UNIT -1
CONTENTS
- 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
CONTENTS
- 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
CONTENTS
- 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 |
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BANKING AND STOCK EXCHANGE
LABOUR MARKET
FACTORS AFFECTING
| DEMAND FOR LABOUR | SUPPLY OF LABOUR |
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INDIVIDUAL CHOICE OF OCCUPATION
| WAGE FACTORS | NON-WAGE FACTORS |
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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 |
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| Male vs Female |
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| Public vs Private sector |
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| Primary vs Secondary vs Tertiary sector |
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| GENERALLY |
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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 |
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| WHY SOME NOT BELONG TO A TRADE UNION? |
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| ADVANTAGES TO THE WORKER |
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| DISADVANTAGES TO THE WORKER |
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| ADVANTAGES TO THE FIRM |
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| DISADVANTAGES TO THE FIRM |
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| ADVANTAGES TO THE /GOVERNMENT ECONOMY |
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| DISADVANTAGES TO THE /GOVERNMENT ECONOMY |
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DIVISION OF LABOUR
A technique of breaking down the production into a large number of specialized tasks
| ADVANTAGES | DISADVANTAGES |
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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 |
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| REASONS FOR SAVING |
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| REASONS FOR BORROWING |
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INCOME AND EXPENDITURE PATTERN
| LOWER INCOME EARNERS | HIGH INCOME EARNERS |
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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 |
|
|
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
