Introduction To Microeconomics

@ Mr K Chabveka MICROECONOMICS NOTES
INTRODUCTION TO MICROECONOMICS
 Human needs and wants are unlimited meaning people will never reach a point of
maximum satisfaction even if they are to be given all the resources of the world.
 People by nature always demand more to less. Resources of the world are not enough
to satisfy human needs and wants.
 Economics is therefore available to device different ways of allocating scarce
resources to try to satisfy people needs and wants.
 Economics is defined in different ways by different authors’ but they all agree on the
fact that economics is all about finding ways of allocating scarce resources.
 Economics is a social or human science that deals with the allocation of scarce
resources among the competing ends to satisfy human needs and wants.
 Scarcity-resources are scarce on the sense that they are not enough to fulfil
everyone’s needs and wants to the point of satiety. The economists’ job is to evaluate
the choices that exist from the use of these resources.
 A social science is the scientific study of human behaviour. Other examples of social
sciences are psychology, politics and sociology.
SCIENTIFIC METHOD
 Both physical and social sciences follow a scientific method of study. The method
involves forming a hypothesis, or idea, which can then be tested.
 In the physical sciences, the hypothesis can be tested repeatedly in a laboratory until it
is proved or disproved. It uses empirical data; that is, factual information.
 A hypothesis in a social science can be tested through using methods such as a survey
or through observation.
TWO ASSUMPTIONS IN ECONOMICS MODEL BUILDING
1. Ceteris paribus-is a Latin expression that means ‘other things equal’. Another way of
saying this is that all other things are assumed to be constant or unchanging.
2. Rational economic decision-making
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 This means that individuals are assumed to act in their best self-interest, trying to
maximise (make as large as possible) the satisfaction they expect to receive from their
economic decisions.
 It is assumed that consumers spend their money on purchases to maximise the
satisfaction they get from buying different goods and services.
 Similarly, it is assumed that firms (or producers) try to maximise the profits they
make from their businesses; workers try to secure the highest possible wage when
they get a job; investors in the stock market try to get the highest possible returns on
their investments, and so on.
POSITIVE AND NORMATIVE STATEMENTS
a). Positive statements
 Deal with facts which had already been experienced. They can be proved to be correct
or incorrect by looking at the facts. They can be tested empirically.
 Statistics are available to help prove facts in Economics. For example, the inflation
rate in a country. This data is available to provide past facts and some information
about the future; for example, when the next set of inflation statistics will be
available.
 In addition, they are concerned about what is, was or will be. The evolution of life and
the society is dynamic and several experiences are encountered and it is “positive
statements” which would analyse these experiences.
b). Normative Statements
 Depend on our value judgements, i.e, what is good or bad and how things should be.
They cannot be tested empirically. For example the statement, ‘unemployment is a
worse problem than inflation’ is both a matter of opinion and involves a value
judgment.
 A person’s opinion cannot be proved to be right or wrong. The economist traditionally
does not make value judgments while analysing problems.
What we want to happen and what really happens are two different issues. What we
want to happen is normative and what really happens is positive.
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 For example, “what policies will reduce unemployment?” and “what policies will
prevent inflation?” are positive ones, while the question “Ought we to be more
concerned about unemployment than about inflation?” is a normative one.
 The statement “A more equal distribution of income would increase national welfare”
is a normative statement, while “An increase in government spending will reduce
unemployment and increase inflation” is a positive one.
 In some cases normative statements normally contain the words; should, ought to,
might and positive include statistics or any form of measurement.
MICROECONOMICS AND MACROECONOMICS
a). MICROECONOMICS
 Micro economics is the part of economics concerned with individual units such as a
person, a household, a firm, or an industry.
 At this level of analysis, the economist observes the details of an economic unit, or
very small segment of the economy, under a figurative micro-scope.
 In micro economics we look at decision making by individual customers, workers,
households, and business firms.
 We measure the price of a specific product, the number of workers employed by a
single firm, the revenue or income of a particular firm or household, or the
expenditures of a specific firm, government entity, or family.
 In microeconomics, we examine the sand, rock, and shells, not the beach.
b). MACROECONOMICS
 Examines either the economy as a whole or its basic subdivisions or

aggregates, such as the government, household, and business sectors.
 An aggregate is a collection of specific economic units treated as if they were
one unit. Therefore, we might lump together the millions of consumers in the
economy and treat them as if they were one huge unit called “consumers.”
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 In using aggregates, macroeconomics seeks to obtain an overview, or general

outline, of the structure of the economy and the relationships of its major
aggregates.
 Macroeconomics speaks of such economic measures as total output, total
employment, total income, aggregate expenditures, and the general level of
prices in analysing various economic problems.
 No or very little attention is given to specific units making up the various
aggregates. Figuratively, macroeconomics looks at the beach, not the pieces of
sand, the rocks, and the shells.
 The micro–macro distinction does not mean that economics is so highly
compartmentalized that every topic can be readily labelled as either micro or
macro; many topics and subdivisions of economics are rooted in both.
PITFALLS IN ECONOMICS REASONING
a). Fallacy of Composition
 Is the assumption that what is true for one individual or part of a whole is necessarily
true for a group of individuals or the whole.
 This is a logical fallacy called the fallacy of composition; the assumption is not
correct.
 a single cattle ranch can increase its revenue by expanding the size of its livestock
herd. The extra cattle will not affect the price of cattle when they are brought to
market.
 But if all ranchers as a group expand their herds, the total output of cattle will increase
so much that the price of cattle will decline when the cattle are sold.
 If the price reduction is relatively large, ranchers as a group might find that their
income has fallen despite their having sold a greater number of cattle because the fall
in price overwhelms the increase in quantity.
b). Post Hoc Fallacy
 If event A precedes event B, A is the cause of B. This kind of faulty reasoning is

known as the post hoc, ergo propter hoc, or “after this, therefore because of this,”
fallacy. Noneconomic example:
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 A professional football team hires a new coach and the team’s record improves.
Is the new coach the cause? Maybe. Perhaps the presence of more experienced and
talented players or an easier schedule is the true cause.
 The rooster crows before dawn but does not cause the sunrise.
 Correlation but not Causation. Do not confuse correlation, or connection, with
causation.
 Correlation between two events or two sets of data indicates only that they are
associated in some systematic and dependable way.
 For example, we may find that when variable X increases, Y also increases. But this
correlation does not necessarily mean that there is causation—that
increases in X cause increases in Y.
 The relationship could be purely coincidental or dependent on some other factor, Z,
not included in the analysis.
TOOLS IN ECONOMIC ANALYSIS
a). Quantitative Data Collection Techniques/ Methods
 They rely on random sampling and structured data collection instruments that fit
diverse experiences into predetermined response categories.
 They produce results that are easy to summarize, compare, and generalize.
 Quantitative research is concerned with testing hypotheses derived from theory and/or
being able to estimate the size of a phenomenon of interest.
 Depending on the research question, participants may be randomly assigned to
different treatments.
 If this is not feasible, the researcher may collect data on participant and situational
characteristics in order to statistically control for their influence on the dependent, or
outcome, variable.
 If the intent is to generalize from the research participants to a larger population, the
researcher will employ probability sampling to select participants.
Strategies of Quantitative Data Collection Techniques
 Administering surveys with closed‐ended questions (e.g., face‐to face and telephone
interviews, mail questionnaires, etc.)
 Experiments.
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 Observing and recording well‐defined events (e.g., counting the number of patients
waiting in emergency at specified times of the day).
 Obtaining relevant data from management information systems.
1. SURVEYS
Survey Methods
a) Questionnaire
 Is simply a list of questions or forms to be completed.

 When properly constructed, a questionnaire can be used as a scientific instrument to
obtain data from large numbers of individuals.
 Construction of a useful questionnaire that minimizes interfering problems requires
experience, skill, thoughtfulness, and time.
Advantages
 data can be obtained on large numbers of participants quickly and relatively

inexpensively.
 Further, the sample can be very large and geographically representative.
 Often, anonymity can be easily maintained; that is, identifying information is not
associated with the data.
 When constructed properly, a questionnaire provides data that can be organized
easily, tabulated, and analyzed.
 Because of these apparent advantages, the use of the questionnaire is a popular
method
Types of Questionnaires
1. Mail Questionnaires
Advantages
 Can be sent to a large number of people.
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 Saves the researcher time and money compared to interviewing.

 People are more truthful while responding to the questionnaires regarding
controversial issues in particular due to the fact that their responses are anonymous.
 Allow the respondent to answer at their leisure.
Disadvantages
 It is too expensive since Wifi or Internet is needed to have access of email

 Mail surveys take longer than other types of surveys.
 In most cases, the majority of people who receive questionnaires don't return them.
Therefore:
 Over‐sampling may be necessary if doing a one‐time mail out in order to get

enough completed questionnaires to be generalizable to the population.
 Follow‐up reminders to participants encouraging them to complete the

questionnaire maybe necessary, thereby increasing the time and cost to
conduct the study.
 May need to offer incentives to increase response rate.
2. Web- Based Questionnaires
 A new and inevitably growing methodology is the use of Internet based research.
 This would mean receiving an e‐mail on which you would click on an address that
would take you to a secure web‐site to fill in a questionnaire.
Advantages
 This type of research is often quicker and less detailed.

 Very cost effective.
Disadvantages
 Excludes people who do not have a computer or are unable to access a computer.
 Need to have access to email addresses.
 Many worksites have screening mechanisms in place blocking access to employee
emails.
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 The validity of such surveys may be in question as people might be in a hurry to

complete it and so might not give accurate responses.
b). Interviews
 Interviewing is one of the most common methods of collecting information from

individuals.
There are various types of interviews that are used to collect data. These include
structured, semi-structured and unstructured interviews.
 Structured interviews. These are more or less like questionnaires since they consist of
closed ended items. In this kind of interview, the respondents must choose from a
limited number of answers that have been written in advance.
 Semi-structured interviews: These are flexible kind of interviews in which the
interviewer asks important questions in the same way each time but is free to alter the
sequence of the questions and to probe for more information. Some items are
structured while others are open. The respondents are free to answer the questions in
any way they choose.
 Unstructured interviews- These are wholly open ended instrument in which
interviewers have a list of topics they want respondents to talk about but are free to
phrase the questions as they wish. The respondents are free to answer in any way they
choose.
Interviews can be conducted in a variety of ways; for example, by telephone or as a face-to-

face interview using an interview schedule to guide your questions.
What to keep in mind when interviewing
 As a student of research or a practitioner, there are a number of points you need to

observe when conducting an interview:
 Provide time limit for interview,

 Collect demographic information of the interviewee(s)
 Ensure you word the questions clearly,
 Gently probe your respondents for details about their feelings and opinions,
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 Accurately record your interviews by writing detailed notes or by tape-

recording,
 Where appropriate, obtain permission to tape-record the interview from the
respondent,
 Collect demographic information at the end of the interview.
Types of Interviews
a). Face to face interviews
Advantages
 Face-to-face interviews help with more accurate screening. The individual being
interviewed is unable to provide false information during screening questions such as
gender, age, or race. It is possible to get around screening questions in online and
mobile surveys.
 It captures verbal and non-verbal ques, but this method also affords the capture of
non-verbal ques including body language, which can indicate a level of discomfort
with the questions. Adversely, it can also indicate a level of enthusiasm for the topics
being discussed in the interview. Capturing non-verbal ques is not possible in online
or mobile surveys.
 The interviewer is the one that has control over the interview and can keep
the interviewee focused and on track to completion. Online and mobile surveys are
often completed during time convenient for the respondent, but are often in the midst
of other distractions such as texting, reading and answering emails, video streaming,
web surfing, social sharing, and more. Face-to-face interviews are in-the-moment,
free from technological distractions.
 Face-to-face interviews can no doubt capture an interviewee’s emotions and
behaviors. Similar to not being able to capture verbal and non-verbal ques, online and
mobile surveys can also not capture raw emotions and behavior.
Disadvantages
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 Cost is a major disadvantage for face-to-face interviews. They require staffs of

people to conduct the interviews, which means there will be personnel costs.
Personnel are the highest cost a business can incur.
 The quality of data you receive will often depend on the ability of the interviewer.
Some people have the natural ability to conduct an interview and gather data well.
The likelihood of the entire interviewing staff having those skills is low. Some
interviewers may also have their own biases that could impact the way they
input responses. This is likely to happen in hot-topic opinion polls.
b). Telephone Interviews
Advantages
 Less time consuming

 Less expensive
 Researcher has ready access to anyone who has a landline telephone.
 Higher response rate than the mail questionnaire
 Can be fully automated using CATI (Computer Assisted Telephone Interviewing)
saving data processing time.
Disadvantages
 The response rate is not as high as the face‐to‐face interview.

 The sample may be biased as only those people who have landline phones are
contacted (excludes people who do not have a phone, or only have cell phones).
c). Computer Assisted Personal Interviewing
 Is a form of personal interviewing, but instead of completing a questionnaire, the

interviewer brings along a laptop or hand‐held computer to enter the information
directly into the database.
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Advantages:
 Saves time involved in processing the data.
 Saves the interviewer from carrying out hundreds of questionnaires.
Disadvantages:
 Can be expensive to set up.
 Requires that interviewers have computer and typing skills.
2. SAMPLING
Sampling Techniques
 In order to answer the research questions, it is doubtful that researcher should be able
to collect data from all cases.
 Thus, there is a need to select a sample. The entire set of cases from which researcher
sample is drawn in called the population.
 Since, researchers neither have time nor the resources to analysis the entire population
so they apply sampling technique to reduce the number of cases. Figure 1 illustrates
the stages that are likely to go through when conducting sampling.
TYPES OF SAMPLING TECHNIQUES
 Probability or random sampling

 Non- probability or non- random sampling
1. Probability or random sampling

a). Simple random sampling
 The simple random sample means that every case of the population has an equal
probability of inclusion in sample.
Disadvantages
 A complete frame ( a list of all units in the whole population) is needed;
 In some studies, such as surveys by personal interviews, the costs of obtaining the
sample can be high if the units are geographically widely scattered;
 The standard errors of estimators can be high.
b). Systematic sampling
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 Systematic sampling is where every nth case after a random start is selected.
 For example, if surveying a sample of consumers, every fifth consumer may be
selected from your sample.
Advantages
 It is simple
c). Stratified random sampling

 Stratified sampling is where the population is divided into strata (or subgroups) and a
random sample is taken from each subgroup.
 A subgroup is a natural set of items.
 Subgroups might be based on company size, gender or occupation (to name but a
few).
 Stratified sampling is often used where there is a great deal of variation within a
population.
 Its purpose is to ensure that every stratum is adequately represented (Ackoff, 1953).
d). Cluster sampling

 It is where the whole population is divided into clusters or groups.
 Subsequently, a random sample is taken from these clusters, all of which are used in
the final sample (Wilson, 2010).
 Cluster sampling is advantageous for those researchers whose subjects are
fragmented over large geographical areas as it saves time and money (Davis, 2005).
 The stages to cluster sampling can be summarized as follows:
 Choose cluster grouping for sampling frame, such as type of company or
geographical region.
 Number each of the clusters.
 Select sample using random sampling.
e). Multi-stage sampling

 Multi-stage sampling is a process of moving from a broad to a narrow sample, using a
step by step process (Ackoff, 1953).
 If, for example, a Malaysian publisher of an automobile magazine were to conduct a
survey, it could simply take a random sample of automobile owners within the entire
Malaysian population. Obviously, this is both expensive and time consuming.
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 A cheaper alternative would be to use multi-stage sampling. In essence, this would

involve dividing Malaysia into a number of geographical regions.
 Subsequently, some of these regions are chosen at random, and then subdivisions are
made, perhaps based on local authority areas. Next, some of these are again chosen at
random and then divided into smaller areas, such as towns or cities.
 The main purpose of multi-stage sampling is to select samples which are
concentrated in a few geographical regions. Once again, this saves time and money.
2. Non probability Sampling

 It is often associated with case study research design and qualitative research. With
regards to the latter, case studies tend to focus on small samples and are intended to
examine a real life phenomenon, not to make statistical inferences in relation to the
wider population (Yin, 2003).
 A sample of participants or cases does not need to be representative, or random, but a
clear rationale is needed for the inclusion of some cases or individuals rather than
others.
a). Quota sampling

 Is a non random sampling technique in which participants are chosen on the basis of
predetermined characteristics so that the total sample will have the same distribution
of characteristics as the wider population (Davis, 2005).
b). Snowball sampling
 Snowball sampling is a non random sampling method that uses a few cases to help
encourage other cases to take part in the study, thereby increasing sample size.
 This approach is most applicable in small populations that are difficult to access due
to their closed nature, e.g. secret societies and inaccessible professions (Breweton and
Millward, 2001).
c). Convenience sampling
 Convenience sampling is selecting participants because they are often readily and
easily available.
 Typically, convenience sampling tends to be a favored sampling technique among
students as it is inexpensive and an easy option compared to other sampling
techniques (Ackoff, 1953).
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 Convenience sampling often helps to overcome many of the limitations associated

with research.
 For example, using friends or family as part of sample is easier than targeting
unknown individuals.
d). Purposive or judgmental sampling
 Purposive or judgmental sampling is a strategy in which particular settings persons or

events are selected deliberately in order to provide important information that cannot
be obtained from other choices (Maxwell, 1996).
 It is where the researcher includes cases or participants in the sample because they
believe that they warrant inclusion.
MEASURES OF CENTRAL TENDENCY
a). Mean
 It adds up (sum) all of the data values (x) and then divide the result by the number of
values (n).
 It is calculated as follows:
EXAMPLE:
The following are shoe sizes of form 5 Economics students.
8, 7, 5, 4, 5, 9, 5, 6, 6, 8, 7, 8, 6, 7, 7, 7, 8, 6, 4, 8.
Solution
μ=
14
= 5.8
Advantages
 It is rigidly defined.
 It is easy to understand & easy to calculate.
 It is based upon all values of the given data.
 It is capable of further mathematical treatment.
 It is not much affected by sampling fluctuations.
Disadvantages
 It cannot be calculated if any observations are missing.

 It cannot be calculated for the data with open end classes.
 It is affected by extreme values.
 It cannot be located graphically.
 It may be number which is not present in the data.
 It can be calculated for the data representing qualitative characteristic.
b). Median
 The median is that value of the variable which divides the group in two equal parts.
 One part comprising the values greater than and the other all values less than median.
 Median of a distribution may be defined as that value of the variable which exceeds
and is exceeded by the same number of observation.
 The arithmetic mean is based on all items of the distribution, the median is
positional average, and that is, it depends upon the position occupied by a value in the
frequency distribution.
 When the items of a series are arranged in ascending or descending order of
magnitude the value of the middle item in the series is known as median in the case of
individual observation.
 The median value of a set of data is the middle value of the ordered data. That is, the
data must be put in numerical order first.
 If the number of items is even, then there is no value exactly in the middle of the
series. In such a situation the median is arbitrarily taken to be halfway between the
two middle items.
 It is calculated as follows:
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Median = value
Advantages
 It is rigidly defined.
 It is not affected by extreme values.
 Even if extreme values are not known median can be calculated.
 It can be located just by inspection in many cases.
 It can be located graphically.
 It is not much affected by sampling fluctuations.
 It can be calculated for data based on ordinal scale.
Disadvantages
 It is not based upon all values of the given data.

 For larger data size the arrangement of data in the increasing order is difficult process.
 It is not capable of further mathematical treatment.
 It is insensitive to some changes in the data values.
c). Mode
 Is that value of the variable which occurs or repeats itself maximum number of times.
 The mode is most “ fashionable” size in the sense that it is the most common and
typical and is “the value occurring most frequently in series of items
Advantages

 It is not affected by extreme values or sampling fluctuations.
 Even if extreme values are not known mode can be calculated.
 It can be located just by inspection in many cases.
 It is always present within the data.
 It can be located graphically.
 It is applicable for both qualitative and quantitative data.
Disadvantages
 It is not rigidly defined.
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 It is not based upon all values of the given data.

 It is not capable of further mathematical treatment.
DATA PRESENTATION AND ANALYSIS
 Data analysis helps in interpretation of data and answer the research question.
 Data analysis starts with the collection of data followed by sorting and processing it.
 Processed data helps in obtaining information from it as the raw data is non
comprehensive in nature.
 Presenting the data includes the pictorial representation of the data by using graphs,
charts, maps and other methods. These methods help in adding visual aspect to data
which makes it much easier and quick to understand.
1. BAR GRAPHS/ CHARTS
 These are one of the most widely used charts for showing the grown of companies
over a period of time.
 Bar Chart Bar chart consists of separated rectangular bars drawn such that the height
is equivalent to the frequency.
 The bars can be horizontal or vertical. Unlike the pie chart, it is easier to make
comparison of the heights than of sectors.
Example:
Schools Economics students

A 10
B 25
C 15
D 30
17
30
25
20
Series 1
15 Column1
Column2
10
0
A B C D
a). Find
i. Mean, mode and median.
2. HISTOGRAM
 This is similar to the bar chart except that the bars are joined to one another.
 The area of each rectangular bar is proportional to its frequency.
 The line joining the midpoint of one bar to the other is referred to as the frequency
polygon.
Example:
Schools A B C D E F G H
Economics
students 10 25 15 30 26 17 35 24
18
40
35
30 A
B
25
C
20
D
15 E
10 F
G
5
H
0
1 2 3 4
a). Find
i. Mean, mode and median.
3. LINE GRAGH/ CHART
Example:
School A School B School C

2015 15 30 13
2016 23 25 24
2018 27 32 15
2018 17 16 19
19
35
30
25
20 Series 1
Series 2
15
Series 3
10
0
2015 2016 2018 2018
4. PIE CHART
 It consists of a circle, divided into sectors, which are proportional to the data.
 The sum of angles in circle is 360 degrees.
 A total of all cases is found and the percentage of each case is found in relation to 360
degrees. Note:
 Pie chart is usually for not more than five categories.
Example:
SCHOOLS Number of Students

School A 10
School B 25
School C 15
School D 30
20
Number of Students
School A
School B
School C
School D
Show all your calculations.
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ECONOMIC RESOURCES / FACTORS OF PRODUCTION
 Refers to the factors of production which is goods and services primarily needed to
produce other goods and services.
 We have 4 main categories:-
FACTORS OF PRODUCTION
(a) LAND --------reward RENT
 Refers to all the goods provided by the nature.

 It covers items like soil farms and, forests, minerals, etc.
(b) LABOUR --------- reward Salaries or wages
 This refers to human effort both physical and mental helpful in the production of
goods and services.
(c) CAPITAL -------- reward INTEREST
 Consists of all the man made or manufactured inputs, all items needed in the
production process such as premises, equipment, vehicles, factories
(d) ENTREPRENEURSHIP-----reward PROFIT
 refers to skill or art of running a business

 enterprise is divided into 2:
 The act of organising other factors of production to produce goods and
services to meet consumer needs and wants
 Making risks associated with business or economic decisions
NB STUDENTS TO RESEARCH ON RENEWABLE AND NON RENEWABLE

RESOURCES.
THE PRODUCTION PROCESS
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LAND LABOUR CAPITAL
ENTERPRISE
PRODUCTION
GOODS AND SERVICES
SATISFY HUMAN NEEDS AND WANTS
 Resources are never sufficient to meet the unlimited needs and wants
 Economic agents cannot satisfy all the desires and therefore must make choices in
resource allocation.
 The basic economic problem of scarcity brings the basic economic questions,
economic agents should answer.
 Economic agents should make choices by answering the following questions:-
1. What to produce
 Individuals, firms and government cannot produce all the needs.

 They have to choose all the kind of goods they desire most and leave other goods
unproduced.
In what quantities
 They have to decide the quantities of each and every good and service produced.
2. How to produce
 People need to consider the method of production

 The best outcomes can be attained by choosing the least cost methods of production.
When to produce
 It is important to decide the time to provide for goods and services.

 Timing is very important because it minimises wastages if not correctly handled.
3. for whom to produce
 Limited resources cannot produce for all the needs and wants of the people.
 It is important to decide which of the needs and wants are to be satisfied.
THE PRODUCTION POSSIBILTY CURVE/ FRONTIER
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 The economic problem of allocating resources (making choices) in a situation of

scarcity can be illustrated by explaining the concept of the production possibilities
frontier (PPF).
Production Possibilities Frontier (PPF)
 It refers to the maximum combinations of goods and services an economy can

produce efficiently using its available resources and technology within a given period
of time. —
 It is the boundary between the goods and services that can be produced from those
that cannot. —
Assumptions
 The society has a fixed amount of available common resources. i.e., the same limited
resources can be used to produce either of the goods.
 The society has a fixed amount of technology
 Full employment of resources
 The choice is between producing two goods: Machines and Food. All other goods and
services are assumed being the same (ceteris paribus). This assumption is to allow the
use of simple graphical analysis. —
NB. Note that these assumptions are realistic for the short run but not for the long run.
POINT ON PPC CLOTHING FOOD

A 30 0
B 28 5
C 25 10
D 21 15
E 15 20
F 0 25
25
 The PPF curve divides production space into 3 distinct areas,
(1) Points on the PPF curve (points like A, B, C, D, E, and F),

(2) Points on the inside of the curve (points like G), and
(3) Points outside the curve (points like H) —
 Points either on or inside the frontier are attainable with the current level of resources
and technology.
 Points outside the frontier are unattainable with the economy's current level of
resources and technology. We need more than the available resources and technology
to reach there. —
 Because scarcity forces the society to give up one choice for another, the slope of the
PPF will always be negative, reflecting the concept of trade off. —
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 Possibility A shows that all resources are devoted to producing clothes and no
resources are available to produce food. —
 Possibility B shows that if some of the resources are assigned to produce 28 clothes,
the production of food would be 5. —
 The pattern continues on to the possibility F, where all resources are in the production
of food and no resources available to produce clothes. This results in 25 tons of food
and zero clothes. —
 Points on the PPF represent the maximum production (output) we can get when all
resources are fully employed.
 The PPF shows the alternative combinations of the two products that the country can
produce if it fully utilises all of its resources.
 However, if the economy were at point G it would signify that the economy was
under-utilising its resources. There would be unemployed resources and by bringing
those resources into use the economy could move to a position on the curve
such as point D, where more clothing and food could be produced.
 It is clearly sensible for an economy to be on the PPF rather than inside it since at
point G the economy is producing 15 units of clothing and 10 units of food, whereas
at point D the economy is producing 21 units of clothing and 15 units of food. Once
on the PPF it is not possible to increase the production of one of the two products
without reducing the production of the other product.
 So, for example, if the economy were at point D a movement along the frontier to
point E would involve a reallocation of resources.
Increasing Opportunity Costs Of Production
 When additional production of one good involves ever-increasing sacrifices of

another.
Efficiency and Inefficiency
 All of the choices on PPF are efficient although they are not equally desirable. —
Efficiency means
 Producing the maximum output from the available resources used in production.
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 The use of the least-cost methods to produce specific quantity of output.

 Using the fewest resources to produce specific quantity of a good or a service
 Using factors of production in the most productive way.
 All points on the PPF are efficient points.
 We achieve production efficiency if we cannot produce more of one good without
producing less of some other good. —
 With inefficient production, we end up on the inside of the PPF —
 Inefficiency is a result of some unemployed (unused) resources or misallocation (waste,
under-use) of the resources, or both. Misallocation means assigning resources not to their
best use. —
 Point G in the graph above means that the country's resources are not being used
efficiently. At such a point it is possible to produce more of one good without producing
less of the other good.
TRADEOFF —
 Every choice along the PPF involves a tradeoff.

 Changes in production from one point on the PPF to another involve a tradeoff. Some
of one good must be forgone (given up) to gain more of the other good. —
 On this PPF, we must give up some machines to get more food or give up some food
to get more food. Thus, PPF has a negative slope —
 Thus, a country that must decrease production of one good in order to increase the
production of another must be producing on its PPF
OPPORTUNITY COST:
 We have defined the opportunity cost of any action or choice as the highest valued
alternative forgone. T
 he concept of opportunity cost could be made more precise using the PPF. Since there
are only 2 goods, there is no difficulty in working out the best alternative foregone. —
 At point A when we use all the resources to produce machines, foregone food would
become the opportunity cost of using all resources to produce machines. —
 At B, we produce 2 tons of food at the expense of not producing one machine.
Therefore, the opportunity cost of producing 2 tons of food is not producing – giving
up- one machine. —
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 At C, the opportunity cost of producing the 3rd machine is to give up 0.8 ton of food.
 Each additional ton of food produced implies the loss (opportunity cost) of machines.
Likewise, every machine produced implies the loss of some food.
Opportunity Cost Of Producing One Additional Unit
 The opportunity cost of producing one more unit of a good is the marginal cost of that
good. It is calculated as the following
Opportunity cost of producing one more unit =
POINT CLOTHING FOOD POITNS OC of OC of producing

producing one one more unit of
more unit of a food
cloth (MC OF FOOD)
A 30 0 --------- ---------
B 28 5 A and B 2.5 0.4
C 25 10 B and C 1.667 0.6
D 21 15 C and D 1.25 0.8
E 15 20 D and E 0.833 1.2
F 0 25 E and F 1 1
Increasing Opportunity Costs —
 It is difficult to move resources from one industry to another because they are not all
equally productive in all activities. People have different skills and abilities, land is
better suited to some uses rather than others, and the equipment used to make one
good may not be suitable for making another good. —
 Because resources are not all equally productive in all activities, the PPF bows
outward (PPF is concave). —
 The outward bow of the PPF means that as the quantity produced of each good
increase, its opportunity cost increases. —
 The difficulties in transferring factors of production from one industry to another are
so common that we often speak of the law of increasing opportunity cost. This law
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says that we must give up increasing quantities of other goods and services in order to
get more of a particular good. The law is not based solely on the limited use of
resources in areas other than what they are specialized in, but also the mix of factors
of production makes a difference as well.
PRODUCTION EFFICIENCY AND ALLOCATIVE EFFICIENCY
 All points on the PPF represent production efficiency. Production efficiency occurs
when we cannot produce more of one good without giving up some of the other good.
 But which point on the PPF gives the society the best allocation of resources on both
goods (i.e., which point has allocative efficiency)? —
 To determine the optimal (efficient) quantities of each good the society should
produce, we should compare marginal costs and marginal benefits.
The PPF and Marginal Cost —
 The limits to production, which are summarized by the PPF, determine the marginal
cost of each good and service. —
 Marginal cost is the opportunity cost of producing one more unit of a good. Since
marginal cost of producing one more unit of a good equals its opportunity cost,
marginal cost increases as we produce more of that good.
MC MB
Food Food
Preferences and Marginal Benefit —
 People have different preferences.
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 Preferences are description of person's likes and dislikes. To describe preferences

economists use the concepts of marginal benefit.
 Marginal benefit of a good is the benefit received from producing (or consuming)
one more unit of the good. —
 We measure the marginal benefit of a good or service by how much a person is
willing to pay for an additional unit of it.
 The marginal benefit curve shows the relationship between the marginal benefit of a
good or a service and the quantity produced (or consumed) of that good or service.
The more we have of any good or service, the smaller is its marginal benefit and the
less we are willing to pay for an additional unit of it. The curve slopes downward to
reflect the principle of decreasing marginal benefit.
Allocative Efficiency —
 When we cannot produce more of any good without giving up some of the other good
that we value more highly we have achieved Allocative efficiency.
 Allocative efficiency exists when the society has the right quantities of both goods we
prefer this point above all other points on the PPF.
 Allocative efficiency exists where marginal benefit is equal to marginal cost or where
marginal benefit curve intersects marginal cost curve. At this point resources are used
efficiently.
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 At point A in the graph below we can see the marginal benefit of the machines is
greater than the marginal cost. This means the society wants more machines. Thus the
society will transfer some of the resources to produce more machines and less food
 At point C the marginal cost of machine production exceeds the marginal benefit.
This means the society has more machines than necessary. Therefore, resources will
be taken from machine production to produce more food.
 Point B is the optimal point. It is the only point on the PPF that has both production
efficiency and allocative efficiency where marginal benefit of producing the two
goods is equal to the marginal cost. At point B the society produce the right (the
optimal) amount of both goods.
ECONOMIC GROWTH
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 All output combinations outside the PPF are unattainable with the available resources
and technology. At these combinations, we could get more goods and services than
what we are currently capable of producing. To attain these combinations, the two key
factors are
1. Capital accumulation is the growth of capital resources, which includes

human capital (increasing or improving the quality of resources
2. Technological change is the development of new goods and of better ways of

producing goods and services. —
 Any of these changes will shift PPF outward to reach new points. The new PPF would
represent the new efficient allocation of resources and the country now has more of its
goods and services. This is what is called economic growth (or an increase in
production capacity).
 Economic growth is the increase of the output (or income) of the country. It is the
expansion of production possibilities.
 Economic growth increases the well-being (standard of living) of the people, but it
does not overcome the scarcity and cannot avoid the opportunity cost.
 Without economic growth, living standards will decline as the population grows.
The cost of economic growth
 To expand our production possibilities in the future, we must devote fewer resources
to producing consumption goods and more resources to accumulating capital and
developing technologies so that we can produce more consumption goods in the
future.
 Some consumption must be given up today so that more capital goods can be
produced.
 The opportunity cost of more future consumption is the loss of current consumption.
Balanced and Imbalanced Growth
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 If the capital accumulation and /or the advancement in the technology result in an
increase in the production in all sectors there will be a balanced outward shift of the
PPF (balanced economic growth).
 But if there is an increase in the resources and/or new advancement in the technology
that lead to a development of only one sector or one good the growth would be
imbalanced.
 For example if a new technology discovered that makes machine production more
efficient and more productive the PPF outward shift will affect only machine sector
and will not affect the food sector, at least in the short run.
Inward Shift
 When the PPF shifts out, we know the economy is growing. Alternatively, when the
PPF shifts inward, it indicates that the economy is shrinking as a result of a decline in
its most efficient allocation of resources and optimal production capability. A
shrinking economy could be a result of war or natural disaster that results in a
decrease in production or a deficiency in technology which might move the PPF
inward and to the left.
EXERCISES
1. Suppose that the PPF for two goods are
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a) How many points are there in the PPF?

b) Draw the PPF for this society.
c) Is it possible to produce 3 units of food and 9 units of machines? Why? Is it a good
choice?
d) Is it possible to produce 2 units of food and 5 units of machines? Why? Is it a good
choice?
e) Is producing one ton of food and 5 machines attainable? is it efficient?
f) Calculate the opportunity costs of producing food from A to B, B to C, C to D and D
to E.
g) What is the opportunity cost of one machine if the economy moves its production
from points D to C?
h) What is the marginal cost if the economy moves its production from points D to C? i.
What is the opportunity cost of 4 tons of food?
i) Assume a discovery of new technology that will reduce the costs of machine
production, what will happen to the PPF of the society? Draw the new PPF on the
same diagram.
j) How does the PPF illustrate scarcity?
2. We can summarize the major PPF concepts through the points on the following graph:
1. At point A: Society is not able to produce either good because it is so inefficient.
2. At point B: Society is producing inside the PPF1. Society is employing some of its
available resources but not all of them. Some of resources are unemployed, operating
inefficiently, can produce more of X without giving up some of Y. Zero opportunity cost.
3. At points C & D: Society is producing on the PPF1. It is employing the most output
possible with the available resources and technology. Full employment of resources.
Efficient use of resources. Producing more of one good implies producing less of another
good.
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4. At points E & F (on PPF2): Society might be able to produce these combinations if
resources increased or technology improved but cannot produce it with current resources
and technology (of PPF1).
5. At point G: Society might be able to produce this combination if resources increased or

technology improved more than what is available in PPF2.
6. An increase in capacity to produce (i.e., economic growth) can be represented by

movement from C or D to E (or F) [PPF shifts outward] {not from B to C or D; not from C
to D}
7. An increase in unemployment can be represented by movements from C or D to B.
8. Decrease in unemployment (increase in employment) can be represented from B to C or D.
9. A movement from D to C (or from F to E) is a reallocation of resources from X to Y.
10. A shift from PPF1 to PPF2 could be caused by: 1) an increase in quantity of resources, 2)
improve quality of workers and other resources, and 3) improve or discoveries of new
technology.
11. If the opportunity cost producing X was zero at all levels of production, the PPF would
best be represented by a horizontal straight line.
12. If the opportunity cost producing Y was zero at all levels of production, the PPF would
best be represented by a vertical straight line.
13. Any economic backwardness because of wars, natural disasters, a decrease in the
available resources or supply of labor, etc. leads to an inward shift of PPF (e.g., from PPF2
to PPF1).
ECONOMIC SYSTEMS / DIFFERENT ALLOCATIVE MEASURES
 It is a mechanism by which a society allocates the scarce resources.
 An economic system attempts to answer the basic economic questions of what, how,
for whom and when to produce.
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There are 3 basic economic systems:-
 Free market economy
 Command economy
 Mixed economy
1. FREE MARKET ECONOMY or LAISSEZ FAIRE (leave-well alone)
 Is where-by there is a deliberate effort to remove government hands in the economy.
 Adam Smith (18th Century) argued that the government must be a mere facilitator and
the political party ought not to dominate the economy in industrial affairs.-
 The system, strongly discourage government intervention in industries.
 This is based on the ground that if individuals are left to pursue their own self interest
this would benefit them and the society as a whole.
 State interference in business and industry is believed only to lead to malfunctioning

of the market system and a reduction in the production of goods and services and real
wealth of societies.
 In this system resources are allocated through the price mechanism (invisible hand)
which is the use of prices to determine by the forces of demand and supply.
 This means that individuals as consumers freely choose what they want to purchase
and producers freely decide what they want to provide.
CHARACTERISTICS
i. In its extreme sense it comprises the private sector only.
ii. Individuals and firms determine resource allocation.
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iii. Limited or no government interference/ involvement in production, distribution and

consumption decisions (allocation of scarce resources).
iv. Private ownership of F.O.P.
v. Freedom of choice and enterprise.
vi. A highest level of consumer sovereignty (consumer is a king and recognised).
vii. Individuals and businesses pursue maximum profits (profit maximisation). They are
in business to make profits.
viii. There is highest level of competition
ix. Relative efficiency in production and allocation of resources.
x. The allocation of resources is via the invisible hand otherwise known as price
mechanism.
xi. Price plays a crucial role in the allocating of resources.
xii. Price answers all the basic questions of production i.e. what, how, when and for
whom to produce.
NB - Productive efficiency is the ability to produce given out put at the lowest possible
cost.
 Allocative efficiency is the ability to produce goods needed by the society.
How resources are allocated in a Free Market Economy
 In a free market economy resources are allocated through the use of price mechanism.
 Price mechanism refers to the use of market prices determined by demand and supply
to answer the basic economic question (BEQ).
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ROLES OF THE MARKET PRICE
 Market price plays very important roles in resource allocation in a free market
economy.
The functions are as follows:
1) Allocative role
 The price tells the producers where to direct their scarce resources.
 It is the price that tells the producers the kind of goods and services to provide.
 In this economy, resources are directed towards the most rewarding undertakings.
 In playing this role, the price answers the questions of what to produce and in what
quantities.
2) Functioning role
 The price rations out scarce resources.
 The price determines / identifies who gets how much.
 In situations whereby a commodity is in short supply the price goes upwards until
demand matches supply.
 An increase in price will remove excess demand.
 When supply exceeds demand the price goes down the reason is to avoid unsold
stocks.
 In this role the price answers the questions for whom shall we produce and in what
quantities.
 However in answering these questions, the price mechanism favours the rich at the
expense of the poor majority.
 It results in an unfair distribution of income and wealth thus creating extremes of

riches and poverty.
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3) Signal role
 Changes in prices, is a signal/indication of quite a number of economic variables.
 Prices might change as a result of seasonal changes, changes into the pattern of
demand, changes in technology.
 Changes in price or profits is important to businesses when timing production and

selling.
 Prices tell producers how to produce goods and services and the most appropriate
time.
 The price determines how to produce and when to produce.
ADVANTAGES TO FREE MARKET ECONOMIES
1. High quality goods are produced
 Since individual get into businesses that they desire they get committed to their
work and thereby tend to produce high quality goods.
 There is also high level of competition so producers tend to or are forced to

produce high quality goods to get customers.
2. Reduce monopoly
 There is a tendency of producers charging exorbitant prices if they are the only
ones who produce certain product.
 In a free market economies producers face tense competition and many firms are
in the same line of production so they usually charge competent price which
reduce monopoly.
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3. There is relative productive efficiency
 Since producers aim at maximising profits they produce goods at lowest cost.
4. There is consumer sovereignty
 There is consumer sovereignty that is a market economy allocates scarce

resources according to consumers’ wants.
 “The consumer is the king”. P Samuelson.
 Since consumers are the king have freedom of choice they tend to get the goods
the really need.
 Producers produce according to demand
DISADVANTAGES TO FREE MARKET ECONOMIES
1. Economic Instability
 Due to freedom of entry and exit there are fluctuations in economic activities.
 A firm might make a loss and decide to leave the industry, this leads to instability
in employment and even BOP.
2. Market Failure
 Firms mainly focus on maximisation of profits which might result in minimisation

of society’s needs.
 Goods that have a high turnover are usually not the basics and firms will focus on
those goods in order to attain profits but at the expense of the society.
3. Firm might get low profits than expected.
 Since firms face stiff competition they produce high quality goods to get
consumers and usually charge competitive prices (low)
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 So the cost of production tends to be high and the prices they sell at are usually
lower and this results in low profits
 Also the government can charge high taxes because it is not in business and tax is
the only source of revenue.
4. Inequality
 In a free market economy resources are allocated using the price mechanism.
 When demand exceeds supply the producers increase price of the product so as to
eradicate excess demand (only those who are rich can get the product).
 Therefore there is elimination of the poor from consumption. That is people

without money to pay for certain goods will be eliminated from consumption of
those goods and even basic goods.
 This means the resources will be crowded out of the poor and crowed to the rich
and the rich become richer and the poor poorer.
5. No provision of public goods
 Since the objective of firms operation is to make profits they allocate their goods
using price mechanism, no goods can be provided to the public for free or at a cost
recovery price because this would mean a loss.
 Production is for profit therefore they will be non production of public goods and
under production of merit goods.
6. Exploitation of consumers
 There is likely to be exploitation of consumers through over charging, short

weighing and misleading adverts.
2. COMMAND ECONOMY or CENTRALLY PLANNED ECONOMY
42
 It is an economy in which all businesses or industry activities are determined and

controlled by the state.
 The government through its machinery (apparatus) owns all factors of production
(FOP)
 The government can be directly involved, it can use its agencies or even private sector
can do business on its behalf (working under government directives).
 Supporters of the system argue that it is the government which know what is good for
its individual citizens.
 It is based :-
i. On the public ownership of all economic/ productive resources.
ii. On complete replacement of the price mechanism by the central planning of all
economic activities.
 Production and distribution are centrally planned by a command at the top.
 The bottom consists of hundreds of individually operated but publicly owned firms
whose task is to carry out directives.
 The command economy must still operate with money.
 Prices are necessary to provide the material incentive and to enable flow of goods and
services.
 However prices are not determined by the forces of demand and supply instead prices
are centrally decided.
Characteristics
 All the factor of production are owned and controlled by the government (no private
ownership of F.O.P).
 Prices are centrally decided.
 Government makes all the economic decisions.
 No profit motive (production is for use).
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 Less or no competition
 Production of goods and services that are regarded as essentials.
 There is relative inefficiency
 No freedom of choice and enterprise.
 Low levels of consumer sovereignty.
 Fair distribution of income and wealth.
How Are Resources Allocated?
 In the command economy, it is the government through the state machinery which
answers the basic economic questions.
 This means that all resources are allocated by the government.
 Firstly the government decide on the kinds of goods and services to be produced and
consumed by the citizens.
 The government carries out the survey to find out the needs of the nation as a whole.
 As a result production is mainly of goods and services that are essential for the society
at large.
 In playing this role the government answers the questions what to produce and in
what quantities.
 The government plans both for long and short term objectives of the nation.
 The government decides on all the programs and activities required for the
development and growth of the nation and individuals families.
 It does not only set objectives but how they are to be achieved and a decision on the
resources to be used.
 The path and destination of the economy is solely in the hands of the government.
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 Thus the government answers the questions how to produce, when and what to
produce
 Lastly the government distributes income and wealth of the nation to individual
citizen
 In this role the state’s objective is to attain a fair distribution of the national cake.
 Prices are set by the government, wages are determined by the government and the
government carries out other distributional tactics such as projects for development.
 The objective is to ensure the protection of basic living standards of an average

citizen.
 The government answers the questions of what, how, when and for whom to produce.
Advantages of Command economies
1. Economic stability
 Since the government controls all economic activities, it aims at having a

stable economy other than fluctuations in the economy such as prices, rate of
employment, balance of payment, etc.
 It decides when people should get into business and when to get out.
 Prices are determined by the state.
 It also protects employment interest and trade.
2. Fair distribution of income and wealth.
 The government tries in as much as possible to reduce income gaps between

individuals and to sale goods at a reasonable price affordable to everyone.
 It aims at protecting the living standards and interests of an average citizen, thus
leads to no extremes of the riches to poverty.
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3. Government plans long and short term objectives
 These supplement shortages in case of crisis e.g. Drought, floods.
4. Provision of public goods e.g. street light, public defence etc.
 It also gives some essential goods to the public for free.
5. No completion
 There will be chances of avoiding unnecessary costs e.g. advertising, packing and
branding.
6. Controls market failure
 The government tries to control negative externalities and promote positive

externalities.
 The production and consumption of demerit goods which impose relatively large
social costs on society can be eliminated and prevented.
7. Low taxes
 Only income tax is charged and the government has a source of revenue because it
is in business.
8. There is also management of resources in one pool.
9. There is also production of essential goods.
10. It is also claimed that command economies are likely to be far more stable than
market economies.
Disadvantages of Command Economy
1. No competition
 This might result in production of low quality products and monopoly tendency.
 With no competition producers will be inefficient and thus produce poor quality
goods.
 As a result, resources will be underutilised.
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2. No economic development
 Government sell goods at a cost recovery and there will be no profits to be used in
economic development.
3. No freedom of entry and exit
 Might lead to limited professionalism and skills thus low productivity.
4. Relative productive inefficiency
 Government does not aim at a profit motive and therefore might not be concerned
about reducing costs on the production process and this result in wastage of
resources.
5. Relative allocative inefficiency
 Government produces goods which regards as essential and this might not
probably be what consumers’ wants and may result in un-satisfaction of society.
6. No consumer sovereignty
7. No freedom of enterprise and choice.
8. Reduce drain due to low wages.
9. Complications in planning for the whole economy arise, that is planning is difficult
task and there are too many stages of decision beaureucracy.
10. There is nobody who has power over the government such that if it fails, it is
answerable to nobody.
11. There are no incentives therefore people are not motivated to work.
3. MIXED ECONOMY
 In real life there is nothing like free market economy nor pure command economy.
 Most if not all economies can be classified basically as mixed (capitalists – socialists).
 F.M.E and C.E are theoretical and used as yardsticks (measuring tools).
 They are used to make a better understanding of real life situations.
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 Mixed economies are characterised by varying degrees of private ownership that co-
exist with substantial public ownership and participation in economic activities.
 Resources are jointly owned by the public and private sector e.g. Mexico and Kenya
with others have large and influential public sectors e.g. Zimbabwe, Bangladesh,
Lybia, Egypt, India and Uganda.
 The Zimbabwean economy is a good example of mixed economy because it has both
privately owned firms and parastatals (that produce goods and services that are
perceived to be of strategic importance to the economy).
PRIVATE SECTOR
 It is a section of a mixed economy made up of organisations made up of organisation

owned and controlled by private individuals or group of individuals.
 Resources are allocated thru the free forces of demand and supply.
 The private sector represents the Free Market Economy.
 The presence of the private sector in a mixed economy brings activities of a F.M.E.
PUBLIC SECTOR
 Refers to a section of mixed economy made up of resources of organisations owned

and controlled by the government.
 It is government domain.
ROLES PLAYED BY THE PUBLIC SECTOR
1. MANAGING THE ECONOMY
 It is the role of the government to fine tune economic variables in order to attain
national objectives.
 The government controls the price level, exports and imports, levels of
employment and production, exchange rates, etc. Thru various macro-economic
policies.
48
 The major objective of government in playing this role is to ensure acceptable

level of living standards, economic stability and growth and development.
 The government is the watchdog of public interests.
2. Mobilise and provide resources for social capital.
 Social capital refers to infrastructure of the nation.
 These are important goods and services primarily required to facilitate

development of societies.
 Facilitate development of the societies.
 Bring good road networks, electricity, education and health facilities, good and
reliable safe water and other social amenities.
3. Welfare attention service to the society
 It is the government that takes care of the socially and economically

disadvantaged groups in the economy.
 They need an acceptable life style just like any other citizen.
 The groups include the unemployed, senior citizens, the sick, low income earners
and many other somehow disadvantaged.
4. Correct market failure
 In the mixed economy there is operation of the forces of demand and supply.
 The free forces of D/S cannot however fully and efficiently provide goods and
services in a socially optimal manner.
 To this end the government creates the public sector to fulfil this entrepreneur gap.
Cases of market failure are as follows:-
a) Failure to provide public goods at all
 Public goods have got the following characteristics:-
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- They are provide for free of charge to whoever is to use them
- Public goods are :-
(i) non excludable in consumption
(ii) Non rival in consumption
(iii) Non exhaustible in consumption
(iv) With a free rider problem.
 Public goods are not profitable therefore are not provided at all by the private
sector.
 The government is responsible for the provision of these goods through the public
sector.
b) Control externalities
 There are spill over effects or neighbourhood effects of economic activities which
affect either economic agents negatively or positively.
 Externalities can be positive or negative.
 The government must encourage positive externalities and discourage negative

externalities.
c) Lack of perfect Information
 In the private sector information is not readily and fully available.
 The public sector is responsible for providing essential information to the public.
 The information may relate to prices, availability of goods and services,

conditions of employment, laws and regulation etc.
d) Redistribution of income and wealth
 The desire here is to move towards a more even distribution of national resources.
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 This can be done in gross subsidisation in pricing.
 For instance essential commodities are offered at affordable prices to cater for the
needs of average citizens e.g. GMB, DMB, etc.
 If they were to be left in the hands of the private sector the rural folks would pay
higher prices or the company would simply stop provision because it will be too
expensive.
 Government therefore subsidises to improve accessibility of these essential goods

/ products of high natural value.
e) Resource mobilisation and revenue maximisation
 This is particularly in competitive environments such as banks and insurance

companies.
 Government cannot entirely rely on tax payer but public enterprise.
 Commercial entities supplement government revenue.
 In some circumstances public enterprise have been used to solve forex problems
e.g. those that seek to promote export oriented industries such as EPZ, ZFC,
ZIMRE.
f) Regional development
 The growth with equity policies adopted by Zim in 1982 ought to develop the
underdeveloped areas.
 This has been by organisation such as ARDA.
g) Employment creation
 Government reaches to the extent of buying and supporting ailing firms with a bid
to stop retrenchment and unemployment as was the case of the Mhangura Mine, it
had failed but government supported it to stop retrenchment of employees.
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h) Provision of public utilities(natural monopolies)
 Organisations whose products are essential and politically sensitive, the

government seek to protect their national sovereignty then the provision of public
utilities.
 They are only suppliers of basic commodities e.g. NRZ.
i) Fulfilment of government plans
 Through the public sector, the government is able to meet its developmental
objectives e.g. provision of infrastructure, indigenisation objectives and
nationalisation of publicly owned enterprises.
 These are politically sensitive areas as they determine legitimacy of regime e.g.
ZISCO, EPZ, ZBC.
POSITIVE AND NORMATIVE STATEMENTS
Positive Statements
 A positive statement in general is a statement that is factual.
 Positive economics therefore is economic statements which are objective

statements of facts.
 They are statements about what was, what is and what will be, they assert alleged
facts about the universe in which we live.
 The statement that they are facts does not mean that they are necessarily true
instead they can be true or false.
 With positive statements an experiment can be done to verify whether the

statement is true/false.
 Positive statements are not based on individual opinion, values, interests and
judgement etc.
Examples of positive statements
I. High income tax discourages effort.
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II. People are more worried about inflation than unemployment.
III. The inflation rate of S. Africa is higher than of Zim.
NORMATIVE/NEGATIVE STATEMENTS
 These are statements that are not factual.
 The statements that depend on personal feelings, interests and opinions.
 They are value-laden meaning that they depend on individual value judgement.
 Negative statements are subjective in nature and therefore cannot be settled by

recourse to facts
 Negative statements cannot be proved or disproved.
Examples of negative statements
i. Capitalism exploit workers
ii. Government shall tax the rich and help the poor.
iii. Technological change is bad because it puts some people out of work.
iv. Murders deserve to die/ death penalty reduces the number of murderers.
NB : Positive statements are statements of facts, they tell us what as, what is and what will be
and are therefore objective. On the other hand negative statements express one’s personal
feeling concerning what ought to be.
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THEORY OF DEMAND
 DEMAND is the amount of goods or services that consumers are willing and able
to buy at a given price over a specified period of time.
 It is the willingness of consumers to buy goods and services at given price over a
given period of time
 From the above definition it is important to observe and note the following :
 Demand refers to quantity.
 Demand is done by consumers
 Demand is not only desire or willingness rather it is desire backed by the ability to
pay for the goods or services.
 This kind of demand is referred to as effective demand.
Effective Demand =willingness + ability
 Demand is different at each price level.
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 Demand refers to a flow of goods – quantities that move over a specified period of
time.
Latent Demand
 It refers to the way dd is defined from a layman’s point of view.
 It is defined as willingness to have a good / services not supported by the ability to

pay for it. Latent demand = willingness only.
 Many people have a desire for many goods and services which they are not able to
pay.
 THUS kind of dd is not important at all to economist and therefore not included in
the business definition of dd.
QUANTITY DEMANDED
 Quantity demanded (qd) is the amount of a good or service consumers are willing and
able to buy at a given price.
LAW OF DEMAND
 States that there is an inverse relationship between the price of goods or service and
quantity.
 It means more goods are demanded at lower price than a higher prices other things
being equal.
 Law of demand states that, “other things being equal, more will be demanded at a
lower price than at a higher price”.
 This describes a negative or inverse relationship between price and quantity

demanded.
Other things being equal (ceteris Paribas)
 It is a phrase that is used as an economic tool to make an economic analysis and

relationships simple and easier to comprehend.
 It means when one factor is under consideration other factors are assumed to
remain unchanged.
 It therefore means one factor’s effect on another variable is analysed at a time e.g. if
we want to analyse the effect of a price change on qd we assume the other
determinants of dd remain unchanged.
 The objection is to analyse the effect of one factor in isolation.

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Demand Schedule
It is the representation of the relationship between qd and the price of a commodity by use of
a table.
Price $ $10 $12 $14 $16 $18
Quantity demanded (qd) 100 80 60 40 20
Units
Demand Curve
 It is a graphical explanation of the relationship between qd of a good and its price.
 A normal dd curve is downward sloping.
 It has a negative slope because of a negative relationship between price and qd.
 As price falls, the quantity demanded rises.
 Conversely, as the price increases the corresponding quantity demanded falls.
 In other words, the demand curve is down sloping from left to right indicating that as
price falls more will be demanded.
 The down sloping demand curve implies that a fall in price from $15 to $12 will lead
to an increase in the number of units demanded from 5 units to 10 units.
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Why the demand curve is downsloping
More is demanded at a lower price than a higher price because:-
1. Consumers prefer cheaper products to dearer ones.
2. At a lower price more goods will be purchased than at a higher price for
instance at $15 one can get 5 cds while at a reduced price of say $5 can get 25
cds. Thus the purchasing power of money increases as prices go down. This
purchasing power can be equated to an increase in real income and hence is
seen as the income effect of a price fall.
3. Consumers tend to substitute cheap products for dear products. For example a
fall in price of butter will provide an incentive to substitute butter for
margarine which is relatively expensive. Purchase of butter will increase as a
result and this is referred to as the substitution effect of a fall in price.
4. Law of diminishing marginal utility / Utility satisfication derived from the

consumption or use of the product. As consumers consume additional units of
a product the additional satisfication derived from that consumption declines.
Thus consumption is subject to diminishing marginal utility hence consumers
will only buy additional units if price is reduced.
Factors that determine level of demand / Factors affecting the demand curve / shifters
of demand
The level of demand of a particular good or service is influenced by a quite a number of

factors.
 The following are some of the factors that determine dd of a good or service:-
1. The price of a good (Px)
- The price of the good itself (Px).
- Basically the higher the price law of dd says the higher the price the lower the
quantity demanded and vice versa.
2. Income effect / changes in household disposable income
- If the price of a good changes the purchasing power of consumers is affected and
therefore the quantity demanded changes.
- Purchasing power (pp) is called real income.
- E.g. if the price falls it means less money is spent on good than before.
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- Consumers are therefore with more real income (purchasing power) can buy more
of the good.
- Even non users (those who were not able to buy) can now afford to buy the good.
- A fall in prices increases the real income/ pp of the consumers
- On the other hand a rise in the price decrease real income / pp and the quantity
demanded (qd) falls.
3. Substitution effect
- There are so many ways of satisfying a want or a need.
- e.g. a desire for vegetables can be satisfied by a cabbage, rape, spinach.
- E.g. a desire to quench thirst can be met by water, soft drink etc.
- It there means that for every good has its own substitutes, thus change in price of a
good will make consumers make comparisons.
- Consumers normally opt for cheaper goods.
- A fall in price of a good will make the good a cheaper way of satisfying a need or
want compared to the substitutes, its dd will increase and the reverse is true.
4. Price of other goods (price of related goods)
- Goods are related.
- In economics there are two important relationships between goods, goods are
either substitutes or compliments.
- Substitutes are good that can be used interchangeably.
- They compete for the same consumer income.
- It means when a consumer buys will forgo the other.
- E.g washing powder and soap, peanut butter and margarine, bread and rice, etc.
- If the price of the one increases its dd will fall because it is an expensive way of
satisfying a need/want as compared to its substitutes.
- The substitutes good’s demand will increase thus in the case of substitute goods
the price of one good and quantity demanded of the other move in the same
direction.
- There is a positive relationship between the two goods.
- Complimentary Goods are goods that are jointly demanded.
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- They are goods that are used at the same time.
- They do not compete for the same income but rather are needed to save the same
need and want at the same time.
- E.g. camera and film, cellphone and sim card, car and fuel, etc.
- If the price of one increases its demand will fall and negatively affect the demand
of the complimentary good.
- Thus the price of one good move in the opposite direction with quantity demanded
of the other good.
- There is a negative relationship between price of one good and quantity demanded
of the other good.
5. Consumer’s Income and wealth
- Income and wealth of the consumers determine the consumer’s purchasing power.
- The greater the size of income and wealth the more consumers can demand a
particular good or service.
6. Consumer’s tastes and preferences
- Consumers can have tastes for or prefer a good thus taste in favour of a good
increases the demand of that particular good.
- On the other hand, tastes can be against a good.
- Taste against a good reduces the demand of the good or service.
- Changing preferences will affect your demand for a product regardless of its price.
7. Population size and structure
- Population size refers to the number of consumers in a given market.
- A high population size is likely to bring more consumers of a given good or

service than a low population size ceteris Paribas.
- Quite obviously, a significant rise in the number of people in a given area or

country will affect the demand for a whole host of goods and services.
- There is a positive relationship between the population size and the quantity
demanded.
- The structure of the population is important as well.
- It refers to the sex or age composition of a given population.
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- Population structure determines the units of a commodity to be demanded in many

ways.
- e.g. a population mainly made of middle aged group has a high marginal
propensity to spend than the one mainly made of senior citizens (old aged).
- Note that a change in the structure of the population (we have an ageing
population) will increase the demand for some goods but reduce the demand for
others.
8. Expectations of future prices.
- If you think that the price for CDs is likely to fall in the near future, perhaps
because of reduced production costs or competition from the US, you may delay
some purchases which will reduce demand in the current time period.
- Alternatively, you may feel that CD prices are likely to rise in the near future,
perhaps due to the lack of competition in the retail market, so you may increase
your demand in the current time period.
OTHER factors
9. Weather or climatic factors.
10. Government policy.
11. Advertising
12. Customs
13. Religion
14. Interest rates
PRICE CHANGES AND QUANTITY DEMANDED
 A change in the price of a good increases or decreases quantity demanded.
 For any product a change in quantity demanded is always caused by a change in price.
 A change in quantity demanded refers to a movement along the existing demand

curve.
 This is in line with the law of demand.
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NB. Changes in quantity demanded are shown as movements along the same demanded
curve as shown above e.g. movement from point C to A along the same demand curve is
described as a change in quantity demanded.
Increase in quantity demanded
- It is reflected by movements down the curve e.g from C, A to B.
- It is caused only by a fall in the price of the good concerned.
- An increase in demand means that more is now demanded at each and every price
than before.
Decrease in quantity demanded
- Is shown by movements up the curve e.g. from B, A to C.
- It is caused by a rise in the price of the good concerned.
- A fall in demand means that less is demanded at each and every price than before.
SHIFTS OF THE DEMAND CURVE
- The demand (dd) curve is drawn on the assumption that it is the price that only
affect quantity demanded (qd/dd).
- However there are many other factors that can change and affect dd for a product.
- A change in one of the other determinants of dd, cause the whole dd curve to shift
to the left or right.
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Shift to the right
- If the dd curve shifts to the right it is called an increase in dd that is a shift from
D1 to D2.
- It reflects an increase in qd at each and every price level.
Reasons for the shift to the right
- Increase in consumer disposable income
- Increasing in or population growth
- Change in tastes and preferences in favour of the good
- Change in season which favours the dd of the good.
- Government policy which support a good or service
- Increace in the price of the substitute.
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- Fall in price of complimentary goods.
Shift to the left
- If the dd curve shifts to the left it is called a decrease in dd that a shift from D1 to
D3.
- It reflects a decrease in qd at each and every price level.
Reasons for the shift to the left
- Decrease in consumer disposable income
- Fall or decreasing in population size or structure.
- Change in tastes and preferences against dd of a good
- Change in season which does not favours the dd of the good.
- Government policy against consumption of a good or service
- decrease in the price of the substitute.
- Increase in price of complimentary goods.
Exceptions of law of demand
 Refers to situation or circumstance that violates the law of demand.
 Exceptional demand curve do not confirm with the law of demand.
 They have a positive slope that is the slope slopes upwards from left to right as
follows.
Exceptional demand curve
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1. The case of Giffen goods
 Giffen goods are special kind of a good with a snob appeal.
 It means a good that is associated with high status, uniqueness or high prestige.
 The price of the good makes it unique, thus the higher the price the higher the good is
demanded by the targeted customers.
 If the price falls, the good became affordable by majority, unique and status
disappears and the dd of the good decreases.
 The giffen goods have an upward sloping dd curve as shown above.
 Example of giffen goods are poshy cars, jewellery and deodorants.
2. Speculative Demand
 Sometimes the law of demand does not hold the truth.
 When people’s dd is determined by speculation.
 Consumers tend to buy more of a product as the price increases if they foresee an
even higher price in the future.
 Eg. If the price of sugar is going up and consumers anticipate an even higher price
they increase the purchase of sugar in order to avoid the higher price in future.
3. Occasional Demand
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 Refers to the demand of a product that respects time of the year or events or occasions
more than the price of the good itself.
 It means people buy a good or service because of the event or occasion taking place
they therefore ignore the direction of change in price.
 E.g. valentine, Christmas, easter.
Questions
ELASTICITY OF DEMAND
TYPES OF ELASTICITY OF DEMAND
1. Price Elasticity of Demand

2. Income Elasticity of Demand
3. Cross Elasticity Of Demand
1. PRICE ELASTICITY OF DEMAND
 Price elasticity of demand measures the responsiveness of quantity demanded to a

change in the price of the commodity. In other words, it shows by how much quantity
demanded has changed given a change in price.
 Price elasticity of demand is calculated as follows:
Price elasticity of demand =
 Price elasticity of demand is always negative, indicating the inverse relationship

between quantity demanded and price.
 Demand for most goods is elastic, inelastic or unitary depending on whether its
coefficient is greater than, less than or equal to one.
 Demand is said to be elastic when a percentage change in price brings about a more
than proportionate change in quantity demanded.
 Hence, an elastic demand occurs when the percentage change in quantity demanded is
greater than the percentage change in price, and the coefficient of the elasticity is
greater than 1 (PED > 1).
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 An elastic demand can be illustrated as follows:
 On the other hand, demand is said to be inelastic when a percentage change in price
brings about a less than proportionate change in quantity demanded.
 Hence, an inelastic demand occurs when the percentage change in quantity demanded
is less than the percentage change in price, and the coefficient of the elasticity is less
than 1 (PED < 1).
 Demand is said to be unitary when a percentage change in price brings about an equal
proportionate change in quantity demanded.
 The coefficient of elasticity is equal to 1 (PED = 1).
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 Demand can also be perfectly elastic when a small percentage change in price brings
about a change in quantity demanded from zero to infinity.
 The coefficient of elasticity is equal to infinity.
 Demand is perfectly inelastic when a percentage change in price brings about no

change in quantity demanded.
 The value of the PED is zero (PED = 0).
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POINT ELASTICITY
 The above diagram shows a demand curve for which the price elasticity of demand is
different at every price.
 It varies according to the level of price. For instance, along the same demand curve,
elasticity is unity at price 0P (mid-point of demand curve), elastic at price 0P1 and
inelastic at price 0P2.
FACTORS INFLUENCING PRICE ELASTICITY OF DEMAND:

 There are various factors which influence the price elasticity of demand.
1. Nature of commodity:
(a) Necessities:
 The demand for necessities is inelastic because when their prices rise, the consumers’
demand will fall very slightly.
(b) Luxuries:
 Demand for luxuries is elastic. If their prices fall, demand will increase by a much
greater percentage, but if their prices rise, consumers will reduce their demand
considerably.
2. Availability of substitutes:
 The closer and numerous availability of substitutes a commodity has, the more will be
its price elasticity of demand, that is, demand is price elastic. This is because if the
price of a commodity rises, consumers would then shift to other substitutes.
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 Thus, the demand for the commodity will fall by a greater proportion. But fewer
substitutes a commodity has, the lower is the price elasticity of demand (inelastic).
However, demand for a group of commodity as a whole has an inelastic demand.
3. Proportion of income spent on a commodity:

 Commodities on which a very low proportion of income is spent, the demand for the
product is inelastic. For example, an increase in the price of match box from 50 cents
to 60 cents (20%) will not reduce quantity demanded to a larger extent.
 On the other hand, commodities on which a large proportion of income is spent, the
demand is elastic.
4. Number of uses of a product:

 A product, which has several uses, has an elastic demand. For example, people use
electricity for many purposes.
 A slight fall in the price of electricity will cause quantity demanded to increase by a
larger extent. Consumers will be in a position to afford its use even for less important
purposes.
 On the other hand, a product, which has a single use, has an inelastic demand, for
example, toothpaste.
5. Habit:
 There are certain goods which people consume because they have developed a habit,
for example, cigarettes for a chain-smoker. Once consumers develop a habit for a
particular commodity, they will continue to demand even if the price increases.
 Thus, the demand for these commodities is inelastic since quantity demanded will
change very slightly to a change in price.
6. Time period:
 Demand tends to be more elastic in the long run than in the short run. This is because
it takes time for consumers to develop satisfactory substitutes. For example, if the
price of petrol rises, consumers will find it very difficult to switch from petrol to
diesel immediately.
 Thus, in the short run, demand for petrol will fall by a smaller percentage.
7. Price of commodity itself:
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 Demand is generally more elastic at higher level of prices than at lower levels. This is
because at a lower price level, consumers can be expected to be already buying as
much of the commodity as he desires.
 Thus, a further decline in price is unlikely to induce him to raise his demand for that
commodity.
RELATIONSHIP BETWEEN ELASTICITY AND TOTAL REVENUE
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Usefulness of PED to a firm/business
 To calculate a firm’s revenue.

 For a firm to know pricing strategies to use/ embark on.
 For a firm to plan carefully its production levels or level of output to produce.
 For a firm to plan on which products to produce i.e. those which give maximum
profits.
 For resource allocation.
 Price elasticity of demand and government policy
 Government levies indirect taxes such as value added tax (VAT) and
excise duty on expenditure in order to raise revenue.
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 To maximize on revenue collected the government should levy a low tax

on goods with elastic demand while laying a high tax on goods with
inelastic demand such as alcohol and cigarettes.
 Price elasticity of demand and monopoly price discrimination
 A discriminating monopolist will maximise total revenue by charging

high price in the market where demand is inelastic and a low price in
the market where demand is elastic.
 For instance, ZESA tariffs in high and low density residential areas or
cell phone peak and off peak call charges
EVALUATION:
 However, the firm cannot only rely on the concept of price elasticity of demand to
increase revenue. The data of price elasticity of demand do not reveal absolute truths.
They are based on survey carried out on small sample of consumers. Hence, they
cannot be completely accurate.
 Moreover, the concept of price elasticity of demand is calculated on the basis of all
other factors affecting demand remain constant. But, in practice, demand keeps
changing due to changes in other factors too.
 Besides, the concept of price elasticity of demand is useful for the producer in order to
increase revenue. But in fact, the producer aims to maximise profits. Hence, the firm
needs to know more about its costs. If the firm faces an inelastic demand curve,
pushing up prices will reduce output, and therefore, costs will fall at the same time.
With revenue rising, and costs falling, profits must go up. But the firm has a more
difficult decision if facing an elastic demand curve. If price is lowered, this will also
increase output, and therefore, costs.
2. INCOME ELASTICITY OF DEMAND (YED)
 The Income Elasticity of Demand (YED) measures the rate of response of quantity
demand due to a raise (or lowering) in a consumer’s income.
Income Elasticity of Demand=
Normal goods:
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 An increase in income leads to an increase in consumption, demand shifts to the right.

Thus YED is positive for normal goods.
Inferior goods:
 Income elasticity is actually negative for inferior goods, the demand curve shifts left
as income rises.
 As income rises, the proportion spent on cheap goods will reduce as now they can
afford to buy more expensive goods. For example demand for cheap/generic
electronic goods will fall as people income rises and they will switch to expensive
branded electronic goods.
 Necessity goods are income inelastic and luxury goods are income elastic.
 Basic or necessity goods have a low income elasticity i.e., 0 < ? < 1. Quantity
demanded will not increase much as income increases (income elasticity for food =
0.2)
 Luxury goods have high income elasticity i.e. ? > 1. Quantity demanded rises faster
than income. For restaurant meals income elasticity is higher than for food, because of
the additional restaurant service.
In different types of economies, the demand for goods and services are determined by the
income elasticity. As economies grow, firms will want to avoid producing inferior goods. The
reason being as income increases more and more people will switch from inferior goods to
superior goods.
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Factors Affecting YED

1. Current standard of living
2. Type of good (normal, inferior)
3. Level of consumer’s income
Usefulness of YED
 For resource allocation. - a knowledge of income elasticity of demand is useful to a

manufacturer as it helps him to plan his sales and allocate resources more efficiently
in order to maximise profits should there be any change in consumer’s income.
 For production levels or level of output to produce
EVALUATION:
 The concept could not reveal accurate information – based on a sample of consumers.
 Demand changes due to changes in other factors too.
3. CROSS ELASTICITY OF DEMAND (XED)
 Cross elasticity of demand measures the degree of responsiveness of quantity

demanded of one commodity to a change in the price of another commodity.
 If two goods X and Y are taken, cross elasticity of demand of X in relation to the
price of Y is calculated as follows:
XED=
 In the case of substitute goods (i.e. goods which can be used in place of another),
CED will be positive i.e. an increase in the price of good A will lead to an increase in
the quantity demanded of good B (and vice versa) e.g. tea and coffee or beef and
pork.
 In the case of complementary goods ( i.e. goods which the use of one will require the
use of another). CED will be negative i.e. an increase in the price of good A will lead
to a fall in the quantity demanded of good B (and vice versa) e.g. cell phone and
airtime, tea and sugar.
 If 2 goods are very close substitutes CED will have a very high positive value.
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 If CED is equal to zero – the goods are not related at all. They are independent goods
e.g. televisions and toilet paper & blankets and sweets.
Usefulness of XED
 For production levels or levels of output to produce.

 For planning on which products to produce i.e. those which yield maximum profits.
 The concept of cross elasticity of demand becomes more relevant in determining price
structure in an oligopolistic market situation where few firms compete with each other.
These firms are interdependent in decision making, and as a result, ignoring cross
elasticity might prove to be disastrous. The concept of cross elasticity of demand allows
the producer to identify whether his product is a complement or a substitute which is
produced by other firms. Hence, he is able to assess the impact of sales and make better
business decisions regarding price and output polices when prices for substitutes or
complements change.
 If the cross elasticity of demand is positive, it means that a cut in price by a rival
business will significantly reduce the firm’s sales. Thus, the cut by others must be
matched with the same to remain competitive. However, to avoid price wars, the
producer could use other policies such as better services, personalised service and
aggressive advertisement.
 On the other hand, if the value of cross elasticity of demand is negative, the producer
must be cautious when supplying the commodities. If the price of its complements
rises, it is not advisable for the producer to increase production.
EVALUATION:
 The concept could not reveal accurate information – based on a sample of
consumers.
 Demand changes due to changes in other factors too.
NB. Take note of the following terms:-
 Joint demand/ Complementary demand i.e demand for complements

 Competitive demand i.e demand for substitutes
 Composite demand - A good is said to be in composite demand if it is demanded for
several uses/different uses e.g. wool would be demanded by the textile industry,
75
blanket manufacturers etc. The demand for such goods are the aggregates of the
demands of the various users.
 Joint supply – this means the production of one good automatically leads to the
output of another e.g. peanut butter and oil, beef and hides, mutton and wool, lead and
zinc.
THEORY OF SUPPLY
 Supply refers to the amount of a good or service firms or producers are willing to sell
at a given price.
 The law of supply states that there is a direct relationship between price and quantity
supplied. When the price of the commodity rises, quantity supplied of that commodity
rises. In other words, more is supplied at higher prices than at lower prices.
 The market supply curve for a certain product is derived from the horizontal
summation of all individuals supply curves at each and every price of the quantity
supplied. Thus, the supply curve is an upward sloping curve from left to right.
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FACTORS INFLUENCING MARKET SUPPLY CURVE:

1. The price of the good itself:
 Changes in the price of the commodity will lead to changes in quantity supplied of
that commodity. For instance, a rise in the price of good X will lead to a rise in
quantity supplied of good X.
 This is because good X is now more profitable and producers supply more of it.
2. Weather / climatic conditions:
 The supply of agricultural products is affected by changes in weather conditions. A

favourable climatic condition may bring bumper (abundant) harvest so that producers
supply more of the agricultural products.
 On the other hand, an unfavourable season which results in a poor harvest may cause
quantity supplied to fall.
3. Technical progress:
 Technical progress means improvements in the performance of machines, labour,

production methods, management control and quality.
 This allows more to be produced and supplied.
4. Changes in the prices / costs of factors of production:
 Movement in wages, prices of raw materials, fuel and power, rents, interest rates and
other factor prices affects the cost of production. For instance, increase in wages paid
to workers increases the cost of production and reduces the profits of firms. Hence,
firms will supply less goods.
5. Government policy – Indirect taxation and Subsidies:
 Governments can also influence supply. If the government wants firms to produce
more, it may give them a subsidy which will lower their costs, boost their profits and
increase supply.
 However, if government imposes indirect taxes on goods and services to the
producers, supply will fall because of the increase in costs of production.
77
Note: Indirect taxes increase cost of production and cause supply to fall (shift to the left),
whereas subsidies reduce cost of production and cause supply to rise (shift to the right).
M0VEMENT ALONG THE SUPPLY CURVE AND A SHIFT IN THE SUPPLY

CURVE:
 A movement along the supply curve occurs when quantity supplied changes because
of a change in the price of the commodity alone, while other factors affecting supply
remain constant.
 A shift in the supply curve or a change in supply occurs when quantity supplied
changes only because there are changes in conditions of supply such as weather
conditions, prices of factor inputs, etc, while the price of the commodity remains
constant.
 The supply curve can shift either to the right or to the left, depending upon the
changes in the conditions of demand. The shift in the demand curve is shown as
follows:
78
ELASTICITY OF SUPPLY
 Price elasticity of supply measures the degree of responsiveness of quantity supplied

to a change in the price of the commodity.
 Price elasticity of supply is calculated as follows:
ELASTICITY OF SUPPLY=
 Price elasticity of supplied is always positive, indicating the direct relationship

between quantity supplied and price.
 Supply for most goods is either elastic, inelastic or unitary depending on whether its
coefficient is greater than, less than or equal to one.
1. Any straight line supply curve that meets the vertical axis (Price axis) will be elastic and its
value is greater than 1.
79
2. A straight line supply curve that meets the horizontal axis (Quantity axis) will be inelastic
and its value is less than 1.
3. Any straight line supply curves passing through the origin whatever the slopes have unitary
price elasticity of supply and its value is equal to 1.
4. Perfectly inelastic supply curve – value of price elasticity of supply is zero.
80
5. Perfectly elastic supply curve - The coefficient of elasticity is equal to infinity. Nothing is
supplied at any price below 0P, while an infinite quantity is supplied at price 0P.
FACTORS INFLUENCING PRICE ELASTICITY OF SUPPLY:
 The extent to which supply is elastic or inelastic depends upon the flexibility or
mobility of the factors of production. If production can be expanded very easily and
rapidly, supply is elastic. Otherwise, supply is inelastic.
1. Time periods:
 The elasticity of supply tends to be greater in the long run than in the short run
because it is easier to increase the amount produced when the firm has more time in
which to do it.
 It may be difficult to change quantities supplied in response to a price increase in the
short run.
 This is obvious if one considers agricultural products. Suppose that the price of an
agricultural product rises unexpectedly. There is little that farmers can do to supply
more agricultural products because it takes time to grow them. Thus, the supply of
agricultural products tends to be inelastic in the short run.
 However, supply is elastic in the long run since the long run offers opportunities to
expand output that are not available instantaneously.
81
2. Availability of resources:
 If a firm wishes to expand production, it will need more resources. If the economy is
already using most of its scarce resources, then firms will find it difficult to employ
more, and therefore, output will not rise.
 Hence, supply of most goods will be inelastic.
 If, however, there is unemployment of resources, firms can easily raise output, and in
this case, supply is elastic.
3. Availability of stocks:
 When suppliers are holding large stocks, supply will be elastic. This is because any
increase in demand can be easily met by running down the stocks.
 However, once the stocks are depleted, it may be very difficult to increase output, and
therefore, supply will be inelastic.
4. Producing at full or below capacity:
 In some industries the expansion of capacity takes a long time. Once such industries
operate at full capacity, supply will be inelastic.
 However, if industries operate below full capacity, supply will be elastic.
5. Risk taking:
 The more willing entrepreneurs are to take risks the greater will be the elasticity of
supply. This will be partly influenced by the system of incentives in the economy.
 If the rates of taxes are very high, this may reduce the elasticity of supply.
82
EQUILIBRIUM PRICE AND HOW IT IS SET IN A FREE MARKET:
 Equilibrium price relates to the price at which the quantity demanded equals the
quantity supplied.
 Equilibrium price refers to a state of rest or a state of balance where there is no
tendency either to expand or to contract.
83
 In other words, there are neither excesses nor shortages of commodities in the market.
Since free market implies no government intervention, the price of any commodity in
the free market is determined by the combined forces of demand and supply.
 Hence, there is an equilibrium price where demand is equal to supply, that is what
consumers wish to buy is equal to what producers wish to sell.
 With a downward sloping demand curve and an upward sloping supply curve,
equilibrium price occurs when these two schedules intersect as shown below:
 The equilibrium price is 0P and quantity traded is 0Q. At any other prices, there is
disequilibrium and this is corrected by reactions to the price level. For instance, any
prices below the equilibrium price, say 0P1, there is shortage of goods and market
forces will push up the price until demand is equal supply [Producers expand their
supply, while consumers contract their demand].
 On the other hand, any prices above the equilibrium price, say 0P2, there is excess of
commodities and market forces will push down the price towards the equilibrium
[Producers contract their supply, while consumers expand their demand].
 However, this equilibrium price is allowed to change due to changes in demand and
supply conditions. For instance, with an increase in demand due to an increase in
income or a successful advertising campaign, there will be an increase in both the
equilibrium price and quantity traded. This is illustrated as follows: 2
84
 With an increase in demand shifting the demand curve to D1D1, at the prevailing
price 0P, there is a shortage Q2Q which causes an upward pressure on the equilibrium
price to 0P1. A similar analysis will prove that a decrease in demand will cause a fall
in both equilibrium price and quantity traded.
 Assume no change in demand, an increase in supply due to a fall in cost of production
will cause a fall in equilibrium price but an increase in quantity traded. This is shown
as follows:
 With the rightward shift in supply curve to S1S1 following an increase in supply, at
the prevailing price 0P, there will be a surplus Q3Q. This will cause a downward
pressure on the equilibrium price to 0P2.
85
 A similar analysis will prove that a decrease in supply will cause a fall in quantity
traded but a rise in the equilibrium price.
CONSUMER SURPLUS:
 Consumer surplus is the difference between the amount consumers are prepared to
pay to obtain a particular good and the amount they actually pay in the market.
 It is a measure of the surplus utility or welfare consumers receive over and above
what they pay for.
Consumer surplus = Total utility – Total amount spent.
 The market price (the price actually paid by the consumer) is 0P and market quantity
is 0Q. But at this quantity 0Q, total amount that the consumer is prepared to pay (total
utility) is 0ABQ, but actual total amount spent is 0PBQ.
 Thus, consumer surplus is given by the area of the triangle PAB.
 Consumer surplus may change due to changes in demand and supply conditions. For
instance, an increase in supply causes price to fall. As a result, consumer surplus rises.
This can be illustrated as follows:
86
 At the initial equilibrium price is 0P, consumer surplus is represented by the area
PKA. A rise in supply to S1S1 causes equilibrium price to fall to 0P1 and quantity to
rise to 0Q1, thereby, causing a rise in consumer surplus to KP1B.
 In fact, consumer surplus increases by PABP1.
 It increases because of the fall in price. On the other hand, a fall in supply causes
equilibrium price to rise, and hence, a fall in consumer surplus.
 Similarly, a change in demand conditions may also change consumer surplus. But, the
change depends upon the price elasticity of supply.
 If demand increases and supply is elastic, consumer surplus may increase because the
price will not rise much when demand rises.
 When demand rises to D1, consumer surplus changes from PAC to P1A1E. Since the
increase in price is less than the increase in demand due to elastic supply, consumer
surplus increases.
87
 On the other hand, when supply is inelastic, consumer surplus may even fall because
the price will rise significantly with a rise in demand. Besides, the change in
consumer surplus depends upon the price elasticity of demand. Consider the following
diagrams when demand is inelastic.
 When demand for a good is inelastic, consumer surplus is high. Thus, when demand
is perfectly inelastic, consumer surplus is maximum.
 On the other hand, when demand for a good is elastic, consumer surplus is low.
Hence, when demand is perfectly elastic, there is no consumer surplus. This can be
illustrated as follows:
PRODUCER SURPLUS
 Is the difference between the price a producer is willing to accept and what is actually
paid
 Producers are very keen to supply consumers who are willing to pay a price above
that which they would normally be prepared to accept.
88
 Producer surplus is shown by the shaded area above the supply curve but below the
price line at P2. Anything the firm sells below price P2 is because it is willing to sell
to consumers at that price.
TAX INCIDENCE
 When a tax is levied on a good, this has the effect of shifting the supply curve
upwards by the amount of the tax.
 In order to persuade producers to produce the same quantity as before the imposition
of the tax they must now receive a price which allows them fully to recoup the tax
they have to pay (i.e. P1 + tax)
The effect of a tax on price and quantity
 The effect of the tax is to raise price and reduce quantity.

 Price will not rise by the full amount of the tax, however, because the demand curve is
downward sloping. Price rises only to P2.
89
 Thus the burden or incidence of such taxes is distributed between consumers and
producers.
 Consumers pay to the extent that price rises.
 Producers pay to the extent that this rise in price is not sufficient to cover the tax.
Elasticity and the incidence of taxation
 If the PED and PES is relatively more inelastic, the quantity will fall less, and hence
tax revenue for the government will be greater, (cases (1) and (3)).
 Price will rise more, and hence the consumers’ share of the tax will be larger, if the
PED is inelastic and PES is elastic (cases (1) and (4)).
 Price will rise less, and hence the producers’ share will be larger, if the PED is more
elastic and the PES is inelastic (cases (2) and (3)).
90
PRICE CEILING AND PRICE FLOOR
1. Price Ceiling
 Maximum price controls or price ceilings are only valid in markets where the
maximum price imposed is below the normal equilibrium price as determined in a free
market.
 It is a price that is fixed below market price.
 Governments use legislation to enforce maximum prices for:
 staple foodstuffs, such as bread, rice and cooking oil

 rents in certain types of housing
 services provided by utilities, such as water, gas and electricity
 transport fares especially where a subsidy is being paid.
 If the government sets a maximum price below the equilibrium (a price ceiling), there
will be a shortage: Qd − Qs.
 Price will not be allowed to rise to eliminate this shortage.
 There danger of black market selling price at Pe
91
2. Price Floors
 A minimum price or price floor is a legal price set above the equilibrium market price.
One can buy at or above the minimum price but cannot buy at a price below it. It is set
to protect incomes of producers when the equilibrium market price for a product is
found to be unfairly low.
 Minimum prices are normally set for agricultural products to protect the incomes of
farmers and labour (the minimum wage). When a minimum price is set for a good it
reduces quantity demanded while quantity supplied increase thereby resulting in
persistent excess supply or surplus of the good.
 The government sets minimum prices to prevent them from falling below a certain
level. It may do this for various reasons:
 To protect producers’ incomes- If the industry is subject to supply fluctuations
(e.g. fluctuations in weather affecting crops), prices are likely to fluctuate
severely. Minimum prices will prevent the fall in producers incomes that
would accompany periods of low prices.
 To create a surplus (e.g. of grains) – particularly in periods of glut – which
can be stored in preparation for possible future shortages.
 In the case of wages (the price of labour)- minimum wage legislation can be
used to prevent workers’ wage rates from falling below a certain level
92
 The introduction of a minimum wage reduces the number of workers employed from
equil to Qd and increase the supply from equil to Qs
 There will be disequilibrium in the market.
93

Introduction To Microeconomics

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Introduction To Microeconomics

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@ Mr K Chabveka MICROECONOMICS NOTES

TWO ASSUMPTIONS IN ECONOMICS MODEL BUILDING

2. Rational economic decision-making

POSITIVE AND NORMATIVE STATEMENTS

a). Positive statements

b). Normative Statements

MICROECONOMICS AND MACROECONOMICS

 Examines either the economy as a whole or its basic subdivisions or

 In using aggregates, macroeconomics seeks to obtain an overview, or general

PITFALLS IN ECONOMICS REASONING

a). Fallacy of Composition

b). Post Hoc Fallacy

 If event A precedes event B, A is the cause of B. This kind of faulty reasoning is

TOOLS IN ECONOMIC ANALYSIS

a). Quantitative Data Collection Techniques/ Methods

Strategies of Quantitative Data Collection Techniques

 Is simply a list of questions or forms to be completed.

 data can be obtained on large numbers of participants quickly and relatively

 Can be sent to a large number of people.

 Saves the researcher time and money compared to interviewing.

 It is too expensive since Wifi or Internet is needed to have access of email

 Over‐sampling may be necessary if doing a one‐time mail out in order to get

 Follow‐up reminders to participants encouraging them to complete the

 May need to offer incentives to increase response rate.

2. Web- Based Questionnaires

 This type of research is often quicker and less detailed.

 The validity of such surveys may be in question as people might be in a hurry to

 Interviewing is one of the most common methods of collecting information from

Interviews can be conducted in a variety of ways; for example, by telephone or as a face-to-

What to keep in mind when interviewing

 As a student of research or a practitioner, there are a number of points you need to

 Provide time limit for interview,

 Accurately record your interviews by writing detailed notes or by tape-

a). Face to face interviews

 Cost is a major disadvantage for face-to-face interviews. They require staffs of

b). Telephone Interviews

 Less time consuming

 The response rate is not as high as the face‐to‐face interview.

c). Computer Assisted Personal Interviewing

 Is a form of personal interviewing, but instead of completing a questionnaire, the

TYPES OF SAMPLING TECHNIQUES

 Probability or random sampling

1. Probability or random sampling

c). Stratified random sampling

d). Cluster sampling

e). Multi-stage sampling

 A cheaper alternative would be to use multi-stage sampling. In essence, this would

2. Non probability Sampling

a). Quota sampling

 Convenience sampling often helps to overcome many of the limitations associated

 Purposive or judgmental sampling is a strategy in which particular settings persons or

MEASURES OF CENTRAL TENDENCY

The following are shoe sizes of form 5 Economics students.

 It cannot be calculated if any observations are missing.

 It is not based upon all values of the given data.

 It is easy to understand & easy to calculate.

 It is not rigidly defined.

 It is not based upon all values of the given data.

DATA PRESENTATION AND ANALYSIS

1. BAR GRAPHS/ CHARTS

Schools Economics students

i. Mean, mode and median.

i. Mean, mode and median.