UNIT -1

Economic problem
Choice & resource allocation
Factors of production
Opportunity cost
Production possibility curve

THE NATURE OF ECONOMIC PROBLEM

Scarcity: – The inability to satisfy unlimited wants using the limited resources.

Choice: – Selection of goods and services to satisfy human wants. This might be in terms of

What to produce?
How to produce?
For whom to produce?

Opportunity cost: – The next best alternative forgone

So, the relationship between scarcity, choice and opportunity cost is the nature of economic problem

FACTORS OF PRODUCTION

Resources used for the production of goods and services to satisfy human wants

Land
- A natural resource used in the production process for the reward, rent.
- For example water, coal, oil etc. land is occupationally mobile but geographically immobile.
Labour
- A human resource which includes human efforts of all types such as physical/mental, skilled/unskilled.
- Labour is occupationally and geographically mobile.
- For example farmer, doctor, teacher etc. Reward is wages/salary
- Occupational mobility means movement of labour from one job to another whereas geographical mobility means movement of labour from one place to another.
Capital
- A man-made or manufactured resource used in the production such as Machinery, tools and equipment’s.
- Reward is interest
Enterprise
- The act of the entrepreneur ( the person who do the tasks such as)
- Taking risks and organizing all other factors of production for the reward of profit.

OPPORTUNITY COST

The next best alternative forgone

For example, a person notes a list of event he would like to attend such as attending cinema as number1 and visiting relatives as number 2. If he attended the cinema, the opportunity cost will be visiting relatives which he could attend instead of cinema.
Opportunity cost is important for economists and resource allocation because it arise every time when there is a choice.
It shows that if a resource is used for one purpose, it cannot be used for another purpose
So, considering opportunity cost enables better allocation of resources and it reduces the wastage of resources.
Opportunity cost is also important for;
- Consumers:- when they want to buy something
- Worker:- when they choose an occupation or when they leave an occupation
- Government:- when they want to finance its expenditures using the limited tax revenue
- Business: – when they want to decide what, how and for whom to produce?

PRODUCTION POSSIBILITY CURVE

A curve which shows combinations of two goods a country can produce using its available resources and technology.

PPC can be drawn like a straight line as shown in the diagram as well as a curve.
Point a shows all resources are used to produce consumer goods
Point d shows all resources are used to produce capital goods
Point b shows resources are used to produce both. But, more consumer goods than capital goods
Point c shows resources are used to produce both. But, more capital goods than consumer goods
Point e shows it’s not possible to produce at that level in the short run
Point f shows some resources are not used.

PPC for resource allocation

Using a PPC we can explain resource allocation.
For example, a country can allocate resources in 2 ways, i.e., producing either consumer or capital goods OR producing combination of both.
The ultimate decisions will depend on the level of revenue and costs.

PPC for opportunity cost

Opportunity cost is the next best alternative forgone
If the country decides to increase the production of consumer goods from 160 to 200, they have to reduce the production of capital goods from 120 to 100.
So the opportunity cost of increasing consumer goods from 160 to 200 is 20 units of capital goods.

PPC for short run economic growth

Short run economic growth occurs when existing unused resources becomes active.
This will be shown as a movement from any point inside the curve up to the curve.

PPC for Long run economic growth

Long run economic growth occurs when newly found resources increases the productive capacity of the country
This will be shown as a shift of PPC to the right.
Other reasons include improved education and technology.
In contrast if resources of a country decline, PPC will move to the left.

UNIT -2- ALLOCATION OF RESOURCES; HOW MARKETS WORKS AND MARKET FAILURE

Market and mixed economic system
Demand and supply
PED and PES
Market failure
Private and social costs and benefits
Private and public expenditures
Exploitation and conservation of resources

MARKET ECONOMIC SYSTEM

An economic system where all the economic activities are owned and controlled by private individual and there is no government intervention

FEATURES OF MARKET ECONOMY

Private property
Freedom of choice
Self-interest ( profit motive)
Price mechanism
Limited role of government

ADVANTAGES OF MARKET ECONOMY

More competition
Lower prices and better quality
Wide variety of choices
Efficient allocation of resources
Better methods of production
consumer sovereignty

DISADVANTAGES OF MARKET ECONOMY

No provision of public goods
Under provision of merit goods
Over provision of demerit goods
Monopoly power
Imperfect information
Inequality
Ignores social cost

MIXED ECONOMIC SYSTEM

An economic system where public and private sector exists side by side and operate for the welfare of the people.

FEATURES OF MIXED ECONOMY

Both private and public sector exists
Profit and welfare motive
Price mechanism and price fixation
Freedom of choice
Major role of the government

ADVANTAGES OF MIXED ECONOMY

Provision of public goods and merit goods by government
Demerit goods controlled
Monopoly power controlled
Equality of incomes
Private sector encouraged by profit motive
Tax revenue for government
Price mechanism and fixation helps both producers and consumers

DISADVANTAGES OF MIXED ECONOMY

Heavy taxes reduce incentives to work hard or make profits
Less efficient private sector can limit the choice
Excessive control over business activity can add costs and discourage enterprise
More government power can lead corruption

DIFFERENCE BETWEEN MARKET AND MIXED ECONOMY

DEMAND

Demand is the desire, willingness and ability to buy a product. The law of demand is more will be demanded at lower price than higher price, other things remains constant.

FACTORS AFFECTING DEMAND FOR GOODS AND SERVICES

Price of the product
Income of the people
Price of related goods ( substitute goods and complementary goods)
- Subsitute goods are goods which can be used instead of others ( Tea and Coffee)
- Complementary goods are those goods which have joint demand( DVD and DVD player)
Expected future price
Taste and fashions
Advertising
Population

CHANGES IN DEMAND

Extension of demand: Increasing quantity demanded due to decreasing price
Contraction of demand: Decreasing quantity of demand due to increasing price.

CHANGES IN DEMAND

Increasing demand:- Shift of demand curve to the right due to changes in non-price factor
Decreasing demand:- Shift of demand curve to the left due to changes in non-price factor

SUPPLY

Supply is the total quantity of goods and services that a supplier is willing and able to sell at a given price. The law of supply is, more will be supplied at higher price than lower price, other things remains constant.

FACTORS AFFECTING SUPPLY OF GOODS AND SERVICES

Price of the product
Costs of production
Improvement in technology
Taxation( a compulsory payment imposed by government from the people and businesses)
Subsidy ( a financial assistance given by the government usually to domestic producer)
Natural disasters and weather conditions
Number of suppliers

CHANGES IN SUPPLY

Extension of supply:- Increasing quantity supplied due to increasing price
Contraction of supply: – Decreasing quantity supplied due to decreasing price.

CHANGES IN SUPPLY

Increasing supply:- Shift of supply curve to the right due to changes in non-price factor
Decreasing supply:- Shift of supply curve to the left due to changes in non-price factor

EQUILIBRIUM PRICE AND DISEQUILBRIUM PRICE

EQUILIBRIUM PRICE	DISEQUILIBRIUM PRICE
A price determined by market forces	Prices fixed by government (minimum and maximum price)
A price where demand and supply are equal	Prices where demand and supply are not equal
No shortages or surplus	Shortages exists when government fix maximum price and surplus exists when government fix minimum price
Minimum price:- A price fixed by government above the equilibrium price in order to help producers
Maximum price: – A price fixed by government below the equilibrium price in order to help consumers.

EFFECTS OF CHANGES IN DEMAND AND SUPPLY ON EQUILIBRIUM PRICE AND QUANTITY

EFFECTS OF INCREASING DEMAND

Increase price
Increase quantity

EFFECTS OF DECREASING DEMAND

Decreasing price
Decreasing quantity

EFFECTS OF INCREASING SUPPLY

Reduce price
Increase quantity

EFFECTS OF DECREASING SUPPLY

Increase price
Decrease quantity

PRICE ELASTICITY OF DEMAND

The responsiveness of quantity of demand due to change in price. It can be calculated using a formula.

Example 1:- A price of rice increases from MVR 5 per kg to MVR 7 per kg. As a result, quantity demand decreases from 250 kg to 230 kg. Calculate the price elasticity of demand.

Note that the value of price elasticity of demand is always negative. Because the law of demand states that increasing the value of price decreases the value of quantity and vice versa. But when describing the elasticity, the negative sign is ignored.

Example 2:- Calculate the price elasticity of demand when the price increases from 15 to 30.

Price	Quantity Demanded	Quantity Supplied
10	250	35
15	230	60
30	170	95
45	50	120

Example 3:- Calculate the price elasticity of demand

TYPES OF PRICE ELASTICITY OF DEMAND

Elastic demand [P E D > 1]

Percentage change in quantity demanded is more than the percentage in price. Elasticity is more than one. Example: Demand for Air conditioner is elastic. In this case firm’s revenue will increase if there is a fall in its price.

When demand is price elastic a decrease in price would increase the revenue and rise in price would decrease the total revenue. So producers fix lower price if the demand is elastic.

Inelastic demand [P E D < 1 ]

Percentage change in quantity demanded is less than the percentage change in price. Elasticity is less than one. Example: – The demand for petrol is inelastic. In this case firm’s revenue will increase if there is a rise in price.

Demand curve takes a steep slope. Elasticity < 1

When demand is price inelastic an increase in price would increase the revenue and a decrease in price reduces total revenue. So producers fix higher price for the goods which have inelastic demand in order to earn maximum revenue.

Perfectly (Infinitively) elastic [P E D = ∞]

At the price Op, people are prepared to buy all that they can obtain. They would buy an infinite amount if it were obtainable. Demand is said to be perfectly elastic. In this case, the more the individual firm produces the more revenue will be earned.

If producer set a price above the existing price the demand becomes zero.

Demand curve will be parallel to the X axis. Elasticity = ∞

Perfectly inelastic demand [P E D = 0]

Demand is said to be perfectly inelastic when the quantity demanded does not respond to any change in price. The more the price rises, the bigger will be the level of consumer expenditure.

Demand curve will be parallel to the Y axis. Elasticity = 0

Unitary Elastic Demand [P E D =1]

Unitary elastic demand means percentage change in quantity demanded is equal to the percentage change in price. Elasticity is equal to one. In this case total consumer expenditure remains constant.

Demand curve will be rectangular hyperbola in shape. Elasticity = 1

When demand is unitary elastic, a rise in price or fall in price has no effect on total revenue

FACTORS AFFECTING PRICE ELASTICITY OF DEMAND

Availability of substitutes
Income spent on the goods
Time period
Habit forming goods
Luxury or necessary good

PRACTICAL IMPORTANCE OF PRICE ELASTICITY OF DEMAND

Helpful to Producers
Important to Monopolists
Helpful to the government
Important in international trade
Consumer expenditure

PRICE ELASTICITY OF SUPPLY

The term price elasticity of supply refers to the way in which the quantity supplied responds to a change in price. In other words it is the rate of change or responsiveness in supply due to change in price

TYPES OF PRICE ELASTICITY OF SUPPLY

Elastic Supply [P E S > 1 ]
Inelastic supply[P E S < 1 ]
Perfectly elastic supply [P E S =∞ ]
Perfectly inelastic supply [P E S = 0 ]
Unitary elastic supply [P E S =1 ]

FACTORS AFFECTING PRICE ELASTICITY OF SUPPLY

Supply is elastic when firms can easily and quickly change the amounts supplied in response to a change in price. Supply is inelastic when the quantity supplied cannot be easily and quickly changed when price changes. Following factors determine the elasticity of supply.

Whether or not there is any excess capacity
Storage facilities
Availability of resources
The level of stocks
Manufactured goods and agricultural products

USEFULNESS OF PRICE ELASTICITY OF SUPPLY

A supplier will be willing to supply more into the market when prices are higher. This is because they can generate more revenue.
A good’s supply tends to be elastic if it can be supplied easily into the market and inelastic if it cannot be easily supplied into the market.
So, a producer has to try to find some ways to make those goods which have inelastic supply to elastic.
This can be done through storage facilities, excess capacities and easy supply of raw materials. As a result, the firm can sell more and generate more revenue.

MARKET FAILURE

This occurs when the market economy fails to allocate the resources efficiently

REASONS FOR MARKET FAILURE

No provision of public goods
Under provision of merit goods
Over provision of demerit goods
Monopoly power
Imperfect information
Inequality
Ignores social costs

GOVERNMENT INTERVENTION TO CORRECT MARKET FAILURE

Taxation
Subsidies
Regulation

PRIVATE AND SOCIAL COSTS AND BENEFITS

PRIVATE COST: – This is the cost to an individual or to a firm regarding an economic activity. Eg. Cost of buying cigarettes, illness caused by cigarettes.
PRIVATE BENEFIT: – This is the benefit to an individual or to a firm regarding an economic activity. Eg, salary gained by teaching
EXTERNAL COST:- This is the cost or negative effects to third parties other than producers and consumers regarding an activity Eg illness and smell to non-smokers due to smoking
EXTERNAL BENEFIT: – This is the benefit or positive effects to third parties other than producers and consumers regarding an activity. Eg. Jobs available
EXTERNALITIES: – It can also be defined as the effects to third parties.
SOCIAL BENEFIT: – Social benefits include the sum of private benefits and external benefits. Eg benefits to the country of having high qualified and educated citizens.
SOCIAL COST: – Social costs are the sum of private cost and external costs. Eg pollution and global warming due to factories and cancer and other dangerous diseases caused due to smoking

PRIVATE EXPENDITURES AND PUBLIC EXPENDITURES

EXPLOITATION AND CONSERVATION OF RESOURCES

UNIT -3

Functions of money, commercial banks, central banks and stock exchange
Labour market and trade unions
Division of labour
Income spending saving and borrowing
Business organization
Demand for factors of production
Labour intensive and capital intensive
Production and productivity
Costs and revenue
Profit maximization and other goals
Market structures
Size of firms
Integrations
Economies and diseconomies of scale

MONEY

FUNCTIONS OF MONEY	CHARACTERISTICS OF MONEY
Medium of exchange Measure of value (unit of account) Store of value Standard for deferred payment	Acceptability Durability Portability Divisibility Scarcity

BANKING AND STOCK EXCHANGE

LABOUR MARKET

FACTORS AFFECTING

DEMAND FOR LABOUR	SUPPLY OF LABOUR
Wages Productivity Demand for product (derived demand) which means factors are demanded due to high demand for goods Education and skill level	Wages Working population Total population Other wage and non-wage influence

INDIVIDUAL CHOICE OF OCCUPATION

WAGE FACTORS	NON-WAGE FACTORS
Basic pay Overtime Bonus Commission Piece rate/time rate	job satisfaction type of work/working conditions working hours size of the firm career prospects/opportunity for promotion fringe benefits number/length of holidays pension scheme job security location of job/distance and time to travel

CHANGES IN EARNINGS FOR AN INDIVIDUAL OVER THEIR LIFE TIME

Entry to the work force, wages usually low
Skilled , experience, promotion will increase wage
End of career or with retirement, wages fall

DIFFERENCE IN EARNINGS

DIFFERENT GROUP OF WORKERS	REASONS FOR THE DIFFERENCE
Skilled vs Unskilled	Skilled workers are greater in demand compared with unskilled workers which push up their wages. Skilled workers are less in supply compared with unskilled workers which may again push up their wages. Skilled workers are more productive compared with unskilled workers.
Male vs Female	Male workers receives higher wages than female on average Female workers are less productive on an average (due to maternity break) Some occupations, female workers are high in demand such as modeling, cabin crew. In some occupations, supply of female workers is higher- for example in Maldives, Teaching and nursing.
Public vs Private sector	Differences in demand and supply may cause difference in wages- for example in some countries, government demand more of the workers and in other occupations, supply of workers in private sectors are high. Job securities in both sector might make a difference Overtime and job satisfaction in both sectors might make a difference. Relative strength of trade union in one sector might make a difference Skills needed and training period might make a difference Type of work in different sector might make a difference.
Primary vs Secondary vs Tertiary sector	In primary sectors, wages are lower since the level of training required is relatively less. Level of output and income from primary production is also less Secondary sector occupation receives higher wages than primary because level of training required is more The demand for the secondary work is also high because secondary productions are greater than primary production. Secondary jobs are subject to different payment scheme such as piece rates which might push up their wages. However, tertiary occupation receives higher wages on average compared with secondary because secondary jobs are repetitive. Tertiary occupations receives higher wages because level of training and demand for services are now a days higher than any other sector. However, type of work, relative trade union strength can also make a manufacturing worker receiving a higher wage compared with a tertiary sector worker.
GENERALLY	Demand and supply Education and training Risky jobs Special talents Payment scheme Trade union power

TRADE UNION

An association of workers formed to protect and promote the interest of their members mainly through collective bargaining.

Collective bargaining is the official negotiations between trade union officials and employer.

FUNCTIONS OF TRADE UNION	they exist to protect the interests of their members gain appropriate wage/salary increases; idea of collective bargaining job security working conditions/health and safety dismissal/redundancy Possible influence on government at national level.
WHY SOME NOT BELONG TO A TRADE UNION?	union doesn’t exist in a particular line of work person is self-employed cost of annual fee/subscription is expensive worker doesn’t agree with views/actions of union employees are satisfied with their pay and working conditions They are illegal in some countries.
ADVANTAGES TO THE WORKER	a trade union will provide a worker with more collective strength this could be helpful in negotiating wage rises improvements in worker conditions a trade union may provide a member with a range of other benefits , e.g. training/ subsidized part-time education courses in some countries trade unions provide members with unemployment benefits a trade union may influence a government , e.g. to increase a minimum wage which workers can benefit from
DISADVANTAGES TO THE WORKER	the trade union(s) in a particular industry may not be very powerful especially if membership is low finance is limited the cost of membership may be expensive there may be difficulties in being a trade union member in some countries/some governments discourage trade union membership industrial action can be disruptive a worker may not receive an income while on strike a worker may lose her/his job as a result of industrial action
ADVANTAGES TO THE FIRM	 may encourage more workers to apply for jobs as they may expect better working conditions/job security Reduce the cost of negotiations Provides a channel of communication Promote training Help to reduce conflicts
DISADVANTAGES TO THE FIRM	May push up the wages and total cost May reduce flexibility May take industrial action
ADVANTAGES TO THE /GOVERNMENT ECONOMY	Improve pay and living standard of workers Reduce government cost of regulating the labour market
DISADVANTAGES TO THE /GOVERNMENT ECONOMY	Create unemployment Create inflation Reputation problems Revenue of firms decrease

DIVISION OF LABOUR

A technique of breaking down the production into a large number of specialized tasks

ADVANTAGES	DISADVANTAGES
Increased productivity Saving time More employment Automation Practice makes perfect	Monotony and boredom Loss of other skills Risk of unemployment

INCOME SPENDING, SAVING AND BORROWING

Types of Income

Original income: – The total amount of money earned by an individual from all the sources.
Disposable income: – The total income left for spending and saving after all deductions such as income tax, insurance, pension etc. are deducted and social security benefits are added.
Real income: – The purchasing power of money income which means the total quantity of goods and services money income can buy.

REASONS FOR SPENDING	Disposable income Credit facilities Lower interest rates Education and health Inflation and expected future price
REASONS FOR SAVING	 Higher interest rates Disposable income A fear that income may fall in future Higher education Future purchase Unforeseen expenses
REASONS FOR BORROWING	Lower income Financial difficulties Spending beyond their means Lower interest rates on borrowing Immediate purchases Ability to repay Able to provide more security Needs money for a short period of time

INCOME AND EXPENDITURE PATTERN

LOWER INCOME EARNERS	HIGH INCOME EARNERS
Spends most of their income, some people spend all. Spends a high % of their income on food and basic necessities. Spends less % of their income on luxuries and entertainment Save very less % of their income. But some lower income earners cannot save. Though they spend a high % of income on food, actual income spend will always be less compared with rich.	Spends a low % of their income on food and basic necessities. But actual amount spend will be more. Spends more % of their income on luxuries and entertainment Can save a high % of their income. Though they spend a less % of income on food, actual income spend will always be more compared with poor

BUSINESS ORGANISATION

Private sector: – A part of the economy where all the economic activities are owned and controlled by private individuals

Public sector: – A part of the economy where all the economic activities are owned and controlled by government.

Nationalization:- changing the ownership of a business from private sector to government.

Privatization :- changing the ownership of a business from government to private sector

SOLE TRADER

PARTNERSHIP

PRIVATE LIMITED COMPANIES

Formation of companies

Promoters with the help of a lawyer submit two documents (memorandum of association& articles of association) to registrar of companies
Memorandum of association includes external information of the company and articles of association includes internal information
Statutory declaration is issued by the registrar which indicates that the documents are true
After that certificate of incorporation is issued to start the business. However, public limited companies should obtain certificate of trading.

PUBLIC LIMITED COMPANIES

COOPEARTIVE SOCIETIES

PUBLIC CORPORATION

MULTINATIONALS

DEMAND FOR FACTORS OF PRODUCTION

Demand for the final goods
Price of each factor
Price of the final good

LABOUR INTENSIVE AND CAPITAL INTENSIVE

Using more labours than machines in the production process is known as labour intensive
Using more machines than labours in the production process is known as capital intensive

PRODUCTION AND PRODUCTIVITY

Any activity designed to satisfy human want is production
Measure of efficiency of production is productivity

COSTS AND REVENUE

PROFIT MAXIMISATION

A principle of increasing the total profit by maximizing the difference between total cost and total revenue.

OTHER BUSINESS GOALS

Growth
Sales
Survival
Welfare
Charities

MARKET STRUCTURES

DIFFERENCES BETWEEN

MONOPOLY	PERFECT COMPETITION
Single supplier Price maker Not homogenous products No perfect knowledge Huge barriers to entry Supernormal profit	Many sellers Price taker Homogenous products Perfect knowledge No barrier to entry Normal profit

FIRMS

HOW TO MEASURE SIZE

Market share/ Level of profit
Type of business
Capita
Employees

INTEGRATION

ECONOMIES AND DISACONOMIES OF SCALE

RETURNS TO SCALE

INCREASING RETURNS TO SCALE – When inputs are doubled, output is more than doubled
DECREASING RETURNS TO SCALE – When inputs are doubled, output is less than doubled
CONSTANT RETURNS TO SCALE – When inputs are doubled, output is constant