Economics - Chapter 1 - Chapter 11

UNIT 1: ECONOMICS AND THE PPC CURVE
Definitions of
Economics:  Study of how scares productive resources is used to satisfy human wants
 Study of how individuals & Society choose to use scares resources that nature
and previous generations have provided
 Study of how scares resources are allocated among various uses
 Study of scares resources to satisfy unlimited human wants
 Study of how society manages scares resources
What is economics
about?  Deals with the choices people have to make
 Science of household management and such;
o Concerned with business of life
 Studies decisions of Business, Government and other decision makers in society
o Example: Should Toyota expand production of vehicles?
 Business and Government must also make choices everyday
Assumptions
in Economics  Economics is a social science
 What is Science?
o In order to meet scientific property of being TRUE in all instances, we
make assumptions
Example:
o If Price of coke increases, quantity demanded in decrease (ceteris paribus)
MICROECONOMICS MACROECONOMICS
* Focus on Individual Participation in Economy *Concerned with economy as a whole*
 Producers  Stability of general price levels (Inflation)

 Employers  Maintenance of full employment
 Workers  Economic Growth
 Firms  Distribution of Income
 Government Spending
 Nation’s money supply
EXAMPLES
MICROECONOMICS MACROECONOMICS
 Price of single Product  Consumer price index (Group of products)
 Change in price of product, e.g. Mangoes  Inflation, e.g. Increase of general level of prices
 Production of wheat  Total outputs of all goods & services in economy
 Market on individual goods, e.g. maize  Total demand for all goods & services in economy
 An Individuals decision to export its products  Total Exports of goods & services to other countries
 A Firms decision to import from abroad  Total imports of goods & services from
other countries
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 Scarcity (Limited Re
Key Economic  sources)
Terms (Factors)  Choice
 Opportunity Costs
Unlimited wants:
o Cannot be met with Limited Resources
o Choices need to be made, as resources are limited
Scarcity
Resources
o Used in the production of goods & Services
o Resources are limited
Wants
 Human Desires, can live without these, e.g. fancy car
 Wants is unlimited we all want everything
Example:
You have R100 = Resource
You want to by for much more than R100 = Wants
Wants, Needs and
You have to choose between the things you want because you only have R100
Demands
Needs
 Essential for survival, e.g. Food, water, clothing
Demands
 For there to be a demand for goods & services, those who wants to buy
them, must have the means and the purchasing power.
* The Opportunity cost of choice is:

 Value of the best alternative that could have been chosen but was not chosen
 The value of the best forgone opportunity
 1 of the post important concepts in Economics
 Captures the essence of the problems of scarcity and choice
 Economist do not only consider monetary costs
 Economist also consider “implicit” cost – asking how scares resources
Opportunity Cost could have been used In alternative way
(Make Choices) *Implicit Cost: Cost of self-supplied Factors of Products
**The value of the best alternative sacrificed when a choice is made**
** Economics uses Opportunity costs to measure the cost incurred in choices - With
Every choice comes Opportunity costs
Example:
Jack has to choose between going to the movies or study
The Opportunity cost of studying is to visit the movies that he forgo
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RESOURCES  Because Resources are scares, there is always a cost involved
(ALSO CALLED  Resources are limited, therefore goods & services to satisfy our wants are
FACTORS OF also limited
PRODUCTION  Individuals & Society: Confronted with Unlimited wants and limited resources
 Time is a limited resource
 Scarcity – affects everyone, therefore NOT poverty
Economic Problem
Society must make difficult choices between different alternatives
Factors of  Natural Resources (Land)

Production  Labour
 Capital
 Entrepreneurship
FACTORS OF PRODUCTION
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PRODUCTION
POSIBILITIES CURVE MOVEMENT ALONG PPC CURVE
(PPC) – or
PRODUCTION The PPC Illustrates
POSSIBILITIES  Scarcity - Resources
FRONTIER  Choice – how much to produce of each product
(PPF)  Opportunity cost – With resources available decide how much of one product you
can produce and forgo, in order to produce another product
 Potential Output: Maximum attainable combinations of 2 goods or services
 Shows: When resources are fully utilized
Example:
PRODUCTION POSSIBILITY SCHEDULE

Possibility Fish (baskets per day) Potatoes (kg per day)
A 0 100
B 1 90
C 2 80
D 3 70
E 4 40
F 5 0
Opportunity cost: Example

To produce 3 baskets of fish,
H: Resources not fully utilised –
forgo 30 kg of potatoes
should produce at “D” with
available resources
G: Unattainable with available

resources
Outward Bulging:
Increasing Opportunity Cost
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ACTIVITY 1: PPC AND OPPORTUNITY COST
A movement from E to D indicates that the opportunity cost of increasing the production of potatoes by 30 kg is 1
baskets of fish.
Use the diagram below to answer the question below:
Point A can only be produced if…
a. resources are used efficiently
b. no beer is produced
c. the economy is at less than full employment level of resource usage
d. no opportunity cost is incurred
 Any point along the curve is

sufficiently utilizing resources
 D is INCORRECT as it is opportunity
cost, as you forgo the production of
Pizza
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Example:
C = Mobile Production – 18 000 units
Laptop production – 3000 units
If you increase production of Laptops the Impact:
Movement from C to B
B = Mobile Production Decrease – 10 000 units
Laptop production Increase - 4 000 units
Opportunity cost: 18 000 – 10 000 = 8000
 To satisfy Human wants

 Most human wants satisfied by goods & services
Goods
 Tangible Objects
Goods & Services o Food, Houses, cars, clothing, books, etc.
Services
 Intangible Object
o Medical Services, Financial Services, Legal services, Services by Public
Servants
CONSUMER Consumer Goods:
GOODS &  Consumed by Households (Consumers) to satisfy needs, e.g.
CAPITAL GOODS o Food, wine, clothing, appliances, vehicles, etc.
Different Categories of Consumer Goods

 Non-durable Goods
o Goods that are only used once, e.g., food, wine, petrol, medicine
 Semi-durable goods
o Can be used more than once
o Usually last for a limited period, e.g., clothing, shoes, blankets, tyres, etc.
 Durable Goods
o Normally last for a number of years, e.g., furniture, washing machine, cars, etc.
Final Goods & Intermediate Goods

 Final Goods
o Used or consumed by individuals, households, firms, e.g., bread
 Intermediate Goods
o Processed further before they are sold
o Used as inputs in producing other goods, e.g., flour for baking
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Private Goods & Public Goods
 Private Goods
o Consumed by Individuals & households, e.g., foot clothing, furniture, cars, etc.
o Consumption by other excluded
 Public Goods
o Used by community or society at large
o Consumption by individuals cannot be excluded, e.g., Traffic lights, roads, trains,
etc.
Economic Goods & Free Goods
 Economic Goods
o A good produced at a cost from scares resources
o Economic goods therefore also called scarce goods
 Free Good
o A good that is not scares and therefore has no price e.g., Air, sunshine, sea water
o Also regarded as a gift of nature
Homogenous & Heterogeneous Goods
 Homogenous goods
o Goods that are all exactly the same (alike)e.g Fine ounce of gold the same
as other
 Heterogeneous goods
o Goods available in different varieties, quantities, or brands
o Most goods fall in this category, e.g., Nike and Adidas
Capital Goods
 USED IN PRODUCTION OF OTHER GOODS
 DOES NOT YIELD DIRECT CONSUMER SATISFACTION, they permit
o More production and satisfaction in future
 Used in manufacturing and construction of, e.g. machinery, plant & equipment
 Used in Production and, construction, e.g. buildings of schools, roads, etc.
 Capital goods have limited lifespan – due to wear and tear
 Value depreciates over time
 Capital goods – important for factors of production
FURTER  Sometimes also called Production Opportunity Curve
APPLICATOIN OF  Cannot move beyond ABCDEF (or AF), therefore sometimes called “production
PPC possibility boundary or frontier.
 It indicates maximum attainable combinations of two goods, also called potential output
Economic System Challenge
 Scares resources should be used fully and as efficient as possible
 To produce 1 of the maximum attainable combinations of goods & services
 This occurs when it is impossible o produce more of 1 good without;
o Sacrificing some production of the other good
Actual Output and Potential Output
 On PPC Actual Output is equal to Potential Output
 Community would have preferred combination beyond PPC like point G on
Graph below, which indicates 80 kg of potatoes and 4 basket of fish
 Because G is beyond the curve it is unattainable, however;
o Should the quantity of available resources increase and/or production
techniques improve;
 Possibilities curve will shift outward
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PPC SHIFT OUTWARD IF:
 Quantity of available resources
increase, and/or
 Production techniques improve
 Outward Movement = Economic
Growth
CONSUMER GOODS
AND CAPITAL GOODS  PPC curve shows potential Output – does not indicate which of the possible
ON PPC CURVE combinations should be produced
 Final choice depends on preferences of society
 The greater amount of capital goods produced – the greater potential output
 The greater current production of capital goods, the greater potential output of
economy – therefore:
o The greater the potential production of consumer goods
 If, on the other hand, most resources currently used to produce consumer goods
o Capital stock of economy will not expand rapidly and;
o Potential output of economy and potential future production of consumer
goods will suffer
 Potential production of consumer goods & capital goods can be increased in a number of ways.
CHANGE CAPITAL GOODS CONSUMER GOODS

Technique  Leads to increase of capital goods  Maximum potential output will increase
with available resources (assuming technique for producing capital
 Outward Shift goods and resources remain the same)
 Outward shift
Available  If amount of available resources and/or  If amount of available resources and/or
Resources productivity of available resources productivity of available resources increase
(e.g. nr. Of increase  Outward shift
workers)  Outward Shift
** Amount of Resources or productivity can decrease, resulting in decline in potential output: then Inward
shift**
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3 FACTORS THAT WILL CAUSE PPC TO SHIFT OUTWARD
 Increase in available resources
 Improvements in current production techniques
 Increase in productivity Levels
IMPROVEMENT – PRODUCING CAPITAL GOODS
SWIVEL CAPITAL GOODS:

Improved technique for producing
Capital Goods
Swivels outward from AB to AC

Shift of PPC
Economic Growth
IMPROVEMENT – PRODUCING CONSUMER GOODS
CONSUMER GOODS:
Improved technique for producing
Consumer Goods- can produce more
SWIVEL
Swivels outward from AB to DB
Shift of PPC
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INCREASE IN QUANTITY OR PRODUCTIVITY OF AVAILABLE RESOURCES
CONSUMER GOODS & CAPITAL GOODS

An increase in quantity or productivity
SHIFT of resources makes it possible to
produce more consumer goods and
capital goods
1. SUMMARY: PRODUCTION POSSIBILITIES CURVE (PPC)
DESCRIPTION ILLUSTRATED BY
Attainable Combinations All points on or Inside PPC
Unattainable Combinations All Points beyond the PCC
Efficient Combinations All Points on PPC
Inefficient Combinations (or Unemployment) All Points inside the PPC
Increase in Potential Output Outward shift of PPC
2. ECONOMICS IS A SOCIAL SCIENCE
 Involves systematic attempt to discover regular patterns of behaviour

 These patterns used to explain what is happening, to predict what might happen and to assist policy makers
to device or choose appropriate economic policy
 Helps to predict what price will be in future or what will happen in the rest of the economy
 Provides useful information to the authorities who decide on a policy in respect of prices
 Emphasis on: “Explanation, prediction and Policy”
 Studies the behaviour of human beings, both individually and as a group
 Economics is an empirical science (Actual experiences are studied and measured)
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3. POSITIVE AND NORMATIVE ECONOMICS
POSITIVE STATEMENT NORMATIVE STATEMENT

An objective Statemen of Fact An Opinion or value judgement
Example: Example
The Rand appreciated against the Euro in 2017 Economic policy in South Africa should be primarily
aimed at reducing unemployment
Normally include words like: “Should”, “Ought”,
“Desirable” or “must”
Example 2:
Capitalism exploits workers
(Contains value judgement and cannot be proved)
4. EQUILIBRIUM, COMPARATIVE STATISTICS AND CETERIS PARIBUS
In attempts to identify and analyse important relationships between variable in the economy, economists have to use a
certain method or approach
Essential elements of economists toolkit are the concept of Equilibrium and Ceteris Paribus assumptions
4.1. Equilibrium
 Central Role in Economic theory

 Refers to a situation in which none of the participants has any incentive to change his or her behaviour
– everyone content to continue with things as they are
 Can also be described as State of Balance:
o A state in which all opposing forces are balanced
 A system is in equilibrium when difference forces offset each other so that there is no net tendency for
system to change.
4.2. Statics and Comparative Statics
 Equilibrium state called: static analysis – does not involve time or motion
 One of the underlying forces then changes and new equilibrium is described
 Comparing new equilibrium with old equilibrium to determine effects of change
 Comparative statics – does NOT involve time
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4.3. CETERIS PARIBUS
 Conditional law which says that the quantity demanded will increase when prices fall – PROVIDED all
other things remain constant.
 Can’t be sure that none of the other elements or forces will change , therefore assuming that all other factors
or forces remain constant or unchanged – Ceteris paribus assumption.
 Essential assumption in economic analysis
 Can only allow for ONE change at a time
5. RELATIONSHIPS BETWEEN ECONOMIC VARIABLES
 Direct (or Positive) Linear relationship between 2 variables

 Also inverse (or Negative) relationships between 2 economic variables
5.1. Example of Relationship between economic variables (Rainfall & Maize)
Annual rainfall and Maize Production

Rainfall Maize Production
(mm per year) (millions of tons per year)
200 5
300 7
400 9
500 11
600 13
Direct (or Positive) Linear Relationship

between 2 Variables
 Points a to e = joined to form

straight line, indicating relationship
between maize production and
rainfall
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Example: Direct (Positive) Linear Relationship between Quantity of Product Supplied and Price of Product
Direct (or Positive) Linear Relationship

between Y and X
EXAMPLE
Relationship between Quantity of a
product supplied and price of the product
Example: Direct (Positive) Non-Linear Relationship between Increasing part of a firm’s Marginal cost Curve
Direct (or Positive) Non- Linear

Relationship between Y and X
EXAMPLE
Increasing part of a firm’s marginal cost
curve
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Inverse (Negative) Linear Relationship
Inverse (Negative) Linear Relationship

between Y and X
EXAMPLE
Relationship between Quantity demanded
of a good or service and the PRICE of that
good or service
Inverse (Negative) Non-Linear Relationship
Inverse (Negative) Non-Linear

Relationship between Y and X
EXAMPLE
Decreasing Park of marginal Product of a
factor of Production
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SUMMARY: RELATIONSHIPS BETWEEN ECONOMIC VARIABLES (POSITIVE & NEGATIVE)
RELATIONSHIP TYPE EXAMPLE

Relationship between:
Direct (Positive) Linear  Quantity of a product supplied and
 Price of Product
In Microeconomics:
Direct (Positive) Non-Linear  Increasing part of a firm’s marginal cost
curve
Relationship between:
 Quantity demanded of a good & service,
Inverse (Negative) Linear
and
 The Price of that good or service
In Microeconomics:
Inverse (Negative) Non-Linear  Decreasing part of marginal product of
a factor of production
CHAPTER 2: ECONOMIC SYSTEM
1. 3 ECONOMIC QUESTIONS TO BE SOLVED

1.1. What goods & services should be produced? - Output
1.2. How should each of the goods & services be produced? - Input
1.3. For Whom are the various goods & services produced? - Production
2. 3 MAIN TYPES OF ECONOMIC SYSTEMS – CO-ORDENATING MECHANISMS

 Traditional System
 Command System
 Market System
** This along with property rights – forms basis of most important economic system**
** Most economic systems are mixed systems, in which Market plays Central Role**
2.1. Traditional System

 Oldest system
 Same goods produced and distributed in same way by each successive generation
 Provides clear answers to 3 economic systems
 Slow to adapt to changing conditions
 Economic system not first priority
 Economic activity secondary to religious & cultural values
2.2. Command System

 Participants instructed what to produce and how to produce by central authority
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 Central authority also determines output distribution
 Economy governed and co-ordinated (Also called centrally planned system)
 Command economies often described as socialist or communist system
2.3. Market System

 Could not be invented – simply happened
 Market:
o Any contact or communication between potential buyers and potential sellers
o Potential Buyers – Demanders
o Potential Sellers – Suppliers
o Can be Local, regional, national or international
 For a Market to Exist:
o Must have at least 1 potential buyer and 1 potential seller
o Seller must have something to sell
o Buyer must have the means with which to purchase it
o An exchange ratio – The market price must be determined
o Agreement must be guaranteed by law or by tradition
 Market prices – signals or indices of scarcity
 Market system – often called capitalist system
 Capitalist system characterised by Private Owner
 Market system can also be use in socialist systems
 Focus on Market Capitalism, categorised by:
o Individualism – Decentralised decision making
o Private Freedom – Limited government intervention
o Private Property
o Property Rights
2.4. Mixed Economy

 In the real world no economic system based on purely tradition, command or market system
 All economic systems are a mixture of all
 One of the 3 systems usually dominates
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CHAPTER 3: PRODUCTION, INCOME AND SPEDINGIN MIXED ECONOMY
1. PRODUCTION
 Generates Income (for various factors of production)
 Part of all income then spent to buy available goods & services
 All these things happen at the same time
2. SOURCES OF PRODUCTION: THE FACTORS OF PRODUCTION
2.1. 4 Major Factors of Production

 Natural Resources (or Land)
o Fixed in supply – availability cannot be increased if we want more
o Often possible to exploit more of the available resources, e.g.,
 New mineral deposit still being discovered & exploited every year, but once used they cannot
be replaced, therefore:
o Refer to minerals as non-renewable or exhaustible assets
o Both Quality and Quantity important. E.g.,
 Desert has little or no agricultural value
o Gifts of nature and include:
 Mineral Deposits
 Water
 Arable land
 Vegetation
 Natural Forests
 Marine Resources
 Other animal life
 Atmosphere
 Sunshine
 Labour
o Goods and services cannot be produced without human efforts
o Can be defined as: “Exercise of Human mental and physical effort in production of goods and services”
o Quantity of labour depends on population & proportion of population that is able and willing to
work, (called labour force) and depends on factors such as:
 Age and gender distribution
 Proportion of children, women and elderly people
o Quality of labour more important that quantity ad described as “Human Capital”
 Refers to the skill, knowledge and health of workers
 Education training and experience important
 Entrepreneurship
o Factors of Production must be combined with people who see opportunities and willing to take risk by:
 Producing goods in the expectation that they will be sold
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o Driving force behind production
o Initiators taking risk
o More than a manager they are dynamic
 Capital
o All manufactured resources, such as:
 Machines
 Tools
 Buildings
o Used in the production of other goods and services
o Produced to make other goods
o Capital in production refers to:
 Tangible things that are used to produce other things
o To produce capital:
 Current consumption has to be sacrificed in favour of future consumption
o Have limited life, due to:
 Wear and Tear
 Obsolete due to technological progress
 This is called depreciation
 Technology
o Sometimes identified as 5th factor of production
o When new technology discovered:
 More goods and services can be produced with given amount of natural resources
2.2. Summary of Factors of Production
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2.3. Money
 Money is a medium of exchange
 Can be exchanged for goods & services
 Facilitates exchange of goods & services
2.4. Choice of technique

 When Production dominated by machines
o Capital incentive Production
 When emphasis is on labour
o Labour Intensive Production
3. 3 MAJOR FLOWS IN ECONOMIC SYSTEM IN SEQUENCE

 Production
 Income Flows in Economy
 Spending
4. STOCKS & FLOWS

 Stocks and flows are related
 Stocks can only change as a result of flows, e.g.,
o Water Level can only increase in a dam, if water flows into the dam)
 Capital stock can only increase if investment occurs
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4.1. Stocks
 Measured as Particular point in time, example:
o When shopkeeper takes stock, she counts all goods in the shop at that particular time
 Stock Statistics = “Still Picture”
4.2. Flows
 Measured over a period of time
 Flow has time and dimension, example:
o When shopkeeper calculates her sales, profit or loss, the calculations is done for a period
o Period concerned must be specified
 Flow provide = “Moving Picture”
4.3. Examples of Stocks & Flows
STOCKS FLOWS
 Wealth  Income
 Assets  Profit
 Liabilities  Oss
 Capital  Investment
 Population  Nr. Of births & deaths
 Balance in Savings Accounts  Savings (difference between income and
 Unemployment spending during a period)
 Gold reserves held by SA Reserve Bank  Demand for Labour
 Gold Sales / Gold Production
5. SOURCES OF INCOME: REMUNERATION OF FACTORS OF PRODUCTION

 Income generated through production
 Only way in which total income in economy can be raised is by increasing production
5.1. 4 Types of Income and associated with different factors of production

 Rent – remuneration of natural resources e.g., land
 Wages & Salaries – remuneration of labour
 Interest – Remuneration on Capital
 Profit – Remuneration of entrepreneurship
** Total Income in economy consist of rent, wages salary, interest and profit**
** Value of total income identically equal to value of total Production**
6. SOURCES OF SPEDNING: 4 SPENDING ENTITIES

 Households
 Firms
 Government
 Rest of the World
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6.1. Households (Consumers)
 All the people who live together, making joint economic decisions or subject to others making decision
for them
 Household can consist of:
o An Individual
o A Family
o Groupe of people who have a joint income making decisions together
 Household basic decision-making unit in economy
 Members of household consume goods & services to satisfy their wants
 Act of consuming goods & services call “Consumption”
 Total spending of all households on consumer goods & services called: “Aggregate
consumption Expenditure” or “Total Consumption”
 Consumption = Symbol C
 In Market economy – households or consumers who largely determine what should be produced
 In mixed economy – most of the Factors of Production are owned by households
 Labour – owned by member of household
6.2. Firms
 Component of mixed economy
 The unit or organisation that employees’ factors of production to produce goods & services that’s sold
in Goods Market
 Firms - Basic Productive units, actually an artificial unit
 Firms primarily engaged with production
 In Market economy firms largely decide how goods & services will be produced
 Capital (Factor of Production) purchased by firms
 Purchase of Capital goods called Investment or capital formation = symbol I

** Profit is the difference between revenue and cost”
**Households responsible for spending in consumer goods**
** Firms responsible for spending in Capital Goods**
Firms Purchase Transform Then Sold to

Factors of factors into Goods Market
Production GOODS &
SERVICES
Factor Market Goods Market
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6.3. Government
 Includes all aspects of local, regional and national government
 Sometimes referred to as Public sector
o Includes everything that is owned by Government as representative of people
 Includes all Politicians, civil servants, government agencies, and other bodies of government
 Assume that government acts in consistent fashion
 Governments economic activity involve 3 important flows:
o Government Expenditure – on goods and services (including factor services) =G
o Taxes – Levied on (and paid by) households and firms – taxes = T
o Transfer Payments – the transfer of income and expenditure from certain individuals and groups
(e.g. wealthy) to other individuals and groups (e.g. the poor)
 Exports constitute additions or injections into circular flow of income and spending
 Imports constitute a leakage or withdrawal from circular flow of income and spending
6.4. Foreign Sector

 This is the rest of the world
 South African economy has strong links with rest of the world – Open Economy
 Many goods produced in South Africa sold to other countries
 South Africa also imports goods from the rest of the world
 BALANCE OF PAYMENT: Various flows between South Africa and rest of the world
 GLOBALISATION: Economic links between different countries became stronger
 EXPORTS: The flow of goods and services between domestic economy and foreign sector = X
o Produced in country and sold to rest of the world
 IMPORTS: The flow of goods and services between domestic economy and foreign sector = Z
o Goods produced in rest of the world and purchased for use in domestic economy
6.5. Total Spending summary
Aggregated spending on south African goods & services consist of spending by 4 sectors
 Spending by households on consumer goods & Services = C

 Spending by firms on Capital goods = I
 Spending by Government on goods & Services = G
 Spending by foreigners on South African goods & services
o Exports = X
o Imports = Z
**Total Expenditure = C+I+G+X-Z**
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 Production created by
Factors of Production
 These factors earn income
 Spending done by:
o Households
o Firms
o Government
o Foreign Sector
6.6. CIRCULAR FLOW OF GOODS AND SERVICES
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6.7. CIRCULAR FLOW OF INCOME AND SPENDING
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6.8. GOVERNMENT IN THE CIRCULAR FLOW OF PRODUCTION
 Government Purchases Factors of Production (mainly Labour) from:

o Households in FACTOR Market
o Goods from Firms in GOODS Market
 Government provides public goods and services to household and firms
 Government spending is financed by Taxes paid by household and firms
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Chapter 4-DEMAND
DEMAND – MOVEMENT - PRICE
 Quantities of goods and services that potential buyers are willing and able to buy
o Which wants to satisfy with available means
o Have intent to buy and have the means
o Quantity demanded may differ from actual sales – depends on availability
Demands o Quantity demanded may be:
 Less than;
 Equal to; or
 Greater than
 Measured over a period

Demand Measurement
 Must always specify the period, e.g., day, week, month, Quarter, etc.
 Consists of combined demand of all households in particular market

Market Demand
o For example: The demand for tomatoes
Determinants of Quantity Demanded for specific period

 Lower Price – Larger Demand (Ceteris Paribus)
Price of Product
 Higher Price – Lower Demand
Price of Related
 How many to buy of a good also depends on related products
Products
 Used jointly
Complements
o Example: Coffee and sugar
 Goods that can be used instead of good in question (replaced by something else)
Substitutes
o Example: Butter – Margarine
 Income determines purchasing power

Income of Consumers o Increase in income – increased purchasing power
o Decrease in income – decreased purchasing power
Taste / Preference  Decision on goods depends on the taste or preference
Number in Household  The more people in Household the greater the demand
** AVAILABILITY OR SUPPLY DOES NOT DETERMINE DEMAND**
Page 26 of 113

Only shows the supply by e.g.
Farmers, manufacturers
 Each Point indicates

Quantity supplied for
each price
Page 27 of 113

SHIFT IN DEMAND - Not including Price
Shift in Demand  Any determinant except Price
Determinants of Quantity Demanded for specific period

Change in Price of
 Quantity consumer plan to buy also depends on price of related goods
Related Products
 Goods that can be used instead of good in question (replaced by something else)
o Example: Butter – Margarine
 Increase in price of substitute – Increase in demand for product in question
o Example: If price of Butter (Substitute)increases, demand in Margarine
(product in question) will increase
o If Price in Butter increase – demand curve for margarine will shift to the
Substitutes
right
(Increase in price of substitute (butter) will thus lead to rightward shift of demand
curve for product concerned (margarine)
Decrease in substitute (butter) will lead to decrease of margarine (product in

question)
 Used jointly
o Example: Fish and chips
 If price of compliment good change, demand for good will also change
o Example: If price for Xbox console change, demand for Xbox games will change
Compliments
o If price for Xbox console decreases – demand for Xbox game will
increase, rightward shift of demand
o If price for Xbox console increases- demand for Xbox games will decease,
leftward shift of demand
 Change in income lead t change in Demand
Income of Consumers o Increase in income – increase in Demand
o Decrease in income – decreased in Demand
Taste / Preference  Chante in consumer tase or preference lead to change in demand
 Demand also depends on size of population

Change in Population o Increase in Population – increase in Demand
o Decrease in Population – decreased in Demand
OTHER INFLUENCES  Change in consumer expectation of any determinant can change demand
Change in expected  If prices expected to fall – consumer will reduce current demand
future price  If prices expected to increase – consumer will increase current demand
 Demand can change if constant total income redistributed among different
OTHER INFLUENCES households
Distribution of income o Example: If High-income households redistributed to low-income households
– demand by Low-income households will increase and visa versa
Page 28 of 113


Quantity supplied for
each price
Page 29 of 113

MARKET DEMAND CURVE - SUMMARY
EFFECT ON MARKET DEMAND CORRECT DESCRIPTION OF
DETERMINANT CHANGE
CURVE EFFECT
Upward movement along demand A Fall in the quantity
Increase
curve demanded
Price of good
Downward movement along the An increase in the quantity
Decrease
demand curve supplied
Price of Related
Goods Increase Rightward shift of demand curve An increase in demand
 Substitutes Decrease Leftward shift of demand curve A fall in demand
 Compliments Increase Leftward shift of demand curve A Fall in demand
Decrease Rightward shift of demand curve An increase in demand

Increase Rightward shift of demand curve An increase in demand
Income
(Normal Good)
Decrease Leftward shift of demand curve A Fall in demand
An Increase Desire Rightward shift of demand curve An increase in demand

to Buy
Taste /
Preference
A Reduced Desire Leftward shift of demand curve A Fall in demand
to Buy
Increase Rightward shift of demand curve An increase in demand

Population
Decrease Leftward shift of demand curve A Fall in demand
Price expected to
Expected Future An increase in demand
increase Rightward shift of demand curve
price of good
Price expected to Leftward shift of demand curve
A Fall in demand
fall
Page 30 of 113

SUPPLY
SHIFT IN SUPPLY - Not including Price
 Quantities of a good / service producers plan to sell at each possible price
 Measured over period of time
 Refer to Planned quantities producers plan to sell
o Quantity Supplied may differ from actual sales
Supply
o Quantity demanded may be:
 Less than;
 Equal to; or
 Greater than
Market Supply  Combined result of all individual suppliers of the product in question
Determinants of Quantity Supplied for specific period

 Farmers decision on how many tomatoes to produce also depend on prices
of alternative products
 Farmers must decide which vegetables to grow and how much of each
Price of Product o Example: If price of cauliflowers increase, relative to price of tomatoes – they
might plan to produce more cauliflower and visa versa
o Increase in demand for cauliflower – rightward shift in supply for cauliflower
o Sometimes referred to as substitutes
 Quantity of tomatoes that farmers plan to sell at different prices also depend on
o Cost of Production
 To Make a profit they have to cover their cost of production
Price of Factors of  If Cost of 1 or more inputs (Labour, fertilizer, machinery) increases
Production& Other
o Smaller Quantity of tomatoes will be supplied
Inputs
o It will cost more to produce products
 If cost of production increase, Quantity supplied decrease – Leftward shift
 Producers have to plan in advance

 Farmers will be influenced by:
o what is happening now; and
o what is expected to happen in future
Expected future Prices  Example: The higher they expect future prices to be, the more tomatoes they
will plan to produce
 For nonperishable crops, they might withhold some of their produce
from market until prices increase
 New technologies that allow producers to produce more and lower cost:
o Will increase quantity supplied at each price
State of Technology
 Example: New fertilizers or a new tomato, less susceptible to plant decrease
will tend to increase supply of tomatoes
Page 31 of 113

OTHER POSSIBLE DETERMINANTS OF SUPPLY
 Subsidies on particular goods or services tent to raise their supply
Government Policy
 Taxes tent to reduce supply
 Such events may have positive or negative impact on supply

 Examples:
Unexpected Events
o Natural disasters, such as floods, earthquakes and droughts – negative impact
o Favourable weather conditions – positive impact
 Some products are produced jointly
 Examples: sugar and molasses, wheat and bran, beef and leather
Joint Products and
 Results can change in supply if major product results in a similar change of
By-Products
by- product
 (sometimes called compliments in production)
 Related to, among other things, technology
 Change in productivity of factors of production will lead to change in supply
Productivity
 Example: Improve technology
 If productivity fails – production costs increase – supply decrease
Quantity of good supplied in particular period is a function of the price of the good, the prices of
alternative outputs, prices of factors of production, expected future prices of good and state of
technology


Quantity supplied for each
price
Page 32 of 113

Movement- Change in
Quantity Supplied
 Change in price pf the

product – leads to
movement along supply
curve
 Example: Quantity
supplied increases from
Q1 to Q2
SHIFT in Supply Curve –

change in supply
 Original supply SS
 Any factor that reduces
supply will shift supply to
left
 Any factor that increases
supply will shift to the
right
Page 33 of 113

MARKET EQUILIBRIUM
 Excess Demand and Excess Supply
 Market in equilibrium when:
o Quantity demanded = Quantity supplied
 Plans of Household (buyers, demanders) coincide with plans of the firms

(sellers, suppliers) – Called Equilibrium
Equilibrium
 At any other price it is called disequilibrium in form of excess supply and
excess demand
 When disequilibrium – Forces set in motion to move market towards equilibrium
 Market equilibrium occurs at intersection of demand and supply curve (point at
which both sellers and buyers agree on quantity of goods to be exchanged and the
price at which they are exchanged
 When Quantity demanded is greater that Quantity supply = excess demand (or
market shortage) at that particular price
 Firms sell total production, but households do not obtain quantity of product
they like to buy at particular price
 In effort to obtain a greater quantity:
Excess Demand
o households bid up the price of product (ie. Offer to pay more for product)
(or Market Shortage)
o Firms then realise the can charge higher price
o As Price rises, Quantity supplied increases along supply curve (firms produce
more – while quantity demanded falls along demand curve
Process continues until equilibrium is reached

 Firms find that they cannot sell all their products – left with unsold stock
 Firms then cut production and compete with each other to find buyers by
reducing prices
Excess Supply  Results in fall in Quantity supplied along supply curve
(or Market surplus)  Some existing firms produce less
 At the same time the falling price raises the quantity demanded along
demand curve
 This process continues until equilibrium is reached
 When quantity demanded = quantity supply
Equilibrium  State of rest in which opposing forces are balanced
 No tendency for things to change (as long as underlying forces remain unchanged)
Page 34 of 113

Price of Quantity Quantity Difference Excess supply or
tomatoes Demanded Supplied Demand Pressure on Price
(R/kg) (kg) (kg) (kg)
10 360 0 360 – 0 = 360 (Excess demand) Upward
50 200 200 200 – 200 = 0 (Equilibrium) None
60 160 250 250 - 160 = 90 (Excess supply) Downward
70 120 300 300 – 120 = 180 (Excess supply) Downward
80 80 350 350 – 80 = 270 (Excess supply) Downward
EQUILIBRIUM
Demand Curve - DD intersects

supply curve – SS
**R50 per kg = Equilibrium Price
** Equilibrium Quantity 200 kg
At R20 Quantity demanded 320

kg and quantity supplied 50 kg
= Excess demand 270 kg -
indicated by bc
At price of R70 per kg quantity

demanded is 120 kg = 300 kg
supplied = excess supply 180
kg indicated by df
Downward sloping Demand Curve
Upward sloping Supply Curve
Page 35 of 113

SURPLUS
CONSUMER SURPLUS
 Downward-sloping Demand curve and Uniform Market price means:
 Consumer actually receive more than their money is worth
 Reason: Market Price usually lower than highest price consumers are willing to
Consumer Surplus pay for all but last unit of product
 Demand Curve = Indicates highest price consumers are willing to pay for
different quantities of good
Difference between:
What Consumer pay  Indicates the maximum amount they are willing to pay = CONSUMER SURPLUS
and value they receive
 P1 = Market Price per unit purchased

 P1 = What consumer are actually paying
 P1 = Less than highest price
consumers are prepared to pay
 Q1 = Quantity Demanded at market price
 Between 0 and Q1 = Consumer willing to

may more than the market price at P1
 The blue triangle is what consumers

gained as they paid less that what they
are willing to pay = Consumer Surplus
Page 36 of 113

SURPLUS
PRODUCER SURPLUS
 Parallel to concept of consumer surplus
 Producers willing to supply units of the product at LESS than market price
Producer Surplus  Reason: Market Price usually lower than highest price consumers are willing to
pay for all but last unit of product
 SS = Different Quantities Producers

are willing to supply at different
prices
 P1 = With Uniform Market price
and equilibrium at Q1 = Implies
that:
**up to Q1 – Positive Difference

between lowest prices producers are
willing to supply different quantities
and price they actually receive
Page 37 of 113

SURPLUS
CONSUMER SURPLUS & PRODUCER SURPLUS AT MARKET
EQUILIBRIUM
Consumer and  Illustrates consumer surplus and producer surplus combined at Market
Producer Surplus equilibrium price
combined
 DD = Demand Curve
 SS = Supply Curve
 P1 = Equilibrium Price
 Q1 = Equilibrium Quantity
 All Quantities less than Q1 = Consumers pay lower price (P1) for product
Example below than highest prices they are willing to pay
o Thus indicates consumer surplus (in green triangle) = (DP1E)
 All Quantities less than Q1, producers receive higher price (P1), than lowest
prices at which they prepared to supply products
 Thus producer surplus, indicated by Blue triangle (SP1E)
Page 38 of 113

MARKET SUPPLY CURVE - SUMMARY
EFFECT ON MARKET SUPPLY CORRECT DESCRIPTION
DETERMINANT CHANGE
CURVE OF EFFECT
Upward movement along Increased in Quantity
Increase supply curve supplied
Price of good
Decrease Downward movement along the Decrease in the quantity
supply curve supplied
Prices of Increase Leftward shift of supply curve Decrease in supply

Alternative
Products Decrease Rightward shift of supply curve Increase in supply
Substitutes
Prices of Joint
Increase Rightward shift of supply curve Increase in supply
Products
Compliments in
Decrease Leftward shift of supply curve Decrease in supply
Production
Increase Leftward shift of supply curve Decrease in supply
Prices of Inputs
Decrease Rightward shift of supply curve Increase in supply
Increase in supply
Rightward shift of supply curve
Expected Future Price Expected to Increase
Price e.g. Perishable
Leftward shift of supply curve
goods (Tomatoes) Price Expected to Decrease Decrease in supply
Leftward shift of supply curve

(Producers withhold supply in
Expected Future Decrease in supply
Price Expected to Increase anticipation of price increase)
Price
e.g. Non -Perishable
Price Expected to Decrease Rightward shift of supply curve
goods (Gold) Increase in supply
(Producers try to sell as much as
possible at current price)
Cost-reducing improvement
Rightward shift of supply curve Increase in supply
Technology in Technology
Cost-increasing change in
Leftward shift of supply curve Decrease in supply
technology
Positive Events
(e.g. favourable weather,
Rightward shift of supply curve Increase in supply
government subsidies,
Unexpected Events reduced Company Tax rates)
Negative Events
Leftward shift of supply curve Decrease in supply
(e.g. Earthquakes, floods,
wars)
More Firms enter the market Rightward shift of supply curve Increase in supply
Number of Firms
(Sellers)
Firms Leave Market Leftward shift of supply curve Decrease in supply
Page 39 of 113

CHAPTER 5: DEMAND AND SUPPLY IN ACTION
CHANGES IN DEMAND
INCREASE IN DEMAND
 Represents Rightward shift in demand
 Increase in Demand will result in:
 increase in price of product, and Ceteris Paribus
Increase in Demand
 Increase in quantity exchanged
 Sources of increase of demand in Chapter 4
 Supply remains unchanged, but

What happens to Supply
 Quantity supplied increases – Upward movement along supply curve
when Demand increases?
 When demand increases – excess demand at original price
 Excess demand – results in price increase because:
o Price of product bid up as purchasers compete to obtain the
available quantity supplied
When Demand Increase  As prices rise, suppliers increase quantity supplied,
o while quantity demand falls
 Process continues until equilibrium is re-established at:
o Higher price and higher quantity that before
Increase in Demand
 Demand curve shifts from DD

to D1D1
 As a result – Equilibrium price
increases from P0 to P1
 While equilibrium Quantity
increases from Q0 to Q1
 Upward movement along
supply curve from E to E1
Page 40 of 113

CHANGES IN DEMAND
Page 41 of 113

Page 42 of 113

Page 43 of 113

CHANGES IN DEMAND
DECREASE IN DEMAND
 Represents Leftward shift in demand
 Increase in Demand will result in:
-decrease in price of product, and Ceteris Paribus
Decrease in Demand
-decrease in quantity exchanged
 Sources which may lead to decrease of demand in Chapter 4
What happens to Supply  Supply remains unchanged, but

when Demand  Quantity supplied decreases – Downward movement along supply curve
decreases?
 When demand decreases – excess supply at original price
 Excess supply – results in price decrease
-Sellers then compete to sell their stock
 As prices fall, quantity supplied also falls
When Demand Decreases
-while quantity demand increases
-Lower price and Lower quantity that before
Decrease in Demand
 Demand curve shifts from DD

to D2D2
fall from P0 to P2
 While equilibrium Quantity in
fall from Q0 to Q2
 Downward movement along
supply curve from E to E2
Page 44 of 113

CHANGES IN SUPPLY
INCREASE IN SUPPLY
 Result in a fall in the price of the product
 Increase in Quantity exchanged Ceteris Paribus
 Supply curve shift to the left (downwards)
Increase in Supply  Increase means more goods are supplied at lower price than before or
 Shift of supply curve as a result of any change in determinants
 Demand remains unchanged, but

What happens to
 Quantity Demanded increases as the price of the product falls.
Demand when supply
 Downward movement along demand curve
increases?
 When demand decreases – excess supply at original price
 Excess supply – results in price decrease
-Firms compete with each other by:
-Lowering the price of the product
When Supply Increase  As prices fall, quantity demanded Increases
-while quantity supplied falls
-Lower price and Higher quantity that before
Increase in Supply
 Increase of supply curve from

SS to S1S1
falls from P0 to P1
increase from Q0 to Q1
 Downward movement along
demand curve from E to E1
Page 45 of 113

CHANGES IN SUPPLY
Page 46 of 113

Page 47 of 113

Page 48 of 113

CHANGES IN SUPPLY
DECREASE IN SUPPLY
 Result in an increase in price of the product
 Decrease in Quantity exchanged Ceteris Paribus
 Supply curve shift to the left (downwards)
 Increase means less goods are supplied at lower price than before or
Decrease in Supply  That each quantity is supplied at a higher price than before
 It leads to a leftward (upward) shift of supply curve
 Shift of supply curve as a result of any change in determinants
 Demand remains unchanged, but

What happens to  Upward movement along demand curve
Demand when supply  When supply increases, there is an excess demand at original price
decreases?
 Excess demand (or market shortage) results in an increase in price of product

 Consumers bid up the price for the product in attempt to obtain product
 As the price increases, the:
o Quantity demanded decreases, while;
When Supply Decrease
o Quantity supplied increases
o Higher price and Lower quantity that before
Decrease in Supply
 Decrease of supply curve from

SS to S2S2
increases from P0 to P2
falls from Q0 to Q2
 Upward movement along
demand curve from E to E2
Page 49 of 113

SIMULTANEOUS CHANGES IN DEMAND AND SUPPLY
 WHEN ONLY DEMAND OR SUPPLY CHANGE:
WHEN ONLY DEMAND OR  IT IS POSSIBLE TO PREDICT WHAT WILL HAPPEN TO EQUILIBRIUM PRICES AND
SUPPLY CHANGE? EQUILIBRIUM QUANTITIES IN THE MARKET.
 PRECISE OUTCOME CANNOT BE PREDICTED

 SPECIAL CASE OF A MORE GENERAL PROBLEM IN ECONOMIC THEORY.
 WHEN MORE THAN ONCE CHANGE IS INVOLVED – SELDOM POSSIBLE TO PREDICT
OUTCOME
METHOD USED:
- REQUIRES THAT ONLY 1 VARIABLE OR FORCE IS ALLOWED TO CHANGE AT
A TIME
WHAT HAPPENS IF
 WE HAVE SEEN THAT AN INCREASE IN DEMAND LEADS TO INCREASE IN
DEMAND AND SUPPLY
EQUILIBRIUM PRICE AND;
CHANGE
SIMULTANEOUSLY?
 DECREASE IN SUPPLY ALSO LEADS TO INCREASE EQUILIBRIUM PRICE
IT FOLLOWS THEREFORE:
 INCREASE IN DEMAND ACCOMPANIED BY DECREASE IN SUPPLY WILL
- RAISE THE EQUILIBRIUM PRICE OF PRODUCT
-
WHAT WE CANNOT PREDICT IS:
- WHAT WILL HAPPEN TO EQUILIBRIUM QUANTITY EXCHANGED IN THE
MARKET?
 INCREASE IN DEMAND RAISES EQUILIBRIUM QUANTITY (CETERIS PARIBUS)
 WHILE DECREASE IN SUPPLY LOWERS EQUILIBRIUM QUANTITY (CETERIS PARIBUS)
THE 2 FACTORS WORK IN OPPOSITE DIRECTIONS AS FAR AS:

- EQUILIBRIUM QUANTITY IS CONCERNED – OUTCOME DEPEND ON
RELATIVE MAGNITUDES OF CHANGES IN DEMAND AND SUPPLY
 IT’S POSSIBLE WHEN BOTH DECREASE TO PREDICT WHAT WILL HAPPEN
TO QUANTITY EXCHANGED – AS BOTH FORCES HAVE THE SAME IMPACT
ON EQUILIBRIUM QUANTITY
BOTH DEMAND AND
SUPPLY DECREASE AT
 COMBINED IMPACT UNCERTAIN ON EQUILIBRIUM PRICE AS
THE SAME TIME
- DECREASE IN DEMAND REDUCED PRICE (CETERIS PARIBUS)
- WHILE DECREASE IN SUPPLY RAISES THE PRICE (CETERIS PARIBUS)
 EQUILIBRIUM PRICE COULD:

- RISE, REMAIN UNCHANGED OR FALL
- DEPENDING ON RELATIVE MAGNITUDES OF CHANGES IN DEMAND AND
SUPPLY

Page 50 of 113

Page 51 of 113

INTERACTION BETWEEN RELATED MARKETS
Market relationship - change in taste or preference
Interaction  Many products related to each other:
o Some are substitutes
o Some are compliments (in consumption)
o Some are substitutes in consumption
o Some are joint products
Interrelationships Example: Change in Taste
between different  Catholics were not allowed to eat mean on Fridays and tended to eat fish instead.
markets  The bad was lifted, and they started eating meat on Fridays
 What was the impact of the decision on the prices and average weekly sales
of fish and meat respectively?
 Demand for fish would have declined – indicated by a leftward shift of demand
curve
 Demand for meat would have increased – indicated by a rightward shift
of demand curve
 Result:
o Price and weekly sales of fish would have declined
o Price and weekly sales of meat would have increased
o Equilibrium prices and Quantities also impacted
Exactly the opposite effect will happen if it was the other way around
Graph Indicates how the decrease Graph Indicates how the increase
of fish is indicated in the market due of meat is indicated in the market due
to change in Taste to change in Taste
Pa ge 52 of 113

INTERACTION BETWEEN RELATED MARKETS
Market relationship - change in Compliment or other factors
Example: Motor cars and tyres
 What will happen in market for new tyres of cost to produces motor
cars increases or f wages increase?
 The cost of production in motorcar industry will increase – indicated by leftward
shift (upward) of the supply curve
 Result:
o Equilibrium Quantity for cars will fall
Interrelationships
o Equilibrium price for cars will increase
between different
o Demand for new Tyres will decrease – as fewer cars are produced –
markets
Leftward shift of demand curve
o As a result, equilibrium price for tyres for fall
o Equilibrium quantity for tyres will also decrease
 Cost Saving technological improvements in production of cars or increase

in productivity of workers will have opposite impact
Graph Indicates how the decrease in

Graph Indicates how the Increase of
Quantity of Motor vehicles reduces the
production cost results in upward
demand for tyres, indicated with
(leftward) movement of supply curve
leftward shift for demand
Page 53 of 113

GOVERNMENT INTERVENTON
Government Focus  Quite frequently, consumers, trade unions, farmers, businesspeople and politicians
are not satisfied with the prices and quantities determined by Market Demand and
Supply
 The dissatisfaction leads to pressure on government to intervene – influence
prices and quantities in the market.
Government  Intervention can take different forms, including:
Intervention o Setting Maximum Prices (Price ceilings)
o Setting Minimum Prices (price floors)
o Subsidising certain products or activities
o Taxing certain products or activities
MAXIMUM PRICES (PRICE CEILINGS, PRICE CONTROL)
Maximum Prices  Government often set maximum prices for certain goods and services
 Government set maximum prices to:
o Keep prices of basic foodstuffs low, as part of a policy to assist the poor
o Avoid exploitation of consumers by producers (unfair prices)
o Combat Inflation
o Limit the production of certain goods and services (e.g. in wartime)
Equilibrium prices  Maximum Prices ABOVE equilibrium (Market-clearing) price:
o No effect on market price or quantity exchanged.
o Prices and quantities will still be determined by demand and supply
 Maximum Prices BELOW equilibrium (Market-clearing price):
 No significant effect
Price Control  With price control introduced, different ways of solving the problem of excess
demand have to be found
 Basic problem is:
 How to allocate available quantity supplied between consumers who demand more
of the product
Ways to solve excess  Consumers may be served with “first come first served” basis -resulting in queues
demand or waiting list
 Suppliers may set up informal rationing system, e.g.:
o Limiting quantity sold to each consumer or
o Selling to regular customers only
 Government may introduce official rationing system by:
o Issuing ration tickets or Coupons to be submitted when purchasing product
** All of the above systems entail additional costs to consumers and suppliers**
o Consumers spend time waiting in queues
o Suppliers have to use scarce resources to administer rationing system
 Government rationing system amount to additional government intervention

and stimulate corruption (e.g. bribery of rationing officials)
Black Market  Also a consequence of maximum price fixing
 Happens when market forces of supply and demand cannot eliminate excess demand
Fixing Prices below  Creates shortages (excess of demand)
Equilibrium  Prevents market mechanism from allocating available quantity among consumers
 Stimulates black market activity
Examples of Fixed  Rent control – page 101 to 102
Pricing  Administered prices – page 102 Box 5-2
Page 54 of 113

Graph Indicates the following:
 Demand Curve (DD)
 Supply Curve (SS)
 Equilibrium Quantity Exchanged (Q0)
 If Government sets price at (Pm) = below
equilibrium price (P0)
 At lower price (Pm) = consumers will
demand quantity (Q2)
 Suppliers, however only willing to supply
Q1 – Lower than Q0 = MARET SHORTAGE
(OR EXCESS DEMAND)
 Equal to the difference between Q2 and Q1
(or ab)
WEALFARE COSTS OF MAXIMUM PRICE FIXING
Government Focus  Concepts of consumer surplus and producer surplus, can be used to illustrate
the welfare loss associated with maximum price fixing
 The dissatisfaction leads to pressure on government to intervene –
influence prices and quantities in the market.
Deadweight Loss  Too little is produced and in the end society (which consist of consumers and
producers) is worse off as a result of the interference in the market system
Page 55 of 113

Prior to Price fixing:
 Equilibrium Price = P1
 Equilibrium Quantity = Q1
 Government then fixes Maximum price = Pm (Below equilibrium Price
 Result of Price Fixing
 Quantity Exchange Falls to Qm
 Triangle B = Transferred from Producer surplus to Consumer Surplus
 Triangle A = Used to be part of consumer surplus
o Represents total welfare loss to society
 Triangle C = Used to be part of producer surplus
o Disappears
 Total Deadweight loss to society is Equal to A + C
Agricultural Products  Usually characterised by relatively stable demand, but also by a supply that
is subject to large fluctuations.
 Prices therefore tend to fluctuate, and farmers income is unstable and uncertain
 To stabilise farmers income:
 Government often introduces minimum prices (or price floors), which
 Serves as guaranteed prices to producers
Pricing  If minimum pricing is BELOW ruling equilibrium price;

o The operation of market forces is not disturbed
 If minimum pricing is ABOVE ruling equilibrium price;
o There is a surplus (or excess supply)
 Minimum prices highly inefficient since;
o All consumers, including the poor households, have to pay artificially
high prices
o Bulk of benefit accrues to large producers or concerns owned by
big companies
o Inefficient producers are protected and mange to survive
o Disposal of market surplus entails further cost to taxpayers and welfare
losses to society
Minimum Prices  Government often set minimum prices for certain goods and services
 When Government sets minimum price – it creates a Surplus
 Surplus usually requires Government intervention with following options:
o Government purchases the surplus and exports it
o Government purchases surplus and stores it (provided it’s not perishable)
o Government introduces production quotas to limit quantity supplied
to quantity demanded at minimum price
o Government purchases and destroys the surplus
o Producers destroy the surplus
Page 56 of 113

Artificially high Prices  Justified by arguments that it is consumers’ interests that producers receive
a stable income (and keep producing the products) or
 That surplus can be exported to earn foreign exchange however,
o Exports normally at a loss, and always expense of domestic
consumer, who have to pay artificially high prices for products
 If surplus cannot be exported, government intervention is required to
dispose of surplus, which;
o Often results in additional cost to taxpayers and always entails a welfare
loss to society
 If government wishes to assist certain producers, direct cash subsidies paid only to those producers is
a better alternative than fixing minimum prices.
 With direct subsidies there will be no interference in price mechanism.
 Only those who are supposed to benefit receive the subsidy and cost of subsidy is explicit, instead of
being hidden
 Supply Curve = SS
 Demand Curve =
DD
Downloaded by Urish Preethlall
 Equilibrium Price =
(urishpreethlall01@gmail.com) R30 per kgPage 57 of 113
WELFARE COSTS OF MINIMUM PRICE FIXING
Welfare loss  Concept of consumer surplus and producer surplus can also be used
to illustrate welfare loss of minimum price fixing
 As in the case with maximum price fixing, too little is produced, and society is worse off as a result of the
interference
 If Producers ignore and do not respond to actual demand – situation more complicated since a surplus
will be produced
Page 58 of 113

Prior to Price fixing:
 Government then fixes Minimum price = Pm – above equilibrium price
 If Producers respond to actual demand:
o Quantity supplied (exchanged) falls to Qm
o Rectangle A = transferred from consumer surplus to producer surplus
o Rectangle B = used to be part of consumer surplus
o Rectangle C = used to be part of producer surplus
o Rectangle B and C disappear
o Total deadweight loss to society = B + C
SUBSIDIES
Subsidies  An alternative to setting maximum or minimum prices is to:
 subsidise consumers and producers
Suppose government want to lower the price to consumers and increase production by subsidising the
producers
Prior to Subsidies:  Original Supply = SS

Original Demand
 Equilibrium Price = DD
P0
Page 59 of 113
Downloaded by Urish Preethlall
(urishpreethlall01@gmail.com)
TAXES
TAX  ONE OF THE LARGEST SOURCES OF TAX REVENUE IS THE:
 TAXES GOVERNMENT LEVIES ON GOODS AND SERVICES
 SOME TAXES, E.G., VAT, IS LEVIED AS A PERCENTAGE OF THE PRICE OF THE GOOD
OR SERVICE
 OTHERS, E.G., TAXES ON CIGARETTES, ALCOHOLIC BEVERAGES AND FUEL, ARE
SPECIFIC AMOUNT PER UNIT OF THE PRODUCT
**SPECIFIC TAXES EXAMINED**

** WHO ACTUALLY BEARS THE BURDEN OF THE TAX?**
ONE OF THE BASIC  PARTIES WHO ACTUALLY PAYS THE TAX TO AUTHORITIES (SARS) DOES NOT
PRINCIPLES OF NECESSARILY BEAR THE BURDEN, OR AT LEAST FULL BURDEN OF TAX.
TAXATION  TECHNICAL TERMS:
 THE EFFECTIVE INCIDENCE OF TAX MAY DIFFER FROM STATUTORY INCIDENCE OF
TAX
SPECIFIC EXCISE TAX  TAX ON CIGARETTES TO ILLUSTRATE
EXAMPLE  SUPPOSE CIGARETTES COST R24 A PACKET WITHOUT THE EXCISE TAX OR DOTY
 GOVERNMENT THEN IMPOSES SPECIFIC TAX OF R8 PER PACKET
 THIS TAX HAS TO BE PAID BY MANUFACTURERS ON EACH PACKET OF
CIGARETTES THEY PRODUCE
 WHO WILL BEAR THE BURDEN OF THE TAX?
o MANUFACTURERS WILL ATTEMPT TO PASS ON THE TAX TO CONSUMERS, BUT:
o EXTEND TO WHICH THEY ARE ABLE TO DO SO IN LIMITED BY THE DEMAND
AND SUPPLY
OF CIGARETTES
BURDEN OF EXCISE TAX  ACTUALLY, SHARED BY 3 GROUPS
 CONSUMERS – WHO HAVE TO PAY MORE
 SUPPLIERS – WHO RECEIVES LESS FOR EACH UNIT SOLD – MEANS THAT PROFITS
OF OWNERS OR SHAREHOLDERS OF SUPPLIERS ARE LOWER THAN BEFORE.
Page 60 of 113
 Employees of Suppliers – as production has fallen, fever jobs available in
industry or existing employees will have to accept wage cuts, which will increase
supply curve to the right
Prior to Excise Tax:

 Original Demand = DD
 Original Supply = SS
 Equilibrium Price = R24.00
 Equilibrium Quantity Exchanged = R150 000 packets per week
 When Tax in levied, suppliers add R8.00 at each level of production Page 61 of 113
 Example:
o To receive R24. 00 per pack, the plan to change to R32.00 – R8.00 = Tax to be paid o
Government t Downloaded by Urish Preethlall (urishpreethlall01@gmail.com)
WELFARE IMPLICATION OF SPECIFIC EXCISE TAXES
Page 62 of 113

Before imposition of the Tax:
 After imposition of Tax
o Government gains rectangle A – At expense of Consumers
o Government gains rectangle B – At expense of Producers
o Triangles X and Y disappear
** X plus Y represents deadweight loss of the TAX
IMPORT TARIFFS
Import Tariffs  Can be illustrated by demand and supply curves
Example: Domestic supply for Textile
Page 63 of 113

Before Import Tariff:

 Production Quota Introduced
o Production Quota = Qm – Lower than Q0
o Supply curve becomes QmQm
o Price of consumer increases to = P1
o Cost of producers becomes P2 per unit
IMPACT OF SPECIFIC IMPORT TARIFF
Specific import  When economy is opened up to international trade:
Tariff  Countries with relative or comparative advantage in production of textiles will
export textiles to SA at lower price = World price
 International supply of textiles in domestic market will now be represented by
horizontal line
o This indicates the that any quantity of textiles can be imported and therefore
supplied at world price
o Domestic price for textiles will thus fall to word price.
 At lower prices quantity of textiles demanded increases
Government  Suppose Government is perturbed about:
o Loss of production and employment in textile industry as well as
o By increase in imports
 Therefore, decides to impose a specific tariff on imported textiles
o Higher prices of textiles reduce quantity demanded
o At the same time the higher price stimulates domestic production of textiles and;
o Quantity produced domestically increases
o Quantity imported will now be smaller than before imposition of the Tariff
o Imposition of Tariff raises domestic production (and employment), and
o Reduces quantity of imports
o Raises revenue for government and raises price of product
Before international trade:

 Original Demand = DD Page 64 of 113
 Domestic price = Ed
Downloaded by Urish Preethlall (urishpreethlalQl0u1@angtmitayil.cEoxmch) anged = Q3
GOVERNMENT INTERVENTION
WELFARE EFFECT OF AN IMPORT TARIFF
Welfare Effect  Part of the increased consumer payments goes to firms as extra profits
 After imposition of the Tariff, domestic producers receive more for their products;
 Because they sell more
 Because they are receiving a higher price
Page 65 of 113

 Demand = DD
 Supply = SS
 Imposition of Tariff results in:
o Transfers and Net Social Losses
o Tariff raises domestic price from Pw to P1
o As a result consumers have to pay more for Quantity Q4 then before Tariff
o FABG = Transfer to government
o P1FEPw = Transfer to firms (in form of extra Profits)
 Triangles X and Y represents pure waste and net social losses, (the deadweight loss of the tariff)
AGRICULTURAL PRICES
PRICES  FLUCTUATE MUCH MORE THAN THE PRICES OF MANUFACTURED GOODS
 WHY DOES IT FLUCTUATE MORE?
 DUE TO SUPPLY CONDITIONS – VARIES FROM SEASON TO SEASON, AND AFFECTED BY
DISEASE, WEATHER
 AS SUPPLY VARIES, PRICES VARY, EVEN IF DEMAND CONDITIONS REMAINS THE SAME
 FLUCTUATIONS MAY INTENSIFY BY REACTION OF FARMERS, ESPECIALLY ANNUAL CROPS
EXAMPLE:
 IF PRICE OF POTATOES INCREASE SHARPLY IN YEAR 1 AS A RESULT OF BAD HARVEST
 THE HIGH PRICE OF POTATOES INDUCES FARMERS TO PLANT MORE POTATOES IN YEAR 2
 ALSO INDUCES OTHER FARMERS TO PLANT MORE POTATOES INSTEAD OF OTHER CROPS
 IF WEATHER AND OTHER CONDITIONS IN YEAR 2 ARE NORMAL, THE RESULT WILL
BE A SIGNIFICANT INCREASE IN THE SUPPLY OF POTATOES IN YEAR 2 AND FALL OF
PRICE IN POTATOES
 EXTEND OF PRICE DECLINE MAY LEAVE FARMERS WORSE OFF
 THIS EXAMPLE IS ILLUSTRATING THE “FALLACY OF COMPOSITION”
(MISTAKE OF ASSUMING THAT THE WHOLE IS ALWAYS EQUAL TO THE SUM OF THE PARTS)
 INDIVIDUAL FARMER, MAY IMPROVE HIS POSITION BY PRODUCING MORE POTATOES,
BUT IF ALL FARMERS TO THE SAME POTATO FARMERS (AS A GROUP) MAY END UP
WORSE THAN BEFORE
Year 1:  Eq
 Demand = DD Downlo
Preethla
 Supply = S1S1 (urishpre
il.com)
Page 66 of 113
SPECULATIVE BEHAVIOUR: SELF-FULFILLING EXPECTATIONS
SPECULATION  BEHAVIOR OF LOOKING INTO THE FUTURE AND MAKING BUYING AND SELLING
DECISIONS BASED ON EXPECTATIONS (OR PREDICTIONS)
 WHEN ALL PARTICIPANTS IN MARKET EXPECT THAT PRICE OF PRODUCT WILL
MOVE IN A CERTAIN DIRECTION, AND THEY ALL INCORPORATE THIS
EXPECTATION INTO THEIR DECISIONS, EXPECTED MOVEMENT WILL BE REALIZED
ALMOST IMMEDIATELY.
EXAMPLE
LET’S LOOK AT INTERNATIONAL GOLD MARKET
 IF ALL PARTICIPANTS IN GOLD MARKET EXPECT PRICES OF GOLD TO INCREASE

SIGNIFICANTLY;
 EVERYONE WILL TRY TO PURCHASE AS MUCH GOLD AS POSSIBLE, BEFORE PRICE GOES
UP
 AT THE SAME TIME, SUPPLIERS OF GOLD WILL HOLD BACK THEIR SUPPLIES AS LONG AS
POSSIBLE If all markets participants expect price of
gold to increase
**THE SAME TYPE OF EFFECT CAN OCCUR WHEN EVERYONE EXPECTS THE PRICE OF GOLD T
FALL AND THE INCORPORATE EXPECTATION INTO THEIR DECISION **
Original
 Demand = DD
 Supply = S1S1
 Price = P1
Page 67 of 113
 Quantity = Q1

After expected price increase
CHAPTER 6: ELASTICITY
5 TYPES OF ELASTICITY
ELASTICITY IS THE DEGREE OF RESPONSIVENESS IN COMPARISON TO ONE VARIABLE TO ANOTHER VARIABLE
INCOME INCOME
ELASTICITY ELASTICITY
 Change in Demand due to  Tells how a change in Price

Change in Real Income impacts demand
 Positive – Normal Goods  Measured in 2 ways:
 Negative – Inferior Goods o Arch
o Point Elasticity
CROSS
PRICE ELASTICITY OF SUPPLY
ELASTICITY
 Change in Demand due to Page 68 of 113
Change in Price of Other Goods  Tells about sensitivity of supply of

products / services due to:
 Positive means Close substitute o Change in its Market Price
CHAPTER6: ELASTICITY
 The measure of the responsiveness of a Dependent variable to change in an
independent variable
o When 2 variables related one often wants to know how sensitive or responsive
the first is to changes in the second
 How responsive is investment spending to change in interest rate?
Elasticity Definition Formal Definition:
The percentage change in a dependent variable (the one that is affected), if
dependent variable (1 that causes the change) changes by 1 %
Example:
We know that the size of maize crops depends on rainfall, but how sensitive or responsive is
the size of the maize crop, if there is a 1% fall in rain?
Elasticity formula
(Ratio)
 Price Elasticity of Demand

 Income Elasticity of Demand
4 Types of Elasticity  Cross Elasticity of Demand
 Price Elasticity of Supply
PRICE ELASTICITY OF DEMAND

PRICE ELASTICITY OF  Concerned with sensitivity of Quantity of Demand to change in Price
DEMAND
Page 69 of 113

Definition  The % change in Quantity demand if the;
Ceteris Paribus
 Price of a product changes by 1%
Formula
Example:
 If price of product changes by 5%, resulting in a 10% change of Quantity Demanded
o 10% ÷ 5% = 2
o This implies that 1% change in Price of Product leads to a 2@ change in Quantity
Demanded
PRICE ELASTICITY  If the % change in price is GREATER than the % change in Quantity demanded, then:
GENERAL RULE o Price Elasticity Coefficient is LESS than 1
o Applies to things such as salt, medical services, fuel, beer, etc.
 Consumers LESS responsive or sensative to change in price
 If the % change in price is SMALLER than the % change in Quantity demanded, then:
o Price Elasticity Coefficient is GREATER than 1
o Applies to things such as private education, restaurant meals, fresh tomatoes, etc.
 Consumers MORE responsive or sensative to change in price
Important when  Elasticity calculated using % changes which are:
calculating o Relative changes
o NOT Absolute changes
 If we use % changes
o The units in which prices and quantities are measured:
 DO NOT affect the result
 Elasticity coefficient enables us to compare how consumers react to changes in the
price of different goods & services
 Changes in price of product and changes in Quantity demanded move
OPPOSITE direction
o Price Increase – Quantity demand falls Ignore Negatives:
o Price Decrease – Quantity demand increase See example below
Example:
If we say Price Elasticity of tomatoes is 0.5, we mean that:
o A 1% increase in price of tomatoes will lead to a 0.5% decrease in demand of
quantity or visa versa
EXAMPLE:
 Rightward shift in supply curve – lead t
decrease in price from P1 to P2
 Increase in Quantity demanded at
equilibrium from Q1 to Q1
You also want to know by how much the
price and quantity will change
To Determine this you need info of price
Page 70 of 113
elasticity
** Sensitivity of Quantity demanded to
change in price, depends on the slope of
Demand Curve
EXAMPLE:
 Demand curve steeper – change in
Quantity demand smaller and change in
price larger
** Sensitivity of Quantity demanded to
change in price, depends on the slope of
Demand Curve
Price elasticity of Demand
Example:
 If decrease in price of product or service, you know that quantity demanded will tend to
increase, BUT
Very Important
 By how much?
Firms wants to maximize profits and;

 Change in quantity demanded and sold will directly influence revenue, thus the profit
 Analyzed by Elasticity of demand
 If % change in Price is GREATER than % change in Quantity demand then:

o Price elasticity coefficient is LESS than 1
o E.g., Salt, medical services, fuel, etc.
o Consumers LESS responsive or Sensitive to change in price
Formula:
General Rule
Price Elasticity
 If Change in price is SMALLER than 1% change in Quantity demand then:

o Price Elasticity Coefficient is GREATER than 1
o E.g., Private education, restaurants meals, fresh tomatoes
o In this case consumers are MORE responsive or sensitive to change in Price
Page 71 of 113

o =Elastic Demand
Formula:
CALCULATING PRICE ELASTICITY OF DEMAND
Q = Change in Quantity demand

P = Change in Price
Q = Initial or Base Quantity
P = Initial or Base Price
Ep = Price elasticity of demand
Steps  Calculate % change in Quantity demand

 Divide it by the % change in price of product
EXAMPLE:
Suppose that price of a commodity falls down from R10 to R9 per Unit and due to this, quantity demanded of
the commodity increased from 100 units to 120 units.
WHAT IS THE PRICE ELASTICITY OF DEMAND?
You are given:

P = Initial Price – R10
P1 = New Price - R9
Q = Initial Quantity Demanded – 100 Units
Q1 = New Quantity demanded – 120 Units
P = Change in Price – (P1 – P) : R9 – R10 = -R1 (less than original price)
Q = Change in Quantity Demand – (Q1 – Q) : 120 units – 100 Units = 20 Units
Now:
Price Elasticity of Demand (ep) =
OR
Price Elasticity of Demand (Ep) = % Change in Quantity Demanded =

% Change in Price
The coefficient of price elasticity of demand is 2

It means 1% increase in price, reduce quantity demand by 2 % and visa versa
PRICE ELASTICITY OF DEMAND & TOTAL REVENUE (OR EXPENDITURE)
 Used, to determine by how much total Expenditure by consumers on a product (revenue
for producer) changes when price f product changes
Page 72 of 113

 Total Revenue (TR) or Total Expenditure (TE) by consumer is:
o EQUAL to the Price (P) of goods or services X by Quantity (Q) sold
 INVERSE RELATIONSHIP BETWEEN QUANTITY DEMANDED ON PRICE OF PRODUCT
 Change in price leads to change in Quantity Demanded in opposite direction to change in price
 Effect on price change on total revenue will depend on the:
o Relative sizes of price change in Quantity demanded
TOTAL REVENUE (TR) OR EXPENDITURE = Price (P) x Quantity (Q)
PRICE OF GOOD OR SERVICE = P QUANTITY OF GOOD OR SERVICE SOLD = Q

RELATIONSHIP BETWEEN PRICE ELASTICITY OF DEMAND & TOTAL REVENUE
Total Revenue will increase as Quantity Sold Increases
1. Price Elasticity GREATER
than 1
Total Revenue reached Maximum point
2. Price Elasticity close or =
to 1
Total Revenue will decrease but Quantity Sold will increase
3. Price Elasticity less than 1
(Price is decreasing)
ELASTIC
Change in price – result in greater change in Quantity Demanded
 Decrease in Price = Increase in Revenue
 Happens when Price Elasticity is GREATER than 1
UNIT ELASTIC
Change in Price – leads to equal or proportional change in
Quantify demanded, e.g.
 10% change in price – result in 10% change in Quantity Demand
 TOTAL REVENUE WILL STAY UNCHANGED
INELASTIC
Change in Price – leads to smaller change in
Quantity demanded e.g.
 10% change in price and Quantity demanded
decrease by 5%
 PRICE CHANGE GREATER THAN QUANTITY
DEMANDED
 TOTAL REVENUE DECREASE – QUANTITY
DEMANDED INCREASED
Page 73 of 113

Reached Max
Profit of Total
Revenue as it
equals 1
NOTES:
From R20 to R40 – Price Elastic & Revenue

Increases
From R20 – R0, Price Inelastic as Revenue

decreases
5 CATEGORIES OF PRICE ELASTICITY OF DEMAND

 If Price increase with e.g. 10%
o Consumers will still purchase same amount of product
o Consumers plan fixed amount of product, regardless of price changes
Perfectly Inelastic
o Price does NOT impact quantity demanded
Demand
 Suppliers therefore can increase revenue by increasing price of
(ep=0)
product Examples:
Life saving Medication – if they need 30 pills a month they will still buy 30 pills a
month
 LESS than 1
 Change in price is greater that change in Quantity
Inelastic Demand demand Example:
(0 < ep < 1) If price has gone up by 10%, quantity demand decreased by 2% so,
Change in price in greater than quantity demand
E.g.. Medical Aid, Petrol, Electricity
 % change in price is equal to change in demand
 E.g., Increase of 10% in Price will result in 10 % decrease in quantity demanded
Unitary Elasticity  Unit Elasticity:
(ep = 1)  Maximum Profit and Revenue Point
Examples:
Microwave, cell phone, stove, etc.
 LESS than 1
 Change in profit is less than 1% change in Quantity Demand
Elastic Demand
 People very sensitive to price change
(1 < ep < ∞)
 If Price increase is 10%, the Quantity demanded decreases with 15%
Example:
Page 74 of 113

Meat, vehicles, restaurant meals, etc.
 Consumers willing to purchase any amount of goods, at certain price
 Raising Price of good results in Quantity Demand falling to Zero
 Small change in Price will result in greater change in decrease in
Perfectly Elastic Demand
Quantity demanded
(ep = ∞)
 Demand will be infinity at correct price
Example:
Boat Cruise, if prices increase demand will decrease
Perfectly inelastic demand (ep = 0)
 consumers will plan to purchase a fixed

amount of the product
 regardless of the price which is charged. In
this case, producers can raise their revenue by
increasing
 the price charged for the product. As the
quantity demanded does not change, raising
price results in an
 increase in total revenue. Remember TR = PQ.
Inelastic demand (0 < ep < 1)
 The percentage change in quantity demanded is

smaller than the percentage change in price.
 Producers have an incentive to raise their prices
Page 75 of 113
in order to increase their revenue.
 Likewise, there is no reason why producers
would decrease the price of their product as
the
Unitary elasticity (ep = 1)
 The percentage change in quantity

demand is equal to percentage change
in the price of the product.
 Thus, producers would not gain
anything by increasing or decreasing the
price of the product.
Elastic demand (1 < ep < ∞)
 The percentage change of quantity

demanded is greater than the
percentage change in price.
 When producers are faced with elastic
demand, decreasing the price of the
product will raise the total revenue Page 76 of 113
received by producers (this is as a result of
the property of elastic demand, also
Downloaded by Urish Preethlall (urishpreethlall01r@emgmeamil.cboemr ) TR = PQ).
Perfectly elastic demand (ep = ∞)
Consumers are willing to purchase any

quantity of goods at a certain price, raising the
price of the good will result in the quantity
demanded falling to zero (even if the price is
only raised slightly).
PRICE ELASTICITY OF DEMAND: SUMMARY

Category Meaning Effect on Total Revenue (TR = PQ)
When Price (P) changes
Perfectly Inelastic Q (quantity demanded) does not change  TR changes with P in the same direction as P
Demand when  There is thus an incentive for suppliers to
(ep = 0) P (price) changes raise prices
Page 77 of 113

% Change in Q (quantity demand) is  TR changes in the same direction as change
Inelastic Demand smaller than % change in P (price) in P,
(0 < ep < 1)  There is thus an incentive for suppliers to
raise prices
Unitarily Elastic % Change in Q (quantity demand) is equal  TR remains unchanged
Demand to % change in P (price)
(ep = 1)
% Change in Q (quantity demand) is  TR changes in opposite direction to change in P,
Elastic Demand
greater than % change in P (price)  There is thus an incentive for suppliers to
(1 < ep < ∞)
lower prices
Indeterminate quantity (Q) demanded at  When P (price) increases, Q (quantity demand)
Perfect Elastic
given price (P) falls to ZERO
Demand
Nothing demanded at a fractionally higher  TR therefore also falls to ZERO
(ep = ∞)
price
INCREASE IN PRICE DECREASE IN PRICE Page 78 of 113

Revenue/Expenditure Revenue/Expenditure
PRICE ELASTIC
Falls Rises
Revenue/Expenditure Revenue/Expenditure
PRICE INELASTIC
Rises Falls
TOTAL REVENUE & PRICE ELASTICITY OF DEMAND

Price Change in Total Change in Quantity
Change Revenue
Elastic Demand Up Down Decrease (More than Proportionally)

(ep > 1) Down Up Increase (More than Proportionally)
Unitary Elasticity Up Down Decrease Proportionally)

(ep = 1) Down Up Increase Proportionally)
Inelastic Demand Up Down Decrease (Less than Proportionally)

(ep < 1) Down Up Increase (Less than Proportionally)
RELATIONSHIP BETWEEN PRICE ELASTICITY AND TOTAL REVENUE
Page 79 of 113

DETERMANANTS OF PRICE ELASTICITY OF DEMAND
 High Complementary goods = Low Price Elasticity of Demand
Degree of Complementary of Product
Goods used jointly with other goods, instead of on their own)
 Price Elasticity of Demand
o Lower for Necessities, e.g., food, electricity, etc.
Type of want satisfied by Product
 Then Price Elasticity of Demand for Luxury goods and services, e.g.,
entertainment, swimming pool, etc.
 Demands tend to be more price elastic in the long run than in the
Time Period under Consideration
short run
Proportion of Income Spent of  The greater the proportion of income spent on a product the greater
Product the price elasticity of demand and visa versa
 The broader the definition of a product, the smaller the price
elasticity of demand
Definition of a Product Example:
Price elasticity of demand for food is lower than the price elasticity of
demand for meat
 Price elasticity of demand for a particular brand product, e.g. Omo,
will be greater than the price elasticity of demand for Non-Branded
Advertising product, e.g. washing powder
 Producers spend large amount on advertising to develop loyalty to
a particular brand
 The more durable the good, the more elastic the demand will
Durability
be (ceteris paribus)
 The greater the number of uses of a particular product, the greater
Number of Uses of Product
the price elasticity of demand
Page 80 of 113

 Argument is that substitute products may be available for certain of
the product uses
 Products that are habit forming (e.g. cigarettes) tend to have relatively
Addiction
low price elasticity
IMPACT ON TOTAL EXPENDITURE

PERFECTLY INELASTIC UNITARY ELASTIC PERFECTLY ELASTIC
INELASTIC ELASTIC
PRICE Total
Total Total Total Expenditure
INCREASE Constant
Expenditure Expenditure Expenditure falls to Zero
PRICE Total Total Total Total Expenditure
DECREASE Expenditure Constant
Expenditure Expenditure falls to Zero
EXAMPLE: POINT PRICE ELASTICITY OF DEMAND

EXAMPLE 1
 You are the Owner of a Bakery and responsible for setting the price of bread
 Current price of 1 loaf of bread is: R16
 From experience you know that the bakery will sell 150 Loafs of bread
 If you Increase the price from R16 to R17, sales are expected to drop to 145 loafs of bread
 Your aim is to increase revenue
Should you Increase the price of bread to
R17?
 Calculate the point price of elasticity of demand and interoperate your answer
(145 – 150) ÷ (17 – 16) x 16 ÷ 150

= -5 ÷ 1 x 16 ÷ 150
= -5 x 0.1066
Ep = - 0.53
The demand for bread is relatively elastic, since the point price elasticity demand is 0.53
If you increase the Price from R16 to R17, total revenue will increase
Therefore, you should increase the price of bread
EXAMPLE: ARC PRICE ELASTICITY OF DEMAND

Page 81 of 113

EXAMPLE 2
 You are a vuvuzela sales person

 You decide to have a big sale and sell the vuvuzelas at a discount
 They are usually priced at R50 each, but you now want to sell them for R30 each.
 You estimate that the quantity demand will increase from 200 to 300
If you aim is to increase total revenue, should you proceed with the price reduction?
Use the definition of arc price elasticity of demand to arrive to your answer
Ep = (300 – 200) ÷ (30 – 50) and (200 + 300) ÷ (30 + 50)

= (100 ÷ 20) and (500 ÷ 80)
= 5 ÷ 6.25
Ep = 0.8
The arc price elasticity of demand is 0.8.

The demand for vuvuzela in therefore relatively price elastic
If you decrease the price from R50 to R30, total revenue will decrease
Therefore you should not reduce the price of the product
ACTIVITY 1
1. If the % change in P is greater than the % change in Qd, then demand is …
a) inelastic.
b) elastic.
c) unitary elastic
2. If an 8% change in price leads to a 12% change in Qd, the demand is
a) inelastic
b) elastic
c) unitary elastic
ACTIVIT 2
You are given the following diagrams (a and b) and must indicate whether the demand is relatively elastic,
relatively inelastic or unitary elastic.
A = Inelastic B = Elastic
Page 82 of 113

ACTIVITY 3
You have the following information
Price Quantity Demanded (Qd)
R8 100
R10 90
If the price increase from R8 to R10, what is the price elasticity of demand?
Steps to Calculate
 The increase in price is R2

 The % increase in price is: R2 ÷ 8 x 100 = 25%
 Quantity Demanded Increased units: 100 – 90 = 10
% decrease in quantity demand: 10 units ÷ 100 units x 100 = 10%
INCOME ELASTICITY
 Income Elasticity Definition
A measure of responsiveness of the Quantity demanded of a good to changes in consumer income (ceteris paribus)
 Income Elasticity SHIFTS in Demand Curve

 The greater the income elastic demand is for a product the more it will shift
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 Normal goods
In increase of income will increase demand for normal goods

A normal good for person A might not be the same for person B, it depends on the level of income
 Inferior goods
In increase in income reduced demand for an inferior good
% Change in Quantity Demand

% Change in Income
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INCOME ELASTICITY DEMAND SUMMARY
EXAMPLE
0.667
Suppose income of a community increases from R10 000 per household p.m. to R11 000 per household p.m..
As a result, the demand for brown bread increases from 150 loaves of bread per day to 160 loafs of bread per day
Calculate the Income elasticity of Demand for brown bread and interoperate your answer
ey (160 – 150) ÷ (11 000 – 10 000) x (10 000) ÷ 150

= 0.01 x 6.667
ey = 0.667
The income elasticity of demand is 0.667, therefore brown bread is a normal good as well as a necessity for the
community.
ACTIVITY 1
If the price elasticity of demand is 0.20, and the price is doubled, this will lead to a in the quantity of
demanded.
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a) 40 Percent increase
b) 20 Percent increase
c) 0.40 Percent increase
d) 0.20 Percent increase
Price Elasticity Demand (PED) = 0.20 x 100% = 20% (multiply by 100% as price doubled, so it is 100% increase)
ACTIVITY 2
If price elasticity of demand is 0.80, then a 10 % increase in the price of the good will lead to a in the quantity
demanded.
a) 8 Percent increase
b) 8 Percent decrease
c) 0.80 Percent increase
d) 0.80 Percent decrease
Price Elasticity Demand (PED) = 0.80 x 10% = 8% Inelastic, as it is less than 1%
DIFFERENCE BETWEEN SUBSTITUTE AND COMPLEMENTARY GOODS

BASIS PRICE ELASTICITY INCOME ELASTICITY
The Ratio of the % change in Quantity Demanded The Ratio of the % change in Quantity Demanded
Meaning
to the % change in Price of a Commodity to the % change in Income of Consumer
Price Elasticity of Demand is denoted by: Income Elasticity of Demand is denoted by:
Denoted by
Ep or PED Ey or YED
The Coefficient of Income Elasticity is:

The Coefficient of Price Elasticity is always
Coefficient * Positive for Normal Goods
Negative
* Negative for Inferior Goods
The Degree of Elasticity varies in between:

Degree of The Degree of Price Elasticity varies in between:
+ ∞ to - ∞
Elasticity 0 to +∞
Depending on Nature of Goods
The Coefficient of Price Elasticity represents The coefficient of income elasticity represents
Elasticity different degrees of Price Elasticities, such as: Types of Income Elasticity to Identify the nature
Coefficient * Perfectly Elastic of goods whether:
Represents * Inelastic * Normal Goods
* Unitary Elastic * Inferior Goods
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Price Consumption Curve Income Consumption Curve
Associated
* Represent different amounts of Quantity * Represent different amounts of Quantity
Curve
Demanded at different prices Demanded at different levels of income
% Change in Quantity Demanded % Change in Quantity Demanded

Calculation ÷ ÷
% Change in price % Change in Income
CROSS ELASTICITY OF DEMAND

Definition  Concerned with sensitivity of the quantity demanded due to a:
 Change in the price of a related product
Focus on relationship Qd = f (Pg) – ceteris paribus

 Focus on relationship Qd = f (Pg) – ceteris paribus
 Quantity demanded of a particular good also depends on the price of the related goods
CROSS ELASTICITY OF DEMAND
% change in Quantity Demanded of Product A

% change in Quantity Demanded of Product B
 Responsiveness of Quantity demanded of a particular good to changes in the price of a related good
SUBSTITUTES: CROSS ELASTICITY OF DEMAND

Positive Signs:  POSITIVE SIGNS
o When Price of one increase, Quantity demanded of the other Increases
o Most important determinant of consumer reaction to price change
o The Larger the number of substitute, the greater the price elasticity
Example:
Butter & Margarine: If the price of butter goes up, demand for margarine will increase
Compliments  NEGATIVE SIGNS
 When price of one good increases, Quantity Demanded of other decreases
Example
Product A: coffee
Product B: Sugar
If the sugar price increases, demand for coffee will decrease
ACTIVITY 4
1. Suppose the cross-elasticity of demand between two products, A and B, is negative. If the price of product A
increases as a result of a decrease in the number of firms supplying the product, the quantity demanded will .
a. increase for both products A and B
b. fall for both products A and B
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c. increase for product A and fall for product B
d. fall for product A and increase for product B
2. Suppose the cross-elasticity of demand between two products, A and B, is positive. If there is a fall in the cost
of producing good B, the quantity demanded will .
a. increase for both goods
b. decrease for both goods
c. increase for good A and decrease for good B
d. decrease for good A and increase for good B
EXAMPLE:
 Price of Xbox game (Product B) decreases from R3 000 to R2 500, and as a result Demand for Xbox “Call of
Duty: Black Ops Game” (Product A) increases from 200 000 units to 230 000 units.
 Calculate the cross elasticity of Demand for A and interpret your answer
30 000 ÷ -500 x 3 000 ÷ 200 000

= - 0.9
The Cross Elasticity of demand is Negative. We can thus conclude that Xbox game consoles and Xbox Cal of Duty:
Black Ops games are compliments in consumption.
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PRICE ELASTICITY OF SUPPLY
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PERFECTLY INELASTIC SUPPLY
When:
 There is a % Change in price
 There is no change in Quantity
Supplied
INELASTIC SUPPLY
When:
 There is Small change in Quantity
Supplied
UNITARY ELASTICITY
When:
 There is Equal change in Quantity
Supplied
ELASTIC SUPPLY
When:
 There is greater change in Quantity
Supplied
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PERFECTLY
ELASTIC SUPPLY
When:
 There is An infinite Change in quantity
SUMMARY PRICE ELASTICITY OF SUPPLY

Definition
The Ratio between the % change in Quantity supplied of a product and the % change in the price of the product
EXAMPLE
Suppose you sell pies on campus for R15 each. If the Price of pies increases to R16, you will be willing to increase the
quantity you supply for 2 000 per day to 2 200 pies per day.
Calculate your price elasticity of supply and interpret your answer.
= (2 200 – 2 000) ÷ (16 – 15) x (15 ÷ 2 000)

Es = 1.5
Price Elasticity of supply is 1.5. Therefore the supply of pies is relatively price elastic
DIFFERENT ELASTICITIES: SUMMARY
Type Definition Possibilities Description
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Price ep > 1 Elastic
Elasticity of
% Change in Quantity Demanded ep < 1 Inelastic
Demand
% Change in Price ep = 1 Unitarily Elastic
ep = ∞ Perfectly Elastic
ep = 0 Perfectly Inelastic
Cross ec < 0 Compliments
Elasticity % Change in Quantity demanded of 1 good ec = 0 Substitutes
of Demand % Change in price of another good
ec = 1 Independent or Unrelated goods
Income ey > 0 Normal Good
Elasticity % Change in Quantity demanded ey < 0 Inferior Good
of Demand % Change in Income
ey > 1 Income Elastic, Luxury Good
ey < 1 Income Elastic, Essential Good
Price es > 1 Elastic
Elasticity of % change in Quantity Supplied es < 1 Inelastic
Supply % Change in Price es = 1 Unitary Elastic
es = ∞ Perfectly Elastic
es = 0 Perfectly Inelastic
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CHAPTER 9: SUPPLY – PRODUCITON AND COST
 Individual Proprietorship
 Cooperatives
 Partnership
Types of Firms  Trust
 Companies
 Public Company
 Close Corporation
Profit: Surplus of revenue over cost
CONCEPT OF REVENUE
Total Value of Sales
TOTAL REVENUE
Total Revenue (TR) = Price (P) x Quantity (Q) (or PQ)
Total Revenue ÷ by quantity sold (Q) or ((PQ/Q)
AVERAGE REVENUE
AR = PQ ÷Q
Total Additional Revenue earned by selling an Additional Unit of the product
Marginal Revenue (MR) Change in Total Revenue (∆TR) ÷ Change in Quantity (∆Q)
MARGINAL REVENUE
Example:
If a firm sells 1 additional Unit, they can calculate the marginal revenue to see if they make a
profit or loss with the sale of 1 additional unit
CONCEPT OF COSTS
EXPLICIT COSTS Monetary Payments for the factors of Production, e.g. Salaries, Machinery, Office equipment
Opportunity cost – not monetary payments

IMPLICIT COSTS (Include costs of self-owned or self-employed resources, e.g., a Dr leaving job to start own
bakery – forgo the salary earn as Dr)
Economic Costs
ECONOMIC COSTS Explicit cost + Implicit Cost
CONCEPT OF PROFIT
PROFIT Difference between Revenue and cost

Difference between Total Revenue from the sale of the firm’s product(s) and Total Explicit
TOTAL (OR Cost
ACCOUNTING)
PROFIT  Accounting Profit = Total Revenue – Total Explicit Cost
Monetary payments that the firm’s resources could have earned in their best alternative uses,
NORMAL PROFIT forms part of the firm’s cost of production
Difference between total revenue from the sale of the firm’s product(s) and total explicit and
implicit costs
ECOMONIC PROFIT
 Economic Profit = Total Revenue – Total costs (explicit + implicit)
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Accounting vs Economic Profit
Economic Profits
Accounting
Implicit Profits
Total Revenue
Economic Cost
Cost
Explicit Costs Explicit Costs

Or Accounting Or Accounting
Costs Costs
IMPLICIT vs EXPLICIT COST

INCOME STATEMENT FOR BAKERY
Notes ITEM TOM SIPHO
SIPHO AND TOM EACH HAVE A BAKERY TOTAL REVENUE R100 000 R100 000
BUSINESS AT 2 DIFFERENT PARTS OF THE
CITY. LESS: EXPLICIT COSTS (R 49 000) (R 49 000)
COST OF FLOUR, MILK, SUGAR, (R23 000) (R23 000)

SIPHO IS A QUALIFIED DR AND TOM A ETC.
QUALIFIED TEACHER, BUT THEY BOTH
WAGES AND OTHER EXPENSES (R26 000) (R26 000)
CHOOSE TO RUN A BUSINESS INSTEAD
OF A BEING EMPLOYED. ACCOUNTING PROFIT R51 000 R51 000
THEY EACH OWN AN OFFICE SPACE

FROM WHICH THEY RUN THEIR LESS: IMPLICIT COST
RESPECTIVE BUSINESSES. LESS: FORGONE WAGES (R15 000) (R40 000)
FROM THE OFFICE SPACE THEY COULD
EARN A RENT OF R16 000, IF THEY WERE LESS: FORGONE RENT (R16 000) (R16 000)
RENTING THE SPACE OUT
ECONOMIC PROFIT/LOSS R20 000 (R5 000)
R23 000 + R26 000 = R49 000
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Activity 1 : Example
You run a business and your total Revenue is R100 000. Your actual payments towards your costs are R40 000
If you did not work for yourself, you could have earned R60 000 working for another firm.
If I tell you that the total cost of your business is R100 000, have I calculated your accounting costs or economic cost?
R100 000 Total Revenue

- R 40 000 Explicit Cost (Actual Payments towards Costs)
- R60 000 Implicit Cost (Forgone Salary)
Economic Cost is Calculated
Activity 2
Assuming that the apple farmer could earn R2 000 as an employee elsewhere, then the total economic profit is…?
Sales of Apples = R 4 000

Explicit Cost = (R3 075)
Implicit Cost = (R2 000) (Salary Farmer could have earned)
Economic Profit/Loss – (R1 075) - Loss
Explicit Cost
PRODUCTION
PRODUCTION THE PHYSICAL TRANSFORMATION OF GOODS INPUTS INTO OUTPUTS
PRODUCTION IN THE SHORT RUN
THE TIME FRAME IN WHICH THE QUANTITIES OF SOME RESOURCES ARE
FIXED FIXED AND VARIABLE INPUTS
SHORT RUN
 IN THE SHORT RUN, A FIRM CAN EXPAND OUTPUT ONLY BY INCREASING THE
QUANTITY OF ITS VARIABLE INPUTS
INPUT TYPES AND COST TYPES
FIXED INPUT AN INPUT WHOSE QUANTITY CANNOT BE ALTERED IN THE SHORT RUN
VARIABLE INPUT QUANTITY CAN BE CHANGED IN THE SHORT RUN ( AS WELL AS LONG RUN)
AS FAR AS A BUSINESS IS CONCERNED –

FIXED COSTS
FIXED COSTS DO NOT CHANGE AS OUTPUT CHANGES – E.G. BUILDINGS AND CAPITAL
EQUIPMENT
INCLUDES THOSE WHICH DO CHANGE WITH
VARIABLE COSTS
OUTPUT, E.G., FUEL, RAW MATERIAL AND
LABOUR
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SHORT-RUN PRODUCTION
 TO INCREASE OUTPUT WITH A FIXED PLANT:
o A FIRM MUST INCREASE QUANTITY OF LABOUR (OR OTHER VARIABLE INPUTS) IT USES
 THE RELATIONSHIP BETWEEN OUTPUT AND QUANTITY OF LABOUR BY USING 3 RELATED CONCEPTS
o TOTAL PRODUCT (TP)

 TOTAL QUANTITY OF A GOOD PRODUCED IN A GIVEN PERIOD
 INCREASES AS QUANTITY OF LABOUR EMPLOYED INCREASES
o MARGINAL PRODUCT (MP)

 THE CHANGE IN TOTAL PRODUCT THAT RESULTS FROM A 1 UNIT INCREASE IN THE QUANTITY OF LABOUR
EMPLOYED
 IT TELLS US THE CONTRIBUTION TO TOTAL PRODUCT OF ADDING 1 MORE WORKER
 MARGINAL PRODUCT (MP) = CHANGE IN TP ÷ CHANGE IN QUANTITY OF LABOUR
o AVERAGE PRODUCT (AP)

 THE TOTAL PRODUCT PER WORKER EMPLOYED
 AVERAGE PRODUCT = TOTAL PRODUCT ÷ QUANTITY OF LABOUR
SHORT –RUN PRODUCTION FUNCTION
EXAMPLE:
TABLE AND GRAPH BELOW SHOWS THE FARMERS PRODUCTION WITH 1 VARIABLE INPUT
SINCE WE EXAMINE SHORT-RUN, QUANTITY OF LAND (FIXED INPUT) REMAINS CONSTANT AT 20 UNITS
If Farmer wants to increase Production (Fixed Input cannot change),

employs Labour (Variable Costs)
Keeps on adding units of Labour
As soon as Max point (200) reached2, production start to decrease
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LAW OF DIMINISHING RETURNS
 As more of a variable input is combined with 1 or more fixed inputs in production process
 Points will eventually be reached where
 First the Marginal Product, then the Average Product and finally the Total Product starts to declined
35 = Highest Marginal Product

 Amount of Labour units utilized productively, if more than 4 Units of Labour added, marginal product
will start to decrease and average product will start to decline
29, 00 = Maximum point of Average Product
Reason for decline in both Marginal Product and Average product could be a result of the Fixed Units (Land) which
cannot increase, or under-utilization of Labour Units
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TOTAL, AVERAGE AND MARGINAL PRODUCT OF LABOUR
MAXIMUM POINT
TOTAL PRODUCT AVERAGE PRODUCT

INCREASING AS LONG AS MARGINAL INCREASING AS LONG AS
PRODUCT POSITIVE MARGINAL PRODUCT IS
ABOVE IT
COST
A Firm’s Total Cost (TC) The cost of all the factors of production the firm uses
Total Costs divides into 2  Total Fixed Cost (TFC)

parts o The cost of a firm’s fixed factors of production
o Land, Capital and Entrepreneurship
o Does not change as output Changes
 Total Variable Cost (TVC)

o The cost of the variable factor of production
o Labour, raw materials, etc.
o To change output in the short run, a firm must e.g., change quantity of labour
o So variable output changes as output changes
TOTAL COST  The sum of Total Fixed cost and Total Variable cost
FORMULA
TC = TFC + TVC
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COSTS: FIXED, VARIABLE AND TOTAL COST
COST OF A FIXED UNIT INPUT = R450
COST OF A VARIABLE UNIT INPUT = R2, 400
FIXED UNIT COST EXAMPLE VARIABLE UNIT COST EXAMPLE TOTAL COST EXAMPLE
Land = 20 Units x R450 = R9, 000 Labor Units = 2 Units x R2, 400 = R4, 800 Total Cost = R9, 000 + R4, 800 = R13, 800
ACTIVITY 3
As the level of production decreases in the short run, fixed cost .
a. stays the same, while variable cost increases
b. decreases, while variable cost decreases
c. increases with less than variable cost
d. stays the same, while variable cost decreases
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ACTIVITY 4
The table below provides the cost data for a firm that manufacturing tables.
Fill in the missing values
a. 20 000 (fixed always the same)

b. 0 (Quantity = 0, therefore no Variable cost)
c. 20000 (Quantity + Total Variable cost)
d. 50 000 (70 000 - 20000)
e. 85 000 (20 000 + 65 000)
f. 20000
g. 105 000 (20 000 + 85 000)
QUANTITY TOTAL FIXED COST TOTAL VARIABLE COST TOTAL COST
0 a b c
1000 20 000 30 000 50 000
2000 20 000 d 70 000
3000 20 000 65 000 e

4000 f 85 000 g
ACTIVITY 5
What is the Marginal Cost of the Fourth Unit?
a. 100
b. 300
c. 350
d. 700
Quantity Produced 1 2 3 4 5
Fixed cost 100 100 100 100 100
Variable Cost 200 300 350 700 1 400
Steps to calculate
Step 1:
Change in Total Cost = (100 + 700 = 800) – (100 + 350 = 450)
= 800 – 450 = 350
Change in Quantity = 4 – 3 = 1
Marginal Cost = 350 ÷ 1 = 350
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UNIT 8: CHAPTER 10 – MARKET STRUCTURE: PERFECT COMPETITION
4 TYPES OF MARKET STRUCUTRE
 As we move from Perfect Competition to Monopoly, the degree of Competition declines, from
maximum to Zero.
 All Markets fit in somewhere along this continuum
SUMMARY OF MARKET STRUCTURE
FEATURE / PERFECT MONOPOLY MONOPOLISTIC OLIGOPOLY
CRITERIA COMPETITION COMPETITION
NO. OF FIRMS MANY ONE MANY FEW
NATURE / TYPE HOMOGENEOUS UNIQUE DIFFERENTIATE HOMOGENEOUS

OF PRODUCT (IDENTICAL) (NO CLOSE D (SIMILAR) (DIFFERENTIATED)
SUBSTITUTE)
CONTROL INTER
NO RESTRICTIONS CONSIDERABLE LIMITED
OVER PRICE DEPENDENCE
INFLUENCES
PRICES
ACCESS LIMITED
NO RESTRICTIONS FREE MAY BE RESTRICTIONS
TO (BARRIERS)
MARKET
NON PRICE MOSTLY ADVERTISING GREAT DEAL, ESPECIALLY
NONE
COMPETITION PUBLIC AND TRADE ON PRODUCT
RELATIONS MARKS DIFFERENTIATION
PERFECT COMPETITION
 Occurs when none of the individual Market Participants can Influence price of Product
 Price of Product is determined by Supply and Demand
 Individual Firm is a price Taker
 Many Buyers and Sellers
 Good are homogeneous (identical)
 Examples: Markets for fresh produce (tomatoes, maize, wheat, fruit, vegetables, etc.)
 No Government interference

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Demand Curve for Product of a Firm under PERFECT Competition
Graph A Graph B
Graph A Graph B
 Price of Product (P1) – determined in market by  Shows Position of Individual Firm
forces of Supply (SS) and Demand (DD)  Can Sell any Quantity at the prevailing market price
 At Higher prices – Quantity demanded will fall to
Zero (as consumers will be able to purchase
product at a price of (P1) from any other Supplier)
 Firm won’t charge lower Price than (P1) because
it can sell all its output at a price of (P1)
 Firm Receives the same price for any number
of units of the product that it sells
 Marginal Revenue (MR) and Average Revenue
(AR) therefore equal to Market price
(MR = AR = P)
 Under Perfect Competition price is given, thus
for each additional unit that firm sells, total
revenue increases by an amount equal to price of
product (MR = AR = P)
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TOTAL, MARGINAL & AVERAGE REVENUE: PERFECT COMPETITON
 Suppose a firm operates under conditions of Perfect Competition and;

 Market price of its product is R20 per unit
 The Firm is a price taker and its total, average and marginal Revenue for the first 5 units sold will be as follows
EQUILIBRIUM CONDITIONS (ANY FIRM)

Shut Down Rule Produce only if Total Revenue is Equal to, or greater than, total variable cost
TR ≥ TVC
OR
Produce only if Average Revenue is Equal to, or greater than, average total variable cost
AR ≥ AVC
NB: If AR < AVC to shut down production

Firm should shut down its business
Profit-Maximising  Profits are Maximised where positive difference between total revenue and total cost
Rules is the greatest
 Profit is maximised where marginal revenue is equal to marginal cost
MR = MC
Different Possibilities
 If MR > MC: Output should be expanded (profit increases)
 If MR = MC: Profits are maximized
 If MR < MC: Output should be reduced (profit decreases)
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EQUILIBRIUM UNDER PERFECT CONDITIONS
Profit  Profit is maximized when firm produces an output where marginal revenue equals
marginal cost,
 Provided marginal cost is rising and lies above minimum average variable cost
Different Possibilities
 As long As Average Revenue (AR) is Greater than Average Cost (AC) – Firm earning
Economic Profit
 When Average Revenue (AR) is Equal to Average Cost (AV) – Firm only earns
Normal Profit
 The Average Cost (AC) Increases and Average Revenue (AR) is Less than Total Cost
– Firm is making Economic Loss
DIFFERENT POSSIBLE SHORT-RUN EQUILIBRIUM POSITIONS – PERFECT COMPETITION
 MARKET PRICE IS P1 = TO FIRMS AVERAGE

REVENUE (AR) AND MARGINAL REVENUE
(MR)
o PROFIT MAXIMISED WHERE MARGINAL
REVENUE (MR) (=P1) IS EQUAL TO
MARGINAL COST (MC)
 THIS OCCURS AT A QUANTITY OF Q1.
 AT Q1 AVERAGE REVENUE (AR) = (P1) –
GREATER THAN ITS AVERAGE TOTAL COST (AC) –
(C1)
 FIRMS THUS MAKE AN ECONOMIC PROFIT OF P1
TO C1
 FIRMS TOTAL PROFIT GIVEN BY SHADED AREA
(C1P1E1M), WHICH IS EQUAL TO PROFIT PER
UNIT OF OUTPUT (P1 – C1) MULTIPLIED BY
 MARKET PRICE IS P2 = EQUAL TO MARGINAL

COST (MC) AT POINT WHERE MARGINAL COST
(MC) INTERSECTS AVERAGE COST (AC)
 AT THIS LEVEL OF OUTPUT AVERAGE REVENUE
(AR) IS EQUAL TO AVERAGE COST (AC) – FIRMS
EARNS NORMAL PROFIT, SINCE ALL COSTS
FULLY COVERED
 POINT E2 – BREAK EVEN POINT
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MARKET PRICE FIRMS (AR AND MR) IS EQUAL

TO
𝑃3. MR OR PRICE IS EQUAL TO MC AT A

QUANTITY OF 𝑄3.
 AT 𝑄3, THE FIRMS AVERAGE REVENUE AR IS
LOWER THAN ITS AVERAGE COST AC.
 IT THEREFORE, MAKES AN ECONOMIC LOSS PER
UNIT OF OUTPUT EQUAL TO THE DIFFERENCE
BETWEEN 𝐶3 AND
The
 shutdown point is point B where the
average revenue (AR) is equal to the average
variable cost (AVC). (AR=AVC)
 At a price lower than P4, the firm will not be
willing to supply goods and services.
 For instance, a price is P5 and the average
revenue (AR) is smaller than the average
variable
cost (AVC), the firm will not produce at all
 At P3 the firm will minimize its economic losses
by producing at Q3 ( c)
 At P2 the firm will make normal profit (AR=AC)
 At P1 the firm’s average revenue AR =(𝑃_1) is
greater than its average total cost AC (economic
profit)
Activity 1
Study the following diagram and answer the questions
a. At what point does the firm maximise profits?

b. What is the output level at the profit maximisation point?
c. What is the total revenue at the profit maximisation point?
d. Is the firm making an economic profit,
a normal profit or an economic loss?
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Activity 2
If the market price for the perfectly competitive firm represented in Figure below is R4.
What should the firm do?
a. The firm should produce 13 units.

b. The firm should shut down.
c. The firm will make an economic loss in the long run.
d. The firm should continue to produce though it
will not recover its variable costs.
Activity 3
Figure 1.1 is a hypothetical economy producing SUV’s and Cars. Economic growth is represented by…
a. A movement from point B to F

b. A movement from point D to E
c. A movement from B to A
d. A movement from B to E
Activity 4
If the price elasticity of demand is 0.20, and the price is doubled, this will lead to a in the quantity demanded.
a. 40 percent increase.
b. 20percent decrease.
c. 0.40percent increase.
d. 0.2 percent decrease.
PED= %change in Q / % change in P PED=0.2

%change in price 100%
0.2= % change in Qd / 100% %change in quantity demanded = 0.2 x 100%= 20%
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UNIT 9: CHAPTER 11 – MONOPOLY AND IMPERFECT COMPITITION
Imperfect Competition  A Situation in which at least one of the conditions for perfect competition in not
satisfied
3 Broad categories of  Monopoly
Imperfect competition  Oligopoly
 Monopolistic Competition
Distinguishing Features of  Demand Curve for product of product slope downward – like normal
Imperfect Competition market demand curve
 Individual firm can be affected by the actions of competitors
Monopoly  Market where there is only ONE seller of a good or service
 Has no close substitutes
 Entry to market should be completely blocked
Monopoly  Should produce where Marginal Revenue (MR) is equal to Marginal Cost (MC)
Equilibrium (or  Profit Maximising rule – provided that Average Revenue (AR) is GREATER
Profit- Maximising than minimum Variable Cost (VC) – THE SHUT-DOWN RULE
Position_
EQUILIBRIUM OF A FIRM UNDER MONOPOLY
 How a Profit-Maximizing Monopoly Decides Price In Step 1,
Step2: Look at the monopoly chooses the profit-maximizing level of
Demand Curve to see
output Q1, by choosing the quantity where MR = MC.
what price to change
 In Step 2, the monopoly decides how much to charge
for output level 1 by drawing a line straight up from Q1
to point M1 on its perceived demand curve. Thus, the
monopoly will charge a price (P1).
 In Step 3, the monopoly identifies its profit. Total revenue
Step 1: MR = MC will be Q1 multiplied by P1.
o Total cost will be Q1 multiplied by the average cost of
producing Q1, which is shown by point K1 on the
average cost curve to be C1.
 Profits will be the total revenue rectangle minus the total
Step 3: Identify Profit
cost rectangle, shown by the shaded zone in the figure.
https://courses.lumenlearning.com/suny-microeconomics/chapter/monopolies-and-deadweight-loss/
Monopoly and Efficiency
The fact that price in monopoly exceeds marginal cost suggests that the monopoly solution violates the basic condition
for economic efficiency, that the price system must confront decision makers with all of the costs and all of the benefits
of their choices. Efficiency requires that consumers confront prices that equal marginal costs. Because a monopoly firm
charges a price greater than marginal cost, consumers will consume less of the monopoly’s good or service than is
economically efficient.
To contrast the efficiency of the perfectly competitive outcome with the inefficiency of the monopoly outcome, imagine
a perfectly competitive industry whose solution is depicted in Figure 10.7 “Perfect Competition, Monopoly, and
Efficiency”. The short-run industry supply curve is the summation of individual marginal cost curves; it may be regarded
Page 107 of 113

as the marginal cost curve for the industry. A perfectly competitive industry achieves equilibrium at point C, at price Pc
and quantity Qc.
Given market demand and marginal revenue, we can compare the behavior of a monopoly to that of a perfectly
competitive industry. The marginal cost curve may be thought of as the supply curve of a perfectly competitive industry.
The perfectly competitive industry produces quantity Qc and sells the output at price Pc. The monopolist restricts output
to Qm and raises the price to Pm.
Reorganizing a perfectly competitive industry as a monopoly results in a deadweight loss to society given by the shaded
area GRC. It also transfers a portion of the consumer surplus earned in the competitive case to the monopoly firm.
Now, suppose that all the firms in the industry merge and a government restriction prohibits entry by any new firms.
Our perfectly competitive industry is now a monopoly. Assume the monopoly continues to have the same marginal cost
and demand curves that the competitive industry did. The monopoly firm faces the same market demand curve, from
which it derives its marginal revenue curve. It maximizes profit at output Qm and charges price Pm. Output is lower and
price higher than in the competitive solution.
Society would gain by moving from the monopoly solution at Qm to the competitive solution at Qc. The benefit to
consumers would be given by the area under the demand curve between Qm and Qc; it is the area QmRCQc. An
increase in output, of course, has a cost. Because the marginal cost curve measures the cost of each additional unit, we
can think of the area under the marginal cost curve over some range of output as measuring the total cost of that
output. Thus, the total cost of increasing output from Qm to Qc is the area under the marginal cost curve over that
range—the area QmGCQc. Subtracting this cost from the benefit gives us the net gain of moving from the monopoly to
the competitive solution; it is the shaded area GRC. That is the potential gain from moving to the efficient solution. The
area GRC is a deadweight loss.
Page 108 of 113

Activity 1
Study the diagram below, in which the monopoly depicted is maximising profit and answer the question.
What is the total profit?
a) R3
b) R4
c) R6
d) R9
Profit = TR – TC
TR= PxQ= 6x3= 18
TC= Acx Q= 4x 3= 12
Profit = 18-12=6
Activity 2
Monopolists may have more incentive to undertake research and development due to:
a. lower cost curves in long run.
b. the pressure for additional sales.
c. the kinked demand curve theory.
d. abnormal profits.
MONOPOLOSTIC COMPETITION
 In a Monopolistically Competitive Market a large number of firms produce Similar but slightly different
products
Type of Shape of Demand curve facing the firm Example (often approximations)
Market
Monopolistic  Downward-sloping demand curve Clothing, footwear, household furniture, fast
Competition – relatively Elastic food outlets, restaurants, butcheries, plumbers,
 Firm has some control over price books, magazines, television repair, used cars,
 Economic Profits possible in short run photographic development, filling stations – in
 Normal Profits in the long run due some instances location might turn market into
to freedom of exit and entry oligopoly or even monopoly, particularly as far
as services are concerned (e.g. plumbers,
electricians, television repair, supermarkets,
hotels, filing stations
Page 109 of 113

SHORT-RUN EQUILIBIRUM OF MONOPOLISTIC FIRM
 is the demand curve for the product of the firm (or
average revenue AR).
 The profit is maximised when MR = MC.
 The firm is in equilibrium at output Q1 and price P1.
 The economic profit is the difference between the AR and
AC.
LONG – RUN EQUILIBRIUM OF MONOPOLISTIC FIRM
 In the long-run thus, the firm only makes a normal profit at

an output of Qe and a price of Pe.
 At that price-output combination, AR is tangent to AC,
MR = MC and AR = AC.
Page 110 of 113

ACTIVITY 3
The figure below represents a monopolistically competitive firm in short-run equilibrium. Use the figure to answer the
question.
What is the firm’s level of output?
a) Q1
b) Q2
c) Q3
d) Q4
OLIGOPOLY
 Under oligopoly a few large firms dominate the market.
 The product may be homogeneous (e.g. petrol, cement : PURE OLIGOPOLY), but it is mostly
HETEROGENEOUS (e.g. motorcars, cigarettes, household appliances DIFFERENTIATED OLIGOPOLY).
 The main feature of oligopoly is the high degree of interdependence between the firms.
 The other important feature of oligopoly is uncertainty.
 The kink in the demand curve is at the market

price P1 with the amount which the firm produces
at Q1; this is the point of profit maximisation.
 The significance of P1 is that oligopolists will be wary
of moving away from it individually because they
cannot be certain of the reactions of their rivals.
 The curve is relatively elastic above P1 and inelastic
below it.
 If they cut prices, their rivals will follow to protect
their own position, which means that all firms will
end up with lower prices and profits on unchanged
market shares.
 The net effect is that if all firms cut price – the
individual firm will only see a small increase
in demand
Page 111 of 113

OLIGOPOLY
Impact of Price Rise Impact of Price Cut
• If a firm increases the price, then it becomes more • If a firm cut its price, it is likely to lead to a
expensive than rivals and therefore, consumers different effect. In the short term, if a firm cuts
will switch to its rivals. price it would cause a big increase in demand
• Therefore for a price rise, there is likely to be a and therefore would lead to a rise in revenue.
significant fall in demand. Demand is, therefore, The firm would gain market share.
price elastic. • However, other firms will not want to see this
• In this case, of increasing price firms will lose revenue fall in market share and so they will respond by
because the percentage fall in demand is greater also cutting price to follow the first firm. The net
than the percentage rise in price. effect is that if all firms cut price – the individual
firm will only see a small increase in demand.
• Because there is a ‘price war’ demand for a
firm is price inelastic – there is a smaller
percentage rise in demand.
• If demand is inelastic and price falls, then
revenue will fall.
MARKET STRUCTURE SUMMARISED
TYPE OF MARKET Shape of demand curve facing the firm(s) Examples
control over price/profit situation
Perfect Competiton  Horizontal demand curve  International commodity markets (gold,
 Firm is a price taker platinum, oil, maize, sugar)
 Economic profits possible in short run  Financial markets (JSE, foreign exchange
 But only normal profits in the long market – when exchange rates are free)
run due to freedom of exit and  Local fresh produce markets (vegetables, fruit,
entry meat, fish)
Monopolistic  Downward-sloping demand curve but Clothing, footwear, household furniture, fast-food
Competition relatively elastic outlets, restaurants, butcheries, plumbers, books,
 Firm has some control over price; magazines, television repair, used cars,
Economic profits possible in short run photographic development, filling stations – in
 But only normal profits in the long run some instances location might turn market into
due to freedom of exit and entry oligopoly or even monopoly, particularly as far as
services are concerned (eg plumbers, electricians,
television repair, supermarkets, hotels, filling
stations)
Oligopoly  Downward-sloping demand curve, Iron and steel, motorcars, tyres, breakfast cereals,
 with elasticity depending on rival banks, cellular phones, cigarettes, cement, petrol,
firms’ reactions to price changes chemical fertilisers, aluminium smelting, golf balls,
 Firm has some control over price; golf clubs, photographic equipment, beer, soft
Economic profits possible in short run drinks, car rental service
and long run due to barriers to entry
Monopoly  Downward-sloping demand curve (the Electricity supply (Eskom), local water supply
market demand curve); (Umgeni Water, Rand Water), stainless steel, local
 Firm has considerable control over monopolies (hotels, bottle stores, universities)
price; Economic profits possible in
short run and long run due to blocked
entry
Page 112 of 113

Activity 4
Figure below represents an oligopoly firm. The existing price and quantity are P1 and Q1 units. The firm’s demand
curve will be…
a. dad
b. DaD
c. Dad
d. daD
Activity 5
"Khula has been in an intensive pilot over the last three years, working with farmers of all sizes across South Africa…
The AgriTech startup has built a digital ecosystem of three platforms aimed at making the agricultural value chain
more efficient.
The Khula Inputs App (recently released) allows farmers to access approved agricultural inputs & services from leading
suppliers (local & international)."
Which of the following is an example of a primary factor of production?
a. The Khula Inputs App

b. A farmer
c. Commercial farmland.
d. Agricultural input suppliers.
Activity 6
"Citing credible industry sources, Attard Montalto said that in Durban’s economic zone R1.5 billion in stock has
been lost, with R15 billion in damages to property. He said that 50,000 informal traders and 40,000 businesses have
likely been impacted by the violence and looting.
He warned that as many as 150,000 jobs are at risk, meaning as many as 1.5 million homes are without incomes…"
The loss of employment as result of the looting experienced in the Durban area will have which of the following
impacts on Durban’s production possibilities frontier assuming that only the industries affected are depicted on it ?
a) An outward shift of the production frontier

b) An inward shift of the production frontier.
c) No change in the production possibilities frontier.
d) An inward swivel of the production possibilities frontier.
Page 113 of 113

Economics - Chapter 1 - Chapter 11

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Economics - Chapter 1 - Chapter 11

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UNIT 1: ECONOMICS AND THE PPC CURVE

o If Price of coke increases, quantity demanded in decrease (ceteris paribus)

 Producers  Stability of general price levels (Inflation)

* The Opportunity cost of choice is:

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Factors of  Natural Resources (Land)

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PRODUCTION POSSIBILITY SCHEDULE

Opportunity cost: Example

G: Unattainable with available

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Use the diagram below to answer the question below:

Point A can only be produced if…

a. resources are used efficiently

c. the economy is at less than full employment level of resource usage

d. no opportunity cost is incurred

 Any point along the curve is

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 To satisfy Human wants

Different Categories of Consumer Goods

Final Goods & Intermediate Goods

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CHANGE CAPITAL GOODS CONSUMER GOODS

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SWIVEL CAPITAL GOODS:

Swivels outward from AB to AC

IMPROVEMENT – PRODUCING CONSUMER GOODS

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CONSUMER GOODS & CAPITAL GOODS

1. SUMMARY: PRODUCTION POSSIBILITIES CURVE (PPC)

2. ECONOMICS IS A SOCIAL SCIENCE

 Involves systematic attempt to discover regular patterns of behaviour

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POSITIVE STATEMENT NORMATIVE STATEMENT

4. EQUILIBRIUM, COMPARATIVE STATISTICS AND CETERIS PARIBUS

 Central Role in Economic theory

4.2. Statics and Comparative Statics

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5. RELATIONSHIPS BETWEEN ECONOMIC VARIABLES

 Direct (or Positive) Linear relationship between 2 variables

Annual rainfall and Maize Production

Direct (or Positive) Linear Relationship

 Points a to e = joined to form

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Direct (or Positive) Linear Relationship

Direct (or Positive) Non- Linear

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Inverse (Negative) Linear Relationship

Inverse (Negative) Non-Linear Relationship

Inverse (Negative) Non-Linear

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RELATIONSHIP TYPE EXAMPLE

CHAPTER 2: ECONOMIC SYSTEM

1. 3 ECONOMIC QUESTIONS TO BE SOLVED

2. 3 MAIN TYPES OF ECONOMIC SYSTEMS – CO-ORDENATING MECHANISMS

2.1. Traditional System

2.2. Command System

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2.3. Market System

2.4. Mixed Economy

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2. SOURCES OF PRODUCTION: THE FACTORS OF PRODUCTION

Value of total income identically equal to value of total Production

Households responsible for spending in consumer goods

Firms responsible for spending in Capital Goods

Total Expenditure = C+I+G+X-Z

AVAILABILITY OR SUPPLY DOES NOT DETERMINE DEMAND