Economics

Economic Principles
Study Unit 1
Glossary
• Capital goods are goods used in the production of consumer goods, example machinery.
• Ceteris paribus is a Latin term which means “all other things being equal”
• Choice exists in every decision made in the economy and refers to accepting one option over another.
• Consumer goods are goods purchased by households, example bread.
• Direct (positive) relationship shows two variables which are causally linked increasing or
decreasing simultaneously.
• Durable goods are goods that can be used repeatedly, example furniture.
• Economic goods are goods that fetch a price.
• Economic growth refers to an expansion in the productive economy.
• Equilibrium is a state of balance when opposing forces are balanced and there is no incentive for
change.
• Final goods are bought by the end user or household, example shoes.
• Free goods are goods that do not directly carry a price, example sea water.
• Graph is a visual representation of the relationship between two or more variables.
• Heterogeneous goods are different in the eyes of the end user.
• Homogeneous goods are exactly the same in the eyes of the end user.
• Intermediate goods are inputs into the production of final goods, example raw materials.
• Inverse (negative) relationship shows two variables which are causally linked increasing or
decreasing in opposite directions.
• Macroeconomics is the study of global or national aggregates, example inflation.
• Means are resources or inputs used in the production process, example natural resources.
• Microeconomics is the study of individual entities in the economy, example a firm.
• Needs are goods and services people cannot do without, example water.
• Non-durable goods are goods that have a single use, example food.
• Normative sciences are sciences based on subjective opinion, example politics.
• Opportunity cost is the cost of the next best alternative given up, or not chosen.
• Positive sciences are sciences based on objective fact, example chemistry.
• Production possibilities curve is a graphical representation of the maximum possible production
possibilities of a community or country.
• Public goods are provided by the government for everyone to use, example parks.
• Resources are means or inputs used in the production process, example human resources.
• Schedule is a table.
• Semi-durable goods are goods that can be used repeatedly for a short period of time, example
sports equipment.
• Services are non-tangible actions, example haircuts.
• Social science is a science that examines humans in the environment, example psychology.
• Wants are nice-to-haves but are not necessary for survival, example holidays.
What is economics?
Economics is the study of the use of scarce resources to satisfy unlimited human wants. This relative
scarcity of resources implies the existence of cost and the need for choice.
Definition
& Economics is the study of how man attempts to satisfy his unlimited wants and needs by way of
limited resources. This relative scarcity of resources implies the existence of cost and the need for
choice.
In order to elevate Economics to a scientific status, the approach should be positive (based on fact)
rather than normative (based on opinion).
In order to examine the effect of one variable on another, which can be proved through controlling the
environment and experimentation in the natural sciences, Economics as a human science must often ignore
or hold other influencing variables ‘constant’ or assume their autonomy. This condition is called the
ceteris paribus assumption. The theories derived in this way can be expressed in words, as
equations, as graphs or as tables (schedules).
Scarcity, choice, and opportunity cost

® Needs and particularly wants are not in short supply.
o This suggests that wants are never really satisfied, irrespective of how well off an
individual or country is.
® Demand for a good or service only if those who want to purchase it have the necessary means to
do so.
Resources are limited

• Natural resources
• Human resources
• Man-made resources
(FACTORS OF PRODUCTION)
Every country has a fixed stock of resources namely:

• Land
• Labour
• Capital
• Entrepreneurship
® These resources are combined to produce products that people need and want
Ñ Because the world’s population has unlimited wants, but resources are in short
supply, competition for existing resources develops.
Ñ Competition implies the existence of a cost and of choice. Individuals must choose what to
spend their limited time and income on, firms must choose which products to produce, and
governments must choose what to spend their limited revenue on.
Opportunity costs
& the value of the next best alternative foregone or given up when a choice is made.
- Example: The opportunity cost for you as a student is the money and satisfaction you could have
earned had you worked full time. The opportunity cost of working full time is however higher
than the opportunity cost of being a student, which is why you made the decision to study. The
long-term advantages will be greater.
® On a broader level, opportunity costs are borne by society and companies. Local governments have
to constantly decide on how best to spend taxpayer’s money. Should a new library be built, or
should the money and expertise be used to build a casino? A company may need to decide whether
to build a steel bridge or to use the steel to build power lines? Each time such a decision is made,
the opportunity costs are considered. The local government or firm will choose those options
where the opportunity costs are lowest. If the decision has some bearing on society, the
opportunity cost is known as a social cost.
Production Possibility Curve
& Shows the different combinations of 2 goods that can be produced using full employment of resources.
® Illustrating scarcity, choice and opportunity cost using the production possibilities curve (PPC)
We begin by making three assumptions:

§ Only two goods are produced.
§ Each good is produced with the same amount of effort and resources.
§ Scarce resources are fully utilised and technology is fixed.
EXAMPLE:
® This graph represents the table and how one can use
their full employment of resources
® Where one is not using one’s full employment of

resources = INEFFICIENT.
® Only point in the curve which is tangible
® Can’t produce beyond the curve

® It is unattainable
How to get there:

• Increase resources
• Increase productivity
• Increase technology
Ñ Ultimately then the graph can move forward
® The PPC curve shifts outward, called economic growth, when:

• there is an increase in the size of the labour force,
• new resources are discovered,
• new inventions lead to greater efficiencies in both products.
® The PPC shifts inward:
• in times of war, famine, drought, or any national disaster.
Figure 1
The PPC can be extended to show the trade-off between the production of consumer goods and capital
goods for a country. See graph 2
Non-linear curve
Figure 2
• If this country chooses to use all resources to produce consumer goods only, it can manage to make
100 consumer goods per year. This represents labour-intensive production, since there will be no
capital equipment.
• If this country chooses to use all resources to produce capital goods only, it can manage to make 10
capital goods per year. Although capital equipment leads to greater production of consumer goods in
the future, the population would starve, since there is no production of consumer goods in the first
year.
• Production at point H requires a sacrifice of 20 consumer goods to produce 5 capital goods per year.
• Sacrificing current consumption to produce capital would increase consumption production in the
future. The result could be an outward shift of the PPC (growth) in the future as the country frees up
resources to produce greater quantities of consumer and capital goods.
Calculating the opportunity cost:

• A to D = 15 hats (30-15)
• B to C = 4 hats (29-25)
• E to D = 1 video
• C to A = 2 videos
The SHAPE of the curve is important:
® Constant opportunity cost

o Produce a certain amount of wheat and give
up a certain amount of corn
o Produce the same amount of wheat and give
up the same amount of corn.
Non-linear curve
® Increasing opportunity cost
o Produce first amount of pineapple you have
a little bit of cactuses
o Produce the next pineapple and you have
even more cactuses
o And the next one even more
The law of increasing opportunity cost:

® When all resources are being used, an increase in the production of one good will lead to greater
forgone production of another good.
Now read and recap these definitions carefully:

& Resources in production are also known as factors of production, which include natural
resources, human resources, capital and entrepreneurship.
& Opportunity cost is the value of the next best alternative foregone (given up).
& Specialisation refers to concentrating effort in the production of the good where the opportunity
costs are lowest. Example: a skilled marketing graduate should ideally not be employed as a cashier.
& Division of labour refers to dividing production into several tasks (also called a production
line). Repeating a single task leads to specialisation.
Goods and services

• Goods are tangible items, such as food & clothing.
• Services are intangible things such as medical & financial services.
o For the sake of simplicity, we call all goods and services ‘goods’.
& A consumer good is used by individuals or households. Consumer goods can be:
o Durable (e.g., a fridge) Durable goods can be used over and over again over a long period of
time.
o Semi-durable (e.g., a tennis racket) Semi-durable goods can be used for a shorter period of
time than durable goods.
o Non-durable (e.g., food). Non- durable goods can only be used once.
& Capital goods are used in the production of other goods, e.g., machines.
o These depreciate (lose value) over time.
& Capital formation/investment is when firms spend money on capital goods
& Final goods are those used by the household or firm, e.g., tea and coffee.
& Intermediate goods are used in the production of other goods, which are to be sold, e.g., wood is
used to make furniture.
o Households do not buy intermediate goods.
& Private goods are used by households, which pay for their use, e.g., clothing.
o It is not possible to use a private good unless you pay for it.
o That means it is possible to exclude certain people from using private goods.
& Public goods are used by everyone, whether they pay for them or not, e.g., street lighting.
o Public goods are non-excludable, which means no one can be prevented from using them.
& Economic goods are scarce and carry a price, e.g., petrol.
o Economic goods are of interest to economists.
& Free goods are found in abundance and do not carry a price directly, although taxation may be used
to maintain these goods, e.g., fresh air.
o Free goods are not studied in economics.
& Homogeneous goods are all exactly alike. (Non-differentiated goods)

o Like gold, water, air etc.
o Example: If you feel that a hamburger from Steers and a hamburger from Spur tastes the same,
looks the same, and you are not particular which one you have; then Steer’s and Spur’s hamburgers
are homogenous for you.
& Heterogeneous goods differ in respect of brand, quality, variety etc.

o Like cars, milk, phones.
o Example: If you feel that a hamburger from Steers tastes and looks very different to a hamburger
from Spur, then Steer’s and Spur’s hamburgers are heterogeneous for you, and you care very much
which one you buy.
∆ These classifications are not mutually exclusive.

- It is possible that one good or service belongs to several of these categories.
- Example: a loaf of bread is a final and a consumer good if a household buys it and intermediate and capital
good if a sandwich shop buys it.
Economics as a social science

® Economics is a human or social science.
• Field of study, which is systematically explored in order to discover laws and truths.
• Concerned with the activities of man in society.
• Empirical science as it attempts to measure or quantify aspects such as inflation, gross domestic
product, and unemployment.
• Not an independent science since it draws on the knowledge gained in other sciences
• The approach should be positive (based on fact) rather than normative (based on opinion).
® Economics as a science explains a situation, predicts what is going to happen and chooses or advises
on policy making.
Microeconomics and macroeconomics

& Microeconomics studies an individual firm, an individual consumer or individual product.
o Microeconomics explains how and why these decision-making units make the decisions they
make.
& Macroeconomics studies the economy as a whole and is concerned with issues such as total
production and inflation.
Examples of micro and macro topics include the following:
Micro topics Macro topics
The price paid by John Smith for a bag of The general price level for all goods and
apples. services in the country.
The production of wheat. The production of all goods and services in
the country.
Eskom’s export of electricity to The export of all goods and services from
Zimbabwe. SA to other countries.
Company Z’s use of resources. The total supply of resources in SA.
Microeconomic topics usually refer to:
• A single firm or industry,
• A single consumer or group of consumers,
• A single product or service.
Macroeconomic topics usually refer to:

• All firms collectively in a country, group of countries or the world,
• All consumer in the country, a group of countries or the world,
• All goods and services collectively.
Equilibrium, comparative statistics, and ceteris paribus

& In an attempt to control the environment while it is being studied, we use the term ceteris paribus,
which means all other things remain the same/being equal/ ignored.
® In order to examine a model in economics, the model or graph is held constant for a brief moment
while we examine the state of balance or equilibrium, between two opposing forces.
® The movement of curves in a graph happens constantly.

o to see the result of each movement on its own we ‘freeze’ the graph = Static analysis
o Compare each ‘picture’ to the last and predict the next = comparative statics.
Production, income and spending in the economy
Study unit 2
Glossary
• Capital refers to goods / equipment used in the production of other goods, example machinery.
• Capital formation is the process of investing in capital equipment.
• Capital intensive production refers to companies that use more capital equipment than labour,
example automation.
• Circular flow refers to the flow of money between households and firms in one direction and the flow of
goods and services in the opposite direction.
• Consumer spending refers to the spending by households.
• Division of labour is when workers are divided into tasks as part of a continual production process
according to their skills, example a labourer who works on a production line.
• Entrepreneurship refers to the skill that people who open and own a business possess. The act of
opening a business.
• Exports refer to goods that are sold outside a country’s borders.
• Factor market is a market where factors of production are traded, example the labour market.
• Factors of production refer to the resources needed to carry out production, example labour.
• Financial sector refers to intermediaries through which funds are channelled from surplus units to deficit
units, example banks.
• Firms refer to all forms of business ownership, including informal businesses.
• Flow is a variable that has time dimension, i.e. it occurs over a period of time.
• Foreign sector refers to all countries, businesses and people outside the national border.
• Goods market is a market where goods and services are traded.
• Government refers to all levels of government, from local councils to national government as well as all
state-owned enterprises.
• Government expenditure refers to spending by all levels of government.
• Household is a collection of one or more consumers that live together.
• Human capital refers to the quality of labour, i.e. skills levels.
• Human resources refer to the quality and quantity of labour.
• Imports are goods and services that flow into the country from beyond the national borders.
• Income as a micro concept refers to earnings for the factors of production.
• Injection refers to money that enters the circular flow.
• Interest is payment for capital, example lease payments for machinery.
• Investment refers to the buying of capital goods needed for production, example machinery.
• Labour intensive production refers to companies that use more labour than capital equipment during
the production process.
• Leakage refers to money that leaves the circular flow.
• Macroeconomic objectives serve as criteria for judging the performance of an economy.
• Money is the lubricant for earnings and spending. Money is not a resource.
• Natural resources are the gifts of nature used in the production process, example land.
• Production using inputs to make outputs. The act of making things for resale.
• Profit is income minus expenditures.
• Public sector refers to all levels of government, from local councils to national government as well as all
state owned enterprises.
• Rent is payment for natural resources, example land.
• Specialisation refers to being successful and skilled in an area of business, example an accountant.
• Spending refers to buying goods and services.
• Stock is a measure that has no time dimension, example the amount of money in your wallet right now.
• Technology refers to the innovation and invention of new equipment which aids the other factors of
production, example computers.
• Transfer payments are one way money flows from the government, example child grants.
• Wages and salaries are payments for the use of labour in the production process.
Production, income and spending
& Production refers to the transformation of inputs into outputs. The relative size of the inputs and
outputs determines whether production is efficient or not. Production units or the firm refers to any
productive effort, whether it is an informal or sole trader or a private or public company.
& Income refers to money earned during the production process. Income can take the form of wages,
salaries, profit, dividends, commissions, rent and interest. Income should not be confused with
wealth, expenses, costs or prices. In economics all of these terms have precise meanings and cannot
be interchanged with income or with each other.
& Spending refers to exchanging money for goods and services. Income that is earned by individuals
is either spent of saved. The purpose of savings is so that one can spend at a future date. It is,
therefore, true to say that ultimately all income is spent.
Interest
Rent, wages, profit
GDP
Factors of production
Production generates income (for the various factors of production) and part or all of this income is then spent to buy the available goods and services. All
these things are happening at the same time.
Because it is a circular flow there is no beginning and no end point. The three flows happen at the same
time. For the sake of description let’s begin with production:
• Firms buy factors of production so that they can produce.
• The payment for these factors is called income.
• The income earned is spent on the goods and services produced by the firms.
® Production, income, spending are all flows
Stock concepts are measured at a point in time.

- The level of the water in a dam can only be measured exactly at a particular point in time. For
example, at 00:00 on 25 April 2014 the level of the Gariep dam was at 95,8 per cent of its capacity.
This kind of variable, which can only be measured at a particular point in time, is called a stock
variable, or simply a stock.
Flow concepts are measured over a period of time.
- The flow of water into the dam, on the other hand, can only be measured over a period, that is as a
rate, irrespective of how short such a period might be. Thus, the flow into the Gariep dam can be
expressed as so many cubic metres of water per second, per minute, per hour or per day. For
example, on 25 April 2014 the inflow into the Gariep dam was measured at 88 cubic metres per
second. This kind of variable, which can only be measured over a period, is called a flow variable or
simply a flow.
Flow concepts lead to stock concepts.

Sources of production
(Factors of production)
® Ingredients needed for businesses to work.
∆ Natural resources (Land)

- These are limited in supply and are generally referred to as gifts of nature, e.g. minerals, ore, raw
materials, animals, water, etc.
- Natural resources are sometimes called ‘land’, although raw materials also form part of this
resource. Minerals, e.g. coal, are non-renewable or exhaustible.
- Land is often referred to as being fixed in supply, although one could argue that high-rise
buildings increase the supply of available land.
- The quality & quantity of natural resources are important.
- The income earned from land is rent.
∆ Human resources (Labour)

- further divided into unskilled, skilled and professional labour. It is debatable whether a person
can be unskilled, as every person is skilled at something, even if it is in taking care of his own
physical being.
- Both quality and quantity are important. Quantity depends on the size of the population
and size of labour force. Quality depends on skill, knowledge, health, etc. Human resources can
be improved through training and education.
o Capital intensive production: automated production / high use of machines
o Labour intensive production: use of manual labour
- Human resources are sometimes called human capital.
- Labour intensive firms use mainly labour.
- Labour earns wages, where the term ‘wages’ refers to all forms of remuneration for labour.
∆ Capital
- refers to productive assets, such as buildings, machinery and equipment. Accountants call this
fixed capital.
- Capital depreciates over time, can become obsolete and may need to be replaced.
- Capital does NOT refer to financial capital, i.e. money.
o Money is not a factor of production since money (as notes and coins) cannot be
used to produce anything.
- Capital earns interest.
- Capital intensive firms use mostly machines. (automated)
∆ Entrepreneurship
- They are the driving force behind a business, the initiators.
- They combine the other three factors to produce goods and services. They are innovators, risk
takers and firm owners.
- The reward for entrepreneurship is profit.
Households Banks Firms

(Savings & deposits go (Banks take money from (Take out loans from bank
into bank) surplus units [households] to gather factors of
of economy in the form of production)
deposits and make it
available to deficit units
[firms] of the economy in
the form of a loan)
How income is spent in the economy
∆ Household
- Any unit of people with purchasing power
- Members of households are called consumers.
o Spending is called consumption (C).
- Household spending is an injection into the circular flow of income.
- Households own the four factors of production.
- Households sell factors of production in the factor market, buy goods in the goods and
international market, and save money in the financial market.
- Consumers are assumed to be rational and want maximum advantage.
§ Savings (S) = withdrawal / take away from economy (not putting it back into the economy)
HOWEVER
§ Banks take those savings and give them to firms as a loan = investment spending (I) (injection
into economy
∆ Firms
- Are units that employ the factors of production to produce goods and services
- A firm’s motive is profit.
- Buy factors of production in the factor market, sell goods and services in the goods market and
international market, and save and borrow funds in the financial market.
- Capital formation / investment spending (I).
- Investment spending is an injection into the circular flow of income.
∆ Government
- Includes all levels of government, as well as public corporations.
- Government decisions are not always consistent and are often politically motivated.
- Government spending (G)
- Government spending is an injection into the circular flow of income.
- Government levies taxes (T) = withdrawal from consumer spending (reduces disposable
income) but reinjects flow by government spending
∆ Foreign sector
- Exports (X) represent an injection into the circular flow of income.
- Imports (Z) are a leakage/withdrawal from the circular flow of income
- In SA: exports more than imports = X – Z = Positive figure
- Net exports (refer to foreign sector)
Total / aggregate spending (A) = C + I + G + (X – Z)
Formula for spending + GDP
Interaction between households and firms
• Goods market provides a means of contact between household and firm. (Makro, PnP)
• Factor markets anywhere where factors of production are bought and sold
• Financial markets bring together borrowers and lenders of money.
• International markets provide the link for importing and exporting.
• Market price is the agreed price of the buyer and the seller (Buyer will attempt to maximise
satisfaction and the seller will try to maximise profit).
Circular flow of goods & services
Circular flow of income & spending

Circular flow of production, income, and spending
Key concepts: specialisation and division of labour
& Specialisation refers to an increase in level of skill and expertise.

& Division of labour refers to the repetition of a single task by each worker, forming a production
line. Division of labour may result in specialisation.
Advantages of specialisation and division of labour include:

• It saves time.
• Production volumes increase dramatically.
• Workers may be allocated tasks according to their own individual strengths.
• Workers develop skills.
• It makes mechanization (and automation) possible.
• It leads to better production quality.
Disadvantages
• Worker alienation can lead to disinterest and de-motivation.
• Interdependence of tasks. Problems in one area could affect the entire production.
Demand & Supply
Study Unit 3
Glossary
• Change in demand refers to a change in every quantity demand at every price, i.e. a shift of the
demand curve.
• Change in quantity demanded refers to a change in the number of items demanded because of a
change in price.
• Complements are products that can be used together, example bread and peanut butter.
• Demand refers to all goods the consumer is able and willing to pay for.
• Demand curve is a graphical representation of a consumer showing the relationship between price
and quantity of a given item.
• Demand schedule is a table representation of a consumer showing the relationship between price
and quantity of a given item.
• Disequilibrium refers to all prices and related quantities above and below equilibrium.
• Equilibrium exists where two opposing forces are equal and there is no motive for change. Example
where quantity demanded = quantity supplied.
• Excess demand when a greater number of goods are demanded than are being supplied.
• Excess supply when a greater number of goods are supplied than are being demanded.
• Individual demand refers to the quantities of a product an individual household is willing and able to
buy at each price level.
• Individual supply refers to the quantities of a product an individual company is willing and able to
produce at each price level.
• Inferior goods are goods that decrease in demand with an increase in income.
• Law of demand states that; as prices rise, quantity demand falls and as prices fall, quantity demanded
rises.
• Law of supply states that; as prices rise, quantity supplied rises and as prices fall, quantity supplied falls
too.
• Market demand refers to the quantities of a product all individual households collectively are willing
and able to buy at each price level.
• Market supply refers to the quantities of a product all individual firms collectively are willing and able
to produce at each price level.
• Movement along a demand curve refers to moving from one point on a demand curve to another
point on the same demand curve.
• Movement along supply curve refers to moving from one point on a supply curve to another
point on the same supply curve.
• Normal goods are goods that increase in demand with an increase in income.
• Relative prices are prices expressed in term of another, example the price of coffee is double the
price of tea.
• Shift of the demand curve refers to moving an entire demand curve to a new position.
• Shift of the supply curve refers to moving an entire supply curve to a new position.
• Substitutes are products that can be used instead of an existing product, example brown bread and
white bread.
• Supply refers to all goods the company is able and willing to produce.
• Supply curve is a graphical representation of a firm / firms showing the relationship between price and
quantity of a given item.
• Supply schedule is a table representation of a firm / firms showing the relationship between price and
quantity of a given item.
Demand
& Demand – is a want or desire which can be afforded
2 types of demand
® Individual demand 3 conditions for demand:
® Market demand Person
+ want/need
∆ Individual demand + means to pay
1) Price of product (Px)
® Negative relationship between demand & price
® A change in price of a product will NOT shift the curve however can MOVE (up & down)
along the curve
® You will notice that the movement along a curve relates to the slope of the curve, while the
shift of a curve relates to its position or intercept.
® One of the things that does not determine demand is the availability or supply of goods.
Law of demand:
• When price (Px) of the product increases = the quantity (Qd) demanded decreases
• When the price (Px) of the product decreases = the quantity (Qd) demanded
increases
Movement along curve (Change in quantity demand):

Table 1
® The points on the demand curve (e,d,c,b,a) correspond to the

different possibilities indicated in the demand schedule.
® By plotting all these points from the demand schedule and
joining them we obtain a demand curve (DD) which slopes
down from top left to bottom right.
® This indicates a negative or inverse relationship
between the price and the quantity demanded.
(The higher the price, the smaller the quantity of tomatoes
demanded.)
® As we have already mentioned, this inverse (or negative)
relationship between price and quantity demanded is called
the law of demand.
Called:
® NEGATIVE SLOPE / DOWNWARD SLOPEING
CURVE
ê The movement along the curve is caused by a change in price

= Change in quantity demand
Figure 1
Various ways in which individual demand and the law of demand can be expressed:
• Using words: Demand refers to the entire relationship between the quantity demanded and the price of a
good or service, on the assumption that all other influences are held constant. The law of demand states that
this is an inverse or negative relationship. The higher the price of the good, the lower the quantity
demanded, ceteris paribus.
• Using numbers: the demand schedule. The demand schedule is a table which shows the quantities of a
good demanded at each possible price, ceteris paribus. Table1 is an example of a demand schedule. The
figures in the table indicate that the quantity demanded decreases as the price increases. The entire demand
schedule in Table 1 represents Anne Smith’s demand for tomatoes.
• Using graphs: the demand curve. The demand curve is a line which indicates the quantity demanded of a
good at each price, ceteris paribus. Figure 1 contains an example of a demand curve. The negative slope of
the curve clearly indicates that the quantity demanded increases as the price decreases. This is a visual
representation of demand. The entire demand curve in Figure 1 represents Anne Smith’s demand for
tomatoes.
• Using symbols: the demand equation. The demand equation is a shorthand way of expressing the
relationship between the quantity of a good demanded and its price, ceteris paribus.
Shift of the demand curve (Change in demand):

® A change in any of the determinants of demand other than the price of the product will shift the
demand curve.
® EXTERNAL FACTORS like:
o Change in price of related goods
o Change income
o Change in tatses and preferences
o Change in population
o Expected future price
The original demand curve for margarine is DmDm. If the price of butter
increases, the demand for margarine increases. At each price of margarine more
margarine is demanded than before. This is illustrated by a rightward shift of the
demand curve to D'mD'm.
SHIFT RIGHT =INCREASES

LEFT = DECREASES
2) Price of related goods (Pg)

a. Complimentary goods
® If the price of complimentary goods increase = curve will shift to the left (decrease
demand)
b. Substitute goods
® If price of substitute product decreases = curve shift to the right (increase demand)
3) Taste & preferences (T)

4) Income (Y) Independent
5) Number of Households (N)
Qd = f (Px, Pg, T, Y, N)
Dependent
Qd = f (Px, ceteris paribus)
• Where f = ‘is a function of’ and

• Px = the price of the product.
• Qd is the dependent variable in this equation, while
• Px, Pg, Y, N and T are the independent variables.
∆ Market demand
+ 6) Future prices (Pe)
Qd = f (Px, Pg, T, Y, N, Pe)
A change in the quantity of demand VS a change in demand:

When the price of a good changes, there is a movement
along the demand curve and a change in the quantity
demanded. Along demand curve DD a movement from a to b
Increase in indicates a decrease in the quantity demanded, while a
demand movement from a to c shows an increase in the quantity
demanded. If one of the other influences on demand
changes, there is a change in demand which is represented by
Decrease
in demand a shift of the demand curve.
An increase in demand is represented by a rightward
shift of the demand curve, such as the shift from DD to
D2D2.
A decrease in demand is represented by a leftward
shift of the demand curve, such as the shift from DD to
D1D1.
Supply
& Supply - the quantities of a good or service that producers plan to sell at each possible price during a
certain period.
The market demand curve: A summary
2 types of supply 3 conditions for supply:

® Individual supply Company
® Market supply + factors of production
+ output
ê Only focus on price and NOT demand
∆ Individual supply
1) Price of the product (Px)
® Positive relationship between price and supply
® Price goes down = supply more
Law of supply
® The law of supply states that this is usually a positive (or direct) relationship.
® The higher the price of the good, the greater the quantity supplied; and the lower
the price of the good, the lower the quantity supplied, ceteris paribus.
Qs = f (px)
Example: Johnny’s supply of tomatoes
Called:
® POSITIVE SLOPE / UPWARD
SLOPING CURVE
Movement along curve (Change in quantity supplied):

® Affected by change in price
Shift of the supply curve (Change in supply):

® Affected by alternative factors
2) Price of alternative product (Pg)

® If price of alternative good increase = supply of original goods decrease
® LEFT SHIFT = decrease supply

® RIGHT SHIFT = increase supply
3) Price of factors of production (Pf)

® The quantities of tomatoes that Johnny plans to sell at different prices will also depend
on the cost of production. To make a profit, he has to cover his costs of production.
• Capital = interest
• Natural resources (land) = rent
• Labour = wages
• Entrepreneurship = profit
4) State of technology (Ty)

® New technologies (or production techniques) that enable producers to produce at lower
costs will increase the quantity supplied at each price.
5) Future prices (Pe)

® Whereas consumers can make decisions fairly quickly, producers often have to plan long in
advance. For example, the higher he expects the future price of tomatoes to be, ceteris paribus,
the more tomatoes he will plan to produce.
Various ways in which individual demand and the law of demand can be expressed:
• Using words: Supply refers to the entire relationship between the quantity supplied of a commodity and the
price of that commodity, other things being equal. The law of supply states that this is usually a positive (or
direct) relationship. The higher the price of the good, the greater the quantity supplied; and the lower the
price of the good, the lower the quantity supplied, ceteris paribus.
• Using numbers: the supply schedule. The supply schedule is a table which shows the quantity of a good
supplied at each price, ceteris paribus. Table 4-4 is an example of a supply schedule. The figures in Table 4-4
indicate that the quantity supplied increases as the price increases. The entire supply schedule in Table 4-4
represents Johnny’s supply of tomatoes.
• Using graphs: the supply curve. The supply curve is a line or graph which indicates the quantity supplied of
a good at each price, ceteris paribus. Figure 4-8 contains an example of a supply curve. The slope of the curve
shows that the quantity supplied increases as the price increases. This is a visual representation of supply. The
entire curve in Figure 4-8 represents Johnny’s supply of tomatoes.
• FIGURE 4-8 Johnny’s annual supply of tomatoes
• Using symbols: the supply equation. The supply equation is a shorthand way of expressing the relationship
between the quantity supplied of a good and its price, ceteris paribus. Equations 4-7 and 4-8 are both supply
equations:
Qs = f (Px, Pg, Pf, Ty, Pe)
• Let Qs = quantity of tomatoes supplied

• Px = price of tomatoes
• Pg = prices of alternative outputs
• Pf = prices of factors of production and other inputs Pe = expected future prices of tomatoes
• Ty = technology
∆ Market supply
+ 6 Number of suppliers (N)
(in the market)
Qs = f (Px, Pg, Pf, Ty, Pe, N)

Market supply
® The market supply curve shows the relationship between the price of the product and the
quantities supplied (by all the firms) during a particular period.
® Like the individual supply curve, the market supply curve also slopes upwards from left to right. In
other words, there is a direct or positive relationship between price and quantity supplied.
® A market usually consists of more than one seller. The total of all individual quantities supplied at
each price level needs to be added horizontally to determine market supply.
PRICE FIRM A FIRM B FIRM C TOTAL /

MARKET SUPPLY
R10.00 5 7 15 27
R20.00 7 11 20 38
R30.00 10 15 25 50
R40.00 13 20 30 63
R50.00 16 25 35 76
Quantity supplied = f (Px, Pg, Pf, Pe, Ty, N…)
Derivation of the market supply curve.
® Just as the market demand curve was derived by the horizontal addition of individual demand curves, so the
market supply curve is determined by adding the individual firm’s supply curves horizontally.
This means that at a certain price each firm will offer an amount for sale in the market, and these amounts together
make up the market supply.
Movement along the market supply curve
According to Graph above:

® A movement along the supply curve can be caused by a change in the price of the product
only. As price changes, quantity supplied changes too.
® When the price increases from P1 to P2, producers will step up production from Q1 to Q2 items.
® The increase in the quantity supplied was thus caused by a change in the price (Px).
® When the price decreases from P2 to P1, producers will slow down production from Q2 to Q1
items.
® The decrease in the quantity supplied was thus caused by a change in the price (Px).
Shifts of the market supply curve

® If any of the factors other than Px changes, the supply curve shifts to a new position.
® If supply increases, S1 shifts to S2. Thus, at a price of P1 the quantity supplied increases from Q1
to Q2.
® If supply decreases, S2 shifts to S1. Thus at a price of P1 the quantity supplied decreases from Q2
to Q1.
These other possible determinants include the following:

• Government policy.
- Subsidies on particular goods or services tend to raise their supply, while taxes tend to
reduce supply.
• Natural disasters.
- Floods, earthquakes and droughts have an impact on supply. In South Africa we are familiar
with the devastating impact of severe droughts or flooding.
• Joint products and by-products.
- Some products are produced jointly (eg sugar and molasses, wheat and bran, lead and zinc, beef
and leather) with the result that a change in the supply of the major product results in a similar
change in the supply of the by-product.
- Joint products are sometimes called complements in production.
• Productivity.
- A change in the productivity of the factors of production (eg as a result of improved technology)
will lead to a change in supply.
- If productivity falls, production costs increase, ceteris paribus, and supply decreases.
ê NB: Illustrating a constant illustrative price is only appropriate is there are no other curves other than
supply curves in the graph. The illustrative price is not an equilibrium price.
Remember that in reality there are multiple illustrative prices along the length of any supply curve, but we
have chosen to retain only one price to show the shift
Market equilibrium
• A market consists of a buyer AND a seller.
• Equilibrium is a state of balance where two opposing forces are equal.
Combining the demand and supply curves: Market equilibrium.
® Market demand slopes downward from left to right and obeys the law of demand.
- Consumers are willing to buy more goods at lower prices than at higher prices.
® Market supply slopes upward from left to right and obeys the law of supply.
- Producers are willing to supply more goods at higher prices than at lower prices.
® The motives of consumers and producers are opposite. There is only one place on the graph where
consumers and producers agree. That is where the quantity demanded, and quantity supplied are equal
equilibrium exists in the market.
NOTE: We do not say that demand equals supply at equilibrium, as demand and supply are concepts that
refer to the whole curve, and not one point on the curve.
What happens if the market price is too low?
Excess
® At a price of P1, consumers demand Q3, but suppliers are only prepared to supply Q1.
= There is thus an excess in demand (which simply means too much demand) at this price.
® Lots of consumers want the product, but not enough will be produced.
® The excess demand sends a signal to producers, and they will respond in two ways.
o They will increase the price and
o supply more.
There will be a movement along the market supply curve from ‘h’ to ‘E’. This is in accordance with the
law of supply.
® As producers increase the price, consumers will respond by demanding less and less. There will be a
movement along the demand curve from ‘j’ to ‘E’. This is in accordance with the law of demand.
® The price will return to the equilibrium price of P2.
What happens if the market price is too high?
Excess
® At P3 a price of, consumers demand Q1, but suppliers are happy to supply Q3.
= There is thus an excess in supply (which simply means too much supply) at this price.
® Lots of suppliers will make the product, but not enough will be demanded.
® The excess supply sends a signal to producers, and they will respond in two ways.
o They will decrease the price and
o supply less.
There will be a movement along the market supply curve from ‘k’ to ‘E’. This is in accordance with the law
of supply.
® As producers decrease the price, consumers will respond by demanding more and more.
There will be a movement along the demand curve from ‘m’ to ‘E’. This is in accordance with the law
of demand.
® The price will return to the equilibrium price of P2.
ê Market equilibrium has both a rationing and an allocating function. Because suppliers are only
willing to supply a certain quantity at the equilibrium, consumers’ unlimited wants are ‘rationed’.
Because consumers only want a certain quantity at equilibrium, producers have to ‘allocate’ their factors
of production accordingly. It is thus the money votes that count.
Demand and supply in action
Study unit 4
Glossary
• Black market is an illegal market where consumers buy up goods at the price ceiling and resell the
goods at a higher price.
• Maximum prices refer to the maximum price producers can charge, also known as a price ceiling.
• Minimum prices refer to the minimum price producers can charge, also known as a price floor.
• Price control exists where a government or agency intervention in the form of floors or ceilings in
the free market.
• Quotas are quantitative restriction on the production of certain goods.
• Rationing is limiting the quantity bought by consumers.
• Rent control is a maximum rental that tenants may be charged.
• Subsidies are cash payments to producers.
• Taxes are a compulsory payment to government.
Changes in demand
Demand will shift to the right (increase) if:
• The price of a substitute increases
• The price of a complement decreases
• Consumer income rises
• Consumers prefer more of the product
• Consumers expect the product’s price to rise in the future.
• The number of consumers rises
Demand will shift to the left (decrease) if:

• The price of a substitute decreases
• The price of a complement increases
• Consumer income falls
• Consumers prefer less of the product
• Consumers expect the product’s price to fall in the future.
• The number of consumers falls
Changes in supply
Supply will shift to the right (increase) if:
• The price of an alternative product decreases
• The price of a joint product rises
• Prices of factors of production fall
• Technology or productivity levels increase
• Firms expect prices to rise in the future
• The number of firms rises
Supply will shift to the left (decrease) if:

• The price of an alternative product increases
• The price of a joint product falls
• Prices of factors of production rise
• Technology or productivity levels decrease
• Firms expect prices to fall in the future
• The number of firms falls
An increase in supply from S1 to S2, due to any of the
factors other than price, mentioned in the market supply
equation, causes a decrease in the equilibrium price from
P2 to P1 and an increase in the equilibrium quantity from
Q1 to Q2.
A decrease in supply from S2 to S1, due to any of the
factors other than price, mentioned in the market supply
equation, causes an increase in the equilibrium price from
P1 to P2 and a decrease in the equilibrium quantity from
Q2 to Q1.
Simultaneous changes in demand and supply

® Demand and supply curves can shift at the same time.
® The result on price and quantity will depend on the direction and size of the relevant shifts.
ê If demand and supply shift in the same direction:

® Quantity change is certain, but the price is uncertain
ê If demand and supply shift in opposite directions:

® Price change is certain, but quantity change is uncertain
a
Interaction between related markets
• Butter and margarine are substitute products.

• Should the supply of butter fall from S1 to S2, the price of butter would rise from P1 to P2 and the
equilibrium quantity of butter would fall from Q2 to Q1.
• Those people who choose not to buy butter at the higher price (i.e. Q1 – Q2) will now switch to
the cheaper substitute product, margarine.
• This can be shown by a shift of the entire demand curve to the right. The result is an increase in the
market price for margarine.
• what happens to demand for DVDs when the price of DVD players changes. DVDs and DVD
players are complementary products.
• If the supply of DVD players decreases from S1 to S2, the price of DVD players rises from P1 to P2,
while the quantity of DVD players decreases from Q2 to Q1.
• Fewer people buying DVD players would have a negative impact on the demand for DVDs. D1 shifts
to D2.
• The decrease in demand results in a fall in the market price for DVDs from P2 to P1.
Government intervention
• Governments can intervene in the market by:
• Setting price ceilings
• Setting price floors
• Subsidising certain products or activities or setting quotas
• Taxing certain products or activities
∆ A price ceiling or maximum price:

& A price ceiling is set by the government as a maximum permissible price. No price above this may
be charged.
The reasons for setting a maximum price are:

• To keep the prices of basic low
• To avoid exploitation by the producer
• To combat inflation
• To limit production.
• A price ceiling can be set below the equilibrium price at P1 in Graph below by:
- Rationing producers
- Queues or waiting lists for consumers
- Tickets or coupon rationing for consumers.
Excess demand
Figure 3: Price ceiling
According to Figure 3:
• The equilibrium price and quantity before intervention is P2 and Q2.
• A price ceiling is imposed at P1.
• No price above this may be charged.
• At P1, producers are willing to supply Q1. At P1, consumers are demanding Q3.
• Excess demand exists (Q1 – Q3), but prices cannot be bid up.
• If producers supply Q1, scarcity prevails, and consumers are willing to pay up to P3 for the short
supply.
• Goods are bought at the price ceiling and resold at the higher price (P3).
• This is called black market trading.
ê NB: If the price ceiling was set above the equilibrium price, the equilibrium price and quantity would
remain. Price ceilings above the equilibrium are ineffective.
An example of a price ceiling is rent control (has been abolished in SA).

∆ A price floor or minimum price:
& A price floor is set by the government as a minimum permissible price. No price below this may be
charged.
Excess supply
Figure 4: Price floor
According to Figure 4
• The equilibrium price and quantity before intervention is P1 and Q2.
• A price floor is imposed at P2.
• No price below this may be charged
• At a price floor of P2, producers are willing to supply Q3, but consumers are only demanding Q1.
• Excess supply prevails and cannot be competed away.
Possible outcomes for price floors

This excess (surplus) can be:
• Exported (at cost of taxpayer)
• Stored (if non-perishable)
• Destroyed either by the government or producer
• Prevented by limiting production
• Given to the poor.
Drawbacks include:
• Export or storage costs can be high.
• Even poor consumers pay higher prices.
• Large farmers benefit more than small ones.
• Inefficient production encouraged.
• Poor cannot bear collection costs.
ê The concept of a price floor can be extended to the labour market, as a minimum wage.
ê NB: Price floors below the equilibrium have no effect as the equilibrium price and quantity will remain.
Elasticity of demand
Study unit 5
Introduction
® Study unit 5 describes the responsiveness of consumers to changes in the price of the product itself, the
price of related products and income. This study unit is particularly useful for marketing researchers.
How would you react to the following situations?

• If the price of bread increased, would you ….
- buy the same amount of bread as before?
- buy less bread?
- not buy bread any longer.
• If the price of margarine increased, would you…
- buy the same amount of margarine?
- buy butter instead?
- buy less butter?
The answers to these types of questions determine the product’s elasticity of demand.
Glossary
• Elasticity is a measure of responsiveness or sensitivity to a dependent variable when an
independent variable changes.
• Price elasticity of demand refers to the sensitivity of the quantity demanded to a change in
the price of a product.
• Elasticity coefficient is the ratio of the percentage change in quantity demanded to the
percentage change in the price of that product.
• Total revenue is the revenue earned when all products are sold. TR = P x Q.
• Perfectly inelastic demand exists when the quantity demanded remains unchanged with a
change in price.
• Inelastic demand exists when the change in quantity is smaller than the change in price.
• Unitary elastic demand exists when the change in the price is matched by an equally
proportional change in quantity demanded.
• Elastic demand exists when the change in quantity is larger than the change in price.
• Perfectly elastic demand exists when the quantity demanded drops to zero with an increase in
price.
• Determinants of price elasticity refers to those factors that affect the consumer’s decision
to but more, less or the same with a change in price and, therefore, determines the price elasticity
of demand.
• Income elasticity of demand refers to the sensitivity of the quantity demanded to a change in
the income of a consumer.
• Essential goods are goods which the consumer needs for day-to-day living.
• Luxury goods are ‘nice to haves’ but are not necessary for survival.
• Cross elasticity of demand refers to the sensitivity of the quantity demanded of one product
to a change in the price of a related product.
& Elasticity is a measure of the sensitivity or responsiveness of a change in the dependent variable
because of a change in the independent variable
The coefficient of elasticity can be calculated by using the following equation:

The price elasticity of demand
& Price elasticity is a measure of the sensitivity or responsiveness of a change in the quantity
demanded because of a change in the price.
® Price elasticity can be subdivided into 5 types, each describing the sensitivity or
responsiveness of quantity demanded because of a change in price.
The coefficient of price elasticity can be calculated by using the following equation:
ê Note that the change is measured as a proportion or percentage.

ê Direct comparisons of the changes on graphs of different scales or different products are, therefore,
not possible.
ê Elasticity must not be confused with slope.
• Price elasticity of demand is usually negative, as the relationship between quantity demanded is a
negative one.
• In the equation above, if the price increases (positive change), the quantity would decrease (negative
change). The answer would be negative. For simplicity and convenience, we ignore the minus sign.
ê Total revenue (TR), which allows the firm to pursue profit maximization = price (P) x quantity (Q). The
relative changes in P and Q, therefore, have an impact on the change in TR.
∆ Type 1: Elastic demand

® If the resultant coefficient is > 1, the good is elastic
® Relatively small change in the price of the good has a relatively large impact on the change
in quantity demanded. The rise in price will be more than offset by the fall in quantity and total
revenue will fall.
® Monopolistic companies (many suppliers, many buyers, many substitutes, differentiation)
® How to raise revenue = decrease the price
Example:
If a producer had to look at
this graph:
To raise revenue they
only have to decrease their
price by 10% and will sell 20%
more quantity.
Consumers are sensitive to

price changes
The co-efficient value of price elasticity of demand is:
Such goods are said to be price sensitive and the marketing department needs to take the possible loss of
market share into account when introducing a price increase. Luxury goods, or goods with a large number
of substitutes, on which the consumer spends a large portion of his income, e.g. luxury cars, tend to be
elastic.
∆ Type 2: Inelastic demand
® If the resultant coefficient is <1, the good is inelastic, i.e. a relatively large change in the price
of the good leads to a relatively small change in the quantity demanded.
® Found in Oligopoly (few large firms) like banks, network providers, insurance etc.
® How to raise the total revenue = keep increasing the price
Example:
If a producer had to look at
this graph:
To raise revenue, they can
increase their price by 20%
and only lose 10% quantity
demanded
Consumers are insensitive to

price changes
∆ Type 3: Unitary demand

® If the resultant coefficient is = 1, the good has a unitary elasticity.
® Any change in the price of the good is exactly offset by the change in the quantity
demanded and total revenue remains constant. Such goods are considered ‘normal’
goods.
® Total revenue cannot be raised = reached max revenue
Example:
• Consumers respond
perfectly
• Normal good
∆ Types 4 & 5:
® Two limiting cases exist, viz. where the value of the coefficient is infinite (perfectly elastic) or = 0
(perfectly inelastic). Both cases have no application in the real world-marketing environment.
• Perfect elasticity:
® Perfect elasticity exists where the % change in quantity is infinite, and the % change in
price is zero.
® The price elasticity coefficient = infinity.
® Total revenue cannot be changed
® Perfect competition (loads suppliers + buyers, standard products)
® An example of such goods is water, petrol, gold.
o Petrol’s price is controlled and if another garage sells their petrol for a higher or lower price = no
one will buy there
ê Perfectly elastic demand graph depends on the equilibrium (affect each other)
• Perfect inelasticity:
® Perfect inelasticity exists where the % change in price is infinite, and the % change in
quantity is zero.
® NO change
® People buy irrespective of price change
® The price elasticity coefficient = zero.
® An example of such a good is electricity or insulin. A diabetic will demand a fixed quantity of insulin
irrespective of the price.
Price elasticity and total revenue (or total expenditure)

A straight-line demand curve, which intercepts both axes, shows different elasticities along its length
Figure 5:Price elasticity along a straight line demand curve.
Referring to Figure 5,
• at a price of R10.00 consumers do not demand any items. The producer’s revenue would,
therefore, be zero (point A on the TR curve).
• At a price of R7.50 per item, consumers would be willing to buy 2 items. The producer’s revenue
would be R15.00 (point B on the TR curve).
Referring to the calculations within Figure 5
• we can see that total revenue is at its highest level when price elasticity of demand is equal to 1.
Any change in price away from this reduces TR.
• When ep = 1, any reduction in price is offset by a proportional increase in quantity, and TR remains
the same. If the producer is charging R5.00 in Figure 5 he should keep his price constant (point C
on the TR curve).
• When ep > 1, any reduction in price is offset by a greater than proportional increase in quantity
and TR rises. If the producer is charging a price in the elastic portion of the demand curve, say at
R7.50 in Figure 5 he should decrease his price as this will lead to greater TR.
• When ep < 1, any reduction in price is offset by a smaller than proportional increase in quantity and
TR falls. If the producer is charging a price in the inelastic portion of the demand curve, say at R2.50
in Figure 5 he should increase his price as this will lead to greater TR.
Income elasticity
® The sensitivity or responsiveness of quantity demanded for changes in income is known as income
elasticity of demand.
Equation to measure income elasticity:
• Normal goods
• If the demand for a good increases with an increase in income, the good is known as a
normal good or a superior good.
• positive income elasticity > 0
• The income elasticity for normal goods may be:
= 1, >1 or <1.
• Inferior goods
• If the demand for a good decreases with an increase in income, the good is known as an
inferior good.
• Negative income elasticity < 0
• Inferior goods are only inferior when comparing them to other goods, e.g. potatoes could be
considered inferior to meat. * Meat would be the superior good.
• Essential good
• Goods such as food show very little increase in quantity demanded when income increases.
• > 0 but <1
• Luxury goods
• Goods such as TVs show large increases in quantity demanded with an increase in income.
• >1
Cross elasticity
® Cross elasticity measures how the quantity demanded of one product changes when the price of
another related good changes.
Equation to measure cross elasticity:
Compliment goods
• usually show negative cross elasticity < 0 (below 0)
• When the price of one of these goods increases, the quantity
demanded of the other good decreases.
• e.g. shoes and shoe laces, DVDs and DVD players, bread and butter, etc.
•
Substitute products
• usually show positive cross elasticity > 0 (above 0)
• When the price of one of these goods increases, it has a positive
effect on the quantity demanded of the other good. Substituting the
values into the equation would give a positive answer.
• e.g. butter and margarine, glass bottles and plastic bottles, mutton and beef, etc.
• The magnitude (size of the coefficient) of cross elasticity will depend on

the degree of complementarity or substitutability, i.e. how strong the
relationship between the products is.
A synopsis:
Production and cost
Study unit 6
Glossary
• Accounting costs are explicit costs only
• Accounting profit is total revenue minus explicit costs where TR > explicit costs.
• Average cost (AC) or (ATC) are total costs incurred per item produced.
• Average fixed costs (AFC) are fixed costs per item produced.
• Average product (AP) is the number of items produced per worker.
• Average revenue (AR) is revenue per item sold.
• Average variable costs (AVC) are variable costs per item produced.
• Economic costs are implicit costs plus explicit costs.
• Economic profit is the result of total revenue minus explicit costs minus implicit costs.
• Explicit costs are reflected in money terms, e.g. salary.
• Firms are those units that employ the factors of production to produce goods and services.
• Fixed inputs or inputs are those inputs that do not change in the short run with the number of
items being produced. Examples of fixed factors are buildings, machinery, salaried staff, transport (trucks,
etc.) and land.
• Implicit costs are not reflected in money terms, e.g. satisfaction. This is used by economists only.
• Law of diminishing marginal returns is where marginal production decreases as more of the
variable factor (labour) is added to the fixed factor (land).
• Law of diminishing returns is when production decreases as more of the variable factor (labour)
is added to the fixed factor (land).
• Law of returns is where production at first increases and then decreases as more of the variable
factor (labour) is added to the fixed factor (land).
• Long run is a situation where all factors are variable.
• Marginal costs (MC) are the extra costs incurred with the production of one extra unit.
• Marginal product (MP) measures the addition to the total number of items produced every time
a new worker is employed.
• Marginal revenue (MR) is the extra revenue made when one additional item is sold.
• Normal profit is where revenue minus explicit and implicit costs equals zero.
• Private costs are costs borne by an individual firm.
• Production function is the process by which goods and services are made using the 4 factors of
production.
• Profit is the difference between revenue and cost where revenue > cost.
• Short run is a situation where some factors (or at least one) are fixed and some are variable.
• Social costs are costs borne by society at large, even those who are not involved in the production
or purchasing of the products, e.g. pollution.
• Total costs (TC) are all costs incurred for all factors of production.
• Total fixed costs (TFC) are incurred by fixed factors of production. They do not vary with the
output level and have to be paid even if nothing is produced.
• Total product (TP) measures the total number of items produced as more workers are hired.
• Total revenue (TR) is the total income received through the sale of goods.
• Total variable costs (TVC) are costs that are incurred by variable factors of production. These
costs vary with the number of items produced.
• Variable inputs are those inputs that vary with the number of items being produced. Examples
include raw materials, stationery, fuel and labour.
Introduction
® When we use the word ‘firm’ in this syllabus, we include every type and size of firm, from sole trader
including the informal trader, partnership, close corporation, trusts, private companies and public
companies.
® The primary goal or motive of every company is to maximize profit.
Basic cost, revenue and profit concepts

• Revenue and profit do not mean the same thing.
• Revenue is the money earned through the sale of a product.
o Accountants call revenue ‘gross profit’.
• Profit is the money left over from the sale of a product once all expenses have been paid.
o Accountants sometimes call profit ‘net profit’.
ê In a perfect competition AR = MR = PRICE

The short run and the long run-in production and cost theory
® An important distinction in production and cost theory is that between the short run and the long run.
& The short run is defined as the period during which at least one of the inputs is fixed.
- An example would be a firm which has a factory in which certain machinery has been installed and
which can only vary its inputs of labour, raw materials, etc.
& In the long run all the inputs are variable.
- For example, this would be a period that is long enough for the firm to decide whether or not to open
another factory or install additional machines.
® The difference between the short run and the long run-in production and cost theory
depends on the variability of the inputs and not on calendar time.
® In some industries, for example the clothing industry, the actual period required for all inputs to be
variable might be quite short, while in other industries, for example the steel industry, the actual
period might be quite long.
Basic cost and profit concepts

® Production is a matter of transforming inputs into outputs.
COST
Ñ Implicit costs
® are not necessarily reflected in money terms, e.g., satisfaction.
® “Opportunity costs”
® Cost of what one would’ve earned had one chosen another option
® Used by economists
Ñ Explicit costs
® are reflected in money terms, e.g., salary.
® “Accounting costs”
® Costs that are incurred and can easily be identified in the books of the company
® Used by accountants
Total cost (TC)

Total fixed costs (TFC) + total variable cost (TVC)
Average total cost (ATC)

® Average costs are costs per item produced.
TC ÷ TP (quantity)
Marginal cost (MC)

® Marginal costs are extra costs incurred with the production of an extra unit.
Change in TC ÷ change in TP
PROFIT
• Normal profit: Revenue - explicit costs - implicit costs = 0
• Accounting profit: Sales – Explicit costs
• Economic profit: Sales – Explicit costs – Implicit costs
Total revenue > explicit costs = accounting profit

Total revenue = normal profit = normal profit (break-even point)
Total revenue > normal profit = economic profit / super profit / pure profit
Total revenue < normal profit = economic loss
IMAGINE THE FOLLOWING:

• Peter is employed by company ‘S’ and earns R15 000 per month.
• Peter decides to open his own company and resigns from his current job.
• In the first month Peter’s new company shows revenue (gross profit) of R20 000.
• His expenses for the new company in the first month are R5 000.
• Is Peter’s new company making a profit?
• Accountants will say yes. Accountants will subtract R5 000 expenses (called explicit costs) from
R20 000 revenue and calculate a R15 000 profit.
• Economists will say no. Economists will subtract R5 000 expenses (called explicit costs) and R15
000 lost salary (called implicit cost or opportunity cost) from R20 000 revenue and calculate a
profit of zero.
Economic profit is, therefore, always lower than accounting profit.
The law of returns according to David Ricardo

® States that in the short run what you produce will be limited to the capacity of the fixed
element/constraint.
Total product (TP) is the total number of products that are produced by a number of workers (per
time period)
Average product (AP)

® is the number of products produced per worker (per time period)
® AP increase = good/productive employees

® AP decrease = unproductive employees / bringing company down
Marginal product (MP)

® is the extra number of products added to the total number of products that are produced when one
more worker is employed (per time period)
IMAGINE THE FOLLOWING
Imagine a potato farm that consists of 100 square metres of land, one tap, one crate and one spade (fixed
factors). Assume an infinite number of potatoes have been grown on that farm.
Harvesting production is as follows:

Step 1:
Dig up a potato.
Step 2:
Wash the potato under the tap.
Step 3:
Pack the potato into the crate.
When no workers are employed, no potatoes are harvested.
Number of workers Total product Average product Marginal product

N TP AP MP
0 0 0 0
If one worker is employed, he will have to dig, wash and pack all by himself.
Let’s assume he can manage 60 potatoes per day.
N TP AP MP
0 0 0 0
1 60 60 60
If two workers are employed, they will have to dig, wash and pack together. Since there is
limited equipment, they will begin to divide their tasks; called division of labour. Perhaps one
will dig and the other wash and pack. As they repeat a small part of the total job they will
become specialised. Division of labour and specialisation leads to increasing returns. The total
production will, therefore, be more than 2 x 60 per day.
Let’s assume they can manage 200 potatoes together per day.
N TP AP MP
0 0 0 0
1 60 60 60
2 200 100 140
ê Notice that the average product and marginal product are rising.
If three workers are employed, they will have to dig, wash and pack together. Since
there is limited equipment, they will divide their tasks again. Perhaps one will dig and the
other wash and the third pack. As they repeat a small part of the total job they will
become even more specialised. Division of labour and specialisation will again lead to
increasing returns.
ê 
N TP AP MP
0 0 0 0
1 60 60 60
2 200 100 140
3 600 200 400
Notice that the average product and marginal product are still rising.
If four workers are employed, they will have to dig, wash and pack together.
Since there is limited equipment, they will want to divide their tasks but one
worker will be left without equipment or will have to share. This will slow the
production down and will lead to diminishing returns.
N TP AP MP
0 0 0 0
1 60 60 60
2 200 100 140
3 600 200 400
4 400 100 -200
ê Notice that the total product and average product are falling, and marginal product has become negative.
Table above:
• If no workers are employed, total product (TP) is zero.
• If no workers are employed AP = zero.
• Marginal product (MP) when no workers are employed is also zero.
• If one worker is employed, TP rises to 60. AP and MP are equal to 60.
• When a second worker is employed, TP rises to 200, which is more than double 60. This is due to
specialisation and the division of labour. Each labourer performs one task and efficiency of
production improves.
• As more labourers (variable factor) are added to the fixed factor (land) TP rises, reaches a maximum
at 600 (3 workers) and then begins to fall (to 400 at 4 workers). This is due to rising
inefficiencies.
• AP and MP also rise, reach a maximum, and then decrease.
Production curves:
• When MP is positive, TP rises.

• When MP = 0 (N1), TP is maximum.
- No additional workers should be employed
beyond this point.
• When MP is negative, TP falls
• MP cuts AP at its highest point.
- Where law of diminishing kicks in
The law of returns
All these measures demonstrate the law of returns, which states that:
Production at first increases and then decreases as more of the variable factor (labour) is added to the
fixed factor (land).
From this:
The law of increasing returns states that:
Production increases as more of the variable factor (labour) is added to the fixed factor (land).
And:
The law of decreasing returns states that:
Production decreases as more of the variable factor (labour) is added to the fixed factor (land).
Costs in the short run

® Looking at behaviour of costs in relation to the law of diminishing return
Average fixed costs (AFC)

® Fixed cost per unit
Total fixed cost ÷ TP
Average variable cost (AVC)

Total variable cost ÷ TP
Average total cost (ATC)

AFC + AVC
OR
TC ÷ TP
Marginal cost (MC)

Additional cost of every unit manufactured
Change in TC ÷ change in TP
Average and marginal costs in the short run
• ATC and AVC curves are U-shaped.
• AFC curves are L-shaped.
• MC curves cut ATC and AVC curves at their
minimum
• The gap between ATC and AVC – AFC (note
the gap is larger to the left than the right).
[AFC + AVC = ATC]

*ATC – AVC = AFC*
Simplified average and marginal costs in the short run
The short-run average curves are frequently used

when analysing or describing the goods market.
For simplicity sake we leave out several sections
of these curves. Note that even although we may
not draw all the curves each time, they still exist;
we are merely applying the ceteris paribus
assumption.
The relationship between AP, MP and AVC, MC
• Where MP starts to go down is exactly

where MC goes up
• Where MC cuts ATC at its minimum
= maximum marginal contribution
• Where AP is at its highest point = AVC is at

its lowest
• Where MC cutes AVC at its minimum
= maximum efficiency of workers
Perfect and imperfect competitions
Study unit 7
Relevance and background
We are going to look at market structure and how these influence the decisions companies make.
There are 4 basic market structures, but firms do not always comfortably fit into one of these structures.
It is best to view these structures as part of a continuum and firms tending more towards one structure
than another.
The 4 structures are, therefore, theoretical rather than practical.
Glossary
• Allocative efficiency exists when resources cannot be reallocated without making at least one
person better off without making another worse off.
• Break-even point exists when average costs (AC) equals average revenue (AR).
• Collusion exists when competing suppliers meet to fix prices or divide market share.
• Company equilibrium exists where the output or quantity produced is where profit is maximised
and where marginal cost = marginal revenue.
• Demand curve for the product of the firm illustrates the quantity of products the firm will
be able to sell at each market price.
• Economic profit is where average revenue (AR) is greater than average cost (AC). Both explicit
and implicit costs are included in average cost.
• Industry equilibrium exists where all firms in the industry make normal profit in the long run.
• Industry or market supply is the horizontal addition of all individual firm supply curves where
the rising part of the MC curve above shut-down point is the individual firm’s supply curve.
• Market structure organisational features that dominate a market such as entry and exit, number
of firms, etc.
• Monopolistic competition is a market form where there are many firms and many close
substitute products.
• Monopoly is often called the perfect form of imperfect competition. There is only ONE producer
and entry to the market is blocked.
• Normal profit is where average revenue (AR) is equal to average cost (AC). Both explicit and
implicit costs are included in average cost.
• Oligopoly is a market from where the number of sellers is limited, but each firm in the market is
large.
• Perfect competition is a market form where there are a large number of small firms, none of
which can influence the market equilibrium price, since each firm’s output is very small compared to
the total market supply.
• Price discrimination exists when firms charge different sectors different prices for the same good
or service, not attributable to cost differences.
• Price taker is a company or consumer who has no influence on the market price.
• Productive efficiency is a situation where all firms are producing where average costs are at a
minimum, and there is no wastage of resources.
• Profit maximising rule
• Shut down rule states that a firm should only produce if average revenue (AR) is equal to or
greater than average variable cost (AVC), i.e. where average fixed costs (AFC) are covered.
• Supply curve of the firm is the rising part of the MC curve above shut-down point where AR =
AVC.
• Total profit is the product of average revenue (AR) X quantity (Q) or (TP).
Perfect competition -
Monopolistic -
Oligopoly -
Monopoly -
Characteristics of the various goods market forms
The equilibrium conditions (for any firm)

® also called the point of profit maximisation
[“At what point does a firm in perfect competition maximise their profits?]
1) “Is it worth producing?
Shut-down rule
® What a perfect competitor will produce if revenue is = or above average costs
AR > AVC: Don’t shut down
AR = AVC: Don’t shut down Shut down: AVC = MR and ATC
AR < AVC: Shut down } Economic loss is greater than MR
2) If yes, at what point do we maximise profits?

Perfect competition
® The market form ‘perfect competition’ does not exist.
® Perfect competition represents the utopia of market forms.
® It illustrates how a free market economy would function if there was no control over any aspect of the
market and all forces were allowed to operate freely.
The demand for the product of the firm in perfect competition

Deriving the firm’s individual demand curve:
Economic profit: MC = MR
Normal profit: MC + ATC = MR
Why profits are maximized where MC = MR
• Restatement: MC = the additional cost incurred when one more item is produced.
• MR = the additional revenue gained when one more item is sold.
• Marginal profit or loss is the difference between MC and MR.

At Q1:
• The cost of producing an additional item (MC) = R5.00
• The revenue gained by selling this item (MR) = R5.00
• To the left of this point the producer makes less marginal profit (MC > MR)
• To the right of this point the producer makes greater marginal profit (MC this item = R1.00.
• The producer will be encouraged to produce this item and more, since MC < MR to the right of Q2
and extra revenue will be added to total revenue.
At Q4:
• Loss off this item = R5.00 (MC > MR)
• The producer will not produce this item and will cut back on production.
At Q3:
• Since every point to the left of Q3 represents marginal profit (up to Q1) and every point to the right
of Q3 represents marginal loss
• Q3 represents maximum possible profit
Short-run profit positions for a perfect competitor

Short-run excess profit position for a perfect competitor:
Graph 7.3 Short-run excess profit position for a perfect competitor

Refer to Graph above for the following explanation:
• The market, through forces of supply and demand, sets the price P3.
• The firm must take the market price of P3. Its average revenue = marginal revenue curve lies
horizontal at P3.
• ATC and MC represent the firm’s average cost curves. Profit maximizing output is at Q3.
• At Q3 average total costs are P2 while average revenue is at P3. The linear distance between these
two points represents average profit (or profit per unit produced).
• The firm’s economic profit is represented by the shaded area (P2 – P3 X Q3).
Short-run loss position for a perfect competitor
Graph 7.4 Short-run loss position for a perfect competitor
Refer to Graph 7.4:

• The market, through forces of supply and demand, sets the price P1.
• The firm must take the market price of P1. Its average revenue = marginal revenue curve lies
horizontal at P1.
• The firm will equalize MR and MC in an attempt to maximize profits (or minimize loss). Q1 will be
supplied by the firm.
• At Q1, average revenue = P1 while ATC = P2. The linear distance between these represents average
loss.
• Economic loss is represented by the shaded area (P 1 – P2 X Q1).
Illustrating producer equilibrium and the shutdown point:
Graph 7.6 Illustrating producer equilibrium and the shutdown point
Refer to Graph 7.6:

• If the market price is P1, AR1 and MR1 apply. Producer equilibrium is where MR1 = MC and Q1 will
be produced, and the firm will make a loss since ATC > AR1. The firm will shut down at price P1 and
produce quantity Q1. This is at the minimum of AVC. This is where the loss = AFC.
be produced, and the firm will make a loss since ATC > AR2.
be produced, and the firm will make a normal profit since ATC = AR3.
be produced, and the firm will make an excess profit since ATC < AR4.
Monopoly
Characteristics of monopoly (or monopolistic firm):
• The monopoly is often called the perfect form of imperfect competition.
• There is only ONE producer.
• There are no, or very weak, substitute products.
• The only form of competition is for the consumer’s income.
• Entry to the market is restricted. Barriers to entry may be natural due to exclusive ownership of
natural resources or due to high set-up costs, or legal, e.g. patents.
• Monopolies are often owned or controlled by the government, especially if the goods are considered
strategic.
Price discrimination
As a single supplier with restricted entry to the market it may be possible for a monopolist to price-
discriminate, i.e. to charge different sectors different prices for the same goods or service.
In order for price discrimination to succeed:

• The firm must be a price maker,
• Consumer segments must be clearly identifiable and separate,
• There must be no leakage or possibility of resale between sectors
∆ 1st Degree price discrimination occurs when:

® The monopolist charges each consumer what he is prepared to pay (i.e. using the consumer
surplus).
® This is called perfect price discrimination.
∆ 2nd Degree price discrimination occurs when:

® Consumers are charged different prices when purchasing different quantities, for example, first
items purchased carry a higher price than the second or third, or unit prices drop when buying
in bulk.
∆ 3rd Degree price discrimination occurs when:

® Different segments show different elasticities of demand and are charged different prices
accordingly.
® Segments showing elastic demand are charged lower prices than segments showing inelastic
demand.
® This could be according to area (e.g. Durban vs Clarens), age (old age discounts), or time (data
usage after hours), etc.
Salient features of monopolistic competition:

• Entry to and exit from the market is free (no barriers)
• There are many firms and many close substitute products.
• Goods are heterogeneous and differentiated according to brands, packaging, trademarks, quality and
conditions of sale.
• There is advertising. Producers attempt to gain market share through advertising.
• There is non-price competition.
• Each firm faces a downward sloping demand curve for its product.
• Each firm can only make normal profits in the long-run.
Oligopoly
Salient features of oligopoly competition:
• The number of sellers is limited, but each firm in the market is large.
• Entry to the market is restricted, as costs are prohibitive.
• Because of their size, each firm can influence the market price, which causes uncertainty among the
sellers. Each firm tries to guess what the other market players’ strategies are and acts accordingly.
• Goods may by homogeneous (pure oligopoly) or differentiated.
• Prices are set by collective collusion, either explicitly (e.g. cartels) or implicitly (market leadership),
and tend to be inflexible.
• If oligopolists act collectively they form a monopoly.
Measuring the performance of the economy
Study Unit 8
Glossary
• Balance of payments stability refers to the macroeconomic objective of having stability regarding
exports and imports.
• Basic prices are used when calculating GDP using the production or expenditure methods. Basic
prices include indirect taxes on production such as payroll taxes but exclude subsidies on production
such as gold mining subsidies.
• Constant prices are expressed in relation to a selected base year’s value or price. Also known as
real prices.
• Consumer price index is an index of the relative prices of a representative basket of goods and
services and measures the cost of living.
• Consumption of fixed capital is the use of all manufactured resources, e.g. machines, buildings,
tools, etc. over time.
• Current prices are expressed in today’s value (i.e. today’s prices). Also known as nominal prices.
• Distribution of income refers to how the country’s wealth is distributed among the population.
• Economic growth occurs when production expands, either through new firms entering the market
or existing ones expanding.
• Expenditure method is one of the methods to calculate GDP by adding all sector expenditure in
the economy.
• Factor cost is a measure expressed as an income or factor cost is used when using the income
method to calculate GDP. These measures exclude indirect taxes such as VAT, but include subsidies on
income such as housing subsidies.
• Full employment is a macroeconomic objective and refers to the full employment of all factors of
production, the most important being labour.
• Gini coefficient measures the degree of inequality using the Lorenz curve, and is expressed as an
index.
• Gross domestic expenditure (GDE) indicates the value of spending within the borders of a
country.
• Gross domestic product (GDP) measures the market value of all final goods and services
produced within the boundaries of a country over a period of time (normally one year).
• Gross national income (GNI) is a measure of national welfare and is calculated thus: GDP minus
foreign factor (primary income) payments plus foreign factor (primary income) receipts.
• Income method is a method of calculating GDP by adding all factor payments.
• Lorenz curve is a graphic device used to show the degree of inequality in an economy.
• Market prices are used when calculating GDP through the expenditure method. Market prices
include indirect taxes (e.g. VAT) and exclude subsidies.
• Nominal GDP is GDP expressed at today’s prices.
• Price stability is a macroeconomic objective which aims to keep inflation at a low and stable level.
• Production method is a method of calculating GDP using the value added at each stage of the
production process.
• Purchasing power refers to what one can buy with one’s income.
• Real GDP is GDP expressed at the prices of a given base year. Real GDP = nominal GDP – inflation.
• Value added refers to the value added to the product at each stage of the production process.
Macro-economic objectives
• Economic growth is an all-encompassing objective. Growth occurs when production expands,
either through new firms entering the market or existing ones expanding.
• Full employment of all resources, i.e., all factors of production, but especially labour.
Unemployment has many social, individual and economic costs. Economic growth is a precondition
for increased employment.
• Price stability does not refer to constant prices, but rather to an acceptable level of increase in
prices. Inflation is measured by the consumer price index (cpi) or producer price index (ppi).
• Balance of payments stability (BOP)(also called external stability) refers to an equal or

favourable balance between money entering and money leaving an economy. Exports and imports
play an important role here. This includes the need for a stable exchange rate.
• Equitable distribution of income does not mean an equal distribution, but rather a less
unequal distribution of national income among the population. A highly unequal distribution tends to
destabilise an economy socially and politically.
- Lorenz curve (measurement of the level of inequality of a country)
- Welfare payment
How are these macroeconomic objectives related?

® Economic growth means more companies establish themselves or existing companies expand.
These companies will require more of all the resources, including labour which leads to higher
employment.
® More people working and earning money will have a positive effect on income distribution.
® As the industry expands more goods will be available for export which improves the trade balance in
the balance of payments.
® As more money flows into the country due to increased exports, the economy is stimulated, and
consumption and investment levels rise. This leads to further economic growth.
® The more companies there are, the smaller each company size will be as they have to share the
market.
® This leads to greater competition between them, which should bring prices down.
Measuring the level of economic activity – gross domestic product

National income accounting: measuring the performance of the economy
• National income accounting attempts to measure the amount of economic activity within a country,
over a period of time.
• Economic activity is a fairly reliable indicator of the level of employment, production and spending.
• The two institutes responsible for calculating the National Accounts in South Africa are the South
African Reserve Bank and Statistics South Africa.
• The results are published in annual, quarterly and monthly bulletins.
& GDP measures the total value of all final goods and services produced within the boundaries of a
country over a period of time (normally one year).
The elements of the definition:

• Total value refers to prices as determined by demand and supply. A market price includes indirect
taxes such as VAT but excludes subsidies. Because GDP adds the prices of the goods and services
rather than the number of goods and services, it is often called Gross Value Added (GVA).
(MONETARY VALUE)
• Final goods and services which are goods that have reached the final stage of production and are
purchased by the end user. Intermediate goods are not counted.
• All production within the geographical boundaries of a country is counted, whether the
goods are produced by South African factors or not and whether they are for domestic consumption
or not.
• Only goods that have been produced within the year being considered are counted, i.e. new
production only. Stocks carried forward from previous years do not form part of this year’s GDP.
• GDP is a flow concept and is measured over a period of time. Quarterly GDP figures are also
published but are less accurate due to seasonal variations.
When calculating the national income

the value of all production = the value of all income earned by factors of production = spending by all
sectors in the economy.
• Current prices / nominal measures are expressed in today’s value (i.e. today’s prices).
Comparing current measures (e.g. current GDP) may be misleading as they reflect inflation.
• Constant prices / real measures are expressed in relation to a selected base year’s value or
price. Comparing constant measures (e.g. constant GDP) is more accurate as values are corrected for
inflation.
• Net values (as opposed to gross values) make allowance for the writing off of assets over a period
of time, known as depreciation.
3 methods to calculate GDP
∆ The expenditure method

® This method calculates all spending by the various sectors of the economy, namely households,
firms, government and the foreign sector.
® GDP is thus = household spending + spending by firms + government spending + export spending by
other countries buying SA goods – SA spending on imports from other countries.
GDP = C + I + G + (X – Z)
® If any intermediate good is included in this calculation, a problem of double

counting arises. Intermediate goods are those used in the production of other goods.
® Inventories carried over from a previous year should be subtracted from investment or capital
formation.
® GDP does include exports but does not include imports, since imports are subtracted from
the equation.
∆ The value added or production method
® The approach concentrates on measuring economic activity within firms themselves.
® The value added at each stage of the production process is measured, i.e., the difference between
total sales and purchase of intermediate goods, or market value of outputs minus market value of
inputs, at each production stage.
GDP = Value of sales – value of intermediate goods
∆ The income method

® Here we measure total remuneration earned by all the factors of production.
® This method relies on information from the Receiver of Revenue.
GDP = wages (which includes salaries, commissions, etc.) + interest + rentals +

profit.
ê Note:
GDP @ Market price (expenditure method)
- Subsides on final products
+ taxation on final products (like VAT)
If you need to work your way down, then
GDP @ Basic prices (production method) you do the opposite
- subsides on production
+ taxation on production
GDP @ Factor cost (income method)

Excludes subsides
Gross domestic expenditure

& Gross domestic expenditure indicates the value of spending within the borders of a country,
irrespective of where the goods come from or who is spending the money.
Gross Domestic Expenditure (GDE) = C + I + G
® GDE does not distinguish between spending on imported goods and those produced locally.
® GDE does not include exports but does include imports, since part of C, I and G spending is
on imported goods and services.
The above point may seem confusing, since if Imports are included, why is the ‘Z’ not in the equation?
® Imagine yourself going to the supermarket. You take a trolley and fill it with whatever you need (or
can afford). At no time do you sort the shopping in your trolley into locally produced goods and
imported goods. It’s all one shop to you. This means that the symbol C (household spending) includes
the value of imported goods you just bought.
® Companies and governments do the same. Some of the goods they buy are locally made and some are
imported.
® When we calculate GDP, the goods in the trolley and the goods that companies and government buys
ARE sorted into local and imported goods. The value of the imported goods are then subtracted from
GDP. Remember the equation is GDP = C + I + G + (X – Z). The imports are subtracted from the
total.
® When Stats SA calculates GDE, the imports are NOT subtracted from C. I or G. That is why imports
are included in GDE.
Gross National Income
& Gross national income refers to the total value of all final goods and services produced by the
citizens of a country within a year.
Gross National Income (GNI) at market prices

= GDP - foreign factor (primary income) payments + foreign factor (primary income) receipts
(GNI = GDP (+ OR -) net factor income)
• Primary income receipts refer to money earned by SA factors (e.g. labour) outside the borders.
• Primary income payments refer to money earned by non-South African factors (e.g. labour)
inside SA.
Real GNI is a better indicator of the standard of living than GDP, since it measures the money accrued to
SA factors only.
Some Problems Associated with GDP

• Non-market production activities are difficult to measure or estimate, e.g. subsistence farming
where goods are not sold.
• Unrecorded activities of the shadow, underground or informal economy are often not recorded,
e.g. drug trafficking. Since 1994 SA tries to estimate the informal sector as part of GDP.
• Data revisions occur, i.e. new and improved methods of recording / counting are developed over
time and may give illusions of growth.
• Economic welfare measures how well people are living. GDP may be increasing, but so may
pollution, etc., which detracts from well-being (called unwanted by-products or negative externalities).
Should these externalities be subtracted from GDP?
• GDP gives no indication of the quality of goods and services, nor of their distribution.
Despite criticisms, GDP (especially real GDP per capita) remains the most accurate measure of economic
activity.
Measuring inequality: the distribution of income

The Lorenz curves
® The Lorenz curve is a graph which shows the degree of inequality in the distribution of income in a
country.
According to Graph 8.1, the line of perfect equality:

At A, 25% of the population earns 25% of the national income.
At B, 50% of the population earns 50% of the national income.
At C, 75% of the population earns 75% of the national income.
According to the Lorenz curve above:

At D, 25% of the population earns 6% of the national income.
At E, 50% of the population earns 13% of the national income.
At F, 75% of the population earns 30% of the national income.
ê Shaded area is called area of inequality

- The larger the shaded area is the more inequality it shows
ê Solid black line is called Line of equal distribution
Monetary and fiscal policy
Study unit 9
• Accommodation policy refers to the SARB as lender of last resort. The SARB holds Repo auctions
where banks can borrow money against assets such as Government Bonds, Land Bank Bills and Reserve
Bank debentures.
• Bank supervision is the regulation of commercial and other banks.
• Fiscal Budget is the main instrument of fiscal policy, which is presented annually by the Minister of
Finance and outlines government spending and government receipts.
• Budget deficit exists when government spending is greater than government receipts.
• Cash reserve requirement refers to the minimum amount banks are required to hold back out of
total deposits.
• Contractionary policy refers to either monetary or fiscal policy aimed at counteracting inflation.
• Demand management refers to fiscal or monetary policy aimed at increasing or decreasing
demand.
• Direct taxes are taxes levied on individuals or companies.
• Expansionary policy refers to either monetary or fiscal policy aimed at counteracting
unemployment.
• Financial intermediary examples include banks, the Johannesburg Securities Exchange (JSE) and
insurance houses, which act as a link between household savings and firms’ investment (capital
formation).
• Fiscal policy outlines government spending and government receipts.
• Government includes all local, regional (provincial) and national levels of government, as well as
public corporations such as the South African Reserve Bank.
• Government spending includes all spending by government in the form of government
consumption spending, capital expenditure, transfers and debt repayment.
• Indirect taxes are levied on actions, such as the purchasing of goods.
• Inflation targeting refers to the effort by the reserve bank to keep inflation between certain upper
and lower limits.
• Lags are time delays associated with fiscal or monetary policy.
• Monetary policy refers to the indirect intervention in economy by the reserve bank through
manipulating money supply and interest rates.
• Nationalisation refers to the transferring ownership of assets and resources from the private sector
to the government.
• Open market policy refers to the buying and selling of Government bills and securities (paper) in
order to influence the amount of money in circulation, and the interest rate.
• Privatisation refers to transferring ownership of assets and resources from the government to the
private sector.
• Progressive tax is where the % of tax paid increases as earnings increase.
• Repo rate is the interest rate associated with the sale and buy-back of repos (financial assets)
between banks and the reserve bank.
• Securities are documents that state the interest rate payable on a loan and when the loan must be
paid back.
• South African reserve bank is the main financial institute in SA.
• Taxation is a compulsory payment to the government.
• Value added tax is a tax levied at each stage of the production process.
Monetary refers to interest rates and money supply
- South African Reserve Bank in control
- Leader is called the Reserve Bank Governor
Fiscal policy refers to the government spending and taxation

- Run by Treasury
- Leader is called Finance minister
The South African Reserve Bank (SARB) uses three measures of money
1) The conventional measure of money is M1.

® M1 is based on the function of money as a medium of exchange, where the medium of exchange
refers to exchanging money for goods and services.
® M1 includes all coins and notes in circulation, outside the monetary sector (this is also known as
M1A), as well as all demand deposits, including cheque and transmission deposits, of the domestic
private sector with monetary institutions.
® Demand deposits are deposits that can be withdrawn immediately by means of a cheque or cash
withdrawal.
® Also known as the narrow definition of money.
The quantity of money (M1) = Cash (C) + Demand deposits (D)
2) A broader definition M2
® M2 = M1 + all short- and medium-term deposits of the private domestic sector with
monetary institutions.
® These are not immediately available for payments.
® These deposits are often referred to as quasi money (near money).
3) Comprehensive measure M3
® M3 = M1 + M2 + all long-term deposits (> 6 months maturity) of the domestic private
sector with monetary institutions.
® M3 reflects the store of value function as well as medium of exchange. The store of value function
refers to money as an asset.
® M3 is the best measure of economic development.
Financial intermediaries
® Financial intermediaries act as intermediaries between surplus and deficit units in the monetary
economy. In other words, they channel money from savers to borrowers. Examples of financial
intermediaries include banks, unit trusts and insurance companies.
Refer to the figure above for the following discussion:
• The government has been left off the saving side, as the government is principally a borrower.
• A security is acknowledgement of a loan.
• Deficit units will issue securities such as share certificates, debentures, bonds, Treasury bills, bankers’
acceptances, etc. in return for funds.
• Surplus units will exchange their savings for cheque and saving deposits, insurance policies, pension
funds, etc.
• The flow of funds from surplus units to financial intermediaries depends on the interest rate. If the
interest rate is high, savings will increase.
• The flow of funds from financial intermediaries to deficit units also depends on the interest rate. If
the interest rate is high, deficit units may be unwilling to borrow money.
• The difference between the interest rate paid for savings to surplus units and
• the interest rate charged for loans to deficit units represents the income of financial intermediaries.
The South African Reserve Bank

® Commercial and other banks as well as the international market play their part in supplying money, the
main controller and issuing authority of money in South Africa is the South African Reserve Bank
(SARB).
® Banks sustain the economy through loans
The SARB main goals:

∆ To protect the value of the Rand so that South Africa can still have economic growth
∆ Protect the value of the Rand in an unbiased way
The SARB has 4 main functions:

Rand decreases
= Inflation
1) Formulating and implementing monetary policy. increases
® About: money supply & interest rates
How it works:
• Maintain economic growth *Moves upwards
• Ensure price stability (To control interest rates, you need to control
spending, if you control spending, you will
ensure price stability which will ultimately
• Control spending maintain economic growth
• Control interest rates
2) Government bank.
® SARB is the main banker and advisor for the government.
- It grants credit, issues Treasury bills, offers advice and administers exchange control
regulations. The government also uses private banks, but the SARB remains the government’s
principal bank.
- The SARB holds all government receipts and funds, from for example taxes and loan
repayments.
- The SARB issues cheques for Government expenditure, e.g. Government consumption
expenditure.
- Where expenditures are greater than receipts, the SARB issues Treasury bills or sells stock
through open market policy to finance this deficit.
- The SARB collects and interprets statistical information. This information is made available
through the quarterly bulletin.
® As custodian of gold and other foreign reserves the SARB keeps all gold and foreign
exchange not held by other banks and the Treasury. Gold is added to SARB reserves at market
related prices. The level of gold and forex is an important economic indicator (also see BOP)
® Administration of exchange control. Exchange control controls the amount of foreign

currency that enters and leaves a country by setting limits on travel, immigration, commercial
transactions and investments. In SA exchange controls have been relaxed but not abolished.
3) Provision of economic and statistical services

® The SARB collects, interprets and publishes statistical information as quarterly bulletins. These are
accessible on the SARB website for all policy makers, researchers, businesses and analysts.
4) Maintenance of financial stability

® Bank supervision refers to the control, monitoring and regulation of the banking sector in the
country.
® National payment system: the SARB acts as an inter-bank clearing bank for mutual claims
banks have against each other.
- Overnight Interbank Market
® The SARB acts as a banker’s bank:

- Sets and holds minimum cash reserves that banks are required to hold. These deposits form
part of the monetary base.
- Serves as lender of last resort to banks that are short of money. Pre 1998 this was done
through overnight loans against approved financial assets (called rediscounting). Post 1998 this
is done through the repurchase (Repo.) tender system.
- The Bank fixes the Repo rate and decides how much liquidity it is willing to provide weekly.
(Also see later notes on monetary policy.)
® Issuing banknotes and coins: The Reserve Bank is the only institute that can issue notes and
coins. SARB instructs the SA Bank Note Company and the Mint to produce notes and coins. These
are entered into circulation through the purchase of assets by the SARB.
ê The SARB wants to ensure that the banks run out of money by:
- Reserve requirements (25%)
- Monitors NPS
- They become the lender of last resort
Monetary policy
& Monetary policy is the indirect intervention in the economy by the monetary authorities, in order
to bring about changes in the macro-objectives of the economy, such as employment and low inflation
by manipulating the interest rate or money supply.
There are two types of intervention, namely

• Direct or non-market-oriented policy
• Indirect or Market-oriented policy
∆ Direct or non-market orientated controls

® Credit ceilings. Here banks are instructed not to lend more than a certain amount of money to
clients. By raising credit ceilings (remember from micro that ceilings are set below equilibrium),
banks are able and willing to lend more money, which in turn stimulates spending and employment.
By lowering a credit ceiling, banks are able and willing to lend less money, which in turn dampens
consumer spending, thereby decreasing inflation. SARB credit ceilings are not in use in SA today.
® Deposit rate control. Banks are instructed as to the amount of interest that may be paid to
depositors. If the monetary authorities increase the deposit rate control, people are encouraged to
save. Consumer spending decreases and prices and employment levels drop. If a deposit rate is
lowered, saving is discouraged and consumer spending increases. Employment levels and inflation
rises. SARB deposit rate control is not in use in SA today.
® Exchange control. Exchange control refers to the intervention by the monetary authorities in
the foreign exchange market. Relaxing forex restrictions encourages imports and the movement of
financial capital between countries, which stimulates the economy, but may worsen the current
account of the balance of payments. Tightening forex control may discourage imports and improve
a trade deficit and decrease inflation but can hamper economic growth. The SARB still uses
exchange control today in SA but many regulations have been relaxed.
® Moral suasion (persuasion). Here the SARB asks bank managers to act in a certain way and
take cognisance of the current objectives of the SARB.
® Public debt management. Public debt management is the process of writing up and carrying
out a strategy for managing a governments' debt in order to raise the required amount of funding
to cover the budget deficit.
In 1977 a commission of inquiry into South African Monetary policy (the de Kock commission) led to
the release of a report in 1985, which recommended a change in the approach of monetary policy
makers from direct controls to more market-oriented measures.
∆ Indirect or market orientated controls

® Accommodation policy:
o This is the prime instrument.
o All the other measures support accommodation policy.
o Previously when banks ran short of funds, and they had no other options available, they could
borrow money from the Reserve Bank at a predetermined interest rate called the Bank
Rate. The Reserve Bank, therefore, acted as lender of last resort.
o The Bank Rate used to be the accommodation rate at which banks borrowed money in the
form of overnight loans from the Reserve Bank.
o On the 9 March 1998 the SARB changed the procedures for providing cash reserves to banks.
When a bank was short of liquidity (cash), it could borrow from other banking institutes
through the overnight inter-bank market.
o If the other institutes were also short of cash, they could borrow from the SARB, as lender
of last resort, by means of the Repo (repurchase transactions) system.
o Under the Repo system interest rates reflected market conditions, i.e. the Reserve Bank
controlled the amount of money made available to banks, rather than the interest rate.
o Banks would bid a variety of interest rates for the short supply of money made available by
the SARB on a daily basis. The highest tenders were allotted first. The Repo rate was the
average rate for the day.
The less money there was available, the higher the Repo rate would be.
o Assets which could be used for these repurchase transactions were:

- Government Bonds
- Land Bank Bills
- Reserve Bank Bills.
The oligopoly nature of the SA banking system meant smaller banks had limited access to
SARB funds.
PRESENT:
o In September 2001 the SARB reviewed the way in which the Repo system operated. Now the
Repo rate is fixed by the SARB (it is no longer the result of tendering) and the spread
between the inter-bank rate and the Repo is reduced.
o Repo auctions are held daily.
o Acceptable assets for Repos are
- Government Bonds
- Land Bank Bills
- Reserve Bank debentures.
& The Repo rate is the rate at which commercial banks borrow money from the SARB.
o In an effort to limit the amount of money in circulation, the South African Reserve Bank
(SARB) sets a cash reserve requirement as a percentage of demand deposits to be held by
commercial banks in a non-interest-bearing account with the Reserve Bank. This supports
accommodation policy as banks are required to change cash for liquid assets and may need to
borrow from the reserve bank to cover cash shortages. (25%)
o The SARB no longer announces its daily cash shortage before the Repo auctions. A
weighted average of overnight lending rates provides a benchmark for inter-bank rates and
banks may no longer deduct their total vault cash from the minimum cash reserve
requirement.
o Banks that are unable to secure funds are accommodated by a final clearing Repo or reverse
Repo auction. A penalty rate of 1.5% above the Repo is at the SARB’s discretion.
o As all other interest rates move in sympathy with the Repo rate, the SARB can influence
the cost of credit and hence the amount of spending.
o If the SARB wants to decrease inflation, it will need to dampen spending. By increasing
the Repo rate the SARB discourages borrowing by banks and restricts the amount money
commercial banks have to lend. Other interest rates rise along with the Repo. Saving would
be encouraged, and loans discouraged. Consumption and investment spending would
decrease. Aggregate demand would fall, and prices decrease. Production and employment
would also be reduced (a trade-off).
o If the SARB wants to increase employment and stimulate the economy, it will
need to encourage spending. By decreasing the Repo rate the SARB encourages borrowing by
banks and increases the amount of money commercial banks have to lend. Other interest
rates fall along with the Repo. Saving would be discouraged, and loans encouraged.
Consumption and investment spending would increase. Aggregate demand would rise, and
employment, production and national income would increase. Inflation levels would rise (a
trade-off).
Open-market policy
& Open market policy refers to the buying and selling of Government bills and securities (paper) in
order to influence the amount of money in circulation, and the interest rate.
ê The main reason for the sale of securities is to raise money to cover the fiscal deficit.
® If the SARB wants to decrease the supply of money in order to dampen spending and
control inflation, it will sell assets (e.g., bonds) to a broker or bank on the open market. The bank
will now have less money to lend. In order to persuade banks to buy bonds the deal must be made
attractive. The yield (interest rate) must be high and the price of the bond low. There is thus an inverse
relationship between prices of securities and interest rates.
® If the SARB wants to increase the supply of money in order to encourage spending and
stimulate the economy, it will buy financial assets (e.g. bonds) from a broker or bank on the open
market. The bank will now have extra cash to lend. In order to persuade banks to sell bonds, the
SARB must ensure a low yield (interest rate) and a high price for the bond.
® The SARB may want to decrease the liquidity of banks, forcing them to make use of the
Repo system and change their interest rates, accordingly, making accommodation policy more
effective.
Links between interest rates and the rest of the economy

® Chains of events are a common way of expressing the knock-on, or chain effect in the
various markets when a government or reserve bank policy is implemented or changed.
® There is no one correct chain of events.
® Chain evaluation is based on whether the events actually follow one another and whether each
event is the correct outcome of the previous event.
® The following two chains are an examination of what happens to interest rates and their impact on the
markets when policy is changed.
Ñ Chain 1: The SARB raises the repo rate

In chain 1:
• The SARB raises the repo rate. An increase in the Repo rate is a contractionary policy
aimed at decreasing inflation.
• Commercial banks that have borrowed money from the SARB at the higher Repo rate will pass
this increase onto their own customers in the form of higher interest rates.
• Consumers will cut back on their borrowing from banks and their own credit spending. Demand
will decrease (shift to the left).
• Firms will cut back on their borrowing from banks and their own investment spending will
decrease.
• Prices will fall, which is the desired outcome, but due to the lack of investment, production
levels will also fall, and employments levels will drop.
Figure 6: Chain 1
Ñ Chain 2: The SARB reduces the repo rate
In chain 2:
• The SARB reduces the repo rate. A decrease in the Repo rate is a stimulatory policy
aimed at increasing employment.
• Commercial banks that have borrowed money from the SARB at the lower Repo rate will pass
this decrease onto their own customers in the form of lower interest rates.
• Consumers will increase their borrowing from banks and their own credit spending.
Demand will increase (shift to the right).
• Firms will increase their borrowing from banks and their own investment spending will
increase.
• Production and employment levels will rise, which is the desired outcome, but due to the
increased spending, prices will rise.
The government or public sector

How does government intervene?
Do not need to
Government intervenes in the economy in five ways: study
1. Provider of public goods and services.
2. Market participant through hiring labour and buying goods and services. (Participant of the factor
market)
3. Government spending in the form of government consumption spending (Buys in the goods market),
government investment spending (build factories / farm), transfer payments (pensions, grants) and
subsidies and debt repayment.
4. Collecting taxation.
5. Providing a legal framework for market regulation.
How government intervenes flow diagram:

Nationalisation and privatisation
& Nationalisation means the government takes over the ownership or control of a private
enterprise. This can be done with or without compensation.
& Privatisation means the private sector takes over the ownership of a government entity.
® There are various arguments for and against privatisation or nationalisation.

® Since they are opposites, arguments for privatisation are synonymous with arguments against
nationalisation. People who propose nationalisation would be opposed to privatisation. The arguments
for and against government ownership are rooted in political ideologies.
ê Socialist or communist ideology proposes government ownership of most of the country’s assets.
ê Capitalist or democratic ideology proposes private ownership of most of the country’s assets.
Arguments for nationalisation or against privatisation include: NB!

• Privatised firms are not exposed to the degree of competition necessary to keep prices low, and
companies may develop into monopolies with an excess of power over the market and labour.
• State owned firms do not have a profit motive.
• State owned firms consider negative externalities (such as pollution).
• State owned firms are more concerned with the population’s welfare and public interest. Services
that run at a loss in some parts of the country, such as rural areas, can be cross subsidised by
parts of the country that are profitable.
NB!
Arguments against nationalisation or for privatisation include:
• Sate owned entities are inefficient, bureaucratic, lack accountability, have low levels of productivity
and are a burden on the taxpayer.
• Privatisation attracts investment from abroad, adding to a country’s foreign reserves.
• Privatisation broadens the tax base since government entities do not pay tax.
• Privatisation increases ownership in a country and can serve as an instrument of upliftment.
Examples of countries that are or were ideologically predisposed to nationalisation include:

The former USSR, modern day Russia, North Korea, Cuba, Vietnam, Algeria and Bangladesh.
Examples of countries that are or were ideologically predisposed to privatisation include:

Norway, Iceland, Sweden, Canada, Australia, Switzerland, Germany, United Kingdom, United States, Botswana and
South Africa.
Fiscal policy and the budget

& Fiscal policy is the direct intervention in the economy through the use of government spending (G)
and government revenue (mainly taxation (T)).
® The main instrument of fiscal policy is the budget, which is presented annually by the Minister
of Finance and outlines government spending and financing government spending.
® The budget reflects political decisions about how money should be spent but has an important
impact on economic variables such as employment and inflation. The government uses the budget to
influence economic behaviour and spending, and this in turn affects these variables. The budget is thus
an instrument of demand management. The effect of fiscal policy is direct, in contrast to monetary
policy, which is more indirect.
® If the government wants to increase employment and stimulate the economy to grow;
an expansionary policy is needed.
Government spending (G) is greater > than government revenue (T), i.e., a budget deficit.
o Here the government would spend more money in the economy than it withdraws from it. The
result is stimulatory, since people would have more money to spend. Companies would expand
production and would need to employ more people. The deficit may be financed through
borrowing. The downside is that prices will rise as demand shifts to the right, as household
income increases, resulting in excess demand which pulls prices up.
® If the government wants to dampen spending and control inflation, a contractionary or

restrictive policy would be used.
Government spending (G) is less < than government revenue (T), i.e., a budget surplus.
o Here the government spends less money in the economy than it withdraws from it. The result is
that people feel poorer and reduce their spending. Companies see the signs of reduced spending
as their stock levels rise (excess supply). They pull back on production, perhaps even laying off
workers. The fall in demand due to decreased household income (demand shifts to the
left) will decrease prices.
A balanced budget is one where G = T and the effect is as neutral as possible.

In reality, and because government expenditure and taxation work in the economy in different ways, the
result of a balanced budget is slightly stimulatory. There is a measure of economic growth, a small increase
in employment and a small increase in inflation.
Summary:
∆ Budget Deficit:
® Government expenditure is greater than Government revenue (Taxation)
® Effect = Stimulatory. Employment, production &income increases.
® Government capital projects can be financed.
® Drawbacks: Inflation rises. Deficit must be financed
∆ Budget Surplus:
® Government expenditure smaller than Government revenue (Taxation)
® Effect = Contractionary. Inflation drops.
® Drawbacks: Employment, production & income decreases
∆ Balanced Budget:
® Government expenditure is equal to Government revenue (Taxation)
® Effect = Should be neutral. In reality employment, production & income increases slightly.
® Drawbacks: Inflation rises slightly.
South Africa’s proposed budget (pre Covid-19)
Foreign sector
Study unit 10
Glossary
& Absolute advantage exists where a country can produce a good or service with less effort or
resources than another country.
& Appreciation is where the value of a currency increases compared to another currency without
interference.
& Autarky exists when a country closes its borders to international trade.
& Balance of payments is a statistical account that records all transactions relating to the flow of
goods, services and funds across international boundaries.
& Comparative / relative advantage exists where a country has a lower opportunity cost in the
production of a good or service than does another country.
& Current account is a record of exports, imports, income receipts and payments and transfers of a
country over a period of time.
& Depreciation is where the value of a currency decreases compared to another currency without
interference.
& Direct investment includes all transactions where the investor gains control of a business, either
through establishing a new business or by buying shares in an existing business.
& Equilibrium exchange rate is where the quantity of foreign currency demanded is equal to the
quantity of foreign currency supplied. Expressed as the value of one currency in terms of the value of
another.
& Exchange rate is where the value of one currency is expressed in terms of the value of another.
& Exchange rate policy refers to policy measures put in place to discourage shifting funds offshore.
& Financial account records all financial flows coming in and going out of a country.
& Floating exchange rates exists when currencies are left free to appreciate or depreciate
according to demand and supply and there is no reserve bank intervention.
& Foreign exchange market exists everywhere and anywhere where currencies are traded.
& Globalisation refers to the international world becoming closer and more open to international
trade.
& Gross reserves refer to borrowing funds to cover the balance of payments deficit.
& Import quotas are quantitative restrictions on the number of imported items.
& Import tariffs are taxes levied on specific goods and services imported into the country.
& Managed floating: a currency is managed or dirty or a managed float when it is allowed to float,
but authorities intervene from time to time to even out short-term fluctuations.
& Net primary income payments are the net result of adding income earned by South Africans
outside the borders and subtracting income earned by foreigners inside SA.
& Open economy is an economy that is open to trade with other countries.
& Portfolio investment refers to the buying of assets such as shares or bonds where the investor
has no say in the running of the business.
& Speculation exists when people buy currencies in the hope that they will increase in value.
& Terms of trade is the ratio between export prices and import prices.
& Trade balance equals merchandise exports – merchandise imports + net gold exports.
& Trade policy is the indirect intervention by government to affect the volume or price of exports
and imports.
The balance of payments
& The Balance of payments (BOP) is a statistical account that records all transactions relating
to the flow of goods, services and funds across international boundaries.
® The balance of payments reflects a country’s position relative to the international economy and is an
important basis for policy formulation.
® The International Monetary Fund publishes guidelines for the recording of BOP transactions
to which South Africa adheres.
® All receipts i.e. payments to SA from other countries are entered as credits (+) while all
payments to other countries are entered as debits (-). Every transaction is recorded twice,
once as a debit and once as a credit, based on the principle of double-entry bookkeeping.
There are 2 types of accounts:
∆ The Current Account
MERCHANDISE EXPORTS Includes exports of all physical final goods, raw

materials and intermediate goods
+ MERCHANDISE IMPORTS Includes imports of all physical final goods, raw
materials and intermediate goods.
= TRADE BALANCE This balance may be in deficit or surplus.
+ NET GOLD EXPORTS This is unique to SA and other gold producing
countries. This originated because gold as a
form of international currency allowed SA to
produce foreign exchange directly.
Although gold is still SA’s most important
export, it is now an ordinary commodity and it
is likely that this entry will be dropped in the
near future. Gold exports will then become
part of merchandise exports.
= TRADE ACCOUNT This balance may be in deficit or surplus.
+ SERVICE RECEIPTS This includes receipts for all transport, financial,
insurance business, tourism, technical services,
etc. which SA provides to the rest of the world.
- PAYMENTS FOR SERVICES This includes payments all transport, financial,
insurance, business, tourism, technical services,
etc. which SA uses from the rest of the world.
In SA service payments are larger than receipts.
+ INCOME RECEIPTS This refers to income earned (wages & salaries)
as well as investment income (dividends,
interest, profits) accruing to South Africans
outside SA. In the national accounts, this was
called ‘primary income’ or foreign factor
receipts’ the adjustment made to GDP when
calculating GNI at market prices.
- INCOME PAYMENTS This refers to income paid (wages & salaries)
as well as investment income (dividends,
interest, profits) paid to non- South Africans
inside SA. In SA income payments are higher
than income receipts.
+ NET CURRENT TRANSFERS This includes the net value of items such as
private transfers of gifts, donations as well as
government social contributions. Note that a
transfer is a one-way money flow, i.e. no goods
or services are rendered in return.
= BALANCE ON THE This balance is sometimes in deficit and
CURRENT ACCOUNT sometimes in surplus
∆ The Financial Account
® This section of the BOP records all international transactions in assets and liabilities.
(Inflow and outflow)
® This account was previously called the capital account.
There are four main sub-sections to this account. They are:
• + Direct investment:
- This section includes all transactions related to the buying of substantial share capital, by,
for example, setting up new businesses, mergers, buyouts, takeovers and real estate.
- This type of investment leads to control and financial gain in the running of the
business.
• + Portfolio investment:
- This section includes all purchases of shares or bonds.
- This type of investment leads to financial gain only.
• + Other investment
- This is a residual section, which includes all financial transactions not included in the
above sections, such as loans and trade credit.
Balance on the financial account

® The above three accounts give this balance.
® This may be deficit or surplus.
® Deficits on the current account are often accompanied by surpluses on the financial account.
The significance of BOP

® A large volume of SA exports are basic commodities such as gold, diamonds, base metals, etc. The SA
export market is thus very vulnerable to changes in the economic conditions in other industrialized
countries that import these goods, e.g. Japan and the USA.
® Similarly, the gold price is dependent on the whim of international buyers. Should the demand for
gold increase, the gold price rises. Should the demand for gold decrease or supply
increase as other countries sell off excess stocks, the gold price falls.
® The difference between imports and exports (i.e. the trade balance (X – Z)) has a multiplier
effect on the economy.
® A deficit on the current account, however, is not necessarily bad, as imports add to supply side
of economy, and the standard of living increases.
An export surplus = boost demand and national income.
Import surplus = contractionary effect.
A surplus on the BOP current account = increases the money supply and decreases the
interest rate. This increases consumption and investment spending.
Introduction to trade
® The extent of a country’s involvement in trade is referred to as the openness of its economy.
South Africa is an open economy; its openness is not particularly high or low.
® The notion of self-sufficiency (or autarky) used to be popular among politicians and citizens
who wanted to be independent of the rest of the world.
® With an increase in technology, globalisation has reduced the world to a global village. Adam Smith
emphasised the benefits of specialisation and the division of labour and advocated that these can lead
to gains from trading with different countries.
® One of the most basic reasons for trade is that the factors of production are not evenly distributed
among the nations of the world. SA has large reserves of gold and platinum. Japan has large supplies of
capital and skilled labour. It would obviously benefit these countries to trade.
Why countries trade
∆ Theory of absolute advantage

® Absolute advantage exists where a country can produce a good or service with less effort
or resources than another country.
® when one country can use fewer resources to produce a good compared to another country;
when a country is more productive compared to another country
Example:
If all resources are used in the production of bicycles, Country A can produce 100 bicycles per day. If
however all resources are used in the production of smarties, Country A can produce 1000 smarties per
day. Country A can, therefore, choose to produce 100 bicycles OR 1000 smarties in a day. Country A can
of course produce a combination of the two products such as 50 bicycles AND 500 smarties.
Bicycles Smarties
100 1000
Country A
If all resources are used in the production of bicycles, Country Z can produce 10 bicycles per day. If
however all resources are used in the production of smarties, Country Z can produce 500 smarties in a
day. Country Z can, therefore, choose to produce either 10 bicycles OR 500 smarties per day. Country Z
can of course choose to produce a combination of the two products such as 5 bicycles AND 250
smarties.
Bicycles Smarties
10 500
Country Z
Country A is clearly better at producing both bicycles AND smarties. Country A, therefore, has
absolute advantage in the production of both bicycles and smarties.
Country A would not gain by trading with Country Z. Absolute advantage is not always the
determinant for international trade however, and it is quite possible for Country A to gain some
advantage by trading with country Z. The answer lies in their comparative or relative advantages.
∆ Theory of comparative / relative advantage
& Relative (or comparative) advantage exists where a country can produce a good or service with
lower opportunity costs than another.
Example:
If Country A chooses to produce 100 bicycles, it must give up 1000 smarties. The opportunity cost
for producing 1 bicycle is thus 10 smarties. The opportunity cost for producing 1 smartie is 1/10
bicycle. Country A’s production ratio I, therefore:
1:10 or 1/10:1
If Country Z chooses to produce 10 bicycles it must give up 500 smarties. The opportunity cost
for producing 1 bicycle is thus 50 smarties. The opportunity cost for producing 1 smartie is 1/50
bicycle. Country Z’s production ratio is, therefore:
1:50 or 1/50:1
By comparing the individual ratios, we can see that country Z is comparatively better at
producing smarties and that country A is comparatively better at producing bicycles. Country Z
should, therefore, produce smarties and trade them with country A. Country A should produce bicycles
and trade them for smarties in country Z.
Both countries will gain from trade.
∆ Theory of equal advantage

& Equal advantage exists where a country can produce a good or service with the same
opportunity costs than another country, i.e., their production ratios are the same.
Countries with equal advantage will not trade.
If we change table 10.2 to reflect the production possibilities shown in the table below:
Bicycles Smarties
100 1000
Country A (10.1)
Bicycles Smarties
10 100
Country Z (10.3)
Using the table 10.1 the opportunity cost for Country A in terms of smarties per bicycle would be 1000 :
100 OR 10 : 1.
Using the table 10.3 the opportunity cost for Country Z in terms of smarties per bicycle would be 100 : 10
OR 10 : 1.
These two countries will not trade, as neither has anything to gain from it.
Trade policy
Instruments of the trade policy:
∆ Import tariffs
& Import tariffs are taxes (also called custom duties) imposed on products imported into a
country.
There are two categories of tariffs:

• A specific tariff is a fixed amount that is levied on each unit of the imported commodity.
For example, a tariff of R30.00 levied on each imported bottle of perfume is a specific tariff.
• An ad valorem tariff is a tariff that is levied as a percentage of the value of the import.
For example, a tariff of 40 percent on the price of an imported motor car is an ad valorem tariff.
Revenue tariffs are usually imposed on items that are not produced locally. Protective tariffs are
imposed to protect a local industry or sector of the economy from foreign competition.
Import tariffs can be quite high, placing foreign producers at a disadvantage (since the tariffs raise
the prices of their products in the domestic market), but they are usually not sufficient to prevent
imports altogether.
∆ Quotas
& An import quota is a quantitative restriction on imports. Import quotas seek to control
the physical level of imports.
® Import quotas are direct intervention in the market mechanism.
® With quota restrictions, the benefit of the higher price resulting from the limited supply goes to
the seller of the goods, unless the government takes prior steps to prevent this.
® Government can auction import licenses to the highest bidders. Alternatively, licenses may simply
be sold (or merely issued) to overseas suppliers on the basis of the pattern of supplies in earlier
years.
® The economic consequences of tariffs and quotas are much the same.
® An import quota also raises the domestic price.
® Most import quotas in South Africa have been abolished, as required by the World Trade
Organization (WTO).
∆ Subsidies
& A subsidy is a payment to local producers in an attempt to level the playing field between local
production and imports.
® The ultimate effect of a tariff is to raise the price of goods in the country imposing the
tariff as well as negatively affecting demand for the goods in the country against which
tariffs are levied.
® If the USA imposes an import tariff on Chinese goods, demand for the Chinese goods will fall and
prices for imported Chinese goods in the USA will rise.
® A producer receiving the subsidy from government will not result in an increase in domestic
prices. The burden of the subsidy however is on the taxpayer who provides the government
with the revenue in the first place.
∆ Non-tariff barriers
& Non-tariff barriers refer to non-monetary barriers.
® These barriers can take the form of technical standards or requirements which goods must
measure up to, special licensing agreements or the awarding of contracts to domestic firms,
whether competitive or not.
∆ Exchange controls
& Exchange controls or regulations are aimed at restricting the amount of foreign currency
available to importers.
∆ Exchange rate policy

& Exchange rate policy refers to interference in the foreign exchange rate market in order to
influence the value of a currency.
® This refers to either fixing or pegging an exchange rate at a desired level. This policy requires large
amounts of foreign exchange.
Exchange rates
& Exchange rate is the price of one currency in terms of another
Introduction
® There is globalization of the foreign exchange market, satellite linkages and integrated computer
networks allow enormous amounts of currencies to cross borders within seconds.
® Foreign exchange reserves are the result of receipts for exports and capital inflows. Imports and
capital flows abroad represent an outflow of foreign reserve.
® During the Gold Standard (prior 1929) and the Bretton Woods system of fixed exchange rates from
1944 - 1972, the SARB and other central banks had no choice but to maintain a fixed exchange rate.
Today central banks have a choice between fixed and flexible exchange rates. While most countries
choose to float their exchange rates, some less developed countries fix their rates to that of their
largest trading partner. SA pegged its rate to the dollar and later to the sterling in the 1970’s.
® Note that just as there is no such thing as ‘the interest rate’, there is no such thing as ‘the exchange
rate’. An exchange rate only exists between two currencies or between a currency and a
basket of foreign currencies. A rate between the US dollar and the SA rand and between the US dollar
and the UK pound implies an exchange rate between the rand and the pound.
® South African importers have to pay for their goods in the currency of the exporting country, e.g. Yen.
South Africans importers, therefore, demand foreign currency and must use rands (or other
currencies) to buy these.
® Other countries have to pay for South African exports in Rands. South Africa, therefore, supplies
(or sells) rands.
® The price, ratio or rate at which the currencies are traded is known as the rate of exchange or
exchange rate. In other words, a ratio of R10.00c = $1.00 means the price of a $1.00 on the forex
market is R10.00c, or the price of R1.00 on the forex market is $0.10c.
® Currencies are traded in the foreign exchange market which has no specific location, but includes all
dealers in foreign currency all over the world.
® Every currency in the world is linked to every other currency via exchange rates. Example: If R10.00 =
$1.00 and $1.00 = €.0.50
Then € 1.00 = R20.00
Exchange rate systems
• Fixed exchange rates
® This is where central banks fix the value of their currency, normally between an upper
and lower value, and stand by to buy and sell currencies to protect this value.
® To do this they must hold a stock of foreign currency and gold that can be sold for foreign
exchange.
® The buying and selling to protect this value are called intervention.
® If a central bank cannot maintain the set value and begins to run out of foreign exchange, it may
decide to devalue (reset the value at a lower level) the currency. Both intervention and
devaluing the currency has important implications for BOP. If a central bank deliberately sets a
higher currency value, the term revaluation is used.
® No countries have fixed currencies = too expensive
• Flexible / floating exchange rates

® Under flexible exchange rates the value of one currency against another is the result of supply
and demand.
® All currencies are floating
§ Free or clean floating refers to no intervention at all.

- Official reserve transactions would be zero, i.e., no foreign exchange would be used.
- Depreciates = loses value
- Appreciate = increase value
§ Managed / dirty floating

- A currency is managed or dirty when it is allowed to float, but authorities intervene
from time to time to even out short-term fluctuations.
- Of course, intervention is only possible if the reserve bank has the necessary foreign
reserves.
- Long run or persistent changes may require too much foreign currency and authorities will
allow market forces to determine the value rather than deplete foreign reserves. SA
adopted a dirty or managed floating rate in 1979.
Demand for dollars

Factors influencing demand for Dollars:
• SA importers buying American goods,
• South Africans who want to buy shares in the USA, ® All these factors increase
• Americans’ investors pulling funds out of South Africa demand
• Speculators who anticipate a weakening Rand ® Opposite = factors causing
it to decrease
• SA tourists going to the USA. (Need to buy foreign currency’s)
® The more expensive the Dollar is (the more Rands must be exchanged for a Dollar), the fewer
Dollars will be demanded. The demand curve for Dollars thus slopes downward from left to right.
The demand for Dollars is a derived demand, since the Dollar is not demanded for its own sake.
® Negative slope / Negative
relationship
= imports / tourism become

more expensive = less demand
Referring to Graph above:

• If the price of the Dollar is R8 per Dollar, 10 billion Dollars per day will be demanded.
• If the price of the Dollar is R6 per Dollar, 15 billion Dollars per day will be demanded.
Supply of dollars
Factors influencing the supply for Dollars:
• SA exporters whose prices are quoted in Dollars and want to change their Dollars to Rands
• Foreign investors in SA.
• SA investors pulling their money out of US. ® All these factors increase
• Foreign tourists in SA. supply
• Speculators ® Opposite = factors causing
it to decrease
® The more expensive the Dollar is (or the cheaper the Rand is) the more Dollars will be
supplied, as buyers / investors take advantage of the lower Rand value. The supply curve for Dollars
rises upward from left to right. The supply of Dollars is a derived supply, since the Dollar is not
supplied for its own sake.
® Positive slope / Positive

relationships
= exporter / foreign investors will get

more money for their dollars
Referring to Graph above:

• If the price of the Dollar is R8 per Dollar, 10 billion Dollars per day will be supplied.
• If the price of the Dollar is R6 per Dollar, 5 billion Dollars per day will be supplied.
The Foreign Exchange Markets

Refer to Graph below:
® Just as with demand and supply in the goods market, we combine the demand and supply curves to
find market equilibrium in the foreign exchange market.
® At rates above R8 per $, say at R10 per $, there is an excess supply of Dollars. There is
downward pressure on the price of Dollars as holders of Dollars try to sell their excess stock
of Dollars for Rands.
® At rates below R8 per $, say R6 per $, there is excess demand for the Dollar. There is upward
pressure on the price of Dollars as buyers compete with one another for the short supply of Dollars
and drive the price upwards.
® At R8 per $ there is no excess demand or excess supply and the market is in equilibrium, ceteris
paribus. 10 billion Dollars per day will be traded.
® Where they meet = becomes
exchange rate
Equilibrium in the foreign exchange market.
The impact of a decrease in the supply of dollars
Refer to the graph above:

• The original equilibrium exchange rate is R8 per Dollar and the number of Dollars traded per day is 10
billion.
• If the supply of Dollars decreases, supply of $1 shifts to supply of $2.
• The new exchange rate is R10 per Dollar and the new quantity of Dollars traded is 8 billion per day.
• The Dollar has appreciated while the Rand has depreciated.
The impact of an increase in the supply of dollars
Refer to graph above:

• The original equilibrium exchange rate is R10 per Dollar and the number of Dollars traded per day is 8
billion.
• If the supply of Dollars increases, supply of $2 shifts to supply of $1.
• The new exchange rate is R8 per Dollar and the new quantity of Dollars traded is 10 billion per day.
• The Dollar has depreciated while the Rand has appreciated.
Inflation and unemployment
Study unit 11
Glossary
& Inflation is defined as a continuous and considerable rise in the general price level over a period of
time.
& Consumer price index is an index of the prices of a representative basket of consumer goods and
measures the cost of living.
& Producer price index is an index of the prices of a representative basket of producer goods
(inputs) and measures the cost of production.
& Distribution effects refer to the redistribution of income between sectors of the economy as a
result of inflation.
& Economic effects refer to the economic benefits and disadvantages between sectors of the
economy as a result of inflation.
& Social and political effects refer to the societal dissatisfaction between sectors of the economy
as a result of inflation and the resultant political choices people make.
& Hyperinflation extremely high inflation.
& Demand-pull inflation where demand increases and pulls prices up.
& Cost-push inflation where supply decreases and pushes prices up.
& Stagflation where supply decreases, pushes prices up and increases unemployment at the same
time.
& Incomes policy is a measure aimed at reducing inflation by dropping wages and increasing supply.
& Unemployment refers to those people who are willing and able to work, i.e. they are potentially
active, but cannot find a job.
& Frictional unemployment refers to those people who are temporarily between jobs.
& Seasonal unemployment refers to people who are employed in seasonal jobs and become
unemployed out of season.
& Cyclical unemployment coincides with a downswing or slump in the business cycle.
& Structural unemployment refers to a mismatch between available jobs and job-seekers
qualifications (or lack of them).
& Informal sector is sometimes called the shadow, underground or hidden economy, and refers to
people who are employed in economic activities that are unregistered, e.g. money lenders and petty
traders.
Inflation
& Inflation is defined as a continuous and considerable rise in the general price level.
The elements of the definition:

• The definition is neutral – it does not suggest a cause.
• The definition describes inflation as a process of continual increase – not a once off occurrence.
• The definition stresses considerable rises in prices in general – a 1% or 2 % increase is not necessarily
considered inflation.
• The definition refers to general prices – not to individual prices. Even although an increase in the price
of some products e.g. petrol have an inflationary effect on the economy, the petrol price on its own
cannot be considered inflation.
Measurement of inflation
Consumer price index

& The consumer price index (CPI) is an index of the relative prices of a representative basket of
goods and services.
® In South Africa the basket consists of goods and services that have been selected to
represent the spending patterns of an average South African household.
® Each good and service is allocated a weighting according to its relative importance and the
percentage of income spent on that item.
® The index is expressed in terms of a selected base year.
® The CPI aims at measuring the cost of living.
® Stats SA updates the basket of goods and services every four years, keeping within the five-year
norm of international best practice, to ensure that it remains relevant.
® Part of the exercise involves removing products from the basket, while others are added.
Producer price index

& The producer price index (PPI) is an index of the prices of a representative basket of producer
goods (inputs).
® The PPI aims at measuring the cost of production.

® Goods are also weighted and expressed in terms of a base year.
® The PPI is usually an indication of what is going to happen to the CPI.
® The PPI is defined as “A measure of the change in the prices of goods either as they leave
their place of production.”
Difference between CPI and PPI
CPI PPI
• Measures cost of living • Measures cost of production
• Includes services • Does not include services
• Includes VAT • Not include VAT
• Measure final goods • Includes capital / intermediate goods
Effects of inflation
∆ Social & Political effects
- Inflation gives rise to political and social unrest. It creates a climate of conflict and
tension.
∆ Economic effects
- Inflation stimulates speculative practices (real wealth effect) as people and companies
anticipate further inflation, they change their spending and production patterns.
- Inflation can discourage saving.
- If inflation in SA is higher than its international competitors, X decreases and the money value of
Z increases, leading to balance of payments problems. The expectation of inflation causes further
inflation as people increase spending and pressure for higher wages, while firms increase prices,
in the expectation of further increases in prices. The result is rampant inflation called
hyperinflation.
∆ Distribution effects
- Inflation benefits debtors (borrowers) at the expense of creditors (lenders). If the
inflation rate is 10% and the interest rate is 5%, the real interest rate is negative (i.e. the interest
rate you’re really getting is 5%)
- Younger people tend to be borrowers and thus benefit. Older people on fixed incomes e.g.
pensions, tend to lose. Income is thus redistributed from the elderly to the young.
- The government is principally a borrower and the private sector a lender. Income is
redistributed from the private sector to the government.
- SA has a progressive income tax system (the more you earn, the more you pay). If you receive
an increase in your nominal income which is less than the rate of inflation, your real income falls
although you find yourself in a higher tax bracket. This is known as bracket creep. The increased
revenue for the government is called the fiscal dividend.
Unemployment
& Unemployment is the rate of people in the labour force who are willing to work that is not
employed or self employed
® The unemployment figure is a stock concept (number of people unemployed measured at a point in
time) but flows, such as the unemployment rate and immigration, contribute to the unemployment
pool.
® Expanded definition of unemployment i.e. those people over 15 years who are not in
employment nor are self-employed and have the desire to work.
- This method is best used in developing countries. Unemployment figures using this
method are generally high (approx. 43% in SA).
® Strict definition of unemployment as set out by the International Labour Organization i.e. those
people who are over 15 years who are not in employment nor are self-employed, who were available
for work 7 days and took specific steps to find work 4 weeks before the interview.
- Unemployment figures using this method are generally low (approx. 23% in SA). This method
relies on the department of labour for figures and is, therefore, dependent on people registering
themselves as unemployed.
Expanded definition Strict definition

• Between 15-65 years • Unemployed between 15-65 years
• Not employed / self-employed • Not employed / self employed
• Available for employment in the last 7 days • Actively searching for employment for the last
4 weeks
• Available for employment for the last 7 days
The costs of unemployment

For the individual:
• Suffers a loss of income, shock and frustration
• Could result in hunger, cold, ill health or death
• Suffers psychological costs of self-esteem
• Could suffer psychological disorders such as divorce, suicide and criminal activity
• Suffers loss of skill through lack of use.
For society:
• May be damaged due to increased crime, riots, unrest, demonstrations, etc.
• May even suffer political overthrow.
The types of unemployment
Two types of unemployment:
• Voluntary unemployment: house mom, have enough money to survive etc
• Unvoluntary unemployment: fired, retrenched
® Voluntary unemployment does not form part of unemployment.

® All unemployment is deemed to be involuntary.
∆ Frictional unemployment refers to people who are between jobs. This is not considered a
serious problem, as it is temporary.
∆ Seasonal unemployment refers to people who are only employed for certain times of the
year, e.g. Father Christmases and agricultural workers.
∆ Cyclical (or demand deficiency) unemployment is the result of a temporary lack of demand,
caused by the business cycle. Sales drop and workers lose their jobs. People may find work again
as the business cycle turns upward.
∆ Structural unemployment is usually confined to certain industries or sectors of the

economy. This occurs because of a mismatch between worker qualifications and job requirements.
The following could cause structural unemployment:

• Lack of education, training or skills
• Changes in production methods or techniques à often called technological unemployment
• Changing consumer preferences
• Foreign competition
• Structural decline in certain industries
• Discrimination and affirmative action.
Policies to reduce unemployment

• Take steps to limit population growth
• Limit immigration
• Sills development
• Increase government spending on special employment programs
• Stimulate consumptions and investment spending
• Increase demand for SA exports
• Limit import spending
• Encourage labour intensive production
• Promote small businesses and the informal sector
• Implement tat incentives or subsidies
• Relax labour legislation

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Economic Principles

Scarcity, choice, and opportunity cost

Resources are limited

Every country has a fixed stock of resources namely:

We begin by making three assumptions:

® Where one is not using one’s full employment of

® Can’t produce beyond the curve

How to get there:

® The PPC curve shifts outward, called economic growth, when:

Calculating the opportunity cost:

® Constant opportunity cost

The law of increasing opportunity cost:

Now read and recap these definitions carefully:

Goods and services

& Homogeneous goods are all exactly alike. (Non-differentiated goods)

& Heterogeneous goods differ in respect of brand, quality, variety etc.

∆ These classifications are not mutually exclusive.

Economics as a social science

Microeconomics and macroeconomics

Macroeconomic topics usually refer to:

Equilibrium, comparative statistics, and ceteris paribus

® The movement of curves in a graph happens constantly.

® Production, income, spending are all flows

Stock concepts are measured at a point in time.

Flow concepts lead to stock concepts.

∆ Natural resources (Land)

∆ Human resources (Labour)

Households Banks Firms

Formula for spending + GDP

Interaction between households and firms

• Financial markets bring together borrowers and lenders of money.

• International markets provide the link for importing and exporting.

Circular flow of goods & services

Circular flow of income & spending

Key concepts: specialisation and division of labour

& Specialisation refers to an increase in level of skill and expertise.

Advantages of specialisation and division of labour include:

Movement along curve (Change in quantity demand):

® The points on the demand curve (e,d,c,b,a) correspond to the

ê The movement along the curve is caused by a change in price

Shift of the demand curve (Change in demand):

SHIFT RIGHT =INCREASES

2) Price of related goods (Pg)

3) Taste & preferences (T)

• Where f = ‘is a function of’ and

Qd = f (Px, Pg, T, Y, N, Pe)

A change in the quantity of demand VS a change in demand:

The market demand curve: A summary

2 types of supply 3 conditions for supply:

Example: Johnny’s supply of tomatoes

Movement along curve (Change in quantity supplied):

Shift of the supply curve (Change in supply):

2) Price of alternative product (Pg)

® LEFT SHIFT = decrease supply

3) Price of factors of production (Pf)

4) State of technology (Ty)

5) Future prices (Pe)

Qs = f (Px, Pg, Pf, Ty, Pe)

• Let Qs = quantity of tomatoes supplied