which buyers and

sellers get into contact for the purpose of exchanging goods and services for

some form of payment.

There are three stages in the operation of a market mechanism:

i. Buyers and sellers meet

ii. There is an agreed upon price

iii. The goods or services are exchanged for some form of payment

Markets can exist in different ways: e.g. personal contact, telephone, Internet,

public media etc. Examples of markets are; Johannesburg Stock Exchange

(JSE), beauty salon, cinema, bar lounges etc.

Different markets exist under different economic systems. The command system

may have the controlled markets, and quite opposite, the capitalist system would

have free competitive markets, i.e. where there is no interference from

authorities. For the purpose of our study, we shall focus on the free or perfect competitive markets.

Characteristics of competitive markets

• Lots of buyers and sellers

• Products are identical

• Individuals (buyers and sellers) cannot themselves determine the price

(ruling price).

5.3 Demand Demand refers to the need for goods and services coupled with willingness and

ability to pay.

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The quantity that consumers want to buy (demand) is called the quantity

demanded or the market demand.

The quantity demanded can vary with price, i.e. the higher the price the lower the

quantity demanded or the lower the price the higher the quantity demanded.

There are other factors that affect the quantity demanded.

Examples:

• Change in income - A rise in income of consumers ceteris paribus

(assuming that other things remain constant), usually causes a rise in

quantity demanded.

• Availability and prices of substitute goods and services – This refers

to goods used for the satisfaction of similar needs, e.g. butter and

margarine, beef and mutton, coffee and tea etc.

• Change in taste of consumers – If the change is to the advantage of a

product, then the quantity demanded will increase and vice versa.

Example, if it becomes a health hazard to consume beef due to mad cow

disease, the quantity demanded of beef will drop at every conceivable

price.

• Change in the price of complimentary products – These are the goods

that supplement the satisfaction of needs e.g. cars and petrol, electric

appliances and electricity etc.

• Expectation/perception of consumers about a product – goods which

do not deliver what they promise or satisfy the need that they promise may

lead to less of them being demanded. E.g. viagra, slimming tablets etc.

Also, if consumers anticipate a shortage of a good in future, this leads to

more of a good being demanded.

• Change in population – An ever-increasing population puts an upward

pressure on limited goods and services. Therefore the will be an increase

in demand for housing, services etc.

26

At this point we can now state the law of demand!

The law of demand states that, at lower prices, a greater quantity will be

demanded than at a higher price, all other things remaining constant.

OR At higher price, lesser quantity will be demanded than at a lower price all other

things being equal.

Thus the law of demand tells us that the quantity demanded of any commodity

is inversely or negatively related to that commodity’s price all other things

being equal.

The relationship between price and quantity demanded can be explained by the

following demand schedule/table

Quantity Demanded Price

(Rand) A B C

Market Demand

(Total Demand)

10

15

20

25

30

20

15

10

5

1

10

8

6

5

2

20

17

14

10

7

50

40

30

20

10

Graphically it can be represented as follows: -

27

Price A 30 25 20 15 Demand Curve 10 B

10 20 30 40 50 Quantity

The demand curve shows the relationship between price and quantity demanded

ceteris paribus.

The price is measured vertically along the vertical axis; the quantity demanded is

measured horizontally along the horizontal axis. The line AB is called the

demand curve and normally declines from left to right (negative decline) that

indicate that more will be demanded when price is low.

A change in the price of the product will lead to a change in the quantity

demanded. This change in price causes an upward or downward movement on

the demand curve while the demand curve stays constant.

For example, when the price changes from R30 to R20 the quantity demanded is

shown as a change from point A to point C.

5.4 Supply Supply refers to the quantity of goods or services that are offered at different prices on the market.

OR Supply refers to making goods and services available to satisfy needs.

28

The quantity that producers or sellers want to supply at a given price is called

quantity supplied.

There are other factors that affect the quantity supplied.

Examples:

• Change in the prices of factor inputs – If the prices of factor inputs

increase, then it becomes too expensive to produce more of that good.

Therefore, the quantity supplied decreases and vice versa.

• Change in technology – Technological improvement in the

manufacturing of a good can lead to a decrease in the production costs.

This implies increased profits and more quantity supplied.

• Change in the price of other products – If a producer is producing two

commodities, say, X and Y. If the price of Y increases, the producer is

likely to produce more of Y than X to maximise profits.

• Government regulation – strict safety regulation or production

processes, which are dangerous to workers, may hamper firms’ profits.

We can now state the law of supply!

The law of supply states that, at higher price, greater quantities will be offered and at lower price lower quantities will be offered.

Thus the law of supply tells us that the quantity supplied of any commodity is

directly related or positively related to that commodity’s price, all other things

being equal.

The relationship between price and quantity supplied can be explained by the

following schedule/table:

29

Quantity Supplied Price

(Rand) Firm A Firm B Firm C

Market Supply

(Total supply)

10

15

20

25

30

3

6

9

14

16

4

7

12

14

17

3

7

9

12

17

10

20

30

40

50

Graphically it can be represented as follows:

e

T

h

f

p

A

a

q

3

Pric

30 25 20 15 10

10 20 30 40 50 Quantity

he price is measured vertically and the quantity supplied is measured

orizontally. The line (curve) AB is called the supply curve and normally declines

orm right to left (positive decline). That indicates more will be produced when the

rice increases.

change in the price of a product will lead to a change in the quantity supplied of

product. E.g. when the price of a product increases from R10 to R20, the

uantity supplied is shown as a change from B to C.

0

5.5 Equilibrium Price and Equilibrium Quantities N.B A demand curve indicates how much of a product will be demanded at a

certain price and time; the supply curve shows how much of a product will be

supplied at a certain price and time.

In principle only one price can exist on the market.

The behaviour of buyers and sellers can be combined to model how the market

would actually work.

Price (R) Total Demand Total Supply

10

15

20

25

30

50

40

30

20

10

10

20

30

40

50

Graphically it can be represented as follows:-

31

D Price

S Excess supply

30 25 20 15

D 10 Excess demand

S 10 20 30 40 50

Quantity

The price on which buyers and sellers agree is called the equilibrium price while

the quantity negotiated at that price is called equilibrium quantity.

At a price of R20, buyers are prepared to purchase 30 units of a product

(Demand), while suppliers are prepared to sell 30 units on the market. Therefore,

the quantity demanded is exactly equal to the quantity supplied on the market at

a price of R20

The market is therefore in equilibrium as far as demand and supply is concerned.

This position of equilibrium is indicated by point E on the graphs above.

At prices below R20, then there is excess demand e.g. AB at price, P = R10.

At prices above the equilibrium price (R20), there is excess supply (e.g. FG at P

= R30)

6. Sources / References

32

Study chapter 7, dealing with markets in your prescribed book. Also check the

business portion of any local news paper and see how they trace markets. Other

websites discussed above will be relevant.

7. Learning tasks / Activities This is not to be formally submitted as an assignment; however you are welcome

to share your findings with me in class or office.

AACCTTIIVVIITTYY 11 IInn tthhee ttaabbllee bbeellooww,, ttiicckk tthhee rriigghhtt ccoolluummnn ttoo iinnddiiccaattee,, wwhhiicchh ooff tthhee iitteemmss aarree

eeccoonnoommiicc ggooooddss,, wwhhiicchh aarree ffrreeee ggooooddss,, aanndd wwhhiicchh aarree sseerrvviicceess..

IItteemm EEccoonnoommiicc ggoooodd FFrreeee ggoooodd SSeerrvviicceess

DDeesseerrtt SSaanndd

AA vviissiitt ttoo tthhee

ddeennttiisstt

MMeeaatt ffrroomm tthhee

bbuuttcchheerryy

HHoouusseess

BBoottttlleedd sseeaa wwaatteerr

aatt tthhee fflleeaa mmaarrkkeett

TThhee hheellpp ffrroomm tthhee

bbaannkk ccaasshhiieerr

SSttrreeeett llaammppss

AACCTTIIVVIITTYY 22 IInn tthhee nneexxtt tthhrreeee sseenntteenncceess,, ccaann yyoouu eexxppllaaiinn tthhee mmeeaanniinngg ooff tthhee wwoorrddss ““nneeeedd””,,

““wwaanntt”” aanndd ““ddeemmaanndd””??

II nneeeedd aa ccaarr..

II wwaanntt aa ccaarr

33

TThheerree iiss aa ggrreeaatt ddeemmaanndd ffoorr ccaarrss iinn tthhee ccoouunnttrryy

IInn tthhee ttaabbllee bbeellooww,, ttiicckk iinn tthhee rriigghhtt ccoolluummnn ttoo iinnddiiccaattee wwhhiicchh aarree nneeeeddss aanndd wwhhiicchh

aarree wwaannttss..

IItteemm NNeeeedd WWaanntt

FFoooodd

AA ffiivvee bbeeddrroooomm hhoouussee

aatt tthhee ccooaasstt

AAnn XX55 44xx44 vveehhiiccllee

SShheelltteerr

CCllootthheess

RRoolleexx wwaattcchh

SSaatteelllliittee TTVV

Activity 3 Trace the Rand/dollar exchange for the day, for a period of one month and try to

plot a graph(s) out of that data. N.B each exchange rate is the equilibrium price

for the day.

8. Assessment 8.1 Assessment Criteria Most of the assessment in this unit will entail written work which will test your

knowledge of terminology, your ability to draw and interpret graphs.

34

UNIT FOUR 1. Unit title: Shifts in Demand and Supply curves 2. Learning Outcomes OOnn ccoommpplleettiioonn ooff tthhiiss ssttuuddyy uunniitt,, yyoouu sshhoouulldd bbee aabbllee ttoo::

•• DDiiffffeerreennttiiaattee bbeettwweeeenn mmoovveemmeennttss aalloonngg aa ccuurrvvee aanndd sshhiiffttss iinn tthhee ccuurrvvee

•• EExxppllaaiinn wwhhaatt aaffffeeccttss sshhiiffttss iinn tthhee ddeemmaanndd aanndd ssuuppppllyy ccuurrvveess

•• IIlllluussttrraattee bbyy mmeeaannss ooff ggrraapphhss,, sshhiiffttss iinn tthhee ddeemmaanndd aanndd ssuuppppllyy ccuurrvveess

3. Introduction Changes in demand (also called market demand), is caused by factors other

than price i.e. income, substitute goods, taste and preference etc.

To understand this we need to differentiate between movements along the

demand curve and shift in the demand curve. Since economics uses tools like

graphical illustrations and figures, we will learn how to employ those to explain

changes in demand and supply.

3.1 Key concepts Movement along a demand curve

Shift in a curve

Movement along a supply curve

Price floors

Price ceilings

4. Learning in Place Unit three is a prerequisite for learning unit four. This serves as a continuation of

unit three. Familiarise yourself with concepts and illustration before attempting

this unit.

35

5. Unit Content 5.1 Movements along a Demand Curve Here we are concerned with the effect of prices on the quantity demanded.

Price D

D

Quantity

5.2 Shift in the Demand Curve Suppose, for example, butter and margarine, are regarded as substitute goods. If the price of butter increases, people will demand more margarine. At

each margarine price there is a larger quantity of margarine demanded when

butter prices are high. Therefore, change in butter prices lead to a shift in the

demand curve. The entire demand curve shifts to the right since a higher

quantity is demanded at each price.

The effect of an increase in the price of a substitute good for margarine.

Graphically:

36

D’

P D

D’ D

Q

Recap: A market is a set of arrangements or mechanisms through which buyers

and sellers interact by exchanging goods and services for some form of payment.

Margarine market

D’ D P

E’

E

D’

D

Q

Butter and margarine are substitutes, therefore, when the price of butter

increases, then more of margarine will be demanded. This is because margarine

is more affordable.

37

In the market for margarine, this process is illustrated by a rightward shift in the

demand curve, thereby indicating that more margarine will be demanded.

When the demand curve shifts to the right, a new equilibrium point, E’ is formed

and a new equilibrium price and quantity are established at a higher level than

they were at initial equilibrium point.

Shifts to the left are also possible!

Suppose, for example video recorders and televisions are complimentary goods/

goods that are used jointly. If the price of Televisions increase, the demand for

video recorders will drop, assuming other things remain constant.

The market for video machines will be thus: -

Market for video recorders

D D’

S

Pe E

Pe’ E’

Qe’ Qe

When the price of televisions increases, then less videos will be demanded. This

is because it becomes more expensive to run videos.

38

In the market for videos, this process is illustrated by a leftward shift in the

demand curve, thereby indicating that less videos will be demanded. When the

demand curve shifts to the left, a new equilibrium point, E’, is formed, and a new

equilibrium price, Pe’, and quantity, Qe’, are established at a lower level than

they were at initial equilibrium point.

5.3 Movement along a Supply Curve Here we are concerned with the effect of prices on the quantity supplied.

P S

Q

5.4 Shifts in the Supply Curve The supply curve will only shift if any of the “other things” are changed. i.e.

technology, factor inputs, government regulation etc.

Suppose an improvement in technology leads to much faster machines and thus

higher quantities of a product are being produced.

Therefore change in technology will lead to a shift in the supply curve. The

entire supply curve will shift to the right, since higher quantities are supplied

at each price.

39

Let us assume that an improvement in technology has boosted a market for

shoes.

Shoes market

Technology has improved the production of shoes (greater supply).

In the market for shoes, a rightward movement of the supply curve illustrates this,

thereby indicating more shoes will be supplied.

S Shift from S to S’ P

S’

Q

S P

S’

E Pe

E’ Pe’

D

Qe Qe’ Q

40

When the supply curve shits to the right, a new equilibrium point E’, is formed

and anew equilibrium price Pe’, and Quantity Qe’, are established at lower level

than they were at the initial equilibrium point.

Shifts to the left are also possible!

Suppose government imposes strict laws/regulation in the shoe industry.

That will result in fewer shoes supplied. Therefore, the market for shoes could be

thus:

Market for shoes

S’ P

S

E’ Pe’

E Pe

D

Qe’ Qe Q

The equilibrium point moves from E to E’. The equilibrium price and quantity shift

from Pe to Pe’ and Qe to Qe’ respectively, implying an increase in equilibrium

price but a decrease in equilibrium quantity.

5.5 Government intervention One assumption that we raised is that there is no government intervention in the

process of determining the ruling price. At times governments may intervene and

41

influence the ruling prices. If consumers, trade unions, farmers and politicians are

not satisfied with the prices and quantities determined by the market forces,

government is usually compelled to intervene. This intervention can take different

forms, including:

• Setting maximum prices (price ceilings)

• Setting minimum prices (price floors)

• Subsidising certain products or activities

• Taxing certain activities or products.

Government set maximum prices, usually below the equilibrium price (see figure

8-9 in text book) to:

• Keep the prices of basic foodstuffs low, as part of policy to assist the poor

• Avoid the exploitation of consumers by producers, that is, to avoid “unfair”

prices.

• To combat inflation

• To limit the production of certain goods and services in war time

Government set minimum prices, usually above equilibrium price to support

agricultural products since farmers are vulnerable to exploitation. When

government fixes a minimum price, it creates a market surplus. This usually

requires further government intervention. These are the options:

• Governments purchases the surplus and exports it

• Government purchases the surplus and stores it (provided it is non

perishable)

• Government introduces production quotas to limit the quantity supplied to

the quantity demanded at minimum price. See fig 8-12 in text book

• Government purchases and destroys the surplus

• Producer destroys surplus

6. Sources/ References Study chapter 8, covering demand and supply in action and government

intervention in your prescribed text book.

42

7. Learning Task This is not to be formally submitted as an assignment; however you are welcome

to share your findings with me in class or office.

AACCTTIIVVIITTYY 11 Below are some of the extracts from newspaper headlines or reports. In each

case, the supply of a product or products will be affected. Explain how the supply

will be affected and draw a graph to illustrate the change. Where applicable, also

mention which factors caused the change in supply or demand.

1. “Research shows that salmon (a type of fish) reduces wrinkles on

persons face”

2. “Iscor workers strike successful: trade union negotiates an 8%

increase for all workers” (explain how the supply of steel will be affected.)

3. “SA winemakers decide to export more wine to overseas countries, but

harvests are affected by a severe drought in the Western Cape.”

4. Illustrate how the concepts, price ceiling and price floors function.

8. Assessment 8.1 Assessment Criteria Written work on the interpretation of demand and supply graphs will assessed.

Also your ability to grasp concepts and definitions will be assessed.

43

UNIT FIVE 1. Unit Title: Elasticity

2. Learning Outcomes On completion of this study unit, you should be able to:

• Explain the elasticity of demand, and illustrate the different values in

graphic form

• Define and explain income elasticity

• Define and explain cross price elasticity

3. Introduction When we describe changes in demand or supply in graphical illustrations, it is

usually not enough and could be misleading at times, since we may not know

precisely by how much either variable has changed. The study of elasticity

puts substance to this problem.

Once we have defined elasticity, we will look into its types and calculations.

This will then be followed by illustration of demand elasticity on a graph.

3.1 Key concepts Elasticity Price elasticity of demand

Perfectly elastic demand Perfectly inelastic demand

Income elasticity of demand Cross price elasticity of demand

Normal good Inferior good

4. Learning in Place Unit four is a prerequisite for unit five as these are closely related. Ensure that

you understand the graphical illustrations before you start looking into the

following calculations.

44

5. Unit Content 5.1 Elasticity of Demand

From the study of demand and supply curves, we observed that quantity

demanded and quantity supplied change as prices change. The question is

however, by how much the quantity demanded and supplied will change if prices

change.

That is, how sensitive (responsive) is demand and supply to price changes?

Therefore, Elasticity of Demand is concerned with the extent of responsiveness

in quantity demanded as a result of changes in goods prices (or consumer

income).

5.2 Types of demand Elasticities i. Price Elasticity of Demand ii. Cross – Price Elasticity of Demand iii. Income Elasticity of Demand

5.3 Price elasticity of Demand Price elasticity of Demand is the measure of the sensitivity (or

responsiveness) of the quantity demanded to changes in price.

When commodities are measured in different units, it is often best to examine

the percentage change, which is unit free. Thus, Price elasticity of Demand

(often denoted by a Greek symbol η, pronounced “eeta”) is measured as: -

P.E.D, η = Percentage change in quantity demanded / Percentage

change in price

Since demand and price are inversely related, the elasticity has a negative

value, but it is usual to ignore the minus sign for analysis purposes.

Alternatively, Price Elasticity of demand can be written in this form:

45

η = %∆Qd / %∆P, where the symbol “∆” denotes change.

Example: If the price of X rises from R1.00 to R1.50 and demand fall from 1000 to 600

units, calculate the P.E.D between these two points on the demand curve.

Solution: Price elasticity of demand = Percentage change in quantity demanded /

Percentage change in price

Old demand -------------------1000 units

New demand-------------------600 units

% change in demand = (Old demand – New demand / Old demand) * 100

= (1000 – 600 / 1000) * 100

= 400 / 1000 * 100

= 40% or 0.4

Old price-------------------R1.00

New price------------------R1.50

% change in price = (Old price – New price / Old price) * 100

= (R1.00 – R1.50/ R1.00) * 100

= - R0.50 / R1.00 * 100

= -50% or –0.5

Price elasticity of demand, η = - 40% / 50%

=- 0.8

Ignoring the negative sign, η = 0.8

46

5.4 Elastic and inelastic demand Elasticity of demand may take any value from zero to infinity, but there are

important dividing lines: -

P.E.D, η = 1 - usually referred to as Unit elasticity or just unity P.E.D, η > 1 - Elastic demand P.E.D, η < 1 - Inelastic demand

Where demand is unit elastic, η = 1, the quantity demanded falls (rises) by the

same percentage (or in proportion) to the percentage rise (fall) in price.

Where demand is elastic, η > 1, the quantity demanded falls by a larger

percentage than the percentage rise in price.

Where demand is inelastic, η < 1, the quantity demanded falls by a

smaller percentage than the percentage rise in prices.

Example: The price elasticity of demand for tickets.

Price

(Rands)

Quantity of tickets

demanded

Price elasticity of

demand, η

12.50

10.00

7.50

5.00

2.50

0

0

20

40

60

80

100

4

1.5

0.67

0.25

0

47

Demand curve for tickets

The price elasticity changes as we move along a demand curve, and we can

expect the elasticity to be high at high prices (i.e. quantity demanded is

sensitive to changes in prices) and low at low prices (Quantity demanded is

less responsive to changes in price)

Sometimes demand can either be perfectly elastic or perfectly inelastic. A

perfectly elastic demand curve has an elasticity coefficient of infinity and is

depicted by a horizontal line. A perfectly inelastic demand has elasticity

coefficient of zero and is depicted by a vertical line (see fig. 9-4 in text book).

5.5 Ticket Demand, Elasticity and Revenue

Price

(Rands)

Quantity of tickets

demanded

P.E.D Total spending (R)

(Price x Qd of tickets)

12.5 0 0

48

10.0

7.5

6.25

5.00

2.50

0

20

40

50

60

80

100

4

1.5

1

0.67

0.25

0

200

300

312.5

300

200

0

At higher prices, e.g. R12.50, P.E.D is very elastic i.e. η >1 so that quantity

demanded becomes sensitive to price changes. Thus total spending (price * Qd)

12.5 * 0 becomes 0.

When P.E.D is elastic, i.e. η > 1, a decrease in prices from R12.50 to R10.00

results in an increase in total spending (because Qd is sensitive to price

changes) so that total spending becomes R200.

As prices keep on decreasing e.g. R7.50 to R6.25 with P.E.D, η > 1, total

spending on the commodity (tickets) increases. Also, when P.E.D is inelastic, i.e.

η < 1 e.g. at Price = R5.00, a further decrease in prices from R5.00 to R2.50

results in a decrease in total spending (2.50 * 80 = 200).

N.B As prices increase from 0 to 12.50, P.E.D changes from being inelastic, η <

1, to elastic η > 1 and that is accompanied by an increase in total spending. But

total spending declines as P.E.D becomes very elastic, i.e. η > 1.

5.6 The Slope of the demand curve and elasticity If a demand curve becomes steeper over a particular range of quantity, then

demand is becoming more inelastic.

A shallower demand curve over a particular range indicates more Elastic demand.

49

Graphically these can be represented thus:-

Business people can make use of Elasticity to establish how consumers will react

to pricing policies.

5.7 Cross Price Elasticity of Demand Sometimes it happens that a change in price of one product (commodity) causes

a change in the demand for another product. Thus, for example an increase in

the price of butter may result in an increase in the demand for margarine

assuming that other things remain constant.

In this case the responsiveness of the quantity demanded should be measured

with regard to the change in the price of a related product. Therefore, the Cross Price elasticity of Demand measures the sensitivity

(responsiveness) of demand for one good to changes in the price of another good. Cross price elasticity of demand, often denoted by η xy , where x and y refers to

good x and good y respectively is measured as:-

50

Cross P.E.D, ηxy = Percentage change in quantity demanded of good x /

Percentage change in price of good y

If the two goods are substitutes, cross prise elasticity of demand will be

positive. A rise in a price of one will increase the amount demanded of another.

E.g. an increase in the price of coffee, ceteris paribus, will raise the demand for

tea.

If the two goods are compliments, cross price elasticity of demand will be

negative. An increase in the price of one will reduce demand for the other. E.g. a

rise in the price of petrol, ceteris paribus, will reduce demand for big cars.

Cross price elasticity can also be written as:

ηxy = %∆Qx / %∆Py,

where x and y denote related goods e.g. butter and margarine for substitutes

and TV and VCR for compliments.

5.8 Income Elasticity of Demand The Income elasticity for a good indicates the responsiveness of demand to changes in household income. The Income Elasticity of demand is measured as: -

Income Elasticity of Demand = Percentage change in quantity demanded

/ Percent change in Income

The I.E.D, also denoted by µ = %∆Qd / %∆I

The income elasticity of demand, measures how far the demand curve shifts

horizontally when income changes.

51

D’’ D’’’ P D

A B C Po

Q

At the given price, Po, a shift to the point B on the demand curve D’D’ reflects

lower income elasticity than a shift to the point C on the demand curve D’’D’’.

Leftward shifts in the demand curve when income rises would indicate negative income elasticity. An inferior good has negative income elasticity. An inferior good is a good that a consumer buys less of as income increases

and more of as income decreases

A normal good has positive income elasticity. A normal good is one that an

individual buys more of as his income increases and less of as income decreases.

Luxury goods have income elasticity > 1, and necessities have income

elasticity < 1

6. Sources /references Study chapter 9 dealing with elasticity in your prescribed book. Also check the

business portion of any local news paper and read how markets are sensitive to

changes in economic variables. Websites discussed above will be relevant.

52

7. Learning tasks / Activities 7.1 This is to be formally submitted as a group assignment.

Activity 1 How much does /did it cost to subscribe to the Economist magazine (any year) if

you were in these countries. Convert the said currency to US dollars equivalent

(of that particular day/ month) and plot a graph that shows on one axis, countries

and US$ price on the other, with appropriate headings and labels.

Austria Belgium Denmark Finland

France Germany Irish Republic Italy

Netherlands Portugal South Africa Sweden

Norway Spain

7.2 Assignment format. • Introduction : Brief description of what the project entails

• Theory and calculations : Your data and relevant calculations

• Analysis of the graph: Comment on which country seems to be expensive

/cheap in terms of subscription.

• Conclusion : Appropriate summary

• References: Who are your sources?

• Names of group participants (Surname & Initials) with student numbers.

• Please see criteria for marking written work!

7.3 Submission modes • Group leaders to personally submit written work.

• Due date: 11 March 2005, (Friday) 12h00!

• Late submissions will incur a penalty of 5 marks on a daily basis

53

UNIT SIX 1. Unit Title: Output supply by firms

2. Learning Outcomes On completion of this study unit, you should be able to:

• Define and calculate revenue, costs and profits

• Define and calculate Marginal Concepts of production

• Define and calculate Total Concepts of production

• Define and calculate Average Concepts of production

• Illustrate the use of marginal and total concepts in production

3. Introduction Businesses or firms decisions about how much to produce and supply depends

on the costs of production (expenses incurred in production), and the revenue

they receive from selling the output. It is from revenue and costs that firms are

able to calculate their profitability and thus determine their long term viability.

Costs and revenue are defined, followed by the concept of profit. Once this is

done marginal concepts are introduced.

4. Learning in place Since this is an independent unit, some basic calculation skills should be

sufficient in learning this unit.

5. Unit content 5.1 Costs Production costs refer to prices of inputs necessary for the production of output.

For example, a shoe manufacturer would be interested in knowing the prices of

inputs to produce shoes, viz: -

54

Price of leather

Price of strings

Price of rubber

Price of glue

Price of labour

The revenue obtained from selling output (shoes), depends on the demand curve

faced by the firm. The demand curve determines the price for which any given

output quantity can be sold, and hence the revenue that the firm will earn.

Example:

Consider the following demand schedule for shoes.

Output Price (R) Revenue (price * Q)

0

5

10

15

150

100

40

10

0

500

400

150

When the price is R150, demand is zero and hence revenue is zero. When the

price is R100, demand is 5, and revenue is R500 etc.

5.2 Revenue, and Profits Revenue refers to the amount that the firm earns by selling goods or services

in a given period such as a year. It is measured as: -

Revenue = Price * Quantity OR

TR = P * Q

55

Costs refer to the expenses that a firm incurs in producing goods or services

during a particular period. They are measured as: -

Total Costs = Variable costs + Fixed Costs

OR

TC = VC + FC Variable costs are costs that vary with output. For example, in a shoes

production firm, the costs will vary with respect to shoe sizes and design.

Fixed costs are costs that do not change irrespective of output. Such costs

are usually associated with the costs of setting up capital or machinery for

production.

Profits are the excesses of revenues over costs.

They are measured as: - Profits, Π = Total Revenue – Total Costs

OR

Π = TR – TC

N.B Any firm maximising profits would want to produce its chosen output level at

the maximum possible cost.

5.3 Marginal Costs and Marginal Revenue At each output level, a firm needs to decide whether it should keep on increasing

output by additional units. There is a need to know the additional costs of

producing an extra unit of output and the accompanying additional revenue

from that extra unit of output to keep on making profits.

56

Marginal cost is the amount by which total cost increases when one extra product is produced. Or Marginal cost = Change in total cost/ Change in output

MC = ∆TC / ∆Q

Marginal revenue is the amount by which total revenue increases when one extra of a product is produced. Or Marginal revenue = Change in total revenue / Change in output

MR = ∆TR / ∆Q

Example:

Output (Q) Total costs (TC) Marginal cost (MC)

0

1

2

3

4

5

10

25

36

44

51

59

-

15

11

8

7

8

When output = 1 and TC = 25,

MC = ∆TC / ∆Q

= 25 – 10 / 1 – 0

= 15

When output = 2. TC = 36

MC = ∆TC / ∆Q

= 36 – 25/ 2 –1

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= 11

Example:

OUTPUT (Q) PRICES (R) TOTAL REVENUE MARGINAL REVENUE

0

1

2

3

4

5

-

21

20

19

18

17

0

21

40

57

72

85

-

21

19

17

15

13

When output = 1, at a price of R21, TR = 1 * 21 = 21 and Marginal Revenue, MR

= ∆ TR / ∆Q

= 21 – 0 / 1-0

= 21

When output = 2, at a price of R20, TR = 2 *20 = 40

MR = ∆TR / ∆Q

= 40 – 21/2-1

= 19

In order to calculate if it is still profitable, to produce an extra unit of output, we

need to equate MR to MC given the same output.

Example:

Using MR and MC to determine output

Output MR MC MR – MC Output decision

0 - - - Increase

58

1

2

3

4

5

6

7

8

21

19

17

15

13

11

9

5

15

11

8

7

8

10

12

11

6

8

9

8

5

1

-3

-6

Increase

Increase

Increase

Increase

Increase

Increase

Decrease

Decrease

At an output where: -

MR > MC, the firm may increase output by an additional unit. E.g. when output =

1, MR = 21 and MC = 15. Therefore MR > MC

MR < MC, the firm should cut (decrease) production or close business as it is not

profitable to produce, i.e. the costs of production exceed the revenue. E.g. at

output = 7, MR = 9 and MC = 12

Therefore, MR < MC

MR = MC, this is the profit maximisation level. At this output where

MR = MC a firm realises the maximum profits possible, i.e. if profits are positive.

6. Sources/References Study chapter 11 dealing with output supply by firms in your prescribed book.

7. Learning tasks Activity 1 As this topic deals with a lot of calculations, it is advisable to practice most

questions in your prescribed book and recommended books. And feel free to

discuss the outcomes with me, in office or class

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8. Assessment 8.1 Assessment criteria Your knowledge of concepts will be assessed formally in tests or examination.

Some calculations will also be done to test your ability to apply knowledge

acquired in this unit.

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UNIT SEVEN

1. Unit Title: Market Structures

2. Learning Outcomes On completion of this unit, you should be able to:

• Define a market structure

• Define perfect and imperfect competition and their existence.

• Explain a monopoly, oligopoly, monopolistic competition

3. Introduction A market structure is an important theory in economics since it allows us to

understand how buyers and or sellers influence the prices. This also helps

government to form policies that would protect consumers from exploitation

from sellers or vice versa. In each economy there are a number of market

structures in existence, and depending on the sector, influence our daily

livelihood.

3.1 Key Concepts Perfect competition

Imperfect competition

Structure of a market

Monopoly

Oligopoly

Monopolistic competition

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4. Learning in Place This is also an independent unit, a lot of terminology will be introduced, as such

your ability to grasp terminology should be useful in this unit.

5. Unit Content 5.1 Market structures The structure of a market is a description of the behaviour of buyers and sellers

in that market.

Different market structures occur in every capitalist-oriented system. One such

structure is that of perfect competition although strictly speaking, it does not exist

anywhere in the world. However, it is useful to study this structure, as it is the

norm or ideal against which all other structures are measured.

The reason why this market form does not exist anywhere is the strict

requirements with which such markets must comply. One of these is that

producers and consumers must have perfect knowledge of everything happening

in the market. This is clearly unrealistic.

The difference between perfect and imperfect competition is the ability of the

buyers and sellers to influence prices.

Perfect competition occurs when there are so many buyers and sellers that no

single individual can influence the price.

Imperfect competition occurs when any buyer or any seller is able to influence

the price.

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5.2 Perfect competition In a perfectly competitive market, no individual buyer or seller has any influence

on the market, so that market forces have complete control over production and

prices.

The model for perfect competition is only used as a criterion against which other

market structures may be compared. The characteristics of a perfect competition

are the following:

• A large number of buyers and sellers – neither group is big enough to

exercise any influence on the market.

• Free entry and withdrawal – no obstacles exist, legally or otherwise, to

prevent firms from participating in that sector

• Perfect mobility of factors of production – all factors of production are

free to move from one firm to another

• Perfect knowledge – consumers and producers are fully informed

about everything that is happening and that is available in the market,

for example, prices and quality. No advertisements are therefore

necessary.

• Homogeneous product – the products of the different producers are

identical, including the service, the packaging, trademarks, and so on.

The existence of many sellers means that no individual firm can control the

market. Every firm is small compared to the size of the market and can therefore

sell everything it produces on the market without influencing the prevailing

market price in any way. Consequently such a firm is a price taker. If the firm

were to set its price higher than the market price, it would not sell anything

because the consumers, with their perfect knowledge, would buy from other

producers.

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5.3 Imperfect Competition It is possible to distinguish several types of imperfect competition. A large

enterprise can, for example, pursue a greater market share by buying out smaller

enterprises. Because of its size it can limit entry into the market by temporarily

lowering its prices to an absolute minimum so that competitors are simply

eliminated by this strategy.

Imperfect competition may occur on the supply side or on the demand side of the

markets. On the supply side of the market there is no competition at all. On the

demand side there may be only one buyer and a large number of sellers.

There are various reasons why competition is necessarily imperfect in practice.

These include economic, natural, legal, technological and spatial reasons.

• Economic reasons – the provision of a product or service may require an

exceptionally large capital outlay, which makes the existence of more than

one enterprise almost impossible, for example transport services and

national road construction. Also, established brand names (e.g. OMO,

BMW etc), stood the test of time. Therefore it would be expensive and

difficult to persuade consumers to buy another brand name.

• Natural resources – an enterprise may be the only owner of certain

scarce resources. For example, oil minerals gas deposits etc. Also, cartels

like Organisation of Petroleum Exporting Countries, OPEC have been

established, since oil is found in large quantities in these countries and

there are a few competitors. Prices can therefore be set arbitrarily.

• Legal reasons – Free competition can be restricted legally by government

action. For example, the provision of water and electricity. In so doing

government protects consumers against exploitation by firms.

• Technological reasons – technological developments may lead to an

enterprise temporarily gaining a lead on its competitors.

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• Spatial reasons – A favourable situation may make it easier for a firm to

serve local consumers. Firms from outside the area will find it difficult and

often expensive to compete effectively, either due transport problems or

tourist attraction sites.

5.4 Monopoly In a monopoly there is only one supplier of a product.

In a pure monopoly there is no competition at all. This situation can only arise if

consumers cannot choose between alternative products. A pure monopoly

occurs where there is only one supplier of a product for which there are no

substitutes and in which it is very hard or impossible for another firm to coexist.

The following may give rise to a monopoly:

• Sole owner of resources – the monopolist may be the sole owner of

strategic resources, which other firms do not have access (for example De

Beers is the only company which has access to diamonds).

• Patent/Copy rights – a monopolist may have a patent or copyright which

means that competitors may not legally copy his product or provide similar

services (for example telecommunication, water and electricity)

• Exclusive rights – a monopolist may be granted exclusive rights by the

government to sell his product in a certain geographic area (for example

transport services and casinos)

• Brand loyalty – a monopolist may produce a popular brand which widely

accepted by consumers (e.g. SA Breweries)

• Scale of activity – certain products can only be produced profitably on a

very large scale and therefore there is no room for competitors (e.g.

ISCOR)

• Financial input – many potential competitors are excluded because entry

to a market may require extensive financial input. (e.g. SASOL)

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5.5 Monopolistic Competition Characteristics of a monopolistic competition can be listed as follows:

• There are a large number of competing firms active on the market

• The product traded is heterogeneous

• Entry to this market by new firms is possible, but there is no free

movement to entry.

• Each seller has control over part of the total market.

• An increase in the price of the product by one firm will not make the firm

lose its share of the market to its competitors since some buyers will still

prefer its product.

• Firms use advertising to make their products seem “different” and to

attract new buyers.

5.6 Oligopoly An oligopoly is the most common market form in a large number of production

sectors, for example mining, the manufacturing industry and the distribution

industry.

An oligopoly refers to a market condition where the number of sellers is so

small that there is a high degree of interdependence with regard to their

market action.

There are only a few firms in the market which compete with each other and

which either offer the same product or a differentiate product. Entry to this

market is usually very expensive and difficult because the competing firms are

large and established.

Products, which are produced by oligopolies, include motor vehicle, aircraft,

construction equipment, minerals, fuel (petrol) and computers.

Each firm has a certain degree of control over the price of the product, which

is sold. If a firm, which produces steel, decreases its production there will be a

decrease in the supply of steel on the market if steel imports do not eliminate

66

the difference. This will cause the price of steel to increase. The ability, which

a firm has to influence the price of a product, is, however, limited by the

available substitute products.

6. Sources/ References Study chapter 13, covering market structures in your prescribed book. Also visit

the following web site to learn how the competition tribunal resolves issues of

unfair competition in our country. www.compcom.co.za

7. Learning Tasks This is not to be formally submitted as an assignment; however you are welcome

to share your findings with me in class or office.

Activity 1 Visit the department of trade and industry, www.dti.gov.za. And look into what

policies is government putting in place to encourage competition in our country.

For example the introduction of the second fixed line operator, unbundling of

Eskom, and privatisation of other previously owned state enterprises. Answer

these questions: who is benefiting from restructuring, why is government doing it,

what are the problems with the process?

8. Assessment 8.1 Assessment Criteria Your knowledge of concepts will be assessed formally in this unit, either

through tests or examination.

67

68

References 1. Mohr, P., Fourie, L & Associates (2000), Economics for South African

students. Van Schaik. Pretoria

2. Begg D, Fischer S & Dornbusch R (1997), Economics, McGraw-Hill,

London

3. Botha RF, Greyling L, J vd S Heyns, Loots AE, Schoeman C, J vd Bergh,

G van Zyl (2001). Introductory Economics. Principles and Issues from a South African Perspective. Second Edition. Library of Congress

Cataloging-in-Publication Data

4. Smit et al (1996), Economics. A Southern African Perspective, Juta,

Kenwyn.

5. Sloman, J. (1991), Economics. Pretoria. Prentice Hall. London

6. John Pape, (2000), Economics An Introduction For South African Learners, Juta & Co, Ltd

7. Phillip Black, Trudi Hartzenberg, Barry Standish (2000), Economics. Principles & Practice, A Southern African Perspective. Second

Edition. Pearson Education South Africa.